Don't Let the Wall Street Journal Scare You

Beware of sheep in wolve's clothing. Today we pick on the Wall Street Journal. Someone at the Wall Street Journal wrote a piece over the weekend that tries to scare you into believing another bank collapse will occur any day now, or in particular, that WFC and JPM are going under before Christmas.

This is such old news, it's sad the WSJ can't find anything better to do than recycle the story with little substance other than innuendo.

For the third straight month, option adjustable-rate mortgages are generating proportionally more delinquencies and foreclosures than subprime mortgages, the scourge of the housing crisis.

...could mean higher-than-expected losses for Wells Fargo & Co. (WFC) and JPMorgan Chase & Co. (JPM), as well as the Federal Deposit Insurance Corp.'s own insurance fund.

R-i-i-i-g-h-t! You can say that about any company any day, can't you? Why do you think the SEC requires the phrase "involve risks and uncertainties and are forward looking" in press releases?

So the obvious question is, does the delinquency proportion change because subprime delinquency and foreclosures have declined so much? We don't know, we haven't been told. The second point obviously presumes these Option ARMs aren't already discounted or had reserves set aside. Is there any data to support that, or is this another type of "If an asteroid strikes the earth..." existential reality?

"The realization of the issues related to option ARMs is just beginning," says Chris Marinac.

Why, because he's fixated on the asteroid belt and sees nothing but trouble? Who the heck is Marinac, anyway? The implication of "realization of the issues ... just beginning" is that nobody saw this coming. How absurd. This is common knowledge in the industry and the internet. There's a famous Credit Suisse mortgage reset calendar floating around the internet for years, originated from the chart on page 47, Exhibit 42 "Adjustable Rate Mortgage Reset Schedule" from the exhaustive report "Mortgage Liquidity du Jour: Underestimated No More" which came out in March 2007, and even updated back in May. Maybe Mr. Marinac hasn't known this for the last two years, but we're highly confident most professionals have.

Now we do have a fact or two in that whole article. Three relevant ones to be exact.

• As of April, 36.9% of [Pick-a-pay] loans were at least 60 days past due, while 19% were in foreclosure
• 33.9% of subprime loans were delinquent as of April, while 14.5% were in foreclosure.
• Wells Fargo holds ... $115 billion of the loans
• [WFC] assigns the loans a value of $93.2 billion

Some facts are just plain wrong. The following relates to some unspecified population that has no indication of it's relevance to the nation as a whole, or the purported facts of this story in particular. Specifically,

"33.9% of subprime loans were delinquent as of April, while 14.5% were in foreclosure."

Actually, according to the official Credit Conditions in the United States:

Only 12.6% were in foreclosure in April (column 26)
Only 28.9% are delinquent (sum of columns 23, 24, 25)
(Source: Subprime Excel Data)

Notice in that excel data: The percentages in the second set of three columns plus the "% current" don't add up to 100% because they don't include loans in foreclosure.

Mathematically, then, we have the following:

• 93.2 / 115 x 100% = 81%
• 100% - 81% = 19% (WFC expected losses)
• 14.5% < 19%

Since we only have Wells Fargo reserve numbers, and we don't have WFC's portfolio data, we really don't know a thing about whether WFC has enough reserves or not. Look again at those delinquency columns (create a sum of columns 23-25 for each row, sort by the summations). A total of 32 states have delinquency rates below the national average. The three lowest delinquencies are in Hawaii, North and South Dakota at about 23%. How is WFC's portfolio distributed around the country? We do know not all delinquencies end in foreclosure, and WFC has discounted their portfolio to practically expect that they will.

WFC discounts their portfolio as if the entire portfolio will be foreclosed at the present rate of Pick-a-pay loans (19%) and that all foreclosures result in 0% recovery. Put another way, you can buy WFC mortgage portfolio for 81 cents on the dollar. That sounds like a bargain! Worse yet, we have nothing at all about JP Morgan's reserves or portfolio allocation. The article says it got some data from a filing. After all that work Eckblad did reading government filings, he can't present any meaningful data from JPM to support the headline and article innuendo. Either he wasn't competent enough to know what to look for, or the data he found didn't support the editorial opinion woven between the lines, so he left it out. Either way, you can't trust this author's expose. He comes out barking, but beneath the covers there's nothing but sheepishness.

"We're just beginning to enter the cycle of resets" on option-ARM loans, says Matt Stadler.

That's perfect, then, isn't it? Interest rates are ripe for refinancing right now. Libor (upon which many ARMs are indexed) has been falling. Resetting them now for another 3 or 5 years is just what we need to buy us time for the economy to turn around. Of course, if the United States of America in 2010 is going to become like the United Soviet Socialist Republic, then indeed, we have a problem. Don't count on it.

