Thursday, April 1, 2010

April Fool's Day

Life is full of signposts and I wonder if today will represent one of those markers.

Beginning in January 2009, and every single business day since then, the US Federal Reserve has been buying up Mortgage Backed Securities.

The program, which ends today, will have transferred $1.25 trillion of MBS 'on behalf' of the US taxpayer. This now represents the single biggest asset on the Federal Reserve's balance sheet, and backing up such liabilities as currency in circulation.

Think about that for a second.

As you know, the US housing market is not faring well and is expected to continue to drop in value. This means the US Dollar is collateralized more than half by rapidly devaluing, and in many cases cash flow non-producing houses and excess reserves.

At midnight last night the Fed's MBS program ended, and the market is now on its own for the first time in over one year.

What happens next is anyone's guess.

But with the Federal Reserve having gone all in and then reraised tenfold courtesy of fractional reserve banking, it is difficult to believe that the Fed will allow house prices to drop further.

Which is what is going to happen in the market sets interest rates on it's own.

Are we going to see the Fed immediately reinstitute QE at the first hint of mortgages at or approaching 6%?

Let's face it, a 1% widening in mortgage rates will be the equivalent of a several hundred billion loss in household net worth.

Meanwhile there is the growing concern of the debt problems of individual states.

California, New York and other states are showing many of the same signs of debt overload that recently took Greece to the brink — budgets that will not balance, accounting that masks debt, the use of derivatives to plug holes, and armies of retired public workers who are counting on benefits that are proving harder and harder to pay.

California’s stated debt — the value of all its bonds outstanding — looks manageable, at just 8 percent of its total economy. But California has big unstated debts, too. If the fair value of the shortfall in California’s big pension fund is counted, for instance, the state’s debt burden more than quadruples, to 37 percent of its economic output, according to one calculation.

Jamie Dimon, chairman of JP Morgan Chase, has warned American investors should be more worried about the risk of default of the state of California than of Greece's current debt woes.

Dimon told investors at the Wall Street bank's annual meeting that "there could be contagion" if a state the size of California, the biggest of the United States, had problems making debt repayments. Dimon believes California poses a greater threat than does Greece.

If markets force the weak hands, as they always do, will it be Bernanke and the printing press to the rescue? Or will the bond market be allowed to push interest rates up to punishing levels as is the current Greek experience?

And then there is the Canadian situation.

The Bank of Canada warned in late 2009 that up to 10% of Canadian homeowners might be in danger of losing their homes when interest rates started to rise from last week's historic lows.

In the United States, subprime represented far less than 10% of the US housing market. It's collapse triggered complete chaos in the housing market. Is Canada heading down the same path as our neighbours to the south? Are we looking at a mortgage meltdown somewhere down the road?

On the day of fool's, there is much to ponder.


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1 comment:

  1. I like your blog, but you need to attribute direct quotes. Much of this post came from: