Whack-a-mole! The Case For Covered Bonds And Why It Is Difficult in the USA

My friend John Wake from Phoenix Arizona asked me about mortgage finance legend Jack Guttentag’s stance on covered bonds. I must say that I am a proponent of covered bonds for the US mortgage market.

What is a covered bond? A covered bond is a debt security backed by cash flows from mortgages or public sector loans. They are similar in ways to asset-backed securities created in securitization, but covered bond assets remain on the issuer’s consolidated balance sheet.  A covered bond continues as an obligation of the issuer (usually a bank).


This is in stark contrast to the experience of the housing bubble where non-bank lenders originated loans, sold them to investment banks who then issued asset-back securities. The non-bank lenders, in this case, kept little or none of the loans on their balance sheets.


Guttentag (whose blog I highly recommend) advocates for a Danish type of covered bond market. In a perfect world, I agree.

But the US mortgage market is anything but a perfect world (or market). It is dominated by The Federal government in the form of mortgage giants Fannie Mae and Freddie Mac and the Federal Housing Administration (FHA).  But lest we forget, there is also the Department of Agriculture and the Federal Home Loan Bank system playing in this market. Not to mention a myriad of regulators (The Fed, Office of the Comproller of the Currency, FDIC, Consumer Financial Protection Bureau, etc).

Like in the game “Whack-a-mole,” you can get rid of, for example, Fannie Mae and Freddie Mac, but you still have the FHA, the Federal Home Loan Banks, the Department of Agriculture remaining. Each provides taxpayer-subsidized financing and have low cost of financing.

How can a superior model like covered bonds compete with the Federal government leviathan of subsidized mortgage financing? At Professor Guttentag suggests, it will take time.

But the tangled web of bank and mortgage regulators makes it even more difficult. Hopefully, stripping the Consumer Financial Protection Bureau of some of their regulatory bite will help.  But there has to be a “meeting of the minds” between the numerous regulatory bodies to make covered bonds work.

Yes, the US mortgage market remains like a “Whack-a-mole” game. You knock down one Federal entity (and taxpayer subsidy) and another one jumps out. Not to mention regulators.



Pension Party! “Zero” Interest Rate Policies Lead To Massive Debt Gorging (CalPERS Massive Pension Underfunding)

The Federal Reserve’s zero interest rate policies (ZIRP) have an unwelcomed effect: both the Federal Government and Private Pensions gorged themselves on low-cost debt.

The Federal Reserve lowered their Fed Funds target rate starting in 2007, then started their asset purchases in late 2008, culminating in a dramatic decline in interest rates.


Then, since the end of Q4 2008, both the Federal government AND private pension funds gorged on debt: Federal devt rose by 77% though the end of 2015 and private pension debt rose by 66%.


Then we have the STATE pension funds where unfunded liabilities will hit $1.75 trillion. Weak investment performance and insufficient contributions will cause total unfunded liabilities for U.S. state public pensions to balloon by 40 percent to $1.75 trillion through fiscal 2017.


Of course, California and their CalPERS are in league of their own. California Governor Jerry Brown is eyeing a 42% increase in the gasoline tax to help bail out the woefully underfunded CalPERS system. Not to mention a 141% increase in vehicle registration fees.

What happens when interest rates RISE and pensions have to refinance their debt at higher rates (just like the Federal government?).

To quote Craig from Parks and Recreation, “What’s wrong with you? You look like Meryl Streep at the end of Iron Weed.”


I fear that CalPERS and the other state, Federal and private pension funds will look far worse.

On a side note, did you ever notice that Hillary Clinton’s outfit resembled the Gorgan from the Star Trek episode “And The Children Shall Lead”?




Is The Fed REALLY Tightening? The Monetary Shell Game (Hint: M1 Money Growing at 8-10% YoY)

The Federal Reservc Open Market Committee (FOMC) has “tightened” the Fed Funds Target rate twice since December 2015. One in December 2015 and once in December 2016.


