The Big Short In One Chart! The Case of Phoenix AZ (The Fed’s And Federal Government’s Forgotten Role In The Mortgage Crisis)

I don’t mean to be a Debbie Downer, but it is important to understand what happened to the US economy and housing market in the US back in 2000s that culminated in such destruction to American households.

The book/movie “The Big Short” laid the blame on subprime adjustable-rate mortgages (ARMs) which is partially true. It also blamed Collateralized Debt Obligations (CDOs). But “The Big Short” ignored the Federal government and Federal Reserve’s role in the financial disaster.

It all started in 1995 under President Bill Clinton when HUD issued its now infamous National Homeowership Strategy  in order to increase homeownership rates, particularly among minorities. The NHS included Action 44: Flexible Mortgage Underwriting Criteria. Flexible? Like ALT-A (no or limited documentation) loans? Yes, the mortgage product that had less that 5% serious delinquencies (60+ days) as of late 2007, but exploded after 2007.

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Using Phoenix AZ was an example, notice that Phoenix’s home price index soared post-1995 as mortgage underwriting became looser coupled with The Fed lowering its target rate as a result of the 2001 recession. But The Fed overdid it, resulting in a massive house price bubble that exploded. The Fed then lowered their target rate to near zero percent but the damage had been done.

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At the national level, adjustable-rate mortgages (ARMs) were higher than post crisis.

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As housing construction collapsed, unemployment skyrocketed as did subprime mortgage delinquencies.

Phoenix was rocked by unemployment in the wake (not John Wake) of the construction boom and collapse. Pre-foreclosure filing rose with the unemployment rate, then subsided.

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So, The Big Short failed to mention the role of the Federal government and The Federal Reserve in the crisis, a dance that was a fantasy with a bad ending.

That is, The Fed and the Federal government were hoping for Heineken but got Pabst Blue Ribbon instead.

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US Average Hourly Earnings (3 Mo Avg) Highest Since President GWBush, Home Price Growth Lowest Since 2012 (Housing Bubble Redux?)

Unlike the housing bubble and “The Big Short” years of 2005-2007, when home price growth was greater than average hourly earnings growth, we are now in the opposite situation: slowing 2% YoY home price growth and the highest average hourly earnings growth rate since 2008 and President George W. Bush.

Home price growth is slowing …

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As average hourly earnings growth rises to its highest level since 2008 and George “Dubya” Bush.

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Using a different home price growth index (FHFA Purchase Only) and an average hourly earnings for the majority of Americans, you can see where home price growth exceeds average hourly earnings growth starting in 1998 and ending in 2006 (the “Big Short” bubble) and the QE3-induced home price bubble starting in 2012 to today.

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Between HUD’s National Homeownership Strategy of 1995 and The Fed’s quantitative easing (particularly QE3). the US Federal government is doing the “housing bubble dance.”

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Perry Omo? Fed Will Likely Restart QE In November (SOFR, Repo Rates Stabilize To Near Normal)

Is Fed Chair Jerome Powell really Perry Como? Or Perry OMO?

To the disappointment of many, Powell did not lower the target rate by 50 points and did not announce a resumption of QE.  Instead, the FOMC realigned both interest on excess reserves (IOER) and the reverse repo (RRP) rate lower by 5bp. Powell noted during his press conference that the Fed would use temporary open market operations (OMOs) “for the foreseeable future” to address pressures in funding markets.

However, and the reason why stocks shot up just before 3pm ET, is that that’s when Powell added that “it’s possible that we’ll need to resume the organic growth of the balance sheet, earlier than we thought. … We’ll be looking at this carefully in coming days and taking it up at the next meeting” in late October. Said otherwise, the Fed may not have announcer QE4 yesterday, but it will likely announce it in the very near future.

Sure enough, as Goldman wrote in its FOMC post-mortem, “we took this as a fairly strong hint and now expect the Fed to resume trend growth of its balance sheet in November with permanent OMOs. It is possible that the FOMC will take that opportunity to also reach a final decision on possibly shortening the maturity composition of its purchases, which it discussed at its May meeting.”

