The housing Crisis has spurred "Forgiveness Loan Initiatives" by Ben Bernanke. Could be the last tool in his shed, but he can't use it without the big banks cooperation, & banks ain't cooperating. Forgiveness in a tight credit environment is a mind-blowing oxymoron. With or with out forgiveness, the US financial system could implode causing a debt deflation spiral.
30 Year Returns to Feb 7 ECB Low on Eve of March 6 ECB meeting
Since the 30 year has returned to the Feb 7 ECB low at 11607 and to the year close at 11612 by trading down to 11606 on Thursday, it may prove helpful to review recent statements in the past month by ECB members Axel Weber, Trichet amongst others. I suspect the tone of this ECB statement will be more hawkish than last months, and so, will not present the downside risks to the treasury markets as happened last month - indeed, there may be upside risks to the treasury market instead.
Secondly, as for tomorrow's trade, investors should also note that the wide range down day for treasuries on Feb 7 was largely exacerbated by the one of the worst 30 year auctions in history. There is no 30 yr auction for tomorrow's trade, so that downside risk to treasuries will be eliminated.
Before I can review recent ECB statements pertaining to inflationary pressures abroad, please excuse the unusually large digression which follows pertaining to the growing risk of debt deflation that the US apt to face in the weeks and months ahead. (This newsletter is morphing into something entirely larger than what I had intended when I started). From an intermediate viewpoint, debt deflation risks are another bullish input for treasuries, suggesting risks on balance will remain to the upside for the treasury markets.
Fed Chairman Bernanke spoke last week before the Senate about "forgiving loans" to homeowners with either negative equity or no equity in their homes. This is not just some innocuous remark. That remark is anything but harmless, and its implication is just beginning to "sink in."
When the Fed Chair suggests we forgive mortgage loans, this should scare the bejeezus out of anyone feeling the risks of a 'debt deflation spiral' like the early 1930's were already escalating before Bernanke's comments about forgiving the loans. We must remember that many of these loans Bernanke is attempting to save from foreclosure homeowners who don't have enough equity in their homes. Undoubtedly many of the homeowner loans at risk of foreclosure were secured with either a No Doc loans or Ni-No loans - mortgage loans with no inc/no down payment.
President Bush's Zero-Down Payment Initiative
In Feb 2004, President Bush passed the "Zero-Down Payment Initiative." By the end of 2005, the Nat'l Association of Realtors reported that More than four out of every 10 recent first-time home buyers financed their purchases with no-down-payment loans. The median down payment first-time buyers was just 2 percent. For all buyers, it was 13 percent.
Median home prices peaked approximately at $230,000 in 2005. 2% of that valuation is $4,600. Today, the median home price, as of January 2008, had fallen to around $208,000. The loan value outstanding today is still around $225,000. Negative amortization of median first time homeowners is approximately $17,000 or 7.5% and growing.
The No-No homeowners that could not show income documentation a few years back likely can't show income documentation today. So with stricter lending standards today for previous No-No and Ni-No homeowners to qualify for forgiveness, new loans would have to be restructured to at least show their income.
Bloomberg reports that Bernanke also indicated a greater willingness to consider using government funds telling lawmakers last week that it was ``worthwhile'' to consider using public money if the housing contraction worsens. Paulson said the use of taxpayer money would just be another ``non-starter.''
``The risks are very high that the steamroller is not going to be stopped. The window's going to close very quickly, and they have about six to 12 weeks to figure out what's next,'' said Mark Zandi - chief economist of Economy.com.
You Can't Overestimate How Tight Credit is Right Now
Banks this month aren't even lending in the auctions for 70% of the AAA municipal securities markets. ``There is a palpable crisis of confidence. You can't overestimate how tight credit is right now'' Jack Dunn, CEO of FTI Consulting Inc., which advises businesses on litigation, bankruptcies and restructuring, said in a Feb. 28 interview.
The housing boom began during WWII. The run-up in home ownership from 1940 to 1960 was unprecedented. The booming war economy and sustained prosperity coupled with government guarantees of low interest mortgages to returning war vets fueled the boom in homeownership. By 1949 lawmakers enacted the 1949 Housing Act which articulated the goal of "a decent home and suitable living environment for every American." That act would have far reaching affect on housing policies for the next 60 years, right up until President Bush signed into law the "Zero Down Payment Initiative" in early 2004. Arguably, we can point to Bush's "Zero Down Payment Initiative" as the straw that broke the camel's back in this 60 year credit boom.
