FedUpUSA

Archive for the ‘Debt’ Category

Our markets have a recent history of missing important warnings. It’s no different now as investors deny the obvious and the economy stumbles along.

I have been in the investment business for more than 30 years now, so I have grown accustomed to seeing lunacy, naiveté and just plain stupidity more often than one would think possible, given that investing is supposed to be about being smart.

It seems extraordinarily obvious to me that the economy is, in essence, broken because of the stock and housing bubbles we have experienced, and that the Federal Reserve is trapped. It also seems clear that at some point we will have a funding crisis (bond yields will leap and/or the dollar will tank) due to excessive government borrowing. (Click here for more on this funding crisis.)

However, that’s not going to occur until certain attitudes shift, so I can see why this is taking some time to unfold. What I cannot understand is how folks don’t recognize the fact that, since the economy has been unable to create jobs for three years now, it isn’t going to start magically generating them now.

Nor do I understand why there is such denial about inflation. The everyday cost of living has been increasing steadily, and at an increasing rate. Just because house prices have collapsed and certain products that folks buy, especially those heavily laden with technology, are cheaper does not change the fact that we are experiencing inflation, and that the environment is really one of stagflation. It is obvious, as are the consequences.

Nevertheless, to a large degree in the investment community, Goldilocks rules.

Déjà eww

The mindset seemed familiar to me, and about a week ago I was thinking of past moments in time where the obvious was there for all to see but maddeningly few seemed to see it. What popped into my head was the spike in first payment defaults leading up to the housing crisis. When that started occurring, as early as August 2006, it spelled the end of the housing bubble (while at the same time proving it was bubble behavior, since people were missing their firstpayments).

I actually decided to search my subscription site, www.fleckensteincapi​tal.com, for references to “first payment.” Lo and behold, one of the headlines that popped up was “Goldilocksters see oil prices as bullish, up or down,” which ran on Jan. 11, 2007 (that is, more than a year before Bear Stearns’ liquidity problems came to light). Here are some key excerpts:

“I wanted to share an email from my insider friend in the subprime arena, whom I’ve quoted so liberally. It’s sort of incongruous to read his thoughts on a day when subprime and other financials were going wild, but this (first payment defaults) is a problem that I guess won’t matter until the day it matters — and then boy is it going to matter.

“He wrote: ‘We had a loan that was FPD (first-payment default) on a home in So Cal. It is a very nice high-end town that had a section of new homes built, but it was in the low end of town. Normal homes sold for $1 million in value. In this new seven-home development, (homes) sold for $1.3 million to $1.5 million each. The homes you had to drive through to get to this place were worth $400,000 to $500,000. The market topped out, and now most of the seven homes are vacant — worth no more than $900,000. Thus, all the lenders are sitting on losses of $400,000 to $600,000. This is just one of many that are happening daily.’

“‘The commentary I am getting from field and legit brokers is that fraud is an out-of-control locomotive. Stated-income loans are now finished for all the unemployed people around. We will quickly see cash-out loans curtailed. This vicious cycle has yet to play out. We are in the second inning of the unwinding.’”

Note that I received that email on a day when subprime and other financial stock prices were rallying big time, the market completely oblivious to what lay ahead.

Selling yesterday’s news

Just as folks were late in figuring out the severity of the housing crisis, I think they still tend to be late in facing current realities. Case in point: For most of this week, it was as if markets in Europe and the U.S. had suddenly realized that the government in Greece was in disarray; that we were about to have a socialist running France; and that Spain, Portugal and Italy are each a teetering financial house of cards, even though none of that should be “news,” especially to supposedly sophisticated market participants.

In the old days, markets tended to discount events (that is, they reflected expected negative outcomes through lower asset prices, or vice versa). If that were still the case, markets should have declined into last weekend’s European elections as they anticipated the results, as well as other problems. But what we saw were markets that appeared notto have discounted the seemingly obvious news.

I have commented on this phenomenon a number of times over the past 10 years: that only after an important event happens (which was usually pretty obvious) does Mr. Market have a heart attack. I don’t really know why that is, although I think a lot of it has to do with how the government’s money printing has warped the markets by causing people to expect to be bailed out.

