Guest Post: What Is Normal?

Tyler Durden — Sun, 19 May 2013 19:53:10 +0000

Submitted by Ramsey Su via Acting-Man blog,

Is a $400,000 house with NINJA loan normal?

How about a $200,000 REO with missing appliances, a dead yard, a long list of maintenance and no financing?

Maybe normal is a $300,000 flip after the flipper fixed everything and colored up the yard, and did some upgrades to the interior.

Some may suggest that normal is more like a $300,000 sale with a 5.5% fixed rate and 20% down.

Then again, it may be more normal if this $300,000 sale is financed with a 3.5% down FHA loan at 4%.

Of course, all of the above is actually referring to the same house.

So what is normal? Analysts and economists have long accepted household formation, population and job creation as the basis for housing supply and demand. There was a study (I can't seem to locate) that showed that there is no correlation whatsoever. I am going to borrow a chart from my cyber friend Calculated Risk as an illustration:

Housing starts, total and one unit structures – click to enlarge.

I think I am going to leave it to the Wharton grads to explain how population and employment fit into the above erratic housing starts chart. In fact, if you use employment as a factor, then we should be tearing down a few million houses since we have lost about 6-7 million jobs since the great recession. If population is a factor, then I suggest you invest in Cairo where the population is definitely growing much faster than that of Silicon Valley.

Is it normal that Wall Street is buying up all these houses? Wall Street OPM ('other people's money') is not only buying up all existing homes, now it is squeezing out the buyers for new homes as well. The numbers work exactly the same way for new and existing homes. The builders would far prefer a no-contingency cash offer with no commissions, no lender fees and no marginal buyers that they have to coach into qualifying. In other words, builders can take a lower offer from Wall Street and still be as profitable as when they are selling to mom and pop.

Is this good housing policy? Of course not. Where are the policy makers? Just like Greenspan during the sub-prime era, Bernanke is like a deer frozen in the headlights. He is busy with his QEs and claiming there is a housing recovery, while he should actually be busy writing his memoirs entitled: "I did not see it coming."

So what is normal? Logically, the past is only relevant if conditions in the future are expected to be similar. We know that with aging baby boomers, housing demand will be substantially different than when the same boomers were at the peak of their productive years. Should the demand rather be for duplex type constructions or grannie flats, as the boomers try to juggle taking care of elderly parents and boomerang kids?

Current economic conditions should also present a different outlook. For example, with youth unemployment so high, with student loans in the trillions, there is no reason why first time home purchases should not be delayed. It seems to me the worst thing policy makers can do is to give this group even more credit, especially long term credit like a 30 year mortgage that will entrap them forever.

However, I believe the new normal is going to be intervention. Here is a recent speech by Fed Governor Elizabeth Duke, entitled "A View from the Federal Reserve Board: The Mortgage Market and Housing Conditions"

This speech is significant because Duke usually labels herself as the Federal Reserve's main voice on housing.

Since joining the Board in 2008 amid a crisis centered on mortgage lending, I have focused much of my attention on housing and mortgage markets, issues surrounding foreclosures, and neighborhood stabilization.

For those who follow the housing market, I believe this speech is a must read. It provides insight into the data that the Fed is looking at and the Fed's understanding, or misunderstanding, of the real estate market. They seem to be overly concerned about lending to borrowers with low credit scores (emphasis mine):

“The drop in originations has been most pronounced among borrowers with lower credit scores. For example, between 2007 and 2012, originations of prime purchase mortgages fell about 30 percent for borrowers with credit scores greater than 780, compared with a drop of about 90 percent for borrowers with credit scores between 620 and 680 (figure 6).5 Originations are virtually nonexistent for borrowers with credit scores below 620…

[….]

At the Federal Reserve, we continue to foster more accommodative financial conditions and, in particular, lower mortgage rates through our monetary policy actions. We also continue to monitor mortgage credit conditions and consider the implications of our rule makings for credit availability. For your part, I urge you to continue to develop new and more sustainable business models for lending to lower-credit-score borrowers that lead to better outcomes for borrowers, communities, and the financial system than we have experienced over the past few years.”

Governor Duke has completely forgotten about the sub-prime disaster. A low credit score is not a given, it is earned. A borrower must carry some balance, miss a few payments or even default on a few loans before they can garner a 620 or lower credit score. The last thing that sub-prime borrowers need is more debt, something that they have proven they cannot manage.

At the moment, we know prices are going up in certain markets, and so are sales. Mortgage rates are higher now than when QE3 started in September 2012. Investors are gobbling up everything in sight in their favored target markets. As an example, they are buying 30% of the houses in Southern California, 38% in Phoenix and 53% in Vegas. First time buyers do not stand a chance, especially if their credit score is an iffy <620, making their contingency offer most unattractive to a seller. The percentage of home ownership is declining. Are policy makers happy with these results? Are these intended or unintended consequences of public policies? What are policy makers going to do – more QE, more HARP, principal reduction or something even more creative?

In my opinion, there will definitely be more intervention. Intervention is the new normal.

Japan Economy Minister: "Yen's Excessive Strength Has Been Largely Corrected; Further Weakness Could Be Harmful"

Tyler Durden — Sun, 19 May 2013 19:32:50 +0000

As if sniffing at the threat the ongoing collapse in JGBs, culminated by Toyota pulling a bond issue on soaring yields, which forced even JPM to come out with an ominously titled piece called the "VaR Shock" driven by the epic plunge in the Yen, Japan's economy minister Akira Amari has hit the wires saying "the yen's excessive strength has been largely "corrected," and further weakness could be harmful, Japan's economy minister said Sunday, suggesting the Japanese government may be happy with the currency's current level. Economy minister Akira Amari, responding to a question on how far the yen should weaken, replied that while he couldn't comment himself, "it's being said that the correction of the strong yen is largely completed. If the yen keeps on weakening a lot more, it will have a negative impact on peoples' lives."" Now the question is will those millions in Mrs. Watanabe housewives suddenly stuck in margin calls scramble to take profit, which could send the USDJPY soundly back into double digit territory, or will the momentum machine, facilitated by Getco's relentless scramble to perpetuate momentum ignition and drift, mean Japan has officially lost control of the Yen, and in a world in which only the BOJ's actions matters, will USDJPY 120 be next, together with the even greater "negative impact on people's lives" such a move would have (but not for those buying apartments at the yet to be built 432 Park).

