Market Update 2 24 10 _ Bernanke Testifies

Testimony

A growing chorus of Fed officials have spoken in the last week and stated that the overnight rate ain’t going up any time soon.  It’s getting loud enough that it is difficult to ignore.  In the last week we’ve heard this sentiment from the following Fed officials:

-          St. Louis Fed President James Bullard

-          San Francisco Fed President Janet Yellen

-          New York Fed President William Dudley

-          FOMC Chairman Ben Bernanke

This morning Bernanke testified before the House Financial Services Committee that low levels of resource utilization and stable inflation expectations are combining to create a need for exceptionally low Fed Funds levels for an extended period of time. 

Additional factors cited were:

-          Weak job market

-          Unemployment rate near 10%

-          40% of unemployed have been without a job for 6 months or more

-          Job openings are scarce

Jobs

As he has done in his prior writings, Bernanke is stressing that job creation involves the extension of credit to small businesses.  He is going to work with banks to ensure that they are giving small businesses a “second look” when it comes to lending. 

More than one question in this morning’s testimony was directed toward bank lending and job creation.  At every opportunity Bernanke stressed that the Fed is working with the banks that they supervise to insure that small businesses can get access to credit.

The peanut gallery

The entertainment value of watching these sessions is priceless.  If the testimony were turned into a movie I wouldn’t know if I would place it in the “Comedy” genre or the “Horror film” genre.  It’s kind of a hybrid.

For instance, when it was Ron Paul’s turn to ask a question of Bernanke he went on a long and rambling diatribe where he accused the Fed of a wide range of activities; from funding the 1972 Watergate break in to perhaps propping up the country of Greece.  When he was finished the camera flashed to Bernanke for his response.  The Chairman looked off into the distance for a moment, mouth slightly agape, as if searching for just the right words.  When he spoke he said “Congressman, the specific allegations that you’ve made are absolutely bizarre” and “I have no knowledge of anything remotely like what you’ve just described.”

It reminded us of the scene from Adam Sandler’s movie “Billy Madison” where the following exchange takes place following Sandler’s answer to a debate question:

Principal: Mr. Madison, what you've just said is one of the most insanely idiotic things I have ever heard. At no point in your rambling, incoherent response were you even close to anything that could be considered a rational thought. Everyone in this room is now dumber for having listened to it. I award you no points, and may God have mercy on your soul.

Billy Madison: Okay, a simple "wrong" would've done just fine.

 

From the scary movie aisle comes Maxine Waters’ turn at the microphone.  This might win the train wreck of the day award.  Congressman Waters statement began well enough…we all thought for a moment that she was going to stumble into a good question…and then right when we thought she was gonna lay it down…it all came off the tracks. 

It became frighteningly obvious that Senator Waters not only doesn’t understand the difference between the Discount Rate and the Fed Funds rate…but she is incapable of understanding it even when the Fed Chairman himself is explaining it to her.

She was adamant in her belief that raising the discount rate would cause an immediate upward shift in ARM rates.  Even after Bernanke explained to her that there is no linkage between the Discount Rate and ARM rates she didn’t give up.  She pressed him for a guarantee that it wouldn’t happen.  It’s a bit like a depositor thinking you’re going to move the location of the drive-through window if they get a new car.   

She simply could not get past the fact that there was no logical basis for her question.  Despite Bernanke’s best efforts to straighten it out and get her an answer to a question that actually made sense, she clung to her initial inquiry as if she could turn it into a “gotcha” type moment.  It is both funny and sad to me that the Fed Chairman has to testify to a room partially filled with people that have no hope of even understanding the problems we face…much less be able to provide answers to them.

There are some good questions, but just when you feel like there is some hope and that the conversation is moving in the right direction, another doozey comes out. 

I’m frequently surprised by how far my little Market Update gets distributed.  I know that a few people on the list are only one “forward” away from the Chairman.  So Bernanke…if you read this…I’ll buy you a beer next time you’re in town.  I don’t know how you sit in front of that panel and answer every question with such professional bearing. 

The Big Picture

The overall tone of the testimony was that things are tough, they will stay tough for a while, the overnight rate has no reason to go up any time soon, and that we can’t sustain long term federal deficits that are several times our annual GDP.  There are more voices clamoring for fiscal restraint recently but it doesn’t have a feel that anyone is remotely close to reigning in spending.