You can see a million trees and still not recognize the forest

Where our current path is taking us has been predictable for quite some time, and I think that continues to be the case. Unfortunately, we have elected officials who are completely incompetent, if not criminal, and the Fed is even worse. None of that is going to change until change is forced upon us (i.e., them) by a crisis. So while events seem to play out at a glacial pace, where we are headed couldn’t be clearer.

On the air

I participated in a rather timely interview with Eric King this week. Those who are interested can listen to it here.

Bill Fleckenstein for MSN Money

In an admittedly strange twist of timing JP Morgan, the same JP Morgan that just announced a surprise $2 billion loss caused by the “London Whale,” became the first and only of 26 banks disclosing subprime investor data to flip me the digital bird, refusing access to the public loan-level performance data for their Washington Mutual loans. WaMu, one of the most reckless subprime lenders, was swallowed whole by JPM and they’re having serious indigestion.

Nelson D. Schwartz and Jessica Silver-Greenberg of the New York Times verify that the purpose of the Chief Investment Office — the London Whale — is to offset risk caused by the Washington Mutual loans:

Under Mr. Dimon’s leadership, the chief investment office — which was responsible for the outsize credit bet — was retooled to make larger bets with the bank’s money, a former employee said. Bank executives said the chief investment office expanded after JPMorgan Chase’s 2008 acquisition of Washington Mutual, which added riskier securities to the company’s portfolio. The idea behind the strategy was to offset that risk.

It isn’t hard to figure out why JP Morgan doesn’t want anybody looking into and through their garbage.  I have not been able to ascertain whether these reports are required under disclosure requirement Regulation AB (the law itself seems to say yes, but the experts I spoke to gave divergent readings). Whether they are or aren’t, JPM’s refusal — when everybody else cooperated speaks for itself.

As those loans sour, and they continue to rot like a dead skunk on a hot July day, the bets needed to offset the losses are increasing.  It looks like the bank, peering into that  portfolio they refuse to share, is becoming more than a little bit desperate.  Like a compulsive gambler after a multi-day bender resulting in crippling losses they decided to double down rather than walk away, leading to their current whale of a surprise and likely a mirror-image follow-up for the WaMu losses this was supposed to offset.

For anybody who believes that JPM’s position is normal .. it isn’t.  Twenty-six other banks quickly popped open the doors to their repositories, as they’re required to do.  Perennial bad-boy Aurora Loan Services  is the only other one that’s ignored my requests, though since it looks like they’ve sold their servicing operations the jury’s out whether their silence is purposeful or whether there’s nobody home on the other side of those requests.

Like I said, I’m not sure whether these disclosures are exempt.  There are certainly many marked private, but they seem to be overwhelmingly CDOs and similar more exotic or clearly closely held instruments.  I’ve never seen an entire series of MBS from an issuer that is exempt: even a few stray WaMu deals that ended up in other repositories are open to the public.

JP Morgan’s insistence that “[t]he site is maintained for JPMorgan Chase RMBS clients,” only, demanding that I include my JP Morgan Chase contact, may be legal but it is unprecedented.  In context of their recent trading losses, the knowledge that those losses were to hedge against the WaMu losses, Dimon’s prior comments downplaying both losses, and strong analysis that the WaMu loans are some of the most impaired MBS it’s fair to conclude that JPM is hiding something in the basin of their loan outhouse.

I’ve spent the past couple months holed away downloading MBS data in bulk to enable investors, analysts, academics, government agencies, or whoever else wants to inspect performance information and project losses for every subprime loan trust.  When finished, this week hopefully, I’ll have a veritable ABS MRI machine that can peer into the true health of the housing and housing finance market.  It’s harder than it sounds: one of those projects where software engineers emerge from their digital caves after months, bleary eyed and long past due for a haircut but holding game-changing technology.

My database, which includes everything except WaMu loans thanks to Jamie, is finally almost finished.  But even in preliminary form it is clear that the AAA-rated senior tranches — the ones that really were never supposed to take losses — are toast that’s burning worse by the day.  Servicers, trustees, government officials have been doing anything to delay the inevitable losses but when people don’t pay their mortgages, and housing has declined by over 50% in many of their markets, there’s only so much accounting chicanery they can do: the money just isn’t there.

