The Market Ticker

Mad props once again to Zerohedge who shone the bright light on Freddie's latest screed.

I'm not going to take from their discussion of The Fed buying up paper at what will (almost certainly) lead to ruinous losses - you can find that there.

Rather, I am going to look at some of the internals from the document published that they didn't focus on.

Specifically, I'm going to go after a couple of graphs.

Let's start with this one (click any for a larger copy):

This seems to show very small declines in home prices.  Or does it?  The very next graph says....

Wait a second!  Now its down ~20%?  Hmmmm.... that's more like what everyone would expect Freddie to report.  Ok, we'll go with that one.

But but but what does this do to the LTV of their portfolio?

I bet you can guess!

That's a very serious problem.

See, Freddie has a lot of loans on their books that are rather old and have a lot of amortization behind them.  That is, lots of principal paid down.

But the newer loans have much less principal paid down and in many cases are underwater.  This has driven an insane deterioration in actual credit quality of the portfolio as a whole.

In fact that single slide ought to peel your whig back.  If it doesn't, these two will:

and immediately following it:

Notice that up until 2007 there were no loans with more than a 100% loan-to-value ratio in their portfolio.

Freddie (and Fannie) detonated because they were operating with an 80:1 leverage ratio, a number that was demonstrably unsound.  Regulators, including Lockhart, Treasury and The Fed, allowed not only Freddie and Fannie but also the FHLB system to operate into this environment with deteriorating fundamentals even though as you can see the deterioration that would cause their explosion was evident in 2007.  NOTHING WAS DONE ABOUT IT.

There is no solution to this problem folks.  These firms have in the neighborhood of five trillion dollars outstanding in either loans or credit guarantees.  The Fed has been furiously buying up these securities even though the black letter of The Federal Reserve Act, Section 14, prohibits it and Section 13 only permits loans, not purchases, because private investors can read balance sheets and graphs and know that there is absolutely no way that this sort of credit book deterioration will end anywhere but a great big fat

We are deluding ourselves if we think this will all turn out ok.  It will not.  The Fed is likely setting on a loss of more than 10% on its "acquisitions" of these securities right now - a loss that exceeds $50 billion dollars in real money.  They are playing musical chairs while juggling nitroglycerin and with every month that goes by another bottle gets added to the juggler's load.

The worst part of it is that in 2006 and 2007, as you can see here, the GSEs were buying right into the maw of the deterioration and these securities are now the ones in the most trouble - just as with all the other lenders.

But that's not what should scare you.  No, what should scare you is what they bought, especially in 2005 and 2006.  Make sure you're sitting down:

You gotta be kidding me.

From this we can figure out what percentage of their loans are likely to explode.  That would be the ALT-A and Option ARM loans.

All of the OptionARMs are at risk of detonating, which is $12 billion.  All of the ALT-A is at risk as well, $176 billion more.  We can't determine what part of the LTV > 90% are not captured in the ALT-A or OptionARM market; let's be conservative and say its none, although I'm quite sure that's not true.

This adds to $188 billion dollars of loans at risk or about 10% of the portfolio, and this assumes that none of the so-called "prime" paper is really ALT-A (e.g. computerized underwriting where the so-called "income verification" was never done by the originator); current foreclosure statistics put recovery value in the bubble areas (where there was a reason to write ALT-A, high-LTV and OptionARM paper) at a conservative 50% when one figures in value deterioration, resale and rehab costs plus other foreclosure expenses (legal, etc.)

This means we have a rough $94 billion in actual losses.

Fannie Mae almost certainly has similar statistics, and has a total book of somewhere around double Freddie's size, meaning that between the two of these organizations there is nearly $600 billion dollars worth of garbage paper on their books and close to $300 billion in actual loss that will happen.

Folks, there is no possible way we can backstop this and The Federal Reserve along with Congress and Treasury are covering it up!

Ponzi ponzi ponzi ponzi ponzi!

The Fed and Treasury are pretending there is a "recovery" imminent on the economy as a consequence of even-looser credit standards (to banks) and even more debt spending (by government).