The Market

The bond market is unchanged on the short end and up a bit from the 10 year out.  The 10-year is currently trading at a 3.66%. 

If you have any questions or if there is anything I can do just let me know.

Steve Scaramastro, SVP

800-311-0707

 

FW: Market Update 2 19 10 _ Dinner with a Fed President

A few nights ago the wife and I were synching our schedules for the rest of the week and I mentioned to her that I had a dinner meeting Thursday evening.  She glanced my direction and asked “oh, is this the thing with your little nerd group?”  The Economic Club of Memphis…yes…my “little nerd group”.  Its times like these that I really understand how Rodney Dangerfield must have felt.  She’s a bean counter anyway so I don’t know where she thinks she has a lot of room to be calling me a nerd.

So last night I had dinner with the Memphis Economic Club.  The guest speaker was James Bullard, President of the St. Louis Federal Reserve Bank (voting member).  The prepared notes to the meeting were fairly bland and best summed up by a friend of mine when he said the speech could be divided into three parts:

1 – The history of the Fed

2 – The “It’s not our fault” section

3 – The “We need more oversight powers to keep this from happening again” section

The main presentation seemed to be a PR campaign to educate people on where the Fed came from, how they do what they do, and how they helped rather than hurt the economy as we moved through this crisis.  One surprising fact in the presentation dealt with the extent to which the Fed is audited.  By the Feds estimation they undergo roughly 425,000 hours of audit on an annual basis.  This includes their internal auditors, Deloitte (their external auditors) and Board of Governors oversight.

If you could ask one question…

The Q&A session, as usual, was far more informative than the main presentation.  My question to Bullard was “given the current state of the “recovery”, when, how fast, and how high do you see the Fed raising the overnight rate?”  Based on daily conversations with bankers I knew this question was on your minds, so I went with that.

Bullard stated that in his view the market’s perception that the Fed Funds rate is going up later this year is “over blown”.  He goes on to state that they have two instruments on the table...the short term rate and quantitative easing, which gives them a degree of flexibility when it comes to executing any monetary policy tightening.  They could move the short term rate “off zero” or adjust the quantitative easing to get the monetary tightening effect that they are after.  His view is that markets get overly focused on interest rates…but they could tighten just as easily through quantitative measures instead. 

As is perfectly reasonable he answered all questions against a backdrop where the data drives the decisions.  There is no set plan that they will execute in a prearranged order…they have the flexibility to move in any direction they deem appropriate given the tone of the economic data as we move forward.

What’s that on your balance sheet?

Bullard spoke of the Feds 1.25 Trillion dollar position in MBS like it was no big deal.  He says that they’ll be done with their purchase program in March, and that they’ll be able to just sell MBS out of that position when they want to.  Listening to him speak you’d get the impression that this is no big deal...like there was nothing that could possibly hinder their plans.

He and I don’t see that program, nor it’s unwinding in the same light.  In his view they will just unwind it at their discretion.  In my view the market has just as big a say in how and when they end as they do. 

On Unemployment

Bullard received a question on whether the Unemployment Rate can return to its long term levels around 4%.  He stated that he thinks it can return to those levels over time but that it will “not happen very soon.”  He expects the Unemployment Rate to tic down but sees no dramatic improvement anytime soon.  Bullard also pointed out that while the flexibility of our labor force and structure allows us to generate very low unemployment rates it takes time for this to happen and that it will be a painful and difficult process.

That’s it.

So those are the highlights from dinner with my little nerd group.  If you have any questions or if there is anything I can be doing for you just let me know.

Steve Scaramastro, SVP

800-311-0707

 

Market Update 2 10 11 _ Prepay Tsunami coming for Freddie pools in Feb

Let the buyouts begin

 

Freddie Mac has issued a press release this morning detailing their plans to purchase delinquent loans out of pools starting this month.  As I read the press release from Freddie Mac and try to picture what is really going on behind the scenes I’m reminded of a tense scene from the movie Jurassic Park.  There was a point in the movie where the computer system that helps contain all of the dinosaurs in the safe area had to be rebooted.  There were serious concerns regarding the safety of this operation but it was viewed as necessary.  Samuel L. Jackson is the computer guy that will have to hit the button, he’s worn down from the stress, he’s smoking a cigarette, and in a gesture half filled with surrender and half filled with frustration, hit’s the reboot button and mutters “hang on to your butts people.”  This press release has the same feel.

