Re-pricing 2014

Age of Wisdom, Age of Foolishness (7)

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Continuing the theme in Age of Wisdom, Age of Foolishness, of playing with dates, the year 2014 comes into focus. As 2013 closes out, forecasters have begun to make projections about the economic environment next year.

The Bank for International Settlements (BIS) is as gloomy as ever. Warning on the bubble threat developing in capital markets, the specific risk from “payment in kind” bonds was emphasized. The “reach for yield”, now sees investors willing to buy bonds which actually pay interest with more bonds in the event that the bubble bursts[i]. The BIS also warned that the global economy has become totally reliant on QE; and that the risks to central banks (and the global financial system by default) from continued QE are greater than the economic benefits[ii]. From the BIS perspective, the global financial system has already passed the tipping point at which QE has become a negative driver.

The American distressed housing environment is deteriorating, even as it ostensibly improves. RealtyTrac opined the improvement, reporting that distressed housing is now in the “Ninth Inning[iii]. Morningstar reported that, whilst distressed inventory is declining, the time estimated to clear these distressed homes from the market is rising[iv]. It is now up five months from the second quarter of this year and 11 months from September 2012. It will now take 49 months to work through the private-label Residential Mortgage Backed Security (RMBS) sector’s distressed inventory “given current market dynamics,” Morningstar forecasts.

The Fed’s previously known as “Flow of Funds” report showed that household net worth increased through Q3 to $1.92 Trillion[v]. Mortgage Debt also increased for the first time since 2008[vi]. In a cruel irony, US households began to evince economic optimism just as their Congressional leaders moved to repay this vote of confidence with the “Shutdown”; and the Fed moved to repay them with “Taper Talk”. The US consumer is running into a Washington brick wall.

“Goldilocks and the Three Bear Markets” July 9th 2013Click to enlarge

What was identified as the “Third Bear” tipping point, in “Goldilocks and the Three Bear Markets”[vii], is therefore now being tested.

“Third Bear” defeated by QE?Click to enlarge

Thus far QE has overcome the “Third Bear”; however it has not overcome the “Bear” on “Main Street”. 2014 looks like it will be the year in which the great debate about helping “Wall Street” or “Main Street” is played out. As was opined in the Age of Wisdom, Age of Foolishness series to date, the Fed has been helping “Wall Street” to such a degree that it has now directly correlated its own survival with the financial fortunes on “Wall Street”. The only way that we can see the Fed satisfying both “Streets” is through the permanent creation of money in addition to a rise in interest rates. The Banks have already initiated this process by raising the rate of interest that the Fed will pay them, for expanding its balance sheet further, to create the asset collateral on which a permanent increase in the money supply will be based. The Congress has effectively prevented US Treasuries from being used as the collateral to be monetised permanently because of the “Sequester”. It is therefore the Banks who will provide this collateral. The Fed will buy this collateral from the banks; and finance this purchase with Reserves from the banks. Since this collateral is more risky than US Treasuries, the banks will then charge the Fed a higher rate of interest on this collateral. The Fed will get charged one fee for buying riskier collateral; and also and extra fee for expanding the volume of risky collateral purchased. The theory currently in fashion (and recently promoted by Alan Blinder[viii]) that the Fed will reduce the Interest Paid on Excess Reserves (IOER), to boost lending, is therefore a total nonsense. The Banks are in control of the credit creation process because they are providing the collateral for monetization. The words of Jamie Dimon were therefore far more important than what Blinder said. Dimon opined that the Banks will be “re-pricing” credit (the inference is higher) going forward[ix]. Dimon chose his timing carefully, to coincide with the announcement that the Volcker Rule (II) would be coming into effect to place greater restrictions on the proprietary trading activities of the Banks. Volcker (II) and Basel (III) raise the cost of doing business for the Banks. The Banks will therefore be charging their customers more. The Banks will also be carrying less inventory; because it is now more costly in terms of capital requirements and also because Volcker (II) precludes them from doing so. Basel (III) and Volcker (II) therefore create a serious headwind, blowing against the creation of affordable credit. The Fed has anticipated this headwind by expanding its balance sheet. The supply of Treasury Bonds to expand this balance sheet has dried up thanks to the “Sequester”. The Fed must therefore respond by buying Asset Backed Securities (ABS). These ABS are now being “re-priced” at higher rates of interest by the Banks. The Banks will also charge the Fed a higher rate of interest to finance this collateral through the Federal Reserve System. Mr Blinder’s notion of the Fed reducing the IOER to stimulate private sector credit creation does not work in reality. The Banks are actually charging more for expanding private sector credit.

