Ponzi Finance Dynamics Still at Play:
Second quarter GDP expanded at a 3.3% pace, the strongest since Q3 2007’s 4.8%. Durable Goods Orders, Existing Home Sales, and the Chicago Purchasing Managers' index were all reported “stronger-than-expected”. And with commodity prices almost 20% off July highs – and crude oil notably unimpressive this week in the face of a major Gulf hurricane – the markets seem to lend support to the waning inflation viewpoint. The dollar rallied further this week. Meanwhile, despite today’s downdraft, Freddie Mac gained 60% this week and Fannie Mae advanced 37%. Monoline insures MBIA and Ambac surged 59% and 35%, respectively. MBIA saw its stock price more than double during August, to surpass $16. The Bank index jumped 3.1% this week and the Broker/Dealers rallied 4.0%. Homebuilding stocks were up 9%.
Investors are increasingly willing to accept that the worst of the Credit crisis has passed. Talk that the nation’s housing markets are bottoming becomes louder each week. And every day market participants seem more receptive to the “economic resiliency” thesis.
First of all, I am certainly of the view that the economy is much weaker than the headline 3.3% growth rate. At the minimum, I am skeptical that the 1.2% annualized increase in the GDP price index accurately captures what I believe is a significant inflationary component in current “output”. It is worth noting that the favored inflation gauge of Greenspan and the Fed, the PCE Deflator, was up 4.5% from a year earlier, the strongest year-over-year increase since 1991.
There is bountiful wishful thinking when it comes to our nation’s mortgage and housing crises. Granted, many of the burst Bubble markets – including some spectacular busts throughout California, Florida, Nevada, and Arizona – have in some cases seemingly reached somewhat of a “clearing price”. Transaction volumes are up significantly in many of the locations with the greatest y-o-y price declines. I’ll suggest, however, that it is unwise to extrapolate trading dynamics in these burst markets to national housing trends more generally. I believe the vast majority of markets around the country are more aptly described as Bubbles leaking air, as opposed to the collapsed markets that garner the greatest media attention.
I’ll turn more constructive on home prices and housing markets generally when mortgage Credit Availability begins to loosen. It remains my view that Credit continues in a tightening dynamic. Notably, the growth in Fannie and Freddie’s Combined Books of Business slowed sharply to a 3.7% rate during July, the slowest pace in two years. And while there is nothing really in the works to compare to the abrupt Credit tightening that emanated from collapsing subprime and Alt-A securitization markets, I’ll argue today’s tighter Credit is a more subtle dynamic resulting from various types of lending institutions restricting, on the margin, loans to even prime Credits.
From the Wall Street firms down to the small community banks, tighter lending terms are leading to higher downpayments and less flexible payment terms for even high quality borrowers. And while the nature of this dynamic specifically does not lead to collapses for the relatively stable housing markets around the country, it nonetheless will definitely continue to pressure prices. And downward home prices will, over time, lead to only more lender nervousness and restraint.
And despite the lull, vulnerable housing markets remain acutely susceptible to any worsening in the GSE crisis. With MBS spreads having tightened somewhat during August, I’ll assume Fannie and Freddie resumed aggressive mortgage purchases in the marketplace after somewhat slowing their buying during July. Importantly, overall marketplace liquidity has deteriorated to the point where the GSEs must expand aggressively in order to forestall another major leg down in the ongoing housing crisis. As such, the marketplace of late is involved in a dangerous game of “chicken” with both the GSEs and Treasury. These days, any time the GSEs slow their marketplace buying of mortgage paper (back away from their “backstop bid”), spreads widen sharply and fears of a liquidity crisis – and forced Treasury bailout – intensify. So, I’ll assume the GSEs have resorted again to ballooning their exposure aggressively - recklessly.
There has been a lot of talk about the GSEs being “privatized.” As the thinking goes, Fannie and Freddie should be temporarily “nationalized,” recapitalized, split up and then released as responsible participants in the free marketplace – Credit providers no longer posing a risk to the American taxpayer. This all sounds wonderful in theory – yet is completely impractical in reality. I fully expect the GSEs to be nationalized. But I suspect the federal government will be running – and recapitalizing - these institutions for many years to come.
The private mortgage marketplace self-destructed, and now the entire “prime” mortgage/housing market is dependent upon ongoing cheap mortgage finance available only through American taxpayer backing and subsidies. The private sector simply cannot today – or at any time in the foreseeable future - provide the hundreds of billions of cheap ongoing new mortgage Credit necessary to forestall a systemic housing/economic/financial collapse. There will be no happy “recapitalize and privatize” ending to this saga. The bill to the taxpayer is now growing rapidly – along with GSE exposure – and will balloon into the trillions over the coming years and decades. And for how long the holders of GSE debt and MBS will be allowed such handsome returns at taxpayer expense is a quite intriguing question.
I also read and hear too much about the continued need for “Keynesian” stimulus. Regrettably, the system has been in non-stop government (fiscal and monetary) stimulus mode for years now. It may have been indirect at the time, but it is now apparent that GSE obligations should be included today right along with debt owed directly by the Treasury. And before all is said and done, the taxpayer will also be on the hook for enormous losses from various federal guarantees of deposits, student loans, pensions, and the like. The bottom line is that a whole range of direct and indirect federal guarantees – especially since the 2001/02 recession – have played an integral role in spurring Credit and Economic Bubbles. “Keynesian” ammunition - fired way too early and freely in order to sustain multiple Bubbles – has definitely buoyed the U.S. Bubble Economy, although such measures will have only limited effect down the road when they’re sorely needed.
Returning back to my initial paragraph, these days the economy and markets don’t appear all that bad - certainly nothing as nasty as we dour prognosticators have been forecasting. I’ll warn, however, that there are some very dangerous “Ponzi Finance” Dynamics Still very much At Play. The most obvious resides with the GSEs. And there are closely related Bubbles throughout the agency and Treasury bond arena. Meanwhile, a view has gained adherents that the U.S. economy is actually in much better shape than Europe and elsewhere. The reality that Europe is not buoyed by their own government-sponsored mortgage behemoths and that their economies are more manufacturing based (and thus vulnerable to cyclical downturns) are only short-term relative disadvantages.
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