From Nikkei:

Mr. Amari was speaking on a Sunday television talk show on national broadcaster NHK.

His comments come after the dollar appreciated past Y103 for the first time in four years Friday, marking a 3% gain in the past week alone, and a 30% rise since mid-November, when Prime Minister Shinzo Abe started his successful campaign for office on a pro-growth, weak-yen platform.

Mr. Abe and his ministers had argued that the yen had been too strong versus currencies like the dollar and euro since the global financial crisis sent the currency soaring in 2008, pummeling Japan's big exporters, which found their Japan-made goods suddenly much costlier in the world's markets. "Correcting" that problem -- as Mr. Abe and his cohorts put it -- was an important goal of the government's economic growth policies, which called for aggressive monetary easing, fiscal spending and deregulation.

But the last several months' depreciation has left the yen near pre-crisis levels, and Mr. Amari's remarks suggest that the government may now be switching its concerns to what would happen if the yen continues to weaken. Although a weak yen boosts profits at exporters, it also raises the cost of imports -- most notably fuel, which Japan has been buying in increased amounts since Japan's 2011 nuclear accident effectively halted operation of most of the country's nuclear power plants.

If a weakening yen does have a negative impact on living costs, "it's our job to figure out how to minimize that," Mr. Amari also said. As examples, Mr. Amari touched on the possibility of importing shale gas from the U.S. and restarting nuclear reactors.

Mr. Amari also sounded a cautious note on Japan's surging stock market, which has jumped 45% so this year, largely on the weakening yen and hopes that depreciation will boost the fortunes of big Japanese manufacturers. Last week the benchmark Nikkei 225 Stock Average breached 15,000 for the first time in over five years.

The stock rise "has been a bit faster than we'd expected," said Mr. Amari.

You mean a central planner could not correctly anticipate what would happen when the latest and greatest Pandora's box of asset bubbles is opened? Surely that's would be a first: as long as the "USDJPY is contained" all is well.

Perhaps Kuroda also just needs 15 minutes of jawboning to put the inflation genie back into the bottle.

Good luck with that.

And good luck turning the epic momentum juggernaut around: you will need it. Unless of course the even more epic short covering the may be unleashed takes the USDJPY lower by some 20-30 big figures, and Abenomics quickly ends where it started: with yet another Prime Minister resignation, and the central-planning emperor is found to have been naked all over again.

The New New York Housing Bubble: Park Avenue "Maids Quarters" Studio For $3.9 Million

Tyler Durden — Sun, 19 May 2013 18:40:28 +0000

To those who have already submitted their applications to launder their cash buy an apartment or better yet, have already wired the money to purchase any of the still to be built residences at 432 Park, the 84-story giant that is set to become the tallest residential building in the Western hemisphere, congratulations.

Although that is technically inappropriate: for full effect we would have to say "congratulations" in the buyers' native tongue, be it Russian, Mandarin, Spanish or Arabic, because it sure won't be English in the ongoing scramble to park trillions in cash away from a global banking system now hell bent on confiscating it, especially away from Europe's insolvent and massively levered banks as shown yesterday, and in the Cyprus template aftermath, the cleanest dirty shirt has once again emerged as midtown Manhattan real estate just as we said would happen last September.

However, to call the emerging, full-blown panic scramble to park cash sight unseen, with zero regard for asking price "a bubble", would a slap in the face of all calm, cool and collected bubbles everywhere. Because any time someone is willing to pay $95 million for a non-duplex one-floor apartment, $44.8 million for a 4-bedroom apartment, $10 million for a two-bedroom, or a paltry $3.9 million for a maid's quarters studio (no really), something far more profound is going on beneath the surface than a simple asset bubble.

The NYT explains:

Only 10 floors have been completed in what is intended to be the tallest residential building in the Western Hemisphere — a slender, 84-story tower on Park Avenue at 56th Street in Manhattan. But the top penthouse is already under contract for $95 million.

Other buyers have snapped up apartments on lower floors for prices that are almost as breathtaking. While their identities are not known, it is likely that many are the rootless superrich: Russian metals barons, Latin American tycoons, Arab sheiks and Asian billionaires.

Ultraluxury housing and construction is booming across Manhattan, which is now beginning to rival London in popularity with the world’s wealthy. The number of condominium buildings in the borough with apartments selling for more than $15 million has risen to 49, up from 33 in 2009, according to CityRealty.

In a sence, New York has joined the rest of the world's "wealth parking" capitals, where the only two profitable construction projects are those targeting the uber-wealthy or the mega poor. Middle class: sorry, you are out of luck

“There are only two markets, ultraluxury and subsidized housing,” said Rafael Viñoly, the architect who designed the tower on Park Avenue at 56th Street, which is called 432 Park.

The rush to build these towers underscores the gap between rich and poor in New York City, said James Parrott, chief economist for the Fiscal Policy Institute, a liberal research organization supported by unions. He said that median family income in the city had fallen 8 percent since 2008.

“Manhattan’s superluxury condo boom, along with rocketing foreclosures in Queens and record homelessness, present an unobstructed view of accelerating polarization in this recovery,” Mr. Parrott said

Recovery? Tell that to those countless middle-class New Yorkers (whose annual income as marginal as it may be in the City is what the rest of America can only dream of) for whom stagnant wages will mean an ever greater portion of income has to go to paying rent with little left for boosting the velocity of money.

Of course, for those close to the banking system's proximity to ZIRP, and the trillions in free reserve-based money (all of which is going into the stock market if not the economy) the current bubble is unlike anything seen before:

Izak Senbahar, the developer of 56 Leonard, a 60-story tower in TriBeCa where penthouses are going for more than $20 million, signed contracts with buyers for 70 percent of the 140 apartments in just 10 weeks.

“We were all surprised,” Mr. Senbahar said. “This was not what we expected. There’s a pent-up demand for condos with helicopter views.” A decade or two ago, luxury buildings were largely confined to Park and Fifth Avenues.

