Category Archives: Economy and Meltdown

JPM Vaulted Gold Slides To New All Time Low

Beginning on May 13, when JPM’s commercial gold holdings tumbled to an all time low of 137,377 ounces, the firm’s daily Comex updates became erratic with daily reallocations out of its Registered holdings into Eligible. Over the next three weeks, some 209K ounces had their warrants detached, and shifted into customer account, all the while the total number of ounces held in the JPM gold warehouse at 1 Chase Manhattan Plaza, remained flat at 817,167. Then two days ago the first withdrawal in nearly one month took place, with 13K ounces pulled out of JPM’s Eligible holdings. Moments ago, the daily Comex update showed that yet another 15.4K ounces were withdrawn out of JPM, following the latest gold withdrawal, offset by a 49K ounces reallocation. This however is still short of the roughly 70K ounces due for delivery. Long story short, as of close of activity on June 3, the total gold held by the JPMorgan depository is now the lowest it has ever been at just 788,786 ounces and once again falling fast.

Then again, as many have noticed, the addition of an peculiar footnote to the daily Comex report which states the following:

The information in this report is taken from sources believed to be reliable; however,
the Commodity Exchange, Inc. disclaims all liability whatsoever with regard to its accuracy or completeness.
This report is produced for information purposes only.

means that it is quite possible that all of the above numbers are just that, and that in reality JPM (and others) are representing whatever they wish. It is, however, odd that the CME decided to add this disclaimer only now.


Taxpayers Could Face (Previously Undisclosed) $115 Billion Losses From FHA

In yet another hit for both the administration’s trustworthiness and the hope of some spin-off of the GSEs, the WSJ reports that the Federal Housing Administration’s projected losses over 30 years could reach as high as $115 billion under a previously undisclosed stress test. The results, which were not included in the agency’s independent actuarial review (because of the potential uproar it might create according to emails), are based on the Fed’s stress-test scenario – which seems like something that should (perhaps) have been included. The fact that this data was omitted from the report is “troubling” to House Oversight Committee head Darrell Issa. In its annual audit, the agency disclosed that under current conditions, total losses would exceed its reserves by $13.5 billion over 30 years (with a $943 million loss this year alone). The projected shortfall under a ‘protracted economic slump’ is $64.5 billion but the ‘tail risk’ event, that was originally included in earlier drafts, based on the Fed’s stress test, is $115 billion. Hardly the upside-encouraging potential that private-finance will be looking for in funding FEDMAGIC.



Via The WSJ,

The Federal Housing Administration’s projected losses over 30 years could reach as high as $115 billion under a previously undisclosed stress test conducted last year to determine how the government mortgage-insurance agency would fare under an extremely severe economic scenario, according to documents reviewed by a congressional committee.


The forecast was significantly worse than the most severe estimate included in the agency’s independent actuarial review that was released last November.



In a letter sent last week, Mr. Issa asked Carol Galante, the FHA’s commissioner, why the agency hadn’t disclosed the figure, which he called “troubling.”



In its annual audit, the agency disclosed that under current conditions, its projected total losses would exceed its reserves by $13.5 billion over 30 years.


A more recent analysis, released in April by the White House’s budget office, showed that the agency would require $943 million this year due to losses in the agency’s reverse-mortgage program



Emails reviewed by the House committee suggest that the FHA didn’t want the bleaker forecast included due to the potential uproar it would create.



Last fall’s annual report included several stress scenarios, but none of them showed losses as large as those contemplated by the Fed’s stress-test methodology. Its most severe estimate of losses under a “protracted” economic “slump” would have resulted in a projected shortfall of $65.4 billion.



Emails from FHA officials to IFE analysts in April 2012 initially floated the idea of using a stress-test scenario like the one conducted by the Fed in order to measure the costs of big unforeseen shocks, known as “tail risk.” …


The Most Over/Under-Valued Housing Markets In The World

House prices – with respect to both levels and changes – differ widely across OECD countries. As a simple measure of relative rich or cheapness, the OECD calculates if the price-to-rent ratio (a measure of the profitability of owning a house) and the price-to-income ratio (a measure of affordability) are above their long-term averages, house prices are said to be overvalued, and vice-versa. There are clearly some nations that are extremely over-valued and others that are cheap but as SocGen’s Albert Edwards notes, it is the UK that stands out as authorities have gone out of their way to prop up house prices – still extremely over-valued (20-30%) – despite being at the epicenter of the global credit bust. Summing up the central bankers anthem, Edwards exclaims: “what makes me genuinely really angry is that burdening our children with more debt to buy ridiculously expensive houses is seen as a solution to the problem of excessively expensive housing.”