Evidence of this credit “re-pricing” was very evident last week. The GSE’s reported that they will be raising “G-Fees” going forward[x]. The November Mortgage Credit Availability Index (MCAI) reported by the Mortgage Bankers’ Association (MBA) signalled credit tightening in November[xi]. Fannie Mae reported its book of business may have grown in October but was still down year on year[xii]. Freddie Mac reported that its book shrank at the fastest rate in October[xiii]. Fannie Mae’s November National Housing Survey clearly showed the “re-pricing” behaviour of consumer expectations[xiv]. This survey took into account the impact of the “Shutdown” and the “Taper Talk”.

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Having digested the “Shutdown” and the “Taper Talk”, consumers took the balanced view that the economy was back on an improving track. The “Taper” was rationalised as being justified because of the economic improvement. It seems more likely that consumers explained away the “Taper” in positive economic terms.

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The “Taper” and the rising interest rate trajectory are now seen as being negative for house prices going forward.

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Deteriorating house price fundamentals make sellers more motivated than buyers.

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Rents are expected to remain the same; which explains the observation by DataQuick that investors are now driving the housing market[xv]. The Fannie Mae Survey explains clearly why the “wise” Banks are rushing to foreclose and pass the risk onto “foolish” private investors.

Fannie Mae’s festive offering provided the clearest insight into 2014. Fannie Mae has offered a moratorium on foreclosure actions over the holiday season; the process will however remain in operation. Families will therefore enjoy Christmas Day at home followed by eviction in January 2014. The “wisdom” and “foolishness” in Congress was also very much in evidence. Terminal Velocity (27) “Held Hostage by a Fortune” explained how President Obama had seized the moral high ground and captured the Republican Party during the “Shutdown”[xvi]. Mindful of their loss of political capital and with an eye on 2016, the Republicans meekly conceded to a budget agreement which maintains the status quo. The “Sequester” remains in place, so the budget deficit continues to improve. The reduced supply of US Treasury Bonds will then deliver the Fed into the hands of the Banks in search of collateral to permanently monetise. US Treasury Bond yields will remain capped because supply is constrained by the “Sequester”; private credit interest rates will however rise as the Banks “re-price” the cost of credit post Volcker (II) and Basel (III). Ultimately therefore, Congress, the Fed and the economy remain held hostage by “Wall Street”.


  1. BIS Sounds Alarm Over Record Sales of Payment-in-Kind Junk Bonds
  2. BIS Borio: Costs Of Ultra Loose MonPol Are On The Rise – Press
  3. Markets approach normalcy as foreclosure crisis enters ninth inning 2013-12-11
  4. Distressed Inventory Declines Eestimated Time to Clear Rises 2013-12-05
  5. U.S. Household Worth Rose by $1.92 Trillion in Third Quarter
  6. Fed’s Q3 Flow of Funds: Household Mortgage Debt increased slightly, First Mortgage Debt increase since Q1 2008
  7. Terminal Velocity (14) – “Goldilocks Economy and the Three Bear Markets”
  8. The Fed Plan to Revive High-Powered Money
  9. JPMorgan’s Dimon Says Banks to Reprice Products
  10. Fannie Mae Mortgage-Guarantee Fees Increased by U.S. Overseer
  11. Mortgage Credit Availability Tightens as Higher LTV Options Expire
  12. Fannie Mae Reports on October’s Book of Business
  13. Freddie Mac’s Mortgage Portfolio Shrinks at Fastest Rate This Year
  14. Home Price Expectations Continue to Decline
  15. Despite Rising Prices, Investors Expected to Remain Most Active Buyers
  16. Terminal Velocity (27) “Held Hostage By a Fortune”

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