Well, 75 basis points is hardly “tight.” But what about The Fed’s asset purchases? The Fed ended their third round of asset purchases in October 2014.  While QE expansion has stoppped (for the moment), The Fed’s balance sheet is being reduced very slowly. Hardly monetary tightening, but not loosening either.


But if we look at a third measure of monetary easing, M1 money supply, it is growing at a rapid rate.


M1 money is growing at around 8-10% YoY. M1 includes funds that are readily accessible for spending. M1 consists of: (1) currency outside the U.S. Treasury, Federal Reserve Banks, and the vaults of depository institutions; (2) traveler’s checks of nonbank issuers; (3) demand deposits; and (4) other checkable deposits (OCDs), which consist primarily of negotiable order of withdrawal (NOW) accounts at depository institutions and credit union share draft accounts. Seasonally adjusted M1 is calculated by summing currency, traveler’s checks, demand deposits, and OCDs, each seasonally adjusted separately.


So while The Fed Funds Target rate is slowly risening and Fed asset purchases have curtailed, M1 Money Stock continues to grow at an unpredented rate YoY since the end of The Great Recession in June 2009.


The M1 Money Multiplier remains below 1 thanks to The Fed’s easing efforts. An M1 Money Multiplier of less than 1 means that every dollar created by the FED (an increase in the monetary base M0) will result in a <1 dollar increase of the money supply (M1). So, the credit and deposit creation of commercial banks is limited in this case. The banks are still holding on to a lot of excess reserves.

At least Excess Reserves of Depository Institutions has been falling since August 2014.


It is a shame that while M1 money grows at 8-10% YoY, average hourly earnings for 84% of the population are growing at only 2.5% YoY.


So while The Fed signals monetary “tightening,” check the third cup to find the EXPANSION pea!






Banca Monte dei Paschi di Siena Trading SUSPENDED

Trading in Italian bank Banca Monte dei Paschi di Siena has been suspened.

[Bloomberg] Italian Finance Minister Pier Carlo Padoan criticized the European Central Bank for not being clear enough in its request for Banca Monte dei Paschi di Siena SpA to boost its capital by almost twice the amount the lender failed to raise on the market.

“It would have been useful to receive additional information from the ECB Supervisory Board on the criteria used for such a valuation, since it has consequences for the other banks,” Padoan said in an interview with financial daily Il Sole 24 Ore published on Thursday.

“In addition to a letter of five lines and three numbers, some explanation would have been useful; opaque moves without an explanation lead people to think that there’s something wrong,” the minister said.

Padoan’s comments were confirmed by his press office. An ECB spokeswoman declined to comment on the minister’s remarks, when contacted by Bloomberg News.

Implementing measures to aid banks, including Paschi, passed by the Italian cabinet last week “will be long and complicated,” Prime Minister Paolo Gentiloni said at a year-end news conference in Rome Thursday. Talks with European Union’s supervisors will “hopefully be marked by productive and effective dialogue,” Gentiloni added, saying that, should not that be the case, there is a risk of tensions and difficulties.

The central bank’s demand to Monte Paschi doesn’t call into question the “capability and relevance” of the decree passed by the Italian cabinet, the premier also said.

The 8.8 billion-euro ($9.2 billion) capital increase requested by the ECB was based on the results of a 2016 stress test, Monte Paschi said in a statement on Monday, citing two letters from the central bank. The troubled lender also said it’s seeking additional information on the calculations. While the ECB saw worsening liquidity for the bank between Nov. 30 and Dec. 21, the ECB still considers it to be solvent.

Gentiloni’s cabinet agreed last week to plow as much as 20 billion euros into Monte Paschi and other banks after the lender failed in its plan to raise about 5 billion euros from the market.


Paschis, jump on it. 


Stagnation: M2 Money Velocity Continues Falling To All-time Lows!

M2 Money Velocity is the frequency at which one unit of currency is used to purchase domestically- produced goods and services within a given time period. It is measured by looking at the change in nominal GDP compared to the change in M2 money stock.

M2 velocity keeps falling after peaking in 1997.  What is notable after the 1997 peak is that asset bubbles have replaced solid economic growth. For example, the highest GDP growth during the Clinton years exceeded 5% YoY, while the highest GDP achieved under George W Bush was 4.41% YoY. Real GDP YoY never exceeded 3.5% YoY under Obama.