Using these indicators, OECD countries can be roughly placed into five categories:

Where houses appear broadly correctly valued. This category includes the Unites States, where prices have started rising again after a substantial correction; Italy, where prices are falling rapidly; Austria, where prices are rising; and Iceland, Korea and Luxembourg where prices are roughly flat.


Where houses appear undervalued and prices are still falling. This category includes European countries hit hard by the crisis – Greece, Ireland, Portugal, Slovenia, Slovakia and the Czech Republic – but also Japan.


Where houses appear undervalued but prices are rising. This category includes only Germany and Switzerland, two European countries where strong growth in household disposable income and favourable financing conditions have boosted prices (despite macro-prudential measures in Switzerland).


Where houses appear overvalued but prices are falling. This category is the largest as it includes many European countries where the post-crisis housing market correction is still ongoing, most notably Spain, but also the United Kingdom, Belgium, Denmark, Finland, the Netherlands and one non-European country, Australia. While price corrections in these countries are necessary, they are also concerning as they weaken households’ financial health and potentially fragilize banking sectors.


Where houses appear overvalued but prices are still rising. This is the case in Canada, Norway, New Zealand and, to a lesser extent, Sweden. Economies in this category are most vulnerable to the risk of a price correction – especially if borrowing costs were to rise or income growth were to slow.


Edwards explains reality:

Why are houses too expensive in the UK?


Too much debt. So what is George Osborne’s solution for first time buyers unable to afford housing? Why, arrange for a government guaranteed scheme to burden our young people with even more debt!


Why don’t we call this policy by the name it really is, namely the indentured servitude of our young people.


The Problems With Japan's Plan B: The Government Pension Investment Fund's "House Of Bonds"

“So long as public funds ultimately are governed by the government, which is controlled by representatives of the general public, risk tolerance is subject to the general public’s risk tolerance, and the general public’s risk tolerance is not necessarily high. If and when the stock market collapses and performance goes negative for some time, people, the media and politicians will complain loudly… Who exactly is responsible for the future payment of benefits? Those who make the promise today may not be the people to actually deliver on the promise in future decades. It is much easier to make a promise that somebody else is supposed to carry out. Here the future generation is not in a position to sign the contract at all. This is the critical agency problem.

      Yuji Kage, former CIO, Pension Fund Association

Now that the BOJ’s “interventionalism” in the capital markets is increasingly losing steam, as the soaring realized volatility in equity and bond markets squarely puts into question its credibility and its ability to enforce its core mandate (which, according to the Bank of Japan Act “states that the Bank’s monetary policy should be aimed at achieving price stability, thereby contributing to the sound development of the national economy) Japan is left with one wildcard: the Government Pension Investment Fund (GPIF), which as of December 31 held some ¥111.9 trillion in assets, of which ¥67.3 trillion, or 60.1% in Japanese Government Bonds. Perhaps more importantly, the GPIF also held “just” ¥14.5 trillion in domestic stocks, or 12.9% of total, far less than the minimum allocation to bonds (current floor of 59%). 

What the GPIF has going for it is that with a total asset size of just about $1.1 trillion, it is the largest government pension fund in the world. It is almost equal to the size of Korea’s economy, has nearly six times as much assets under management as CALPERS, the biggest US pension fund, and nearly four times as much as Europe’s largest pension plan, Stichting Pensioenfonds ABP of the Netherlands. Which means that the mere whisper of capital reallocation sends assorted asset classes scrambling.

It is this massive potential buying dry powder that has led to numerous hints in the press (first in Bloomberg in February, then in Reuters last week, and then in the Japanese Nikkei this morning all of which have been intended to serve as a – brief – risk-on catalyst) that a capital reallocation in the GPIF is imminent to allow for much more domestic equity buying, now that the threat of the BOJ’s open-ended QE is barely sufficient to avoid a bear market crash in the Nikkei in under two weeks.

There are some problems, however.

