I wasn’t sure whether to send this, as it reveals my lack of clarity on current events, but decided to send it to make the point.

Here’s what I see:

Markets are already discounting a large QE and are also discounting that QE actually makes a difference:

The dollar went down
Gold went up
Commodities went up
Interest rates fell
Stocks went up

So we have a big ‘buy the rumor sell the news’ leading up to the Fed meeting.

AND a potential ‘QE doesn’t work anyway’ let down.

I’ve never seen a more confused set of circumstances.
I recommend all traders stay out of this one.
Making money on this probably falls into the ‘better lucky than good’ category.

One of two things will happen- QE will or will not happen, data dependent

1. Good news for the economy means QE might not happen.

So the dollar reverses, and it went down for the wrong reason anyway, as QE fundamentally doesn’t alter the dollar, so it’s probably net short.

But how about the euro? It’s fundamentally strong with no end in sight, and good econ news helps them as much as anyone.
But an over sold dollar reversing can rally it against most everything while the unwinding goes on.

Stocks up, as that would be good news for stocks?
Or stocks down as rates go up and the dollar goes up, and the world goes to ‘risk off mode?’
(Stocks were helped by the weak dollar and lower rates.)

Is good econ news good or bad for gold? More demand in general is good, but less risk, less fear, and a strong dollar hurts. And it could be over bought in the QE craze as QE in fact has nothing to do with demand, currencies, or gold. It’s just a duration shift for net financial assets.

10 year notes? QE buying reverses and they go higher in yield.
But strong dollar and weak commodities and weak stocks and the Fed still failing on both mandates means low for long is still in place, even without QE.

It’s been strange enough that rates fell with a weak dollar (inflation) and rising commodities, so who knows what actually happens when whatever has been going on is faced with some combo of no QE and/or the realization that QE doesn’t do anything of consequence.

2. Bad news for the economy means QE happens.

Dollar keep falling? Or already discounted?
Gold and commodities keep rising? On bad econ news? And when already discounting QE working?
Stocks keep rising? On bad econ news? And already discounting QE working?

To a point, based on the presumption that QE actually works to add to domestic demand.
But has it already been discounted? And if markets believe QE works won’t they discount the Fed hiking after it works and the economy ‘takes off’???

The answer?

Don’t think of the medium term, just the short term.
Short term technicals will rule due to what’s been discounted.

The dollar is the pivot point, as it’s moved the most and for the wrong reason (except maybe vs the euro).

If nothing else, the dollar will appreciate if:

No QE due to good econ news
Buy the rumor sell the news/already been discounted forces
There is awareness that QE doesn’t do anything in any case
Foreign govt buying (currency war, etc.)

The dollar continues to fall if QE is larger than expected and the belief that it does something holds.

Recent economic news and Fed speak indicate that is not likely.

The other short term market moves will be reactions to the dollar move, and not so much reactions to what made the dollar move.

I do continue to like BMA forwards.
The one thing there is to be know is that high end marginal tax rates won’t go down, and that forward libor rates won’t fall below 50 bp.

52 Responses

  1. To me, the real news now is the mortgage paper fiasco. This is going to result in another step down in the financial crisis. It will require either1) TARP 2 (probably impossible politically), 2) putting some banks into resolution (“nationalization” is political poison), or 3) institutionalizing crime (hey, if we can institutionalize war crimes like torture, why not endemic fraud?). Take your pick. I’d pick #3 as most likely and conclude that the US is on its way to becoming a banana republic, where the rule of law and equality before the law are merely slogans.

    It looks to me like FIRE is undermining itself by using its clout to institutionalize its overreach in finance, insurance, especially health care, and RE, both residential and commercial, essentially holding the rest of the country hostage. This cannot be good for the economy, although how long it will take to breakdown is unclear. It could be quickly if the austerians become more predominant, or we could see a series of financial crises developing over the next decade, with problems unable to be addressed by a dysfunctional political system. This US mess also threatens global stability, especially since some large foreign financial institutions are shaky, too.

    Question is how markets may react to this short term. Given the administration’s record, I suspect that they will discount it, presuming a political fix. But how long such fixes can work is questionable before the system itself become questionable.

    See recent posts by Randy WrayRandy Wray, Marshal Auerback, Bill Black.