Today, they are rising all over Manhattan — from One57 and the Baccarat in Midtown Manhattan to 825 First Avenue on the East Side, 150 Charles Street in Greenwich Village and 30 Park Place downtown.

“It’s not that location is unimportant,” said Nancy Packes of Signature Marketing Services. “But it’s now all about bigness, lifestyle and views.”

But back to what is set to be the most recent residential crowning glory in the city: 432 Park.

In an interview, the developer of 432 Park, Harry B. Macklowe, said he and his partner, CIM Group, already had contracts for nearly $1 billion worth of apartments at the building. Total sales are expected to surpass $3 billion for a building that will cost about $1.25 billion to complete, he said.

The cheapest apartment in the building, a 351 square-foot studio, costs $1.59 million, according to the offering prospectus.

Of course, it is unclear what foreign money-laundering conglomerate baron would want to be seen in polite public having bought their in house butler a meager $1.6 million apartment. Luckily, there are maids' quarters studios in the same building for nearly $4 million, which we expect there will be a biddin war for.

“This is the building of the 21st century, the way the Empire State Building was the building of the 20th century,” Mr. Macklowe said.The penthouse has six bedrooms, seven bathrooms and a library. A sculptured bathtub sits in front of a window, offering IMAX-like views of the city. A buyer can also pick up a $3.9 million studio for the housekeeper and a private wine cellar for $300,000.

Visually:

To summarize the conditions of modern-ray Rome, a world of unprecedented wealth for some, where real estate has become a simple proxy for parking capital (at least until such time the administration reminds all foreign buyers you don't really own, you lease from the government, a government which may and will hike property taxes to any level it desires at a moment's notice) most of it lying unused, yet where living conditions for "everyone else" are at Great Depression levels:

About half the buyers are foreigners, Mr. Macklowe said.
As with many of these buildings, only about a quarter of the units will be occupied at any one time.

Surely, high fives are due to all 1%'ers, even if, on the other end of the social spectrum, it means this:

New York's Homelessness Worst Since The Great Depression

State and local governments nationwide have struggled to accommodate a homeless population that has changed in recent years - now including large numbers of families with young children. As the WSJ reports, more than 21,000 children - an unprecedented 1% of the city's youth - slept each night in a city shelter in January, an increase of 22% in the past year; as homeless families now spend more than a year in a shelter, on average, for the first time since 1987. New York City has seen one of the steepest increases in homeless families in the past decade, advocates said, growing 73% since 2002, and "is facing a homeless crisis worse than any time since the Great Depression."

Homeless advocates said the Obama administration has focused on more visible problems, such as those sleeping on the streets, taking resources away from families. The steep rise has reignited questions about whether New York's economic turnaround of the past two decades has helped the city's poorest residents as they note (despite today's Dow record highs), "the economy is nowhere near where it was."

The blame apparently lies at the cessation of 'entitlements' as the DHS adds, since the end - in Spring 2011 - of a state-funded program that subsidized rent for people leaving shelters; homeless families have gone up 35%; but they also added that the city was working to find employment for the homeless, "a long-term solution." Boston and Washington DC are also seeing homeless numbers surge.

But why end on a depressing note.

Instead, take a look at what those living at the top of the building (at least on those rare occasions they come to visit their "assets") and breathe the ultra clean air some 1271 feet above street level, will see as they do their best to avoid any interaction with a world mired ever deeper in a global recession... but only for others.

Jeff Gundlach: "We Are Drowning In Central Banking"

Tyler Durden — Sun, 19 May 2013 17:15:14 +0000

Last week, Bill Gross did not mince his words when he said that he now "sees bubbles everywhere" and that "when that stops there will be repercussions" but for now Benny and the Inkjets, not to mention his band of merry statist men, who take from the poor and give to the wealthy, are playing the music on Max, and so one must dance and dance and dance. And after one legacy bond king, it was the turn of that other, ascendant one - Jeff Gundlach - to share his perspectives Bernanke's amazing bubble machine. His response, to nobody's surprise: "there is a bubble in central banking. We are drowning in central banking and quantitative easing.... And it's not ending until there are some negative consequences."

What are those negative consequences? This too should be perfectly expected for regular readers: currency devaluation leads to trade wars (as either is a zero sum game, and in a zero sum game it is very easy to blame someone else for one nation's suffering and economic malaise), trade wars lead to real wars (see the 1930s), and so on. We are not there just yet: quote Gundlach "With global growth slowing not everyone can increase their imports [indeed: observe just how it was that Spain managed to post its first "trade surplus" since 1971 - hint: not by boosting exports] you're playing a market share game." But it is rapidly approaching: "We are looking at competitive currency devaluations, which causes rancor, causes unhappiness, and fingerpointing and god-forbid tariffs and things that cause even slower economic growth a la the 1930s." Good choice of words, considering it was just a week ago that none other than stagnating metals magnate Lakshmi Mittal, head of ArcelorMittal, who was urging Europe to just go ahead already and declare trade on China asap. For his own selfish reasons of course.

Toyota Pulls Bond Deal Due To Soaring Yields: The Japanese "VaR Shock" Feedback Loop Is Back

Tyler Durden — Sun, 19 May 2013 16:18:17 +0000

Despite the eagerness of Abenomics and the new BOJ head Kuroda to have their cake and eat it too, in this case manifesting in soaring stock prices, plunging Yen, rising GDP and exports, and most importantly, flat or declining bond yields, so far they have succeeded in carrying out three of the four (assuming Japanese economic data reporting is more accurate than that of its neighbor China), as it is physically impossible for any central planner to completely overrule the laws of math, economics and physics indefinitely. In this vein, we have described on numerous occasions in the past several days the shock to the system that the massive one-way transfer out of all asset classes and into equities has engendered, and resulted in several JGB futures trading halts in an attempt to normalize a market where bond volatility has suddenly exploded. Volatility aside (and it shouldn't be as the below section from JPM explains), the recent surge in yields higher is finally starting to take its tool on domestic bond issuers. As Bloomberg reports, already two names have pulled deals from the jittery bond market due to "soaring" borrowing costs. The first is Toyota Industries which as NHK reported, canceled the sale of JPY20 billion debt. Toyota is among Japanese firms that put off selling debt as long-term yields on government debt have risen, increasing borrowing costs, public broadcaster NHK says without citing anyone. Last week JFE Holdings announced it would delay plans to sell bonds due to market volatility. Two names down... and the 10 Year is not even north of 1%.

