Tuesday, June 29, 2010

The Debts of the Spenders: PIMCO Blasts Fannie and Freddie for MBS Manipulation

And here I thought PIMCO would be happy with these high prices. . . Oh wait, they sold most of their MBS months ago. For more irony, compare this story against the backdrop of strategic home defaults where 1 in 5 or 20% of homeowners (err...isn't that the wrong term?) choose to default on their mortgages even when they have the funds to meet payments.

"The 30-year 5.50 percent coupons are insanely expensive," Scott Simon, head of mortgage and asset-backed securities at Pimco, manager of the world's biggest fixed-income fund, said in an interview with Reuters. "If they (Fannie and Freddie) could make the most money selling agency MBS, they should."

The global financial turmoil has benefited not only U.S. Treasury securities, but also agency MBS as foreign and domestic buyers have sought the relatively safe-haven investments.

But Simon also said prices on the MBS are too rich for his taste.

"Even if this coupon cheapened a full point, I would still not like them and we are not even close to levels where I would consider buying them," he said.

"We have to assume that somebody must have been telling them not to sell," Simon said. "They are not supposed to be running a business where they lose money holding on to their positions."


Thursday, June 24, 2010

The Debts of the Lenders: Bill Gross Claims Stocks Will Outperform Bonds Within the Next Few Years

Continuing on the bond vein, Bill Gross of the famed PIMCO bond fund, came out today and said that now is the time to go long equities (when has he ever said that?). His argument is that the bond rally of 2008-2010 is at its peak and we'll see bonds lose their value as interest rates slowly climb.

I think he's got the right idea about the eventual return on assets but I have my doubts about his timing - especially after the Fed confirmed low rates again at this week's meeting. Continuing distress in European and US credit markets means that the 10 year yield may see 290 or lower. (The last time that occurred was in the dark days of Fall 2008 and early spring 2009).

Note - the right chart is of the 10 year yield which is inverse to price. The left chart is of the US corporate bond returns from July 2009 to the present.

If you are curious to know more information about bond returns click here to sort bonds by total return, yield, price, and volume.


The king of bonds is now talking up stocks as a better long-term investment. He says that as U.S. Treasury returns fall, investors will have to take more risk with high-yield bonds, equities and, eventually, real estate.

“If you're talking about the next 10, 15, 20 years, there's certainly the recognition that assets will grow faster in those categories,” he says. “Over the long term, stocks return more than bonds when appropriately priced at the beginning of an investment period.”

The Debts of the Lenders: Mortgage Bonds Rally On Irony

Several months after Bernanke ended his purchase of MBS securities, the market is seeing even loftier heights. The reason?

Speculators are betting that since the housing market remains weak so too will mortgage refinancings. (Lending standards are a lot tougher and so are the supply of mortgage brokers). Combine that with a limited supply of bonds and you have a recipe for bonds trading well above par.

Even PIMCO, the fixed income giant that spearheaded the initial MBS purchase drive in late 2008/early 2009 was stunned by the rally in prices.

The average price of $5.2 trillion of bonds guaranteed by government-supported Fannie Mae and Freddie Mac or federal agency Ginnie Mae climbed to 106.3 cents on the dollar yesterday, according to Bank of America Merrill Lynch’s Mortgage Master Index. That’s up from 104.2 cents on March 31, when the Federal Reserve ended its program purchasing $1.25 trillion of the debt.

“It’s gotten insane,” said Scott Simon, the head of mortgage-backed securities at Newport Beach, California-based Pacific Investment Management Co., manager of the world’s biggest bond fund. “This is rarefied air.”

So, what could cause the rally to end? If the government were to figure out a way to force lenders to re-finance (profitably).


Here is some historical perspective:


Tuesday, June 15, 2010

The Debts of the Spenders: Greece Attracts Chinese Investment

Earlier this year, China had rebuffed efforts by the Greek government to invest (e.g.bailout its moribund banking sector). But apparently all that has changed now. China is apparently realizing its responsibility to the rest of the world as a key pillar of economic stability - even if such efforts may lead to months or even years of initial losses.