As for Bernanke's "Forgiveness Loans" following Bush's "Zero Down Payment Initiative," we can "Fuggetaboutit. It would appear as Paulson says another "non-starter," or as CEO Jack Dunn put it the other day `` You can't overestimate how tight credit is right now.'' If Jack Dunn is right, and this tight credit persists much longer, Soros may indeed be proven correct that we have reached the end of a 60 year credit boom. Mark Zandi gives the interventionists until mid April to June 1, at best and forewarns that no matter what they do, the "risks are very high that the steamroller is not going to be stopped."
Heck, it has taken New York Insurance Superintendent Eric Dinallo a full six weeks to "almost" raise a stinking $3 billion dollars for bond insurer Ambak amongst the major financial institutions. If the major banks are loathe to cough up stinking $3 billion for a bond insurer, and at the same time are refusing to bid on 70% of AAA muni auctions this past month, just how far do you think Gentle Ben is going to get with them when he sits down to discuss forgiveness loans.
With Forgiveness Loans are for all intents off the table of reality, Bernanke's remarks is a virtual concession the US economy is up the proverbial creek without a paddle. All of which implies the US economy is going to experience some sort of debt-deflation spiral over the next several months persisting perhaps several quarters. I can't see how it could be otherwise. If you had to imagine a more bullish script for US treasuries across all spectrums of the yield curve, you'd have a hard time coming up with a better one than this economic backdrop. That said…
Looming US Debt Deflation Amidst Worsening Global Inflationary Pressures
Years ago, Greenspan spoke of the need to create a 'firebreak' to cushion the economy against deflationary shocks. With the fed funds rate at 5.25% in August 2007, there was ample room to cut rates to cushion the US economy from a downturn. As the Fed fights off a looming debt deflation spiral in the US, with its aggressive rate cuts, they are at the same time eroding the purchasing power of the US dollar.
Since crude oil is priced in dollars, and many countries are de facto pegged to the US dollar, global inflationary pressures are running amuk. Foreign central bank goals of "price stability" in these countries is more difficult than ever to achieve. Individuals in China, for example, have even begun to hoard food to the point where people have been trampled to death in the marketplace. Inflation is enjoying a veritable boom in Russia, Eastern Europe, Australia, China, India, South Africa and the countries I know of experiencing inflation pressures
Returning to Trichet and the ECB
Yes, Trichet offered some dovish remarks about worsening financial turmoil in his Feb 6 ECB statement that helped to pressure the 30 yr lower that day. On Feb 26, the German business confidence unexpectedly rose for a second month in February, which will augment the ECB's desire to leave interest rates at a six-year high. ``It shows all the doom and gloom is misplaced,'' said economist Kenneth Broux at Lloyds TSB
On Feb 27 Greenspan notes that the "growth in money supply in Russia has been very large, well in excess of nominal GDP, and this is a major factor, I think, in the upward pressure on prices." Inflation in Latvia accelerated to 15.8% in January, the quickest in the EU. Poland raised its benchmark on Feb 27 to 5.5% to quell inflationary pressures. Inflation in the 15 nations sharing the euro accelerated to 3.2 percent last month, the fastest pace in 14 years. The ECB aims to keep the rate just below 2 percent.
``The consensus expectation for interest rates on the market at the moment clearly underestimates, in my opinion, the inflation risks. `In 2009, inflation will not slow as markedly as supposed.'' said Bundesbank President Axel Weber, said in a Feb 27 speech. Weber added that the inflation pressures were not just in Europe, but in the US as well, "where PPI rose in January at the fastest pace in 26 years."
``Interest-rate expectations for the euro region don't reflect the monetary-policy assessment of a central bank that's obliged to maintain price stability. `Be assured, our aim is and remains price stability in the medium term.''
So what is my bottom line for the impact of the ECB statement on 30 year Thursday morning? If the statement is not as dovish as last month's Feb 7 statement, and the 30 yr is not below the Feb 7 low at 11607 or the year close at 11607, then up she goes - at least for the day. NFP may have an upside surprise since expectations are so low, but that is a story for tomorrow afternoon to consider.
For more info, with charts on homeownership from 1890 and the 30-yr treasury and Part Two of "Every day feels like the 1987 stock market crash", go to SuccessfulTradingTips.com.