It won't and can't work because the inevitable contraction in the economy (and home prices) that must come is simply made worse by the interest expense that comes when the government (or anyone else) borrows and spends forward.

Losses are created when bad loans are made; there is nothing you can do about it after the fact other than choose who takes the loss.

There is no solution to this other than to cut these two organizations loose and let them blow up.  Yes, the losses will be horrific.  And?  There is no other option!  We cannot absorb the losses on this portfolio without creating the potential for destruction of the government's funding mechanisms which is exactly what The Fed is trying to shove down the throat of The Taxpayer without a vote of Congress and without telling you, the people of this country!

There is only one way to bring private buyers of this credit back to the table: We must permanently reform what qualifies for a GSE mortgage and set it into law, with criminal penalties for violations.  We must require 20% cash down payments, no more than an 80% loan-to-value at origination (that is, no "silent seconds", no games, no BS) and no more than a 36% back-end ratio (or "DTI", that is, "all debt service to income.")

The Fed circle-jerk MBS game is being played precisely because there is no private market for these things any more.  Those who bought got burned and everyone understands that the credit quality on the GSE's book is utter and complete garbage.

But The Fed and Treasury programs to "stabilize" the GSEs mathematically will and must fail.  Every dollar borrowed by Treasury to prop these institutions up is one that has to be paid back with interest, and thus the economic damage still remains and is in fact added to by the interest cost. 

The longer we keep this fraud going between Treasury and The Fed the worst the impact on our economy will be when it unravels - and unravel it will. 

It is inevitable.

Did you keep your bomb shelter around after the 50s?  You might need it for shelter from this economic storm - the one that all the pundits claim is "over" when in fact we are simply sitting in the eye of a Cat 5 hurricane and the eyewall is bearing down on us at 30 knots.

Don't believe the lies - the math is never wrong.

Updated: Table reading error on Table 35 pointed out and corrected.  Its not AS horiffic, but its still REALLY bad.

Just when you thought "there will be a recovery" comes this:

June 26 (Bloomberg) -- The ratings on $235.2 billion in debt backed by commercial mortgages may be cut by Standard & Poor’s as it seeks to reflect how the securities would fare in an “extreme economic downturn.”

That's a colossal slab of those things.

Oh, but don't mind the pump monkeys; they assert it will all be ok:

The Fed is counting on the TALF to make borrowing cheaper and help facilitate new lending.

Riight. We're supposed to believe that with the consumer tapped out on credit availability, housing prices correcting to remove the entire speculative premium from 2003-2007 and credit card default rates in excess of 10% that commercial real estate will be just fine and there will be no real loss taken on these TALF'd securities?

Nice try guys; go run that line of bilge on someone who can't find two working neurons to rub together.

Back in the real world, on the other hand, we'll be anticipating the next big blast (as per my annual Tickers in 08 and 09), coming soon to a credit market near you.

From Marketwatch:

NEW YORK (MarketWatch) -- Dresdner Kleinwort Securities has withdrawn from the Federal Reserve's primary U.S. government security dealers, the U.S. central bank said Friday.

The change is net neutral in terms of numbers as a new dealer just came online, but in general this is a major net negative for the Treasury market.

Why?  Because being a primary dealer is, in general a license to print money.  You get to field customer orders for Treasuries and make your spread, and you have a privileged trading position with The Fed.

There's only one fly in the ointment, and that is that the position comes with a requirement that you bid.  This is distinct from most other nations where no such system exists, and essentially guarantees that there can never be a "failed" Treasury auction.

There was no reason cited for the withdrawal but one can surmise that the issue is that they're stuffed to the gills with Treasuries and are finding it difficult or impossible to earn their spread, think there is a material safety risk in their participation (e.g. getting stuck long with a deteriorating position), or both.

Either way there is no possible means to read this as bullish.  While the issue may be with their liquidity demands and thus not reflect severely on the Treasury market with the issuance that has gone on this year and will for the foreseeable future I wouldn't take that bet.

The "Chosen" or "Protected" dealers will of course never withdraw but if the changes made to reporting of indirect bid are in fact concealing deteriorating demand and these folks have detected a potential problem in the offing we are fixing to get a severe spanking in our government debt issuance in the near future.