My suspicious are more grounded than tin-hat delusions we’ve been hearing from the housing is hot again crowd.  R&R Consulting, a well-regarded structured valuation expert I work closely with conducted a portfolio-wide analysis of undisclosed (“limbo”) losses on RMBS.  In a special in-depth report dated February 2012, long before JPM told me piss-off when asking for access to the more granular WaMu loan-level data, they reported that WAMU had the highest limbo loss level–about $810 million—in just one transaction. Repeat: experienced analysts dug this out even without loan level data. It sounds likely that it won’t be long until Dimon reports another ten-figure surprise that I’m sure he’ll apologetically pawn off on the US taxpayer.

For anybody asking “um — isn’t this over — didn’t all this fall apart back in 2008?” the answer is not really.  That mega-meltdown was really a mini tremor caused by the lower and smaller tiers of these securities; last time junior visited to stir things up but this time papa’s walking down the street carrying a mean look and a big stick.  That’s because the mezzanine level tranches of most bubble-era MBA are either gone or guaranteed to be gone — finally eaten up by current or pending losses — leaving the lower AAA tranches to take their place as the bearer of losses.  This was never supposed to happen.  Everybody knew that CDOs created from the lower tranches were risky, even if the ratings agencies said otherwise, but nobody thought the meltdown would last this long that the actual top tranches would be nicked.  But the data couldn’t be clearer: those bottom level A-class tranches of yesterday are the new bottom level M-class tranches of yesterday.

All this is surprising because these same MBS tranches have been on fire lately.  Hedge funds bought them for very little when nobody wanted them — setting their own price — and now they’re selling them back at steep gains because housing is peachy again, never mind the enormous amount of shadow inventory.  Hopefully the buyers of these same securities aren’t being set up, again, because nobody would be stupid enough to fall for that same trick, again.  Hopefully.

It is these lower tranches and other derivative products, which are by definition exponentially smaller than the more senior securities like the ones JPM is hiding (well, before the banks multiplied them several times over using credit default swaps) that blew up the world economy in 2008.

I’m guessing that it is the inevitable meltdown of what remains of the AAAs (the amount outstanding has been reduced considerably by refis) that has been at the impetus for the housing cheerleaders.  By refusing to move their foreclosures forward, then refusing to take title, then refusing to REO those homes, the trusts don’t have to recognize the losses because, ya’ know, the abandoned and dilapidated properties will magically double in value as long as we hold our breath and wish.

My mountain of data that shows loss severity in excess of 100-percent is not uncommon.  When we look at the loans, compare similar loans from those who report them more honestly, multiply the average severity by pending reported and, um, overlooked foreclosures, then it becomes clear that the lowest rated AAA’s are toast. This reaffirms the report by R&R Consulting report that $175 billion of loan level losses had not been allocated to the trusts. Whoops!

Jamie Dimon admitted his $2 billion loss “plays right into the hands of a bunch of pundits out there” on his conference call explaining his stinky.  Dimon went on to call the losses “egregious” and “self-inflicted.”  In light of the London Whale it is clear that when it comes to sky-high risk, like JPM’s WaMu exposure, the bank has adopted an advanced risk management strategy: telling researchers to piss off then hiding.

By Michael Olenick for Naked Capitalism, creator of FindtheFraud, a crowd sourced foreclosure document review system (still in alpha). You can follow him on Twitter at @michael_olenick or read his blog, Seeing Through Data

This morning Jim Cramer, along with the rest of the CNBS crew, actually “endorsed” a return to Glass-Steagall in the wake of the JPM disaster.

When asked “but won’t that make American banks less competitive?” he answered with a bluster that was basically this: “What, like BNP Parabas?”

Yep.

Glass-Steagall is a good idea but it doesn’t go far enough.  The correct solution, as I have repeatedly pointed out, is One Dollar of Capital.

This is the only solution to both preventing banking panics and long-term economic stability.