The first of which, is that GPIF appears to be a “jack of all trades” when it comes to its potential utility. It was only in March that HSBC wrote in “Japan’s trillion dollar bond rotation” that “there is clearly a bias to shift more public funds into international markets“, and that “Crucially, the GPIF is conducting a review to accelerate divestments in domestic bonds in favour of EM.” Wait, reallocation from domestic bonds into international markets, and specifically bonds? Oh yes, that’s because back then Europe needed backstopping and the mere threat of a Japanese carry trade tsunami was sufficient to send peripheral bond yields plunging to near record lows (despite Europe’s imploding economy).

Fast forward to today, when we now learn that this mythical reallocation from domestic into international bonds has been put on hiatus (PIIGS yields plunging notwithstanding), and has been replaced by a new narrative – one which is suddenly the much more critical, and Abenomics preserving one: reinvesting out of domestic bonds and into domestic stocks, thus providing a backstop to the BOJ. Problem is, cry capital-reallocating wolf enough times, and soon someone will demand to see proof before taking you at your word.

This problem is compounded by another problem: as we wrote several years ago, in 2010, due to the demographic crunch of Japanese society, the GPIF became, for the first time ever, a net asset seller. This can be seen on the charts below.

Worst of all, and as can be very vividly seen on the charts below, not only has the GPIF been consistently leaking assets in the past four years, it has already been actively reallocating away from bonds: in fact, at 60.1% of total assets, the JGB holdings as of December 31 a % of total assets are the lowest they have been in decades (and just above the 59% threshold), while the allocation to domestic stocks has soared from 12.3% in Q3 to 14.5% in Q4: the highest in two years. Just how much dry powder does this pension fund really have before it literally bets the bank on the riskiest of all asset classes, and – in the off chance it bets incorrectly – dooms tens of millions of people to retirement in poverty? So the GPIF needs a reallocation program?  Sounds to us like it needs to invest more into JGBs!

Total GPIF assets:

Relative GPIF assets:

So will the GPIF indeed scramble to reallocate into equities or is this merely the latest bluff in a long series of pseudo-political gambits? Here are some thoughts from HSBC on this issue:

Domestic equities might be an obvious target for the reallocation of assets, especially if the impressive rally in the Nikkei continues. But Japanese investors will be very reluctant to immediately pile into the local stock market. The asset bubble that burst more than 20 years ago left its mark. More than half of households’ USD15trn financial assets were kept in cash as of September 2012 and only 6% in equities, according to BoJ data. Other significant domestic holders of JGBs such as banks and pension funds will also be constrained to match liabilities and meet regulation requirements, implying bond investments, including overseas bonds, are more likely than equity investments.

Well that’s great for Spanish bonds, but does nothing to help what may soon be the next great Japanese equity market bubble. 

But wait, it gets worse.

As we have been showing over the past several weeks, suddenly a far bigger problem that has emerged for Japan is not what happens to the Nikkei, but whether it suffers an out of control collapse in its bond market, and sees a rapid, vicious and sharp sell off in the JGB complex as nearly happened on May 23, the day when the the Nikkei225 crashed. It is this that is the biggest structural threat to Abenomics, not whether or not Mrs. Watanabe will have generated enough money daytrading to avoid the 20% price surge in McDonalds.

So if indeed the GPIF does reallocate into equities (a very big if considering its multi-functional usage depending on the dry-powder threat need du jour), it will have to sell JGBs. Even more than it has sold so far. Which will then precipitate yet another rout in the JGB market, from where we go into such issues as the “VaR shock” we described two weeks ago (a topic the FT caught up with today), and all too real capital losses for Japanese banks who mark JGBs on a MTM basis.

Here is what HSBC had to say on this issue:

There is also an asymmetric risk to JGB yields in the very long term (ie beyond the next couple of years), making diversification compelling on a risk-adjusted basis. If official policies in Japan begin to bite and inflation rises on a more sustainable basis, this would place pressure on interest rates and materially reduce the value of JGBs held by banks. Yet, given the scale of such holdings, reducing exposure to JGBs would be difficult. Japanese financial institutions hold a substantial amount of JGBs. According to the BIS, Japanese banks hold 90% of their tier 1 capital in JGBs. Japan’s largest bank, Bank of Tokyo-Mitsubishi, has already acknowledged that reducing its USD485bn holdings of JGBs would be disruptive for the markets

Wait, what? Let’s read more from the FT, shall we:

Nobuyuki Hirano, chief executive of Bank of Tokyo-Mitsubishi, admitted that the bank’s Y40tn ($485bn) holdings of Japanese government bonds were a major risk but said he was powerless to do much about it.…The risk facing Japanese banks from their vast holdings of government bonds has been underlined by the chief executive of the country’s largest bank who said it would struggle to reduce its exposure.