What happens to corporate bond funding when the one way slide that it the USDJPY continues on its way to 105, then 110, then 120, and so on, as equities explode on their way to doubling in 2013 (the NKY225 should surpass the DJIA in absolute terms in tonight's trading session), and how will corporation raise that much needed capital to fund CapEx (if one believes Abe of course) if they can't even handle a 10 Year that is well shy of 1%? Maybe they can all just fund their capital needs with equity going forward?

Perhaps, more importantly, what happens to JGB holdings as the benchmark Japanese government bond continues trading with the volatility of a 1999 pennystock, and as more and more VaR stops are hit, forcing even more holders to dump the paper out of purely technical considerations: a topic we touched upon most recently last week, and which courtesy of JPM, which looks back at exactly the same event just 10 years delayed, when in the summer of 2003 10y JGB yields tripled from 0.5% in June 2003 to 1.6%, now has a name: VaR shocks.

For those who wish to skip the punchline here it is: A 100bp interest rate shock in the JGB yield curve, would cause a loss of ¥10tr for Japan's banks.

Oops.

For those who wish to keep reading, JPM's Nikolaos Panigirtzoglou explains how Japan's toxic volatility loop may very soon send JGBs soaring in yields: a perfectly logical outcome in a world that can't have the disconnect between equity-implied growth (and inflation) and bond-implied contraction (and deflation) for ever.

And all this just as Abenomics was desperately clinging to any validation it was working.

From JPM's Flows and Liquidity: VaR Shocks

The recent rise in JGB volatility is raising concerns about a repeat of the 2003 “VaR shock” i.e. volatility-induced selloff.

The rise in JGB volatility is raising concerns about a volatility-induced selloff similar to the so called “VaR shock” of the summer of 2003. At the time, the 10y JGB yield tripled from 0.5% in June 2003 to 1.6% in September 2003. The 60-day standard deviation of the daily changes in the 10y JGB yield jumped from 2bp per day to more than 7bp per day over the same period.

As documented widely in the literature, the sharp rise in market volatility in the summer of 2003 induced Japanese banks to sell government bonds as the Value-at-Risk exceeded their limits. This volatility induced selloff became self-reinforcing until yields rose to a level that induced buying by VaR insensitive investors.

Banks typically set limits against potential losses in their trading operations by calculating Value-at-Risk metrics. Value-at-Risk (VaR) is a statistical measure that banks use to quantify the expected loss, over a specified horizon and at a certain confidence level, in normal markets. Historical return distributions and historical market volatility measures are typically used in VaR calculations given the difficulty in forecasting volatility. This in turn induces banks to raise the size of their trading positions in a low volatility environment, making them vulnerable to a subsequent volatility shock.

What was the flow evidence in the summer of 2003? By looking at quarterly Flow of Funds data from the BoJ, it was Japanese banks, Broker/Dealers and foreign investors who sold JGBs at the time. And it was VaR insensitive investors, Postal Savings and domestic Pension Funds and Insurance Companies who absorbed that selling.

How sensitive are Japanese banks currently to an interest rate volatility shock? The latest Financial System Report by the BoJ, April 2013, does not look encouraging. While Japanese major banks are close to average in terms of their vulnerability to interest rate rises, Regional and Shinkin (i.e. cooperative banks) are the most vulnerable they have ever been.

A theoretical 100bp interest rate shock, i.e. a parallel shift in the Japanese bond yield curve of 100bp, would cause a loss of ¥3tr for Major banks, ¥5tr for Regional banks and ¥2tr for Shinkin banks. As a % of Tier 1 capital, these theoretical losses are close to 35% for Regional and Shinkin banks vs. only 10% for Major banks. The maturity mismatch, the difference between the average remaining maturity of assets minus that of liabilities, has risen for all banks over the past few years. But it was the highest ever at the end of last year for Shinkin banks at 2.2 years, and the highest ever for Regional banks at1.8 years. Major banks had a much lower maturity mismatch of 0.8 years at the end of 2012.

This divergence between Major banks and Regional/Shinkin banks largely reflects differences in the maturity of their bond holdings. The average remaining maturity of bond investments has lengthened to around 4 years at Regional banks and nearly 5 years at Shinkin banks vs. 2.5 years for Major banks.

So in terms of their sensitivity to JGB interest shocks, Japanese banks appear to be more vulnerable than they were in 2003. For example in 2003, the expected theoretical loss from a 100bp interest rate shock was around ¥2tr for Major banks, ¥3tr for Regional banks and ¥1tr for Shinkin banks, significantly lower than they are currently. The maturity mismatch was around 0.8 years for Major banks, i.e. similar to the mismatch reported by the BoJ for the end of 2012. But the maturity mismatch was a lot lower at the time for Regional and Shinkin banks, at 1.2 and 1.5 years, respectively.

By themselves, these maturity mismatches and the sensitivity to interest rate shocks, appear to be increasing the chances that the Japanese government bond market will see a higher frequency of VaR shocks and thus more elevated volatility vs. other government bond markets. The potential offsetting factor is anecdotal and other evidence that Japanese banks have become more sophisticated in terms of the risk management and have gradually shifted away from mechanical Value-at Risk frameworks towards Stress Testing frameworks. This shift should have prevented banks from taking more interest rate risk in response to declining volatility and thus made them less vulnerable and less responsive to a subsequent interest rate shock.

Indeed, by looking at the risk management behavior of Major banks, for which the interest rate sensitivity and maturity mismatches are little changed since 2003, there is evidence of prudent interest rate risk management. But this is less true for Regional and Shinkin banks for which interest rate sensitivity and maturity mismatches have been rising sharply over the past years. This divergence is not surprising given that Major banks are typically a lot more sophisticated than Regional or Shinkin banks. And it is Regional and Shinkin banks which present a volatility risk for JGB markets. It is true that Regional and Shinkin banks are smaller than Major banks, but they together hold a large ¥50tr of JGBs (vs. ¥120tr of JGB holdings for Major banks).