In the following chart, you can see the decline in M2 Money Velocity with the infamous Dot.com bubble burst and then the decline in M2 Money Velocity with the dreaded housing bubble burst. Given the tepid GDP growth that followed the housing bubble burst (and the dramatic increased in M2 Money stock), it is not surprising that M2 Money Velocity keeps falling.


As you can see, each exploding asset bubble is met with a recession and a massive surge (over 10% YoY) in M2 Money stock. The difference in the Obama years was a non-recessionary surge of 10% YoY in M2 Money stock without a recession.


Measures such a M2 Money Velocity become more and more useless as money printing becomes more prevalent (along with the failure of GDP to grow at previous levels). In fact, since the massive Federal Reserve intervention during The Great Recession,

The good news? The M1 Money Multiplier is almost back to 1.0!


In place of healthy GDP growth, the US has replaced it with asset bubbles that invariably burst creating even more problems.

Here is a GIF of The Federal Reserve trying to stimulate more GDP growth.


Cyclone! The Fed/Obama Labor Recovery In 5 Charts (And They Are Ugly!)

Both outgoing President Obama and lingering Federal Reserve Chair Janet Yellen are making claims about the number of jobs added under their leadership.

Yellen: “Job market strong, signs of wage growth.” And the “strongest job market in nearly a decade.”

Obama (during his farewell press conference last Friday): “Since I signed Obamacare into law, our businesses have added more than 15 million new jobs,”

Sounds impressive, unless you look closely at the numbers.

First, about the 15 million new jobs added since Obama signed Obamacare into law. The black box in the chart below shows the real average hourly wages since 2010 (through 2014). They were declining.


And, of course, my least favorite labor market chart: Average hourly earnings of production and nonsupervisory employees YoY (about 82% of the US population). The WORST wage recovery from a recession since President Lyndon B. Johnson.


Meanwhile, productivity growth has fallen to its lowest level since the Jimmy Carter malaise era.


In fairness to Obama and the Federal government, they did expand Medicaid, Welfare and food stamps (Snap) by 46% since Obama became President. Unemployment insurance and Social Security increased by 26% since December 2008. Partially to compensate for their poor track record for high paying job creation.


Wage growth is the worst since 1965 for most Americans. How is this the strongest job market in nearly a decade? Particularly when U-6 underemployment is still higher post recession that the previous two recessions?


So, it is literally a cyclone of bad news for the majority of American workers. None of whom will be attending the World Economic Forum in Davos Switzerland in January.


At least World Economic Forum attendees will be able to grab some swag in Davos!






Whip It! U.S. Mortgage Rates Jump to More Than 2-Year High (4.30%) After Fed Hike

The 30-year mortgage rate jumped to 4.30% shortly after Janet Yellen and The Fed raised interest rates on December 14.

(Bloomberg) – Prashant Gopal – U.S. mortgage rates rose, with the 30-year reaching the highest level since April 2014, after the Federal Reserve increased its benchmark lending rate.

The average rate for a 30-year fixed mortgage was 4.3 percent, up from 4.16 percent last week, Freddie Mac said in a statement Thursday. The average 15-year rate climbed to 3.52 percent, the highest since January 2014, from 3.37 percent, the McLean, Virginia-based mortgage-finance company said.

Federal Reserve policy makers last week rose interest rates for the first time this year and projected more increases for 2017 as the economy strengthens. Mortgage rates have shot up since early November, tracking a jump in Treasury yields …

Of course, the 10 year Treasury yield and the 30 year fixed-rate mortgage started to rise shortly after the general election where Donald Trump was elected President.


There was a negative reaction to the rate increase, but then again it is the end of the year when mortgage applications generally decline. So, all things considered, mortgage purchase and refinancing applications have fared pretty well despite the rate increases.


Now housing is less affordable.


Whip it good, Janet!


Devo  Janet courtesy of Jesse at Jesse’s Cafe Americain.