Contrary Investor (*) ran with the idea that structured finance is now behind a lot of these market distortions, and thin credit spreads. If so, it's basically another in a series of leveraged casino-like bets. The trade to develop here is some kind of credit spread trade, rather than just a long treasury or ED trade. Rates going lower is still problematic, the real story will be Treasuries outperforming junk. So I think the trade might be a long T-bill trade (but T-Bills don't even have a futures market), short some kind of junk or non-investment grade (again no futures market here either). You have to be careful of Eurodollars because those are nothing more than USD deposits stuffed into banks throughout the world. If the banks start upchucking then ED will have credit risk too.
In terms of this credit quality issue here is what I have experienced:
1. I sent in my paperwork for Treasury Direct three weeks ago. I called Monday, and they said my account number was mailed out last Friday. To date, I have received nothing. This tells me the Treasury is either not competent in running this program, or would rather spend it's time engaging in TIO scams.
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2. My commodity broker said T-bill futures don't trade. When I broached the idea of a credit spread trade, he (actually have talked with three guys), was clueless about what I was talking about. Is this a sign? No wonder the Vix is 10, people aren't even paying any attention to this trade.
3. Meanwhile people all over America just leave deposits sitting in what are likely to be seriously vulnerable banks. What a sigma set up this is.
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4. Even alert and savvy types like me, can't really buy T-bills easily, or develop credit spread trades. What's going on here, institutional walls? Easy to find vehicles to throw money into fund ABS ratholes, hard to buy a T-bill.
(*)
It's the asset backed securities market that was responsible for the bulk of home mortgage financing for the year ended 3Q 2004. It wasn't the banks. It wasn't the S&L's. And it wasn't even the GSE balance sheets proper, it was the conduit ABS market that was generating the bulk of the liquidity. Furthermore, there is absolutely no question in our minds that the Fed is fully aware of these dynamics. They are fully aware of the circumstances surrounding the turbocharged change in residential real estate mortgage liquidity. Why? Because this is their data. It comes directly from the Fed Flow of Funds report. And, as you already know, the fact that conduit markets such as the ABS market are primarily responsible for this type of credit creation is one of the primary reasons the derivatives complex in this country continues to grow at accelerated rates over the last few years. Twenty years ago, the ABS markets didn't even exist. Ten years ago, the ABS market was a rounding error in the greater scheme of systemic credit and liquidity creation. In 2004? Well, the ABS issuers simply took center stage when it comes to the US residential real estate market, now didn't they? We're clearly at the point in the greater credit cycle where credit examiners (banks, etc.) are now an afterthought. Purveyors and participants in modern era "structured finance", along with their hedge fund brethren, are now calling the shots. In many senses the structured finance crowd must be thinking to themselves, "Hey Al, move over, you're yesterday's news, brother. Get out of our way, we'll show you how it's done. We got yer Maestro riiiiight heeere."
Take A Load Off Fannie, And You Put The Load Right On Me...As you know, the news regarding Fannie seems to get a little worse with each passing day. $9 billion in unreported losses related to derivatives. Another $2.8 billion in further capital problems last week. Have we heard the end of the story? Don't count on it. Even Greenspan got into the act recently when he suggested legislatively capping the ability of Fannie and Freddie to expand their balance sheets. That's all well and good, but the Fannie and Freddie's of this world do not just trade for their own account, so to speak. They also act as essentially off balance guarantors. Yes, Fannie and Freddie do buy mortgages to hold as investments. That was their raison d'etre when they were originally set up. But, much like an MBIA or Ambac who "insure" muni bond issues, Fannie and Freddie also act as guarantors in mortgage pools that are created but not actually held on the balance sheet of either FNM or FRE, in whole or in part. No problem as long as there are no losses. In traditional days of mortgage lending when buyers actually had to come up with real down payments, the pools could look to companies like PMI (the private mortgage insurers) to make good on the first 20% of a potential loan default anyway. What a sweet deal. Like MBIA and Ambac, acting simply as a mortgage pool guarantor is almost like coining money.
So as we look ahead, although Fannie and Freddie may indeed be restricted from mushrooming their own balance sheets by buying up mortgage paper as they did over the past decade, there's nothing to stop them from "guaranteeing" mortgage pools as we move ahead. Nothing. And whether FNM and FRE are actually buying physical paper or simply guaranteeing paper, do you really think financial market participants are not assigning the ultimate implicit guarantee ticket to the US government? Don't fool yourself, that's exactly what's happening.
Again, we are absolutely convinced that the Fed is fully aware of this situation. They are implicitly sanctioning it. Again, without belaboring the point, it's the reason we remain convinced that the US credit cycle is the key to what lies ahead. And that credit cycle includes the very significant influence of the mortgage and ABS issuer "paper pools", as well as the derivatives complex so necessary to the perceptual hedging of risk inside these massive pools of capital. The future will not be found strictly in business cycle dynamics alone because the business cycle is being driven by the greater credit cycle.
The Financiers...So on we go for now in terms of residential housing and the foundation of credit and liquidity creation that surrounds it, right? Although the ABS issuers were clearly leading the mortgage creation and lending bandwagon in 2004, we believe it's worthwhile to keep an eye on a number of other components of the mortgage finance foundation. Fidelity runs a fund called the Home Finance Select Fund. It includes the Fannies and Freddies, as well as a good number of smaller banks, title companies, private mortgage lenders, etc. It's a broad smattering of the mortgage finance foundation, if you will. Much like many a homebuilder stock, it's been on a tear since early 2000. The trend line (drawn in green) is clear. Keep an eye on the 50 week moving average here. It has contained the fund price like clockwork since the latest equity rally began almost two years ago. |