These maturity mismatches and sensitivity to interest rate shocks have been intensified by QE because 1) of the mechanical rise in duration as yields decline and 2) because banks struggle to maintain their interest margins by extending the maturity of their bond portfolios so that they can capture extra yield. Indeed, the sharp lengthening of the maturity of the bond portfolios of Regional and Shinkin banks would appear to be a reflection of the pressure QE and a persistent low yield environment exert on banks to extend maturity. The average maturity of the bond portfolios of Regional banks was 3 years in 2007 vs. 4 years in 2012. The average maturity of the bond portfolios of Shinkin banks was 2.5 years in 2007 vs. 4.7 years in 2012.

And this is one of the unintended consequences of QE more broadly: Investors who target a stable Value-at-Risk, which is the size of their positions times volatility, tend to take larger positions as volatility collapses. The same investors are forced to cut their positions when hit by a shock, triggering selfreinforcing
volatility-induced selling. So QE potentially increases the likelihood of VaR shocks. The proliferation of risk parity investors and funds, which are strict Value-at-Risk investors and are heavily invested in bonds currently, is also likely raising the sensitivity of bond markets to sel-freinforcing volatility-induced selling.

What is the evidence of leverage outside Japanese banks? By looking at the bond holdings as % of total assets in Figure 2, Japanese banks are indeed the outlier followed by US and Euro area banks. The steady increase in the share of government bonds in Japanese bank assets reflects a sustained period of excess deposit inflows as households and corporates recycle their savings via the banking system. In a way Figure 2 suggests that Japanese banks are more vulnerable to interest rate rises and thus more likely to be the cause of a VaR shock.

Admittedly US banks feature high in Figure 2, raising concerns about their vulnerability to interest rate shocks. The problem with Figure 2 is that it does not include hedges that banks have via swap or option positions to protect themselves against duration risk. Therefore a better way to assess interest rate leverage by US banks could be to look at the quarterly trading profits of US commercial banks available from the Office of the Comptroller of the Currency (OCC). The latest observation is for Q4 2012. We proxy leverage by the ratio of the volatility of their interest-rate trading profits over bond market volatility. Figure 3 suggests that US banks’ interest-rate leverage was about average in 2012. The Dec 2012 observation is well below the highs seen in 2009/2010.

Global Thermonuclear Devaluation

Tyler Durden — Sun, 19 May 2013 14:50:23 +0000

Submitted by Mark Grant, author of Out of the Box,

“Now, witness the power of this fully operational battle station.”

-Star Wars

We are all embarked upon a grand new adventure. It just hasn't been announced yet. It will never be officially announced but we will all get to play this brand new game in any event. Originally I and others had provided the name, "Currency Wars," to our new game but recent comments and subtle indications have invalidated the title.

The new title is, "Global Thermonuclear Devaluation."

Japan leads off in first position. It will devalue against the Euro and the Dollar in a significant fashion. All approved by the G-7 of course. Then Europe has begun and will continue the same process which will be followed by America. It is the second in the grand schemes with the first great foray being entitled "Quantitative Easing." One game got old, the next one got sold. You have to know when to hold or fold them.

This new plan has been devised by the hedgehogs of Davos. Devalue all of the currencies in the world against goods and services and pay a far smaller price for what is desired and needed. The scheme is not exactly friendly to commodities either. Never in the history of the world have the economies been so connected or the central banks acting in such concert to be able to pull something like this off but the bet has been made. The money is on the table.

“Only at the end do you realize the power of the Dark Side.”

-Star Wars

The outward appearance will be a "Currency Wars" game but that is just a distraction. There are other motives afoot here and deviousness and distraction are always part of great political maneuvers. This quite complex multi-tiered move is a methodology to systematically reduce the value of all of the major currencies on the planet. In the currency markets all values are relative but by a coordinated effort each currency may be reduced to new lower valuations by one following the other down in price as coordinated by the Pied Pipers of Davos. Hamelin has been abandoned.

The massive selling of gold may also figure into this equation. Gold is the alternative currency afterall so that as its price declines then the national currencies and the global currency (gold) all are valued at new and lower levels by this systemic central bank effort. The word "manipulation" does not even begin to cover this ground. There are also a wide variety of consequences here.

If Quantitative Easing is soon to be curtailed then the effects of higher bond yields and a weaker equity market may be partially defused by lower currency levels. The absolute and relative value of a currency or all of the major currencies on the planet may also have a devaluation impact on commodities so that oil, copper and other basic materials may plunge in price as currencies are lowered globally. It is a dangerous game though and never before tried so that the ugly head of "unintended consequences" could play out in ways that no one fully appreciates or understands.

“Told you I did. Reckless is he. Now, matters are worse.”

-Obi Wan Kenobi

Devaluation by fiat may also lead to Deflation by fiat and then we may well all find ourselves on the Dark Side.

It’s Official: Gold Is Now The Most Hated Asset Class

Tyler Durden — Sun, 19 May 2013 01:37:57 +0000

Submitted by Pater Tenebrarum of Acting-Man blog,

Full Court Press

Not a day passes without the financial media denouncing gold as an investment option and hailing the bureaucrats heading the world's monopolist monetary central planning agencies as superheroes. It began prior to gold's recent breakdown, with widely cited bearish reports on gold published by Credit Suisse and Goldman Sachs, among others. Never mind that most of their arguments were easily unmasked as spurious. It should be no wonder though: gold's rise was the most conspicuous evidence of faith in central banking being slowly but surely undermined. The banking cartel relies on the fiat money system remaining intact; the legal privilege of fractional reserve banking provides it with what is an essentially fraudulent profit center unparalleled by any other in the world (fraudulent in terms of traditional legal principles, but not in terms of the current law of course). Not surprisingly, ever since the completely unrestrained fiat money system became operational in the early 1970s, the financial sector's share of corporate profits has inexorably risen and finally eclipsed all other sectors of the economy.