      1. Thanks, JKH.

        The question is the difference between “cutting corners” and fraud. It’s difficult to prove fraud, but that is not going to stop the civil suits, unless there is legislation that obviates it. I suspect there will may after the election another move in this direction, but there’s going to be pressure from powerful interest on opposite sides.

        This is not only an issue between the original parties to the mortgages but the parties involved in the securitization, e.g., the big banks that handled the securitization and the pension funds that bought them. There are plenty of aggrieved parties, so winding this up is going to be interesting. Without some kind of deal, there will be a morass, and it looks like it could last awhile in the courts.

        Where’s Beowulf to help us out here?

      2. It seems symptomatic of the frenzied nature of the originate to distribute model that was the catalyst for the more substantial, structural elements of the fraud where it existed. Still, that sample affidavit in the CR story is interesting to look at. It looks like a field day for some technically fraudulent book keeping activity at that level as well.

      3. I think that the question now is whether the Obama administration will place someone like Bill Black in charge with authority to go in there and find out what went down. I doubt it.

        Otherwise, a few low level scapegoats, like a few robo-signers and maybe one “bad apple midlevel exec, will be all that’s offered up. I doubt this will dispel the widespread anger, and it isn’t going to stop civil suits.

        Given the Obama’s previously demonstrated penchant to “look forward” rather than back to what happened, as evidenced in the decisions not to investigate the war crimes and constitutional violations of the previous administration and the rescue without reform of the financial sector in 2008, I think that some fix will be worked out to keep the system afloat without rocking the boat.

        But just about any fix without accountability would be tantamount to institutionalizing endemic criminal behavior, which would ultimately serve to undermine the system. The big institutions are already badly tarnished.

      4. Both parties will probably go with the quickest fix. But if the GOP takes over the House then they will be too busy investigating the president’s birth certificate to undertake serious investigations. If there is one though, you can count on a few few public wrist slaps and a another whitewash.

    1. Disappointing to see Randall Wray write such a hyperbolic and ill-informed screed. The title documentation issues that are in the headlines today have nothing to do with the fraud committed at the loan origination level. And the idea that a mortgage loan is assigned to a particular tranche of a securitization (either before or after it defaults) is so stupid that it’s obvious Wray has no clue how mortgage backed securities work.

      1. JKH’s link provides a fair assessment of the situation.

        Wray is conflating two separate issues. One is fraud at origination, i.e. creating loans that did not meet underwriting standards, along with inflated home value appraisals. The second is corner-cutting when it comes time to foreclose. Both happened, but they don’t have anything to do with each other, except in the indirect sense that the creation of massive amounts of bad loans led to a massive amount of foreclosures years later that is overwhelming the system.

        The tinfoil hat brigade (and Wray has now included himself among them) is claiming that the banks lost or destroyed documents on purpose. They are also claiming that it is now impossible for banks or servicers or MBS trusts to prove ownership of mortgage loans. I am not on the front lines of this, so I don’t have personal knowledge, but combining what I know with what I have heard from people who understand these things, I find both of these claims completely implausible.

        What I think happened is as follows:

        Mortgage loans traded hands many times before being transferred to a trust as part of a securitization. In theory, title transfer docs have to be signed by the seller and the buyer each time a loan changes hands and filed with the county land records office. In practice, the transfers were recorded electronically (just as with almost every security in the world).

        It was assumed that if the end buyer ever needed to prove ownership in a court (for the purposes of foreclosing, or whatever), then a transfer document would be created at that time, filled in properly, and then recorded with the relevant county. My understanding is that this process is generally considered valid, and that in every case it has been challenged at the state level, the courts have ruled that it is acceptable.

        One of the corners that banks, servicers, and their agents cut was to file the foreclosure action first and sign and file the transfer documents months or years later, or never (creating an affidavit in lieu). Obviously, this is improper. The remedy is to restart the foreclosure process and punish anybody for filing fraudulent documents with a court (e.g. backdated paperwork with false notarizations).

        It simply makes no sense to think that the original loan documents were lost or destroyed. They’re all filed with the county land record offices after all (many of which have publicly available, searchable online databases – I can find anybody’s mortgage loan in most counties in Florida or Massachusetts in a matter of minutes, by the way). But it is costly to dot all of the “i”s and cross all of the “t”s on an individual mortgage loan. It’s a manual process, and the servicers wanted to avoid it.