Beware.

See what happens when Congress refuses to enforce The Federal Reserve Act's provisions that require that equity ownership be taken only in instruments that have the full faith and credit of the US Government behind them?

Under the agreement, AIG will split off AIA and Alico into separate company-owned entities called "special purpose vehicles," or SPVs. The New York Fed will receive preferred shares now valued at $25 billion -- $16 billion in AIA and $9 billion in Alico -- and in exchange will forgive an equal amount of AIG debt.

So now The Federal Reserve (actually the NY Fed) partially owns an insurance company through more off-balance-sheet Frankenstein monsters.

This is blatantly in violation of The Federal Reserve Act but nobody in Congress seems to care.

The FRA was written as it stands to explicitly preclude this sort of transaction.  If we are to take an equity ownership position in AIG linked to the taxpayer it has to be done through an appropriation passed by and overseen by Congress, not through an administrative action by The Federal Reserve or one of its districts!

The New York Fed said in a statement that the agreements "further the goals of enabling AIG to fully repay the assistance that it has received from U.S. taxpayers and advancing the company's global restructuring process. The exchange of senior secured debt for preferred equity interests reduces AIG's financial leverage and facilitates the independence of these two key subsidiaries."

And who authorized The New York Fed to engage in that transaction?  Where is the explicit legislative authorization permitting the creation of an SPV that amounts to EQUITY OWNERSHIP of an insurance company?

The NY Fed just nationalized an insurance company without a bill proffered in Congress and signed by The President!

WHERE ARE THE DAMN COPS?

Props to Zerohedge on tracking this:

Just released NYSE data indicate a 50% ramp up by Goldman's principal Program Trading unit. Whereas the prior week saw Goldman trading only 631 million principal shares on the NYSE, the most recent data indicate a massive rise to 977.8 million. Also notable is Credit Suisse's doubling in principal program trades to 586 million from 245 million. Zero Hedge is compiling materials to demonstrate the phenomenal gamble CS is taking by being the largest holder of the ETF-underlying pair trade. The ensuing implosion, once the market loses the invisible futures bid, will likely destroy Switzerland's second biggest bank and likely take down the country with it.

This is ridiculous.

Someone needs to start listening to Volcker, who has strongly promoted returning to the Glass-Steagall separation of commercial banking and trading activity.

Program trading is now up to 40.4% of all NYSE volume - approaching half.

For those who aren't savvy in this stuff what's going on here is a pair trade between the underlying instrument(s) and the ETFs on the exchanges.  This is an arb play and it works until it doesn't - for an example of "doesn't" in the single-name world witness what happened to VW/Porsche earlier this year when the arb speculators on their merger got rammed, or those hedgies who were playing the Citibank preferred-conversion arb earlier this year.

These are allegedly "hedged" transactions in that there is an alleged unbreakable correlation that protects the person doing it from loss.

In truth there is no such thing as an unbreakable correlation and the alleged "protection" against getting reamed is illusory.  This is the same sort of "genius trade" that was run with AIG's CDS positions - remember the claim that "we're unlikely to ever see a loss"? 

How'd that work out?

Here's the chart from Zerohedge (original source the NYSE itself; click for a larger version):

Someone has to get out in front of this and stop it before it blows up in everyone's face and we have yet another round of "banking problems", this time among so-called "investment banks" that in fact are now commercial banks since they converted and thus have an "Uncle Sam" backstop.

This sort of principal trading is outrageous and in this sort of volume amounts to market manipulation writ large.  Like all manipulation it can only work for a certain (but impossible to determine in advance) amount of time, and when it fails it will inflict ruinous losses on the participants in the scheme along with anyone inside the blast radius (which includes you if you happen to be long the markets when it comes apart!)

I have no problem with speculators pressing their bets.  I have a major problem with them doing it with taxpayer money and backstops, where the inevitable losses that will come when, not if it blows up will not be their loss, it will be our loss.

CONGRESS MUST PUT A STOP TO THIS CRAP RIGHT NOW, SINCE OUR SO-CALLED "REGULATORS" ARE CLEARLY REFUSING TO DO SO!