The share of financial profits of total corporate profits – a direct result of the fractional reserve banking privilege and the central bank monopoly on money (via Ed Yardeni) – click to enlarge.

In other words, the banks have to protect a major franchise. It is a good bet that if gold had continued to rise in the face of money printing being accelerated all over the world, the inevitable loss of faith in central banks would have happened sooner rather than later. That it will eventually happen is unavoidable – the modern monetary system was fated to self-destruct the moment it was conceived. This is so because central planning and price controls cannot work in the long run, even though central banks are socialistic institutions adrift in a capitalist sea, so to speak. They can to some extent observe prices in the market, but the problem is that the market price most relevant to them – namely the ratio of future against present goods as expressed in interest rates on the credit markets – is not independent of their actions. There is therefore nothing that can tell them whether their administered interest rates are too high or too low. It is a system that is condemned to fail at some point (unfortunately with grave consequences for the economy at large).

The fact that a great many people ostensibly believe in its viability is not proof that it is viable; most of those who are most vocal about retaining the central bank money monopoly are directly profiting from its existence after all. That the commercial banks only want to protect a source of large profits and an invaluable backstop in case their speculations go wrong is clear, but the same is true of most academics in the economics profession. The great bulk of them derives its income from the State, and the central bank is at the forefront of supporting the livelihood of its apologists.

Among commercial banks, Credit Suisse has been a leader in the recent rhetorical onslaught against gold, and has just published a follow-up, duly repeated by Bloomberg under the non-too-subtle title: 'Gold Seen Crushed'.

“Gold, down 17 percent since January, is poised to lose 20 percent in a year as inflation fails to accelerate and with the worst risks to the global economy waning, Credit Suisse Group AG said.

Gold will trade at $1,100 an ounce in a year and below $1,000 in five years, according to Ric Deverell, head of commodities research at the bank. Lower prices are unlikely to lure more central-bank buying, said Deverell, who worked at the Reserve Bank of Australia for 10 years before joining Credit Suisse in 2010.

“Gold is going to get crushed,” Deverell told reporters in London today. “The need to buy gold for wealth preservation fell down and the probability of inflation on a one- to three-year horizon is significantly diminished.”

Investors are losing faith in the world’s traditional store of value even as central banks continue to print money on an unprecedented scale. Bullion slumped into the bear market last month after a 12-year bull market that saw prices rise as much as sevenfold. Gold is a “wounded bull,” Credit Suisse said in a Jan. 3 report.

(emphasis added)

Color us unsurprised that the main author of the report is an ex-central banker. As regards inflation, below is a chart we have recently shown, US money TMS-2. The good people at Credit Suisse neglect to mention in their report that official 'CPI inflation' has rarely risen beyond the central bank's 'target' of 2% during the entire gold bull market to date. It was completely irrelevant to the gold market thus far, so why should the outlook for the government's 'inflation' data suddenly become relevant now? Monetary inflation has been higher over the past five, 10 and 15 years than at any time since the end of WW2 in a comparable period – and it continues to accelerate.

It is therefore erroneous to claim that 'the probability of inflation on a one to three year horizon is diminished' – the exact opposite is the case. As noted above, Credit Suisse's argumentation has been spurious in its first bearish gold report already and it continues to be so. It seems more likely that a concerted public relations campaign against gold is underway, while parallel to that, a pro-central banking campaign is in full swing. We're not really big fans of conspiracy theories, but in this case, everything points to this being the case; it is just as transparent as the pro-war campaign prior to the Iraq war was.

Monetary inflation in the US since the year 2000. Money TMS-2 has more than tripled – click to enlarge.

Success! Gold Now Seen as 'Worst Performing Asset' by Investors

The gold market is of course complying so far, as the clients of the banks issuing bearish reports are bailing from their gold positions. Skeptical voices like Elliott Capital Management's Paul Singer have been drowned out by the incessant barrage of propaganda. Gold continues to decline in the near term and its chart has begun to look rather ominous.

Gold over the past week (most active futures contract) – down every day of the week – click to enlarge.

As Credit Suisse incidentally also reported, its campaign has been crowned with success: not only has the gold price declined sharply, gold has now become the 'most hated asset class' with the 'worst outlook among commodities' according to a recent CS survey among institutional investors:

“Gold has the worst 12-month outlook among commodities and will trade below $1,400 an ounce in a year, according to an investor poll by Credit Suisse Group AG.

Sixty percent of respondents named bullion as having the worst outlook, 18 percent picked copper and 16 percent selected corn, the bank said in an e-mailed report today. Fifty-one percent predicted gold will fall under $1,400 in 12 months, it said. The bank polled 185 investors including hedge funds, pension funds and family offices on May 15 in London.

“Bearishness for gold was a very clear consensus,” said Kamal Naqvi, the head of commodities sales for Europe, Middle East and Africa at Credit Suisse. “It’s not about just not buying gold, it’s about shorting it,” or wagering on a drop.

Gold slumped into a bear market last month as investors lost faith in the metal as a store of value. Bullion is down 17 percent this year, compared with the 2.9 percent drop for the Standard & Poor’s GSCI gauge of raw materials.

Fifty-three percent of investors expect commodity prices to stay near current levels, Credit Suisse said. Most were underweight raw materials or had zero exposure, while they expected to be overweight or neutral in 12 months, the bank said. Investors named relative value trades, fundamentally based directional trades and volatility as the best ways to extract value from commodities.”

(emphasis added)

The general bearishness on commodities jibes with what we have seen in the recent Merrill Lynch fund manager survey. The bearishness on gold is in keeping with what we have seen in the Barron's 'Big Money' survey and other polls. Apparently though the people who write the gold reports at Credit Suisse are oblivious to the contrarian implications of their own survey.

As we have recently pointed out, just before Japan's stock market embarked on a 75% rally in the space of a few months, fund managers absolutely hated Japan (they love it now!). As we wrote in our October 30 review of the Barron's Big Money poll:

“However, what we really love is that they hate Japanese stocks even more! As it were, we are busy writing an article on Japan that will be entitled 'Reconsidering Japan' and should be published sometime this week. There are quite a few reasons to believe that Japanese stocks will finally do the unexpected and come back to life.”