A delegation led by Zhang Dejiang, a Chinese vice-premier, will seal a series
of agreements on Tuesday with local companies, a Greek government official

“These concern maritime affairs, telecoms and a project to renovate a
landmark tower building in Athens’ port of Piraeus,” the official said.

Deals for joint ventures, charter agreements and shipbuilding deals worth
€500m ($615m) with Greek shipping companies will also be signed.

China’s state shipping company Cosco already controls a container terminal at Piraeus under a €3.4bn long-term concession deal. Cosco is expected to make a joint bid later this year with Greece’s state ports company to create a €150m-€200m logistics hub near Athens to distribute goods for China in the Balkans.


Friday, June 11, 2010

The Debts of the Spenders: The Continuing Greek Tragedy

Here's the problem. Greece cannot devalue its currency.

Since the beginning of the euro, Germany has become some 30% more productive than Greece. Very roughly, that means it cost 30% more to produce the same amount of goods.

Labor costs must fall by a lot. And not by just 10 or 15%. But if labor costs drop (deflation) then that means that taxes also drop. The government takes in less and GDP drops.

It looks like Greece will have to eventually leave the Euro someday. Just imagine the legal bills involved because all the contracts are in Euros. That will be a great day for the lawyers.

So in the meantime, banks that have pledged to refinance (e.g. are holding Greek government bonds) are stuck in a game of Prisoner's Dilemma where each side is waiting for the other to engage in mutually harmful retaliation.

(Prisoner's Dilemma is a popular Economics/Political Science stratagem taught to university students. It is a study of BEHAVIORAL economics rather than RATIONAL economics and was popularized during the Cold War to study the effects of Mutually Assured Destruction). The emphasis on behavioral economics is not accidental - studies have repeatedly shown that actors rarely act in their best, or rational, interest.

Here is how one analyst describes the current situation:

“From an individual bank’s perspective, it would be great to get rid of the sovereign debt,” Hoffmann-Becking said by telephone. “However, if everybody did it you’d have a rapid collapse of the government bond market and then you’d have the default. And in the default, the fact that you have no sovereign debt actually doesn’t help you at all.”


The Debts of the World: Where Do We Grow From Here? Part II

A history of US federal interventions (bailouts):

A) Late 1970s - US bails out municipal bonds by guaranteeing state and some local (NYC) bonds.

B) Early- Mid 1980s - US bails out third world nations and Latin America via Brady Bonds.

C) 1989 - US bails out commercial real estate via the Resolution Trust Corporation

D) 1997-1998 - US bails out emerging markets in Asia via IMF.

E) 2008 - US bails out investment banks (except Lehman Bros) via TARP and sovereigns holding housing finance agency bonds (Fannie and Freddie Mac).

F) 2009 - US bails out municipal bonds (again) by underwriting the Build America Bonds (BAB) which covers interest payments for the states.

G) 2010 - US pressures EU to bail out itself while granting hundreds of billions dollars in currency swap guarantees

Notice a pattern here?

The current crisis is not materially different from past crises (except in the scale). America's net worth is TRILLIONS of dollars. We are the world's biggest consumer and driving engine. A few trillion here and there will not destroy us.

The formation of the EU itself would not have been possible without America's help. A continent that had been at war with itself for hundreds of years has endured 60 years of peace because of a US taxpayer funded NATO. European nations that were used to, on average, one war every generation suddenly found quiet. Even the Balkan conflict in the 1990s has been (largely) resolved through American military power.

Debt is fine as long as there is productivity growth behind it. The EU's formation was supposed to usher in a period of productivity. Instead, it produced a stagnant continent that has grown used to some of the highest living standards in the world. But how can governments pay for it?