One Dollar of Capital:

• Stops counterfeiting of the currency.  Without the ability to create unbridled credit money the commercial banks and Fed can no longer create pretend GDP, which instantly reflects into asset prices in a bubble, foisting the costs off on those who cannot take advantage of those asset price increases.  This is how your wealth and future have been systematically and intentionally looted over the last 30 years, and it’s one of the oldest games out there when it comes to banking.  President Jackson knew it, as did others before him; this scam job literally goes back to Hammurabi!  This old con must go away.
• Ends — without question — systemic risk.  Since there is no longer unbacked emission into the economy there is no longer any possibility of systemic risk.  A bank that wishes to loan more than the immediate liquidation value of an asset must attract actual capital from stockholders or bondholders to lend; it cannot create credit money unless it can show a perfected security interest against an asset that is worth more than the credit money created.
• Returns credit to its legitimate function in the economy — self-liquidating lubrication for trade.  A self-liquidating loan is not inflationary and has no longer-term impact on the economy.  It permits the use of credit for legitimate lubrication of commerce; trans-national trade, for example, relies on letters of credit to guarantee payment for goods in transit; the goods are the asset securing the paper.  Likewise, a loan for 80% of a house’s market value is secured by the house, and if marked to the market on a reasonable basis (e.g. every three months or so) it is safe as additional capital calls will certainly occur before the value goes negative.

One Dollar of Capital simply says that you cannot issue unbacked loans.  Period.  You can lend against an asset, but only to it’s immediate liquidation value in the marketplace.  That’s it.

Our current paradigm requires a roughly 6% excess asset valuation in banks.  We retain this standard.  Banks are then free to choose how close to that line they wish to dance; invasion of that 6% safety threshold results in immediate liquidation of the firm.  If they wish to lend at 94% of a house’s value they can, but any movement against them results in the position going underwater.  Most will choose to build in some sort of reasonable cushion — like 20% down — to prevent this.

All derivative positions must be individually reserved; nobody may depend on someone else’s promise to cover a transaction as a promise is not capital.  If I wish to be short a derivative that requires me to deliver a given instrument then at the instant that position goes into the money against me I must be able to clear the underlying trade and must possess the actual capital to do so.  If I can’t clear the trade at any instant in time then my firm is liquidated — period.

It’s not that difficult to understand folks.  Oh sure, the mavens of Wall Street have screamed bloody murder about any such proposal, claiming that this would “damage American competitiveness in financial services.”

My retort in 2008 was “If you wish to juggle jars of nitroglycerin I hope you don’t mind if I ask that you do it in your country rather than in ours.”

Now, four years on, we’re finally hearing similar sounds in the mainstream media.

The effect of this regulatory change would be to end derivative trading by any actual bank.  “Investment banks”, which take no deposits and are funded entirely by investor capital with no ability to write credit money into existence, can trade all they want.  Margin supervision is perfectly adequate here, as the risk lies entirely within that firm.  That’s fine.

As I wrote in Leverage (click on the book cover to the right to buy):

But One Dollar of Capital as presented above both goes further and shuts down all the schemes and risk-hiding that banks can engage in, making a bank an effective public utility, while retaining private ownership of the financial system. Whether a bank takes deposits under this standard becomes immaterial as deposit-based lending cannot happen on an unsecured basis.  Banks that wish to loan against a known asset value can do so but to lend unsecured they must acquire lent capital from the market via the sale of stock or bonds, and cannot use depositor funds for this purpose.

We must end the unbacked emission of credit money into the system.  That is where all of these problems come from — fake GDP, destruction of purchasing power, buying of votes and systemic instability.

It all begins and ends there and any Presidential, House or Senate officeholder or candidate who does not understand this is unfit to hold the office.

Those who do understand this and yet refuse to act are aiding and abetting economic terrorism and must be held to account.

When news broke of a 2 billion dollar trading loss by JP Morgan, much of the financial world was absolutely stunned.  But the truth is that this is just the beginning.  This is just a very small preview of what is going to happen when we see the collapse of the worldwide derivatives market.  When most Americans think of Wall Street, they think of a bunch of stuffy bankers trading stocks and bonds.  But over the past couple of decades it has evolved into much more than that.  Today, Wall Street is the biggest casino in the entire world.  When the “too big to fail” banks make good bets, they can make a lot of money.  When they make bad bets, they can lose a lot of money, and that is exactly what just happened to JP Morgan.  Their Chief Investment Office made a series of trades which turned out horribly, and it resulted in a loss of over 2 billion dollars over the past 40 days.  But 2 billion dollars is small potatoes compared to the vast size of the global derivatives market.  It has been estimated that the the notional value of all the derivatives in the world is somewhere between 600 trillion dollars and 1.5 quadrillion dollars.  Nobody really knows the real amount, but when this derivatives bubble finally bursts there is not going to be nearly enough money on the entire planet to fix things.