You can see that will a little effort, it doesn't take long to show Eckblad's main premise is lacking substance to give it more credibility than a weather report from a quick glance out the window. We hope you aren't paying for that kind of advise, and worse, basing your investment decisions on such shallow insight.

Fed Funds Hits the Upper Limit

On Tuesday June 16th we pointed out the banks don't think they need bailing out any more as no one asked for any money through the CMBS TALF operations. On Thursday, "Effective Fed Funds" hit the upper limit set by current monetary policy of 0.25%. The Federal Reserve provides daily Fed Funds Data. For many weeks now the high of the day has been 1/8 point above the effective rate (a type of average), with the effective rate steadily rising. On Thursday that affective rate "hit the limit." So what?

To the extent that people believe Fed Funds are important, and to the extent computer models make decisions based on interest rates, monetary policy, and the fed funds rate in particular, it's very important to the direction of your stocks, bonds, and currencies.

Prognosticators and speculators have been suspecting the Fed would raise the fed funds rate.

Traders’ expectations of a Fed rate increase in November surged to more than 70 percent on June 5, according to federal-funds futures contracts traded on the Chicago Board of Trade. Expectations have since fallen to show a 32 percent probability of an increase. (Source: Bloomberg, June 17)

Now you know why. The bank's reserve requirements are dictating that it should, and futures traders know what that means to interest rates, just as bond market king Bill Gross pointed out in his November 2008 Investment Outlook "So CQish". Furthermore, if the fed funds rate rises, it indicates diminishing excess reserves. In a nutshell, that means either bank lending or loan loss write offs have returned. In absence of news about the latter, we conclude it must be the former. The natural expectation then is that GDP, interest rates, inflation, and bond market prices will soon be returning to normal, and by normal we mean 10 and 20 year time frames, not 2006.

But you don't have to speculate on what the Fed will do. Their hands are tied by the market place as far as Fed Funds go. John P. Hussman, Ph.D., President, Hussman Investment Trust, pointed out years ago that market prices of federal funds force the hand of policy planners. While we can't find the exact article, we were able to find a compelling discussion of the market mechanics from 2006 titled "Superstition and the Fed":

I should note at the outset that yes, as long as investors believe the Fed matters, it is important to consider the Fed. The real issue, however, is whether the Fed actually has any impact, and my argument is that it does not. It's an argument that goes against what we're conditioned to take for granted (and even what I once used to teach my own economics students). Nonetheless, the evidence against an effective Fed, when you scrutinize the data, is fairly compelling.

We encourage you to read the full article carefully and apply it to a market moving in the opposite direction. Most notably, the federal reserve has been building its inventory of bonds like never before. We all know it's part of the Quantitative Easing policy to stimulate the economy and provide liquidity to refinance the comatose mortgage markets. The side effect is that it provides more assets to help them become more effective. Unfortunately, Congress is working against that benefit by creating a huge mountain of new debt.

Now you understand what Bernanke means when he tells Congress their deficit spending puts stress on the economy and monetary policy. Just when he has a chance to get a leg up on controlling the marketplace with a larger SOMA inventory, Congress provides Bernanke's market competition with a massive new influx of inventory of their own. One of the points Hussman made is that the size of foreign bondholders inventory outweighs The Fed's inventory 3-to-1. That was yeas ago. Only time will tell which way that ratio changes in the coming months.

If we are right and the fed funds rate continues rising, the fed will raise their target this year. The only other possibility in light of rising fed funds rates would be an announcement of yet another 'facility'. With the RMBS market still under pressure from a high level of mortgage resets on the horizon, Bernanke can't afford to let rates rise this year. Our bet is on a new facility or policy announcement that doesn't involve a target rate increase giving them some additional influence on fed funds that they desperately need.

For more on the Federal Reserve's ineffectiveness to control the marketplace, read Hussman's special study on the topic from their Investment Research and Insight, "Why the Federal Reserve is Irrelevant". First published in 2001, he provides in depth discussion of the history of American policy and the effects on the influence of The Fed on the marketplace. It may be even more important than ever as the size of other market forces grow larger. China's Treasury inventory is the most obvious, and the huge inflow of new reserves provided by quantitative easing, but those are topics for another day.

It is a common saying, one who does not learn from history is prone to repeat it. The ever-analytical C. S. Lewis explains why in his essay titled Learning in War-Time:

... the scholar has lived in many times and is therefor in some degree immune from the great cataract of nonsense that pours from the press and the microphone of his own age.

Don't be duped by the cataract of nonsense. Check back with us often, learn how to see below the nonsense that pours from the press, and post your insights and data sources here at Stocks, Bonds, and Currencies, Oh My!

FED Funds Rising

Recently Fed Funds futures have been predicting a rise in the target rate by the Federal Reserve. Many pundits talk about how unlikely that is, (especially our friends at Across the Curve).