        So were some of the foreclosure practices fraudulent? Yes, they were, but there are degrees of fraud, and this was of the very, very minor variety. The net effect of the fraud was to advance the foreclosure timeline marginally for many homeowners (thus giving them less time to live rent-free) and to make the foreclosure process less costly (thus saving money for banks, servicers, insurers, bond investors, and the government). It’s a scandal and a headache, but a pretty minor one compared to what we’ve already seen over the last 3 years.

      2. That makes sense to me. Two separate issues. Fraud at origination and fraud where false affidavits were signed.

      3. Not sure I agree. Existing law can be very powerful when wielded by a good attorney. I see a class action settlement in the future.

        If the paperwork isn’t proper, the loan likely exists but it likely won’t allow for a forced foreclosure. Instead the bank could have to stand in a bankruptcy line with all other creditors. Bankruptcy by itself usually won’t force the liquidation of a principle residence and could instead result in a ‘cramdown’ determined by the judge.

        Also reading up a bit on REMICs, it does sound like they have very tight restrictions on the types of transactions they can make without incurring very high penalties. Wray seems to believe they made mistakes and are now subject to the penalties.

        “Though REMICs provide relief from entity-level taxation, their allowable activities are quite limited “to holding a fixed pool of mortgages and distributing payments currently to investors.”[22] A REMIC has some freedom to substitute qualified mortgages, declare bankruptcy, deal with foreclosures and defaults, dispose of and substitute defunct mortgages, prevent defaults on regular interests, prepay regular interests when the costs exceed the value of maintaining those interests,[23] and undergo a qualified liquidation,[24] in which the REMIC has 90 days to sell its assets and distribute cash to its holders.[25] All other transactions are considered to be prohibited activities and are subject to a penalty tax of 100%,[26] as are all nonqualifying contributions.”


      4. from Wray:

        it is not enough in 45 states to have an affidavit. this is a violation of state law and also of IRS tax code.

        in some reported cases 98% of the notes are still with the originators, who in some cases have gone bankrupt. back taxes are owed on all this stuff and since there are no longer any employees there is no way to do the docs now. this is why they are being manufactured, falsified

        second we have many people inside the industry who say the docs were indeed destroyed. even now during the foreclosures they have untrained secretaries tossing docs.

        i gave 2 cited explanations for the industry’s failure to follow rules. this guy just wants to claim it was a tiny little oversight. that is not plausible. 98% failure rate to follow the law? it must be purposeful. so what is the explanation?

        this is a scandal. this is why they have been foreclosing on the wrong people. fraud is rampant through the industry.

      5. right – I should have said origination fraud is the economically material one; both are legally important

    2. Tom,

      It looks like they are going to need a TARP2 if they have to sell all the foreclosures…I cant see that happening the public will not stand for it….Maybe they could convert all bust banks (which looks like most) into a giant residential REIT, and rent the REO houses out….

      Then take the 1.4T that the corporate non-financial sector (per latest Z.1) has in cash and capitalize an entire new banking industry capable of 15T+ in lending… only this one would be owned and operated by/for productive capitalism.

      Somebody is going to have to come up with something post election or we’re going to be a country with a lot of vacant housing for a long time.. In my area now, new homes are a better value than an existing homes, and as far as REOs it is often hard to get financed on a REO as they are usually run down, then the bank doesnt want to reduce the price enough to get the rehab work done so they are stuck. Catch-22 for them, if they reduce the price to get it sold, they take a hit to capital, if they leave it vacant, the property continues to degrade which ultimately makes the eventual day of reckoning even worse (Outside of politics FIRE is indeed stupid).

      It’s going to be interesting to see how the Tea Party types who get into Congress vote on this one…they could be the swing vote on this.


      1. Bond Market Association?

        Whatever they are, I just dug up a pot of them buried in my garden. My Nigerian bankers are sending Warren some emails, requesting a minimal deposit of a few million so he can get all my treasured BMAFs.