Let's look at productivity gains. Growth from the last generation of innovative American companies (there is a distinct lack of start-ups in Europe due to business cultures and government tax regulations - Indeed, the tax burdens behind the EU bailout will stifle growth even more.) is falling.

The Microsofts, Dells, and Intels of the 1980s and 1990s have turned into moribund mega-corporations with smaller profit margins. Generally, past innovations are already factored into equity share prices. Maintaining the past pace of productivity will be difficult. Which is why the world is looking to the India's, Brazil's, and China's for the next big gains.

The Debts of the World: Where Do We Grow From Here?

Growth is only one factor. The more important thing to examine is PROFITABLE growth. Let us examine a country that is always on the lips of pundits - China.

Much of China's growth is real but whether such growth is strengthening the economy is questionable.

Chinese growth, much like Japan in the 1970-80s, is living off the legacy of cheap, government controlled money and low prices. While the entire world was lauding the "Japanese economic miracle", the entire structure was rotten from within. The number of NPLs (non performing loans) grew steadily. Instead of writing off losses, the corporations - with the connivance of the state - covered up the losses with even more losses to keep the system alive. More alarmingly, the demographics began to shrink. All this came to a head on December 29, 1989 when the Nikkei reached an intra-day high of 38,957.44 before closing at 38,915.87.

The following 20 years were not pretty.

We are beginning to see the same things in China. Except China's 1 child policy will only make things worse.

Smarter people than me have already written volumes about this. But I'll put things in recent perspective. The spate of suicides in Chinese sweatshops is a symptom of a systemic problem - a corporate culture wedded to near term profit and nothing else.

Besides cheap labor do you know what the other Chinese competitive advantage is?

"Quality Fade."

Quality Fade is a term made by Paul Midler, an old China hand who is an importer agent stationed in southern China.

Made in China may be more expensive than you think. There are many reasons why a manufacturer would agree to make merchandise for next to nothing. One reason is that "switching costs" in manufacturing are high. It was important to many manufacturers to catch the order first. Later, once the importer was relaxed and the orders were assured, the factory could raise prices bit by bit, and then quality could be cheapened. After winning the initial order, many Chinese suppliers systematically degrade the quality of their production in order to cut costs.

I highly encourage all to read "Poorly Made in China" which covers this in more detail:


Or for those with less time:


Thursday, June 10, 2010

The Debts of the Spenders: EU Pledges Unlimited Support for PIIGS Bonds

June 10 (Bloomberg) -- Jean-Claude Trichet said the European Central Bank will extend its offerings of unlimited cash and keep buying government bonds as it tries to ease tensions in money markets and fight the European debt crisis.

“It’s appropriate to continue to do what we’ve decided” on purchases of sovereign and corporate bonds, Trichet, who heads the ECB, said at a press conference in Frankfurt today. Earlier, the central bank kept its benchmark interest rate at 1 percent. “We have a money market which is not functioning perfectly.”

The ECB is buying state debt and pumping unlimited funds into the banking system as part of a strategy by European policy makers to stop the euro region from breaking apart. While Trichet refused to bow to some investors’ demands for more details on the bond purchases, he said the ECB plans to offer further help to banks struggling to raise cash in money markets.


Friday, June 4, 2010

The Debts of the Spenders: US Homeowners Walking Away From their Mortgages

A growing number of the people whose homes are in foreclosure are refusing to slink away in shame. They are fashioning a sort of homemade mortgage modification, one that brings their payments all the way down to zero. They use the money they save to get back on their feet or just get by.

“Instead of the house dragging us down, it’s become a life raft,” said Mr. Pemberton, who stopped paying the mortgage on their house here last summer. “It’s really been a blessing.”
This type of modification does not beg for a lender’s permission but is delivered as an ultimatum: Force me out if you can. Any moral qualms are overshadowed by a conviction that the banks created the crisis by snookering homeowners with loans that got them in over their heads.