However, few bloggers or news services point you to the actual fed funds market. The Federal Reserve doesn't control fed funds directly, they can only "help it along" with the purchase and sale of bonds (it used to be Treasurys only, but to legitimize the "full faith and credit" implied support of agency bonds they now buy those, too).

If you've been watching that market, you'll know the rate has actually been moving up toward the higher end of the range. If you are interested in the bond market, you should bookmark the Federal Funds Data.

Like the CBOE e-mail we pointed out today, you can also sign up for free e-mail alerts on Fed Funds. We always recommend you get your data direct from the horses mouth, rather than rely on some editor to tell you what it says. You might think they are experts and know how to interpret it better than you, but read this blog daily and you won't need them to think for you.

CBOE Answers Your Questions

The Chicago Board Option Exchange is a great place for both option market data as well as education. Today's Ask The Institute question was a common question many people ask (even some of those who know the option market well), namely, what happens to my puts if the company goes bankrupt? Can I still exercise the option if the stock stops trading?

Check out the answer at Ask The Institute. It might surprise you.

If you want to learn the basics of options, you can also get some nice video tutorials on basic option strategies at the CBOE Online Media Center. Click the "Strategy and Education" link under the Channel Guide on your left.

Finally, if you want to get the same e-mail alerts and news that brought this to our attention, go to the CBOE login page. The "benefits" promo links to the sign up screen to create your own personalized CBOE home page.

The End of National Currency

If the Council on Foreign Relations wasn't so full of influential powerful traditional men and women from around the world, I'd write this off as ranting from some deluded conspiracy theorist. But it's no joke -- these people really think like this and carry weight with people that matter.

In "THE RISE OF MONETARY NATIONALISM", Benn Steil, Director of International Economics, argues that national currencies create nothing but trouble for the global economy. The premise is that the troubles we've seen are created by the inability to manage economic activity because of a lack of an organized over-arching system of "good" currencies so those dumb little "emerging" nations don't mess people up with their uninformed and inexperienced economic planning.

I like the implications of the first part -- if we just had a lot fewer currencies, maybe one global one in fact, then we could regulate and manage a perfect economic world. Those darn national currency speculators are just nothing but trouble for everyone, wrecking all our lives. What we need are professionals to plan the global economy. He even goes so far as to say, "The economics profession has failed to offer anything resembling a coherent and compelling response to currency crises." Poor Benn, he appears to have been isolationg himself.

George Reisman offers a much better answer to the many global crisis in his essay, "Our Financial House of Cards". Lo and behold, he's part of the economic profession, too! The reason you won't find this in prestigious [cough] institutions like the Council of Foreign Relations is it doesn't provide men and women with the power they want over other people's lives.

It never ceases to amaze me how those who are afraid of the Moral Majority and "Right Wing Radical Religious Zealots" have no problem putting some other group in control over their private free-will behaviors. Oh no, we don't want religious slavery, but economic slavery, that's fine. How 'bout we just liberate ourselves from slavery, period?

If you plan to be an investor for 30 years you might want to read these two points of view and consider how you'll protect yourselves when "they" sell the idea of one global currency. It shouldn't be too hard. Imagine how your little lone nation has messed up your finances, then imagine what it would be like if they do it on a global scale and remove your ability to allocate your assets in some safe harbor. I suspect it won't be a very obscure idea in the next 5 years when all the global money printing press operators have had their fill and we start reaping the consequences of our new love for Quantitative Easing.

And all this time I thought it was the unregulated credit futures and derivative speculators that got us into trouble this time. Ha, so glad I now know better who the real villains are. Do you?

Banks Don't Need a Bail Out Any More

Ok, I admit, the title is a bit of a stretch. The Federal Reserve press release came out with the title "No loan requests were submitted through June 16 CMBS TALF operation".

Still, it's significant that no one needs any Asset Backed Security loans from the central bank today. Why not? How are they managing the debt? Aren't the banks supposed to still be on the verge of collapse? After all, Robert Prechter is still touting the demise of the U.S. AAA credit rating.

Well, some might say the banks are simply back to the same old tactics of denial and self-deception. I say half a trillion dollars of quantitative easing can't go unnoticed. Well, we might not see it, but the invisible hand of the market knows full well there is a lot of money sitting around that needs a home. There just aren't many places to put it other than stocks, bonds, and currencies, and the banking system has quite a hand in that middle tier.

Barclay's Capital Keeps SOMA Assets in thier indexes

The headline from Barclay's reads, "Barclays Capital Announces Decisions Regarding its Benchmark Fixed Income Index Family".

This should shore up the bond market, since many use the indices as benchmarks, and the Feds purchases will provide support (since they won’t be selling those bonds any time soon). Other pending changes include excluding certain types of asset backed securities.

I can’t find the list of directly affected index tickers.