With all the OMO (or Perrys), the Fed’s Secured Overnight Finance Rate (SOFR) stabilized to normal levels.

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And the repo rate returned to near normal with the massive intervention with OMO.

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Fed Chair Jerome Powell (aka, Perry Omo).  Hot diggity dog. …

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On a side note, I tripped on a weight at the gym and fell against a weight machine. Fractured rib, badly swollen knee and dislocated perhaps broken finger(s). I call for a ban on power lifters dropping their weights and having them bounce in front of me!

The Big Squeeze! GC Repo Rate Crashes To 0% Amid Liquidity Squeeze And The Fed’s $53.2 Billion Flood Of Liquidity

Panic?

(Bloomberg) — The Federal Reserve took action to calm money markets on Tuesday, injecting billions in cash to quell a surge in short-term rates that was pushing up its policy benchmark rate and threatening to drive up borrowing costs for companies and consumers.

While the spike wasn’t evidence of any sort of imminent financial crisis, it highlighted how the Fed was losing control over short-term lending, one of its key tools for implementing monetary policy. It also indicated Wall Street is struggling to absorb record sales of Treasury debt to fund a swelling U.S. budget deficit. What’s more, many dealers have curtailed trading because of safeguards implemented after the 2008 crisis, making these markets more prone to volatility.

Money markets saw funding shortages Monday and Tuesday, driving the rate on one-day loans backed by Treasury bonds — known as repurchase agreements, or repos — as high as 10%, about four times greater than last week’s levels, according to ICAP data.

More importantly, the turmoil in the repo market caused a key benchmark for policy makers — known as the effective fed funds rate — to jump to 2.25%, an increase that, if left unchecked, could have started impacting broader borrowing costs in the economy. Because that’s at the top of the range where Fed officials want the rate to be, they are likely to make yet another tweak to a key part of their policy tool set to try to get things back on track when they meet Wednesday to set benchmark rates.

But the central bank didn’t wait until then to do something, resorting to a money-market operation it hasn’t deployed in a decade. The New York Fed bought $53.2 billion of securities on Tuesday, hoping to quell the liquidity squeeze. It appeared to help. For instance, the cost to borrow dollars for one week while lending euros retreated after almost doubling Monday.

For repo traders, hedge funds and others that rely on that market for financing, this intervention came none too soon.

A bit of an overshoot?

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And something that went unnoticed by many …

The New York Fed bought $3.001b of T-bills in the secondary market Tuesday as part of its planned reinvestment purchases.

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Yes, it is The Big Squeeze (not to confused with The Big Short).

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What up with that?

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The Big Short: Part Deux? US Home Prices Slow As Wage Growth Highest Since Early 2009 (Tiny Bubble OR BIG Bubble?)

No matter which US home price index you choose, US home prices have risen above the peak of the housing bubble in April 2007 (as highlighted in the book and film “The Big Short”).

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Thanks to relaxed credit standards, including the infamous NINJA (no income, no job) loans, the US saw a steady and increasing growth in mortgage credit and a corresponding growth in home price growth … until 2005. Then the bottom fell out out the housing market.

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Today, we are witnessing a slowing of home price growth even as earnings growth is at its highest level since early 2009.  The last time we saw home price growth and earnings growth so in alignment was back in the 1995-1998 period following the enactment of HUD’s National Homeownership Strategy. 

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The big difference between the 2000s housing bubble and today’s housing bubble is that the 2000s housing bubble was driven by subprime and ALT-A credit. But today’s housing bubble is in part driven by foreign investors on both the west and east coasts, not to mention the Federal Reserves low interest-rate policies. And we are seeing a softening of credit standards from Fannie Mae and Freddie Mac.

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And Fannie and Freddie’s debt-to-income (DTI) is rising to 2008 (financial crisis levels).

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So does the US have a tiny bubble? Or a big bubble?