Sadly, a lot of mainstream news reports are not even using the word “derivatives” when they discuss what just happened at JP Morgan.  This morning I listened carefully as one reporter described the 2 billion dollar loss as simply a “bad bet”.

And perhaps that is easier for the American people to understand.  JP Morgan made a series of really bad bets and during a conference call last night CEO Jamie Dimon admitted that the strategy was “flawed, complex, poorly reviewed, poorly executed and poorly monitored”.

The funny thing is that JP Morgan is considered to be much more “risk averse” than most other major Wall Street financial institutions are.

So if this kind of stuff is happening at JP Morgan, then what in the world is going on at some of these other places?

That is a really good question.

For those interested in the technical details of the 2 billion dollar loss, an article posted on CNBC described exactly how this loss happened….

The failed hedge likely involved a bet on the flattening of a credit derivative curve, part of the CDX family of investment grade credit indices, said two sources with knowledge of the industry, but not directly involved in the matter. JPMorgan was then caught by sharp moves at the long end of the bet, they said. The CDX index gives traders exposure to credit risk across a range of assets, and gets its value from a basket of individual credit derivatives.

In essence, JP Morgan made a series of bets which turned out very, very badly.  This loss was so huge that it even caused members of Congress to take note.  The following is from a statement that U.S. Senator Carl Levin issued a few hours after this news first broke….

“The enormous loss JPMorgan announced today is just the latest evidence that what banks call ‘hedges’ are often risky bets that so-called ‘too big to fail’ banks have no business making.”

Unfortunately, the losses from this trade may not be over yet.  In fact, if things go very, very badly the losses could end up being much larger as a recent Zero Hedge article detailed….

Simple: because it knew with 100% certainty that if things turn out very, very badly, that the taxpayer, via the Fed, would come to its rescue. Luckily, things turned out only 80% bad. Although it is not over yet: if credit spreads soar, assuming at $200 million DV01, and a 100 bps move, JPM could suffer a $20 billion loss when all is said and done. But hey: at least “net” is not “gross” and we know, just know, that the SEC will get involved and make sure something like this never happens again.

And yes, the SEC has announced an “investigation” into this 2 billion dollar loss.  But we all know that the SEC is basically useless.  In recent years SEC employees have become known more for watching pornography in their Washington D.C. offices than for regulating Wall Street.

But what has become abundantly clear is that Wall Street is completely incapable of policing itself.  This point was underscored in a recent commentary by Henry Blodget of Business Insider….

Wall Street can’t be trusted to manage—or even correctly assess—its own risks.

This is in part because, time and again, Wall Street has demonstrated that it doesn’t even KNOW what risks it is taking.

In short, Wall Street bankers are just a bunch of kids playing with dynamite.

There are two reasons for this, neither of which boil down to “stupidity.”

• The first reason is that the gambling instruments the banks now use are mind-bogglingly complicated. Warren Buffett once described derivatives as “weapons of mass destruction.” And those weapons have gotten a lot more complex in the past few years.

• The second reason is that Wall Street’s incentive structure is fundamentally flawed: Bankers get all of the upside for winning bets, and someone else—the government or shareholders—covers the downside.

The second reason is particularly insidious. The worst thing that can happen to a trader who blows a huge bet and demolishes his firm—literally the worst thing—is that he will get fired. Then he will immediately go get a job at a hedge fund and make more than he was making before he blew up the firm.

We never learned one of the basic lessons that we should have learned from the financial crisis of 2008.

Wall Street bankers take huge risks because the risk/reward ratio is all messed up.

If the bankers make huge bets and they win, then they win big.

If the bankers make huge bets and they lose, then the federal government uses taxpayer money to clean up the mess.

Under those kind of conditions, why not bet the farm?

Sadly, most Americans do not even know what derivatives are.

Most Americans have no idea that we are rapidly approaching a horrific derivatives crisis that is going to make 2008 look like a Sunday picnic.

According to the Comptroller of the Currency, the “too big to fail” banks have exposure to derivatives that is absolutely mind blowing.  Just check out the following numbers from an official U.S. government report….

JPMorgan Chase – $70.1 Trillion

Citibank – $52.1 Trillion

Bank of America – $50.1 Trillion

Goldman Sachs – $44.2 Trillion

So a 2 billion dollar loss for JP Morgan is nothing compared to their total exposure of over 70 trillion dollars.