At the time, a full 76% of the 'big money' fund managers surveyed declared themselves bearish on Japan. Currently, 69% of the managers surveyed in the most recent Barron's poll are bearish on gold. One must of course admit that from a technical perspective gold currently looks weak. That is undeniably the case and there could therefore be more near to medium term downside. However, the most important fundamental data as well as the sentiment backdrop clearly remain bullish. In fact, the skepticism of investors regarding commodities in general and gold in particular in the face of the biggest money printing orgy of the modern age is what we would call an 'extreme long term bullish dichotomy'. It seems highly likely to us that a year from now or maybe even earlier, the conversation will have profoundly changed.

What Did Obama Know About The IRS (And When)?

Tyler Durden — Sun, 19 May 2013 00:30:32 +0000

Amid the sound and fury of yesterday's IRS hearing were a few small tidbits which raise significant questions about who knew what and when within the Obama administration. While getting the answer (the real honest truth) is highly unlikely, as the Wall Street Journal notes, the IRS's watchdog told top Treasury officials around June 2012 (when Republican lawmakers were complaining publicly about alleged IRS targeting of tea-party groups) he was investigating allegations the tax agency had targeted conservative groups, for the first time indicating that Obama administration officials were aware of the explosive matter in the midst of the president's re-election campaign. The revelation nonetheless raised a fresh set of questions about who was aware of the problem within the Obama administration. However, the hearing left numerous other fundamental questions unanswered, including who ordered the targeting and why it continued so long, pointing to a protracted investigation ahead as Rep. Paul Ryan exclaimed, "how can we not conclude that you misled this committee?" As Doug Ross' full timeline below suggests, this is fascism on the part of the IRS and White House...

Via Doug Ross of Director Blue blog,

Reading this timeline, I have come to three conclusions:

1. Steve Miller lied to Congress
2. Lois Lerner lied to Congress
3. Barack Obama lied to the American people

This scandal has the fingerprints of Axelrod, Jarrett and/or the Chicago Machine all over it.

This is fascism on the part of the IRS and the White House. It is fascism, straight up.

Or, as I call the IRS: Organizing for Revenue.

Via The Wall Street Journal,

The Internal Revenue Service's watchdog told top Treasury officials around June 2012 he was investigating allegations the tax agency had targeted conservative groups...

...

The revelation nonetheless raised a fresh set of questions about who was aware of the problem within the Obama administration.

...

the agency had taken "absolutely inappropriate" actions in targeting conservative groups seeking tax-exempt status for often heavy-handed scrutiny.

...

The hearing left numerous other fundamental questions unanswered, however, including who ordered the targeting and why it continued so long, pointing to a protracted investigation ahead. Mr. Miller conceded the agency likely disciplined the wrong employee in one effort to address the problem.

...

House Ways and Means Committee Chairman Dave Camp (R., Mich.), "I think the most interesting revelation was the overall arrogance of the IRS and the lack of information from somebody who was in charge,"

...

White House officials say they learned about the targeting of conservative groups from the report, and not before. President Barack Obama on Thursday said, "I can assure you that I certainly did not know anything about the IG report before the IG report had been leaked through the press."

...

At the hearing, lawmakers of both parties expressed anger that IRS officials didn't reveal the problems to them in 2012.

...

then-commissioner Douglas Shulman about that in March 2012. He testified before the Ways and Means committee then that there was "absolutely no targeting,"...

...

"Throughout this time, the IRS leadership has demonstrated a total disregard for the oversight role of the Congress and this committee," said Rep. Sander Levin

...

"How was that not misleading this committee?" said Rep. Paul Ryan (R., Wis.) to Mr. Miller. "How can we not conclude that you misled this committee?"

...

The Bermuda Triangle Of Economics

Tyler Durden — Sat, 18 May 2013 23:30:43 +0000

Excerpted from Jacob Steen's Chronicle blog at Tradingfloor.com,

The mystique of the Bermuda Triangle has caught the imagination and interest of generations. In much the same way it has also caught my attention and I feel that now there is a Bermuda Triangle of economics - a space where everything tends to disappear without radar contact, a black hole in which rationality and science is replaced by hope, superstition and nonsense pundits like myself pretending to understand the real drivers of the economy.

The Bermuda Triangle in real life runs from Bermuda to Puerto Rico to Miami. The economic one runs from high stock market valuations to high unemployment to low growth/productivity. Just like the real Bermuda Triangle, in the Bermuda Triangle of economics there is plenty of scientific evidence that can explain most, if not everything, of what is going on. But that does not suit Hollywood, sorry, the US Federal Reserve.

Neither does it suit mainstream banking analysis or the media in dealing with reality and facts: the mystique simply sells better! After all, there is a reason why people leave science education for PhDs in apps and virtual reality.

There is a myth that the sunken Atlantis could be in the middle of this triangle. It has been renamed Modern Monetary Theory (MMT) to make it suit the black hole's main premise of ensuring there is a fancy name for what is essentially the same economic recipe: print and spend money, then wait and pray for better weather.

The economic Bermuda Triangle, or EBT, is getting harder and harder to justify - if for nothing else because the constant reminders of crisis keep us all defensive and non-committed to investing beyond the next quarter. We all naively think we can exit the "risk-on" trade before anyone else. A less cynical person than me could think that some things in life need to be experienced - not talked about.

Where to from here?
A long time ago, policymakers entered a one-way street where reversing is, if not illegal, then impossible. Enough though about the polices. What is more important is what is next?

If a political scientist should create a simple model for how this Bermuda Triangle works, the first action point would be to test the premise of the policy. No theory is better than its premise - clearly.

The Federal Reserve version of the premise is to create a positive wealth effect that ultimately leads to better sentiment and investment. The barometer of success is the stock market, but does the stock market really correlate to wealth? Clearly the stock market has been on a tear, but is everyone, including the average Joe, benefitting? Clearly not. Ownership of stocks is almost exclusively for the top 10 percent of the population. Social divide is much higher today than it was before the crisis.