 

The idea at this point is to pull out all loans that are 120 days delinquent.  You might be asking something along the lines of “why wouldn’t they do that anyway?”  The answer is that Freddie guarantees timely payment of P&I on the mortgage pools.  One way to do that is to just use capital to keep the loans current…basically Freddie is paying the note to keep it current rather than paying to pull it out.  The “keep it current” method burns less capital than the “buy the whole loan out” method.  The GSE’s did this extensively during the height of the crisis.  The owner of the security doesn’t care because they get their money on time, every time. 

 

Now however there are new accounting rules in place.  Under the new rules it is reportedly cheaper to buy the non-performing loans out of the pools than to simply keep them current.  Keep in mind that Fannie and Freddie just received unlimited lines of capital from the US Government…they will be able to buy as many loans as they need to buy...they are not limited in any way by capital constraints. 

 

So what does this mean to holders of Freddie MBS? 

 

At a minimum it means you should be looking for a material spike in one-month speeds as Freddie buys a bunch of loans out of the pools.  Every loan they buy will be the equivalent of a refi in the pool.  Word on the street is that they will be more consistent with this process going forward so the big spike should be a one-time event.  However…if they are going to be more consistent going forward I would expect prepays to increase by some amount across the board going forward. 

 

Essentially it looks like they are going to clear a log-jam of stuff they’ve been putting off for a while.  Once they get that taken care of it will be a “clean up as you go” process. 

 

If the new operating plan is to “clean up as you go” then prepays should definitely increase by some amount going forward as the loans will be purchased out as soon as they hit 120 days delinquent.  Will the speed increase be material on an ongoing basis?  Time will tell.

 

 

Where the rubber meets the road

 

The most immediate and concrete impact for holders of Freddie pools will revolve around sales for FEB settle.  There will be a high degree of reluctance for anyone to put a bid on a Freddie pool for Feb Settle since everyone knows that a big spike in prepays is coming.  I’m not saying there will be NO bid for Feb settle…but if you can find one don’t expect it to be wonderful.

 

My mortgage trader is saying that everyone will wait to see what the speeds were, and then bids should come back for March settle. 

 

What about Fannie?

 

Fannie Mae has not yet released such a press release but it is expected to something similar. 

 

Other stuff in the news and rumor mill

 

From a “what’s in the news” perspective this has been a very interesting week.  We’ve recently seen the market take a wild ride on concerns that Greece would default on its debt, only to have that reversed as traders around the world got comfortable with the fact that the EU would step-up and deal with the issues. 

 

We also have Iran in the news promising a big surprise and to deliver a big punch to the west on February 11^th.  In a WWF type move Iran also told Britain they were about to get “smacked in the mouth”… for those of you who’ve never stepped foot inside a mobile home,  own a Lynard Skynard T-shirt, or been to a monster truck show, “WWF” stands for World Wrestling Federation.  If these guys weren’t working on a nuke I’d actually get a kick out of watching them.  So far the Iran news doesn’t seem to have affected the markets much. 

 

Moving on we have China’s military openly calling for dumping US debt as a punitive measure to demonstrate their displeasure with our foreign policy.  There is some scuttlebutt that China is telling its larger institutions to begin selling Asset Backed Securities and Corporates and hold only Treasuries or Agency debt.  I’ve not substantiated this bit of information yet but when my sources in China wake up I’ll see what they know and I’ll let you know if they have anything to add. 

 

Someone in the office commented this morning that there is simply no telling how much money the country is saving due to the fact that a snow storm is keeping everyone in Washington from getting to work.  I couldn’t agree more. 

 

The markets

 

The bond market is fairly quiet at the moment.  The curve is relatively unchanged through the 10-year spot.  The 30-year is up 12 tics.   Stocks are materially unchanged on the day. 

 

If you have any questions or if there is anything I can do for you just let me know.

 

Steve Scaramastro, SVP

800-311-0707