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!






FHA Lowers Mortgage Insurance Premiums (MIPs) By 31.25%

HUD Secretary (for the moment) Julian Castro just lowered the Mortgage Insurance Premiums (MIPs) across the board by 31.25%. The purpose? To lower lending costs, partially offseting the increase in mortgage rates.


The FHFA Home Prince is now officially above the peak of the home price index prior to The Great Recession. And serious delinquencies on FHA-insured loans is less than half of was at the peak (good news), but remains over twice as high as Freddie Mac’s (and Fannie Mae’s) serious delinquency rates).


It is strange to me that the FHA is still insuring 30 year fixed-rate mortgages for loans in excess of $625,000. Ordinarily, that should be the domain of private mortgage insurers (PMI). While FHA share has diminshed during the housing bubble, it expanded greatly during and after the financial crisis. While it has been generally shrinking since 2010, FHA share remains higher today than during 2002.


Here is current HUD Secretary Julian Castro saying “It was fun while it lasted!”



Obama’s Final Jobs Report: Still Worst Wage Recovery From A Recession Since 1965

The last jobs report (December) for the Obama Administration is out. And it was ugly as usual, at least in terms of wage growth.

Total nonfarm payroll employment rose by 156,000 in December, with an increase in health care and social assistance. Job growth totaled 2.2 million in 2016, less than the increase of 2.7 million in 2015.


Employment in health care rose by 43,000 in December, with most of the increase occurring in ambulatory health care services (+30,000) and hospitals (+11,000). Health care added an average of 35,000 jobs per month in 2016, roughly in line with the average monthly gain of 39,000 in 2015.


Yet wage growth remains terrible.

Average Hourly Earnings of Production and Nonsupervisory Employees YoY rose 2.5% in December. This is the first “recovery” since 1965 without at least one month above 3.0% YoY growth in hourly earnings growth.


And there are 95.1 million people NOT in the labor force, up 80.4 million when Obama first took office.


And Federal Reserve Chair Janet Yellen has another year as Chair! So cum on and feel the noize … of low wage growth and skyrocketing asset prices like housing.


“Hoddy Yellen” photo courtesy of Jesse from Jesse’s Cafe Americain.




Mortgage Refis Near Obama-Lows As Mortgage Rates Continue To Rise

Its that time of year (turn of the year) when mortgage applications hit the lowest level of the year.  But the last report of mortgage refinancings from the Mortgage Bankers Association (MBA) just hit the third lowest level during the Obama era.


We are experiencing the secon largest surge in mortgage rate during the Obama era, after the May 2013 anxiety attack about Bernanke’s curtailing monetary expansion.

But we finally have Yellen and The Fed slowing the monetary expansion (if you call raising The Fed Funds Target rate twice during the Obama era slowing). And whether we use the SF Fed’s Rudebusch calibration of the Taylor Rule or a similar rule, the Fed Funds Target rate is at its biggest gap between where the Fed Funds rate is and where the Taylor Rule says it should be (see spread chart below in green and red).


The Fed continues to keep its massive foot on the monetary gas pedal, despite  softening conditions in the housing market (as measured by concessions by floorplan). The red dots like in Zuckerburg (San Francisco) and Los Angeles are greater than or equal to two months of concessions (“free” rent).


I was asked by a TV show to appear today to discuss what President-elect Trump is going to do with mortgage giants (in conservatorship) Fannie Mae and Freddie Mac. I declined.  First, even if they turn Fannie and Freddie lose in the wild again, there are still the Federal Home Loan Banks, the FHA, the Department of Agriculture, Farmer Mac, etc. all involved in the mortgage market. And no discussion of what to do with those entities. Second, there is nothing of substance being released from the Trump camp on what his plans are concerning Fannie and Freddie.

Let’s see where the New Year takes us.


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.