In Japan, they are more open - they simply want to create a bubble. I repeat, a bubble. That is interesting when policymakers for years have said it is impossible to figure out when there is a bubble! I guess - proactively wanting a bubble makes it more transparent? Confused? Certainly I am, but then again Abenomics is "double Dutch" to me anyway.

So the premise does not hold, but how will the policymakers deal with failure? Change course? Never! It would be worse than blasphemy! A one-way street means cars can only go one way - not in reverse. Optionality is for democracies and capitalistic systems, not for a time of crisis. In times of crisis, we need the foresight of our great supreme leaders, sorry, politicians and central bankers, to guide us. Their divine insight will lead us safely ashore to the beaches of Lalaland, where the sun always shines.

No, the response is to do more. Take the Bank of Japan's quantitative easing (QE) infinite released on April 4. One month into the experiment and Japanese Government Bond (JGB) yields are higher, not lower.

The yield curve is steeper, inflation expectations are flat but the Nikkei and USDJPY are higher. A success? Yes, except in the one area you wanted to impact: the yield and the yield curve!

The other part is that for this to work, the stock market needs to keep outpacing the fall in JGBs. The Government Pension Fund manages more than USD 1 trillion. Its allocation? Sixty-five percent in JGBs and less than 11 percent in stocks. Hence, the present scoreboard would read:

USD 650 billion x (146.50 - 143.50) = 2% = - USD 13bn. USD 110bn x 40% = USD 48bn. A net gain of USD 35bn but...

What if the Nikkei comes off 10 percent - then USD 48bn becomes USD 37bn and the new equilibrium price of 138.50 is only five figures away.

A price point that will make Japan less well off, not better, plus it would have increased the funding price of the 240 percent debt-to-GDP ratio. Some strong macro fund managers think that a collapse in Japan is less than 12 to 18 months away, among them Mr. Kyle Bass stands out. Maybe Japan should be careful about what it wants. My conclusion on Japan is:

1. The Japan scenario is neither black nor white, but a continuous gradual process. Japan is notoriously slow in changing its political process and ultimately nothing will have changed materially one year from now. Yes, the Nikkei could be the start of a secular bull market as Stanley Druckenmiller recently said in New York, but it is already up 60 percent from the low. And with China and Europe slowing, it is likely to see a major correction and probably soon.

2. The unintended consequence of QE Infinite in Japan is so far (as shown above) a higher yield - even higher than the recent rise in US rates - USDJPY becomes vulnerable for a major correction down to 95/96.

3. Japan will not go bankrupt inside 12 months or even 12 years, but the hope of a recovery will wane and soon. Watch how the Upper House election in the Diet in July becomes the final destination for Abenomics. Prime Minister Shinzo Abe needs to secure 63 and 100 new seats; 63 seats to maintain momentum behind his economic policy and 100 to secure the majority to change the constitution.

Delivering "cheap money" is the easy part of his three pillar strategy, which got him elected. Using stimulus correctly and working on the supply side of the economy will be impossible due to structure, lack of immigration, health care and ageing costs. I wish Japan well, but nothing will be saved by using the economic Bermuda Triangle. Of all countries, Japan should know - it invented the economic version of it!

Another key event will be the German election.

In Germany, Chancellor Angela Merkel will win the battle (the election), but will probably lose the war: she needs to step up. Europe expects it. The market wants it. The problem is, she can't afford it.

Bailing-in will mean a loss of rating for Germany, while staying austere will cost exports and long-term growth. Which scenario to choose? I personally think she will fail - fail to reconcile. She is already short of a Chancellor's majority and after the election, the Greens and SPD will hold her hostage. Staying in power will mean giving in. Simply.

That, however, will be the end of the honeymoon for Europe. Germany cannot save Europe. Each country in Europe needs to realise that its recovery comes from its own political willingness to reform and eat reality pills. Europe is destined to repeat the history of Japan, unless an even more severe crisis makes us wake-up.

This means we see the July to October period as a very important time frame for this experiment. We firmly believe the German election will be the game changer, but we could get a surprise in July unless Mr Abe gets JGB yields under control.

Policy conclusion

The Federal Reserve is testing the waters with its "tapering", but Fed chief Ben Bernanke is financing the budget deficits via his QE. Hence, he will continue less aggressively, but QE is not ending.

The Bank of England gets a new boss in July. This will kick-start American-style policies, which sits right in the middle of the economic Bermuda Triangle, with GBP being the main casualty.

The Bank of Japan will soon correct its maturity in buying - buying longer and deeper - as the July election looms.

The European Central Bank is close, very close to doing something that smells and feels like QE. Selling the sick man of Europe - France - makes a lot of sense here.

Strategy

We are entering the realisation part of this global slowdown. Unlike three months ago, policymakers now realise that growth is not coming back in six months' time as they all love to estimate at their press conferences. So over the summer, the Federal Reserve, Bank of England, Bank of Japan, International Monetary Fund and European Central Bank will all go back to their drawing boards and... do more of the same.

The policy is not wrong; clearly, it is only the amplitude of it. I agree with Jeff Gundlach, who believes QE is here to stay for a long, long time, but also that the only thing that will get us out of this funk is innovation and reality. How do I reconcile this?

By allowing the 70 percent likelihood for Extend-and-Pretend Season 4 through to the July to October period (German and Japanese elections), which will lead us to Japanisation (dis-inflation, no growth and productivity plus an ageing population).

There is a 30 percent chance of failing before July - failing as in the market collapsing or social tensions rising, governments falling and the financial system under pressure.

We are due for a new crisis. We have governments and central banks proactively pursuing bubbles. Hence, the probability of bursting one of those bubbles will need to have risen by the same magnitude as the desperate moves of policymakers.

Visualizing The Silver Squeeze

Tyler Durden — Sat, 18 May 2013 22:30:59 +0000

Despite 'crashes' in the market, the demand for physical silver continues to rise. "Buyers are already outpacing sellers by a stunning 50-to-1 ratio. We are seeing the beginning of shortages; but this will only accelerate if Western governments continue with this raid on paper gold and silver."

The Silver Squeeze – An infographic by the team at The Silver Squeeze Free Infographic