    1. BMA ?

      The BMA Municipal Swap Index (“BMA Index”, formerly PSA) is a market basket index of over 200 active high-grade, governmental, tax-exempt, variable rate demand obligation bonds with weekly interest resets. The BMA index is the market benchmark for short-term, tax-exempt rates. See http://www.bondmarkets.com and select “swap Index” for a description, including a 10-year history of rates.

    2. Boy, what a helpful crowd.

      BMA refers to the Bond Market Association index for a certain kind of AAA-rated floating rate municipal bond. It’s the tax-exempt rate equivalent of LIBOR. There exists a market for BMA swaps where one side receives/pays the BMA index rate, and the other side receives/pays either LIBOR or a fixed rate.

      It’s been a while since I’ve been involved in this market, so I may have it backwards, but I think the lingo is reversed so that it lines up with regular fixed-for-floating Libor swaps. That is, if you receive BMA on a BMA swap, then you are actually receiving a fixed rate and paying the floating rate BMA index. Thus, you are synthetically long a fixed rate municipal bond if you are receiving BMA on a swap.

      If you like BMA forwards, then it means you want to receive fixed on a BMA swap starting some years in the future. You think that fixed rate municipal bonds are too cheap in price (too high in yield), and that the effect is pronounced as you go out further on the curve.

      Warren is saying that the implied forward yields on muni bonds is too high versus equivalent taxable synthetic bonds (i.e. fixed-floating Libor swaps). One can think about this mispricing in terms of implied tax rates. The cheapness of muni bonds far out on the curve means that the market implied future tax rates are way too low.

      Ironically, if Warren got some traction with his MMT prescriptions, it would lower future tax rates, make muni bonds less attractive in the future, and hurt the trade he is advocating now. He either doesn’t believe he will have any impact on future fiscal policy, or he is hedging his bets.

      1. I’m not familiar with this, so some dumb questions:

        So it’s a forward start for receive fixed swap?

        Why forward? Because there’s no value in the near term curve ? Too flat?

        I realize the underlying is tax-exempt, but these swaps actually deliver tax-exempt interest income on the receive portion? The swap income is tax effected in the same way as the underlying?

        Does the mis-pricing occur on the non-taxable curve or the taxable curve, or can you tell?

      2. Per last point, to the degree it’s tax driven, don’t you want a spread trade?

        receive fixed non-taxable; pay fixed taxable?

      3. Good questions:

        “So it’s a forward start for receive fixed swap?”

        Why forward? Because there’s no value in the near term curve ? Too flat?
        Yes, short-dated muni bond yields are pretty close to the yields on taxable equivalents x (1 – T) where T is the highest marginal federal income tax rate. The risk premium due to tax rate uncertainty, illiquidity, and creditworthiness do not seem to kick in until you get out past 3-5 years.

        “I realize the underlying is tax-exempt, but these swaps actually deliver tax-exempt interest income on the receive portion? The swap income is tax effected in the same way as the underlying?”

        No, the swaps are normal taxable instruments. The IRS does not allow people to create tax-exempt instruments out of thin air. If you were to buy muni bonds and hedge them by paying fixed on a BMA swap, there would definitely be some tax issues to deal with. Your hedge ratio would not be 1:1 because the Federal government would essentially be your partner on the swap trade.

        “Does the mis-pricing occur on the non-taxable curve or the taxable curve, or can you tell?”

        The mispricing is in the tax-exempt curve. Muni bonds are strange beasts. Of course, munis have always been very cheap when you compare them to taxable bonds on an after-tax basis. Buying BMA swaps has been a bread and butter trade for Warren for a very long time. But there are apparently sophisticated considerations that make it look more attractive now than usual (see Warren’s cryptic comment about how forward Libor rates won’t fall below 50bps — I think I understand this, but it would require some work to explain).

      4. “Per last point, to the degree it’s tax driven, don’t you want a spread trade?
        receive fixed non-taxable; pay fixed taxable?”

        Yes. That’s why Warren has to believe that forward Libor rates won’t drop below 50bps. If they did, he would lose more on his pay fixed Libor swap than he would make on his BMA swap.

      5. Thanks. Now I’ve learned something today, offsetting the time I’ve probably wasted beating my head against the arguments of a couple of monetarist economists.

