Wednesday, March 10, 2010

A Random Look At RMBS And The Economy

¹²A Random Look At Rmbs And The Economy

By Karl Denninger, Marketticker | 10 March 2010
Mar 10, 2010

From The Forum:

A random assortment of 2006 and 2007 securitizations from our friends at JP Morgan and Countrywide (mostly.) The last number is the 60+ delinquency percentage. A lot of this is Home Equity lines.

Remember my Ticker yesterday and my rant on Blogtalk regarding Barney Frank and the outrageous hidden losses being carried by our banks? That none of this is being pursued, yet every week we see proof of it in FDIC bank seizures and the loss ratios? That this sort of book-cooking, were you or I to engage in it in a public company, would lead us to be criminally charged? That, in fact, this is exactly what Ken Lay and Jeff Skilling were charged with doing?

Folks, this is endemic throughout the financial system. The best performing issue on that list has a 60+ delinquency rate of 35.8%. A material number of them have more than half their loans in hard default.

Every home equity line behind an underwater first that is also not being paid is worth zero. There is no recovery. This is not like most bonds, where there is a meaningful recovery percentage after the default happens. This is subordinated debt that is worth exactly bupkis if the senior lien cannot be fully satisfied from a foreclosure on the property.

These bonds are literally everywhere. They're in pension funds. They're on bank balance sheets. They're held by The Fed through the garbage Fannie and Freddie paper they bought. Foreign governments and foreign banks hold them.

Yet we have banks that are carrying very similar portfolios of loans on their books— second liens, either home equity or "silent seconds" used to get around various ratio requirements such as PMI on loan origination, and essentially none of them are being carried at anywhere close to these levels of loss. There has been no— and I do mean no— recovery of balance sheets in the United States when it comes to financial companies, pension funds or anyone else holding this crap. Zero. Zip. Bupkis.

Servicers have in some cases, it appears, even co-mingled funds in order to advance coupon payments, which has the effect of hiding these delinquency rates from investors. For a while. But, cash flow always wins though folks.

I continue to hear "look, the market has a year under its belt now from the low, this means that it's a long-term bull market and will go higher for years to come." Ok, let me make a major point then ask you one question— and I will not provide the answer: You will, by doing your own work, because if you don't, then you won't take responsibility for your own outcomes. If you're in that camp, then stop reading The Ticker right now and start watching Jim Cramer on CNBS.

Every previous recession and market swoon post WWII had, by the time we were a year from the bottom of whatever it was that ailed the economy going in, been resolved. Let's go through a few of them:

  • In the 1970s by this time oil prices had relaxed and the risk of the embargo was over.

  • The S&L crisis, at this point, was under control— the S&Ls were under FDIC control, people were being sent to prison by William Black (and others), and we had a dimension on the losses and who had done what to whom (those loss estimates turned out to be way low, but at least we knew where they were.)

  • Post-1981 recession interest rates were on their way down; the back of inflation had been broken.

  • Post early-1990s the California military bubble had popped and was mostly mopped up.

  • By the end of 2003, most of the Internet companies that had no business being in business were gone and buried; their bogus claims had led to their demise, and they had filed for bankruptcy.

Now let's contrast this with today:

  • The credit default swap monster has not been caged. In fact, there has been no change whatsoever in how these are traded and written. Nor has anyone in the banks been indicted even when there is evidence of blatant wrongdoing (as in the bribery case of Jefferson County Alabama.)

  • All of the large banks, and a lot of mid-sized banks have enough second line exposure on their balance sheets written in the bubble states, carried at or near full value, to severely damage their capitalization ratios if not outright force them into receivership. Not one of these institutions is marking their second line exposure to anywhere near what the delinquency rates in these securities implies about their recovery values. Yet these are real current losses and the overwhelming evidence says that the impairment is permanent.

  • Existing home sales numbers have [[temporarily?: normxxx]] flattened at an extremely low level, even with the $8,000 tax credit. This implies that the value of this credit has been reached in the marketplace, and that no actual recovery in housing is or will take place in the near term [[and probably not for another year or so— certainly not until after the Alt-A ARMs refi peak of 2011: normxxx]]. Yet the entirety of the premise that the economy has turned the corner— some 20% of GDP is housing related— rests on the belief that housing is in the 'process of recovery'.

  • We are told that the auto industry has "recovered" with an estimated annual sales rate of 11 million cars. The peak of the auto production cycle was seventeen million. Even if half of that difference remains to be recovered, it will leave some 17% of that capacity idle and those people who used to man it unemployed. Where are they going to go for jobs?

  • The labor employment rate (of all employable adults) is back to levels last seen when we had less than half the consumer and industrial debt in the system we have today as a percentage of income. This sort of job loss into ramping debt has never happened before in the post-Depression era. How are the interest/mortgage payments to be made by the unemployed?

  • The 'lockup' in credit markets and economic malaise that followed occurred as a direct result of fraudulent balance sheets— that is, claims that firms had liquidity and assets that in fact were false. When that falsehood was unmasked they failed instantly, as occurred with ENRON and MCI. Do we, today, have balance sheets that accurately reflect the valuation of all assets by firms across the economy— not only in banks, but also in firms like GE and GM and CISCO?

  • The government is literally providing 9% of GDP via deficit spending that exceeds the records set during the 2003-2007 years. That is, they've replaced a full nine percent of the economy's final demand since 2007 and, despite the claim that the economy is 'recovering', the amount of replacement activity they're supplying has increased since the spring of 2009 and continues to do so. If the government is going to supply this replacement for the indefinite future and that is necessary to avoid the recognition of an instantaneous economic Depression (defined as a 10% contraction in GDP) can the government continue to do so on an indefinite forward basis?

  • The entirety of the market rally from March of 2009 to today, and its sustainability on a forward basis, is dependent on the above— especially the government being able (and willing) to continue in its new role of providing 9% or more of GDP (beyond what it used to provide, of course!) along with the continuing ability to mark assets that are worth little or nothing to well above their actual market prices.

DO YOU BELIEVE that this can and will occur on an indefinite forward basis?

If you do, then you should be fully invested here and now, because indeed, profits will continue to advance, revenues will continue to advance, and the market will continue to advance. We have a new bull market predicated on The Government legalizing balance sheet fraud and indefinite forward support of nearly half of the GDP all-in-all (total State and Federal spending is close to 50% of the GDP), with that additional 9% of the last two years continuing into the indefinite future (and likely expanding too, especially with "health care" reform.)

If you do not then you should be hiding under the desk, because just as occurred in 2000 and 2008 when the breakpoint comes it will occur without warning, without recourse, and without the ability for you to get to the exit in time, and since the amount of the fraud and bogosity exceeds both the 2000 and 2007 levels by far, so will the reaction— when it occurs.



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