Well that’s not good: if the largest Japanese bank can’t handle what may soon be concerted selling by one of the largest single holders of JGBs, who can? And what can be done then?

Oh, that’s right: this is where Kuroda’s plea to please not sell bonds, just to buy stocks comes into play. The problem is only the BOJ can come up with money out of thin air, for everyone else buying something, means selling something else first. So unfortunately unless the BOJ wishes to further increase its QE, which will be needed to absorb all the selling without a surge in yields (something Kyle Bass warned about last week), a move which however would further break the connection between bonds and inflation expectations, and further destabilize the equity, FX and bond markets.

So in short: Japan’s Plan B is not only not a panacea, but it is a House of Bonds Cards that would not survive an even modest gust of wind, and an even more modest contemplation into its true internal dynamics. We would urge Messrs Abe and Kuroda to come up with a fall back plan to the fall back plan before it, once again, becomes too late.

Finally, for those who just can’t get enough, we recommend the following piece by James Shinn for Institutional Investor which should explain all lingering questions about what really goes on at Japan’s Plan B.


GSE Privatization, Or "Fed Magic" – Here Are The Alternatives

Between Fairholme’s back-up-the-truck in GSE Preferreds (demanding his fair share of the dividend), the crazy oscillations in the common stock of FNMA, and the ongoing debacle of what to with the government’s implicit ownership of the US mortgage business, tonight’s news from Bloomberg – that a bipartisan group of U.S. senators is putting the final touches on a plan to liquidate Fannie Mae and Freddie Mac (FMCC) and replace them with a government reinsurer of mortgage securities behind private capital – is hardly surprising. Details are few and far between except to note that the proposed legislation, which could be introduced this month, would require private financiers to take a first-loss position. The new entity, to be named the Federal Mortgage Insurance Corp (or FEDMAGIC), would seek private financing to continue existing efforts to help small lenders issue securities. The ‘old entity’ – where existing equity and debtholders would seemingly reside would contain the existing MBS portfolio and be put in run-down mode. The following from BofAML provides a possible primer and pitfalls (we think the endgame is very unlikely to be positive for holders of the capital structure below subordinated debt) of this approach.


From Bloomberg we know:

  • The GSEs will be liquidated within five years
  • Private financiers will fund the newco, taking a first loss position adequate to cover price declines as steep as those seen during the recession
  • Proceeds from the liquidation would first go to the US government as senior preferred shareholder (and lastly to holders of the common stock).
  • The new entity will be called the Federal Mortgage Insurance Corp (FEDMAGIC)

That is all we know for sure. The following from BofAML provides the best primer for the possibilities that we have seen (beware the details are not particularly positive)…

What a privatization plan would look like


With a stroke of the pen, the government can choose to direct some or all of GSE profits away from taxpayers and back into Fannie and Freddie. This would be a first step toward recapitalizing Fannie/Freddie with the ultimate intention of selling them, as Millstein and Swagel have proposed. Instead of the current government backstop capital lines (117bn for Fannie and 140bn for Freddie) provided by the Preferred Stock Purchase Agreements, an explicit government guarantee would be purchased by Fannie/Freddie at fair market value. The government guarantee would back the MBS, not the equity, and probably not the debt, which would be spun off into a company with a mortgage portfolio that is federally managed and wound down. This government guarantee would be available for purchase by other private competitors – assuming they met strict standards – at a cost that would be a function of the riskiness of the loans and the company itself.


The proceeds of selling the recapitalized Fannie/Freddie would provide the return on taxpayer funds that policy makers have demanded, and would also accomplish the consensus policy goal of privatizing most of mortgage finance. The resulting privatized companies would compete with other private companies as issuers of MBS securities with access to government reinsurance that kicks in after private capital is wiped out.


Although we can envision such a possible path for Fannie and Freddie, we think it is highly unlikely, and we discuss why below. If the plan were to be agreed upon by Congress and put into motion, however, it’s still not clear that existing equity holders would benefit. That would depend on how the deal is structured. And given the history here and the political pressures involved, we think it would be less shareholder friendly than other such deals.


