Mortgage Backed Securities

The 2011 actions of the FDIC ending the safe harbor for true sales locked in a solution to TBTF

It’s always a bit amusing to meet an investor making money in the markets right now who actually thinks it’s because he’s smarter than everyone else. Everyone knows the Fed’s quantitative easing program calls for them to buy $85 billion worth of bonds and mortgage backed securities each and every month. And the connection to market performance is clear. But, as is clear with USDJPY, Nikkei, and European sovereigns, the end of this exuberance is beginning to happen. All of this indicates that the leveraged investing herd seems to be squaring positions, going to cash, and paying back some of the USD-denominated debt they’ve borrowed. So far it’s all been an orderly move lower. And herein lies the trouble. Few investors are spooked right now because there is so much calm in the markets. But that calm can quickly turn into anxiety, which can quicly turn into all-out panic. It’s taken years (since 2008) to print so much money. This means that a market panic will unwind years’ worth of liquidity in a matter of weeks. It’s a financial tsunami that no investor should underestimate.

Those following day to day flow (buys and sells) data of Treasurys and MBS by the Fed, are aware that in the past few months Ben Bernanke's net purchases of MBS have declined modestly. Naturally this is not due to a stated policy of tapering one or more purchasing programs (at least not yet), but due to what appears to have been a drop off in origination, as confirmed by recent plunging mortgage applications data (and which today literally crashed out of bed). So is this net change in Fed flow, in a world in which Fed flow is all that matters (sorry "Stock" purists: 2009 called, they want their discredited ideas back) an indication of stealth Fed tapering? Read on for Cashin's explanation.

Peak collateral is just a notion - one we have discussed in detail many times (most recently here). The notion that at the time we want yield and growth we are running out of collateral which is supposed to underpin the high yielding assets and loans. Such a shortage would cause the ponzi-like growth that is necessary to sustain a bubble, to stall and then implode. We think our lords and rulers know this and have decided that it must not be allowed. And this – the need for collateral – is the reason for the endless QE. If this is even close to the mark, then recent murmurings about the Fed tailing off its bond buying will prove to be hollow. The Fed will quickly find it cannot exit QE without precipitating precisely the disorderly collapse, to which it was supposed to be  the solution.

I see this evolving story as a possible turning point. The key CB's will have gone from Offense to Defense.

Up until today, the narrative was one trying to explain how a soaring dollar was bullish for stocks. Until moments ago, when Bill Dudley spoke and managed to send not only the dollar lower, but the Dow Jones to a new high of 15,400 with the following soundbites.

• DUDLEY: FED MAY NEED TO RETHINK BALANCE SHEET PATH, COMPOSITION
• DUDLEY SAYS FISCAL DRAG TO U.S. ECONOMY IS `SIGNIFICANT'
• DUDLEY: FED MAY AVOID SELLING MBS IN EARLY STAGE OF EXIT
• DUDLEY: IMPORTANT TO SEE HOW WELL ECONOMY WEATHERS FISCAL DRAG
• DUDLEY SAYS HE CAN'T BE SURE IF NEXT QE MOVE WILL BE UP OR DOWN

And the punchline:

• DUDLEY SEES RISK INVESTORS COULD OVER-REACT TO 'NORMALIZATION'

Translated: the Fed will never do anything that could send stocks lower - like end QE - ever again, but for those confused here is a simpler translation: Moar.

MERS: The Center of the Mortgage Scam

Since the Financial Crisis erupted in 2007, the US Federal Reserve has engaged in dozens of interventions/ bailouts to try and prop up the financial system. Now, I realize that everyone knows the Fed is “printing money.” However, when you look at the list of bailouts/ money pumps it’s absolutely staggering how much money the Fed has thrown around.

The 2011 changes by the FDIC to the safe harbor for "true sales" may have been the end of "Too Big To Fail."

How many trillions of Dollars are we going to let the Fed spend? The Fed balance sheet is now over $3 trillion… making it larger than the GDP of France, the UK, or Brazil. Indeed, if the Fed’s balance sheet were a country, it’d be the FIFTH LARGEST COUNTRY IN THE WORLD.

Unfortunately, the spectacular rise of Wall Street’s securitization machine will likely forever frustrate attempts to ascertain the extent to which the Fed is responsible for what happened to the U.S. housing market and financial system in 2008.  After all, it wouldn’t be fair to short sell (no pun intended) all the Special Purpose Vehicle sponsors, CDO asset managers, investors, and ratings agencies who, for at least five years, worked so hard to collapse the system.

In the same way as any and every risk-asset in the world, the price of yield-providing CMBS (commercial mortgage backed securities) have risen to post-crisis highs in the last few months. These are some of the epicentric deals from the crisis that now trade close to par once again. However, the last month or so has not seen CMBS prices push higher with stocks and it appears, as the FT notes, that the reason is becoming clear in the post-holiday-shopping period. CMBS cash-flow streams are set to drop considerably as up to 15 per cent of the country’s suburban retail centres forecast to close over the next five years in the face of online competition. Retail is regarded as an especially risky component of CMBS as a mall can go downhill if an important tenant shuts its store because other tenants are usually able to renegotiate their leases if a traffic-driving anchor tenant leaves. That can have severe consequences for CMBS exposed to the mortgage on the property.

Collectively, the world’s Central Banks have pumped over $10 trillion into the financial system since 2007. This money printing has resulted in a massive expansion of Central Bank balance sheets, spread inflation into the system, and done nothing to address the key solvency issues that lead up to the great crisis.

The one thing that all of us know, surely all of us must know at least this, is that markets do not go forever in one direction. I am not speaking here of the pecularities of a day or of trying to eke out some trade but of shifts in circumstances and sentiments that sets the direction upon a new course. We live in a world recently comprised of three basic tenets; postpone, make up facts to suit the goals of some nation or nations and throw money at anything that moves. This is an inherently unstable construct and yet that is what our brilliant leaders have embraced. I will tell you this; when chicanery is trotted out as truth, when liabilities are not counted, when losses are termed investments, when the only answer to anything is the printing of more small pieces of green and blue paper then trouble is approaching with a capital “T” and the future is a bleak cloud of foreboding.

"Jesse Litvak arranged trades for customers as part of his job as a managing director on the MBS desk at Jefferies.  Litvak would buy a MBS from one customer and sell it to another customer, but on many occasions he lied about the price at which his firm had bought the MBS so he could re-sell it to the other customer at a higher price and keep more money for the firm.  On other occasions, Litvak misled purchasers by creating a fictional seller to purport that he was arranging a MBS trade between customers when in reality he was just selling MBS out of his firm’s inventory at a higher price.  Because MBS are generally illiquid and difficult to price, it is particularly important for brokers to provide honest and accurate information. The SEC alleges that Litvak generated more than $2.7 million in additional revenue for Jefferies through his deceit.  His misconduct helped him improve his own standing at the firm, as his bonuses were determined in part by the amount of revenue he generated for the firm."