Overall, the 9 largest U.S. banks have a total of more than 200 trillion dollars of exposure to derivatives.  That is approximately 3 times the size of the entire global economy.

It is hard for the average person on the street to begin to comprehend how immense this derivatives bubble is.

So let’s not make too much out of this 2 billion dollar loss by JP Morgan.

This is just chicken feed.

This is just a preview of coming attractions.

Soon enough the real problems with derivatives will begin, and when that happens it will shake the entire global financial system to the core.

The Economic Collapse

So this morning comes and not only has there been no “progress” on Greece but opinions are hardening, as I expected.

“This is not finished: it is about Greece, but it is also about Spain, and Italy and maybe France,” said Jacques Porta, who helps manage 500 million euros ($657 million) at Ofi Patrimoine in Paris. “The whole thing seems very dangerous. You have to be cautious, and that translates as not being in equities but being in cash.”

No, really?  What have I been saying now for four years?  We’ve done exactly nothing to resolve the problems that underlie our banking system — excessive leverage.

What’s important is to understand why.

Here it’s quite simple.  It’s why politicians won’t talk about it, including Presidential candidates Romney and Johnson along with President Obama.

The credit money that these banks “created out of thin air”, if it is removed from the system (and removing the excessive leverage must inevitably mean removing that credit money) immediately reverses the monetary inflation that has powered higher prices in stocks, education, and (believe it or not, still) housing.  This credit money has been and is nothing other than legalized counterfeiting of the currency.

When, not if, this is forced to stop all that monetary inflation comes out of the system.  Prices collapse, especially for assets.  And the feral government’s addiction to deficit spending, which has falsely inflated GDP by more than 10% for the last four years, instantly ends, all at the same time.

Some of the politicians involved appear not to understand this — Gary Johnson being one of them.  But others, particularly Mitt Romney who has the chops in the investment world to grok this, most-certainly does understand.

But none of them will have this discussion with the American people, and yet we must, because this is part and parcel of rationalizing the size of government — and returning it to a size in which every dollar of spending that the government undertakes on behalf of the people is supported with a dollar of current tax revenue — and not borrowed funds.

We’re not doing it here and they (in Spain, Greece, France, etc) are not doing it “there.”

But we all must have this conversation, and we must do so now, as the wolf is literally at the door.  We’ve spent our resources on “mitigating” the dislocation in 2008 and do not have the resources to attempt to stop a second collapse — a collapse that is certain to come unless the policies that are making it mathematically inescapable are altered.

Until that conversation takes place and is brought front and center in the debate on policy and politics, replacing the puerile and stupid distractions such as “gay marriage”, the only “respect” that any of these candidates or office-holders deserve is an upturned middle finger.

The wise person with exposure to the markets considers and executes a plan that hedges his exposure with full and due consideration that the alleged “safety” of his or her funds at so-called “sound” banks and other financial institutions in fact may be nothing more than claims on counterfeited credit money that does not actually exist.

And so it begins (sorta) for some of their executives….

JPMorgan Chase & Co. (JPM) executives in the bank’s chief investment office will leave as early as this week after the firm suffered a $2 billion trading loss, according to a person familiar with the matter.

Ina Drew, who oversees the unit, is among three executives set to leave, the Wall Street Journal reported today, citing unidentified people familiar with the situation. Chief Executive Officer Jamie Dimon previously resisted accepting her resignation, said the person, who requested anonymity because the discussions were private. Drew didn’t immediately respond to a message seeking comment.

A better question is Dimon himself.  As CEO he is responsible for knowing what the bank is doing.  He obviously failed.

But the bigger question is why he’s on the board of the NY Fed, when they are the primary big bank regulator.

Why should there be any of the big bank officers also serve on the board of the entity that regulates them?  That’s outrageous and an effective block on any sort of actual regulatory oversight.

So…. when does Dimon get ejected — or does he?

I’m not alone in this, incidentally.  Elizabeth Warren has called for him to leave as well.  She’s right, but it shouldn’t be limited to Dimon.  Indeed, the very presence of a director class to “represent banks” is inherently bogus, since banks are the target upon which the NY Fed’s regulatory powers are aimed.

Necessary but insufficient Elizabeth…..