      6. it’s because the euro dollar (libor) futures are higher further out. the trade ‘breaks down’ when 3 month libor is below maybe 50 bp as rates are so low
        the economics of the % of libor are less powerful than the technicals of the weekly auctions, and investors lose interest in the auctions because rates are so low it doesn’t matter enough to participate.

  2. So we have a big ‘buy the rumor sell the news’ leading up to the Fed meeting.

    Well its more like “frontrun the insider tip and sell the news”, its a crooked market Warren.

    In all the commotion over yesterday’s FOMC announcement, some may have missed the following line uttered by the Newportbeachian [Bill Gross]: “What is important going into November is the staff forecast for economic growth for the next 12-18 months. Our understanding is that the Fed is about to downgrade their forecast from 3% down to 2%.” At which point the CNBC anchors conveniently confirm that Mr. Gross just disclosed something which is completely non-public: “We don’t have that forecast yet, right Steve?.. We won’t get that for 3 weeks Erin that’s when it comes out with the minutes of this meeting.”

    Reuters has just released a stunning special report detailing how the Fed leaks all important, non-public, and ever so material, information to private parties.

    And yes, the Treasuries market is covered by SEC insider trading rules.
    Ex-fund manager liable for insider T-bond trading
    Mon Jun 22, 2009 5:49pm EDT
    * Jury finds ex-MFS executive liable for insider trading

    * MFS bought $65 mln in bonds before official announcement

    1. Besides the GM IPO can not fail.

      Larry still retains power, until January, right?

      I’m betting QEII will be implemented on schedule, economic news will not be sufficient to derail it.

      The rising stock market is good at least until Jan 2011 when Larry officially retires and GM IPO is named a ‘success’.

  3. Interesting idea on Fed capital:


    It’s all a wash and irrelevant in MMT terms, of course.

    It’s also very unlikely to be needed.

    But it’s a point of risk for institutional optics now in place.

    First time I’ve seen this suggestion.

    TARP for Fed? Or forbearance?


    1. Next Fed officials will claim they deserve million dollar fees for making the Fed so ‘profitable’.

      Bernanke will ‘need’ a $400 million retention bonus or he might move on the ECB.

      As the California surplus proved, extra cash is corrupting.

    1. Not so.

      9% budget deficit still chugging away in support of earnings, along with valuation help from low for long policy.

      I just see a lot of near term risk with this whole confused qe thing which has been pushing traders and portfolios into selling off the dollar possibly reversing.

      1. Regarding “valuation help from low for long policy”, how do you explain why low rates have not helped valuation multiples in Japan? (I don’t mean to keep focusing on this topic, but it is very widely discussed right now and I respect your opinions).

        The third chart here ( http://pragcap.com/shifting-correlations ) shows Japan stocks’ price/book ratio peaking around 5 and drifting down to around 1, despite low rates. US stocks’ price/book also peaked around 5, and is closer to 2 now. Why would ours diverge from Japan’s precedent and go up not down in conjunction with low rates, beyond the short term?

        (I can think of two potential reasons myself… we might sustain lower REAL interest rates if our disinflation abates, and we might price in higher growth, partly as a result of demographic advantages… but overall I’m still not sold on the low rates drives high [medium term] valuations argument.)

      2. how about PE’s in japan rather than price to book? why would an investor care all that much about book? an equity position represents the cash flow from earnings.

      3. I agree that earnings matter more than book, but it’s been extremely difficult to find any reliable earnings or dividend information on Japan’s TOPIX (I’ve looked several times in the last couple years). If anyone knows how to get at the data or even decent graphs of it, I’d love to hear it.

        From the smattering of [possibly unreliable?] results I see now as I look again, it appears Japan’s P/E ratio has trended down mostly continuously since 1990, despite nominal interest rates falling to about 1% by around 1998. And reports of earnings yield within the last couple years have showed it in the 5-6% range (thus P/Es in the 15-20 range), which is still substantially higher than bond yields that are closer to the 1% vicinity. So if low interest rates are a force in driving up equity valuation multiples, it seems that in Japan at least there may be a stronger opposing force driving them down.

        Ah, here we go… the economist magazine is probably reliable (1998-2005 graph):


        Other than a large correction around the 1998 recession (when earnings probably fell sharply without prices falling as far), valuation multiples have been trending down since the early 1990s, despite falling and then very low interest rates.

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