The biggest problem with privatization is privatization


One of the stickiest points of such a plan is that debt holders would be swept off into a new company that is winding down. Debt outstanding is currently about $1.1 trillion. As the current government capital backstop would be replaced with a purchased reinsurance agreement on the MBS, there would be no capital available to protect debt holders. Explicitly guaranteeing the outstanding debt would add substantially to the federal debt burden, and given historical precedent, we think it’s not an option. This is why the government designed the capital backstop plan rather than taking the companies onto the government balance sheet. Since the conservatorship began and the Preferred Stock Purchase Plan was put into place in 2008, the government has consistently stood by its promise to protect all obligations of the GSEs, today and in the future. As the Treasury department wrote on September 11 2008 in HP-1131:


The [Preferred Stock Purchase] agreement is designed to prohibit any amendment that would decrease the amount of Treasury’s funding commitment or add funding conditions that would adversely affect debt or mortgage-backed securities holders. Some may speculate that a future Congress could pass a law that would abrogate the agreement. But any such law would be inconsistent with the U.S. government’s longstanding history of honoring its obligations. Such action would also give rise to government liability to parties suing to enforce their rights under the agreement. The U.S. Government stands behind the preferred stock purchase agreements and will honor its commitments. Contracts are respected in this country as a fundamental part of rule of law.


In other words, privatization could be a big legal mess for the Treasury department. Even the MBS reinsurance guarantee envisioned in the privatization model would likely be more limited than what the Preferred Stock Purchase Agreement provides. Depending on exactly how the MBS backstop would work, under what conditions and with what limitations it would apply, it could render both MBS holders and debt holders in a vulnerable position.


In addition to what could be substantial disorder in agency financial markets, it’s also not clear that anyone would want to buy the GSEs from the Treasury department after they were deemed sufficiently capitalized. This is a matter of the future profitability of the GSEs: how high a fee the GSEs could charge in the future, and what volume of MBS securities they could produce. The Treasury would be forgoing profits (earnings sweeps) today in hopes of gaining something later. Our sense is that within the context of a private mortgage finance system, volumes of MBS production would be much lower overall than they are today, and fee pricing would be so competitive that it would likely require the same sort of ultra-specialization that we see in most industries today.


The idea of Fannie/Freddie maintaining a monopoly on securitizing and guaranteeing all conforming loans seems to be very wishful thinking in such a competitive environment, especially if the machinery of securitization is separated out into the Common Securitization Platform as the FHFA is currently doing. It is not clear what advantage Fannie and Freddie would have in such an environment, where loan data is available for all insurance companies to price risk competitively, and the profitable and complex portfolio management businesses are stripped away.


The other problem is FHFA doesn’t seem to like it


In addition to these issues that make us negative on buying preferred or common equity today, there is the problem that the FHFA is now leaning away from the privatization model. The most recent discussion of the future of GSE reform coming from FHFA, which is arguably the most important voice on the matter, is that there are two main paths to choose from: one is the issuer model, which encompasses any system of regulated private entities who issue and insure MBS (like Fannie and Freddie) with purchased government backstop insurance, and the other is the security model, which would be a world of structural subordination in private-label securities market in which buyers of securities are essentially the capital providers.


In the security model the buyers of lower-rated tranches would essentially be the capital providers, and no large-scale government re-insurance backstop would be necessary except for special crisis conditions where either Ginnie Mae or FHLB or some other special government entity could become activated. The FHFA has not made a final decision. Instead it is leading the discussion. But it is clear that it favors the security model, because in a nutshell, the issuer model will always be fraught with the sticky problem of how to conduct a private enterprise with an integral government component.


We are still far from knowing the future of Fannie and Freddie, and we expect the common and preferred stock to rise when Freddie announces its $20 or $30 billion of dividend payments in the next quarter or two.


But we think the endgame is very unlikely to be positive for holders of the capital structure below subordinated debt.


In our view it is all a matter of timing, and our recommendation would be keep the trade horizons very short and not hope for the best.

Putting the Bloomberg news and the BofAML ‘strawman’ together, it seems like:

  • current equity and debtholders remain with BADFANNIE along with the existing MBS portfolio in wind-down liquidation mode… and
  • newco FEDMAGIC will be created – via new private financing – that explicitly buys the government’s guarantee ‘rights’. This fee pays back the government, but
  • there are many hurdles yet