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US Treasury 2Y Auction Sees 1.516% High Yield (Down From 1.825% At Previous Auction), Yield And Swap Curves Remain Cratered

The US Treasury just auctioned $40 billion of 2-year Treasury Notes at a high yield of 1.516%, down from the prior auction of high yield rate of 1.825%.

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As a result, the cratered yield and dollar swap curve remain … cratered.

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Sadly, the US Treasury yield and swaps curves remind me of the Lochnagar mine in France.

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Beyond The Sea! Boston Fed’s Rosengren’s Plea To Not Cut Rates While Europe Slows (17 European Nations Have Negative 2Y Yields, 13 European Nations Have Negative 10Y Yields)

What a difference 10+ years make in financial markets.

Here is the US Treasury yield curve at the height of the housing bubble (2005) compared to today. Back on July 1, 2005, the yield curve was upward sloping whereas today the curve is inverted at tenors of 5 years or less, then upward sloping.

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At the ten year maturity, both Canada and the US are below 2% in terms of yield (Venezuela is at a whopping 55%!). Chile, in USD, is just about 2%.

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Beyond the sea (Atlantic), there are 13 nations will negative 10-year sovereign yields. Plus the European Financial Stability Facility is at -0.357%.

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At the two-year maturity, Europe has 17 nations with negative yields. And tanking.

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The Boston Fed’s Rosengren is arguing against further rate cuts from an effective Fed Funds rate of 2.1250% while the European Central Bank (ECB) target rate is … -0.40%. That is quite a spread!

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(Bloomberg) — Federal Reserve Bank of Boston President Eric Rosengren continued to push back against further interest-rate cuts by the central bank, arguing he’s not convinced that slowing trade and global growth will significantly dent the U.S. economy.

Meantime, President Donald Trump urged the Fed to cut by a full percentage point to aid U.S. and global growth while complaining the “dollar is so strong that it is sadly hurting other parts of the world”

The German government is getting ready to act to shore up Europe’s largest economy, preparing fiscal stimulus measures that could be triggered by a deep recession, according to two people with direct knowledge of the matter.

Rosengren’s point is that the US economy is still growing with low unemployment while Europe is grinding to a halt. Germany is at 0.40% YoY, Italy is at 0% YoY and France is at 1.30%. The US is at 2.3% YoY. This is, in part, Rosengren’s point.

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While the US economy is humming along at 2.3% YoY growth, Treasury is considering issuing 50- and 100-year bonds. Both will have huge duration and convexity risk.

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So, economic slowdowns beyond the (Atlantic) sea may spill over to the US.

President Trump needs a Dream Lover to enact his rate cuts. Otherwise, markets will be splishy-splashy.

 

 

Come Dancing? US Treasury Considering Issuing 50- or 100-year Bonds As 30-Year Treasury Bond Yield Hits All-time Low (Negative Yielding Debt Growth Sends Gold Skyrocketing – 14 European Countries Have Negative 10-year Yields)

As the US House of Representatives (that controls the purse strings of the Federal government) escalates spending, the US Treasury has to issue more debt. In fact, the US has now exceeded the 100% debt to GDP that was first exceeded back in 2012 in the wake of the financial crisis.

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And with the US Treasury 30-year yield hitting all-time lows,

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Treasury is exploring longer-term maturities to refinance its debt and issue additional debt to cover the Federal budget deficit.

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(Bloomberg) — With interest rates on 30-year U.S. debt hitting all-time lows this week, the US government is once again considering whether to start borrowing for even longer.

The U.S. Treasury Department said Friday that it wants to know what investors think about the government potentially issuing 50-year or 100-year bonds, going way beyond the current three-decade maximum.

Well, US dollar swaps go out to 50 years, so 50-year Treasuries are not that much of a leap.  But can we try 40 years first??

But given the unusual shape of the Treasury and Swap curves (both inverted in the short-term), is this Fed-caused disturbance in the yield curve or a signal of recession in the coming 5 years.

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And as global negative yielding debt explodes, so does gold prices.

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Its the same all over the world in terms of negative yields.

In fact, 14 European nations have negative 10-year yields.

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