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April 12, 2007
Mortgage rates are no worse this week than after last week’s strong-payroll surprise, and the 10-year T-note yield is a hair lower. As suspected here, the payroll data made the economy look stronger than it really is.
The Fed’s meeting minutes concede that inflation is “higher than expected” and that their cherished forecast for continuing downward trend is in question. If inflation stalls above target in the high-two-percent range, then the Fed not only can’t ease, but will have to tighten. So, mortgage rates will rise?
Perverse rules are in play: if the Fed tightens now, all the more reason for bonds to expect a recession, and they would love one. We’ll be okay unless Perfesser Bernanke blinks as an inflation-fighter.
Regarding the mortgage meltdown: never in the history of either elephants or blind men have so many of the latter had hold of so many wrinkled but mysterious body parts. “A-HA!” rings throughout the land, one mistaken discovery after another.
To grasp the whole pachyderm, consider Wells Fargo.
Until this week, Wells preened as the largest sub-prime lender, $89 billion in 2006 alone. Analysts and stockholders began to poke at Wells: If you’re the sub-prime gong-winner, then you must be a wreck?
Stock tanking, Wells now says, we really only did $28 billion, and sold the rest in “co-issue arrangements.” Wells, like all megabanks has insisted that it is a “lender” which does not sell its loans and is therefore vastly superior to those scruffy little brokers. It is a broker itself, just like everybody, but big enough to have its clerks collect your payments.
Okay, what about the credit quality of that $28 billion you still have? Wells’ CFO, Mr. Atkins: “There is no credit risk to Wells on those loans.” Wells apparently sold the risk component into the nouveau “credit derivative” market.
A large crowd of blind newsies is trying to blame the sub-prime damage on Main Street lenders, and certainly they are culpable. However, credit has not merely been supplied by the nouveau and disembodied derivative markets, mortgages have been suctioned from Main Street, from borrowers and lenders alike, on easier and finally suicidal terms. In the derivative wonderland, nothing is as it seems, nor whole -- anything can be re-made and sold in pieces, elephants included.
You just think these loans are risky: borrow a little yield from there, add an enhancement here, spin a credit-rating agency dizzy, and -- voila! Risk is gone! Sometimes risk is distributed reasonably (there is a lot of net worth in the world over which to distribute risk), often not (with leverage, heh-heh). The pachyderm in the room: if Wells sold the credit risk on $28 billion in loans, who has that risk now?
If a couple of trillion dollars in questionable mortgage paper is out there (and it is), and 20% of it goes into foreclosure, who holds the risk? If you know, please send an e-mail. Wells ain’t talkin’, The Street ain’t talkin’, and neither are the rating agencies. The Fed is sound asleep, and wouldn’t talk anyway.
These credit-derivative sales work like insurance, and soon the Wells’ of the world will begin to make calls to file claims for recovery. Some of those phones are going to ring with no pick-up. Derivative-based suction is weakening, and can stop altogether: the first stage was tightening guidelines, now we see A-paper intermediaries scurrying to cover the risk of market interruption.
We will move our offices this weekend...
After 20 years downtown, and only-in-Boulder good luck with our building (never confuse a bull market with brilliance), we’re off to 95th and Arapahoe and infinite free parking. For address and directions: icon on home page. Phones down on Friday 4/13, back up on Monday, numbers all same. Meantime, my cell is 303-641-4341.
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