Repudiation of US Financial Engineering

I have to be honest with all the readers, I am having a hard time finding much to write about since returning from vacation. Maybe it was the week off from all the news, or maybe I am just having a hard time getting back into a groove. A short piece tonight, and I will be borrowing heavily from the spectacular work of others to highlight a key point.

Housing Bottom?
The economic landscape was awash in warm feelings after seeing home sales numbers and prices that are trending up. While seasonality has something to do with this (the year over year numbers are still abysmal) many are seeing the vaunted "bottom" in housing. So is this the bottom? Well, I cannot answer.

How is that for evasive!

My opinion simply cannot be final until I get a clear reading on just how many homes are out there right now, today, with a full technical default but no action by the bank holding the mortgage. I have seen reams of ink detailing how banks are dragging their feet to move on a foreclosure even thought the home "owner" is seriously delinquent. The average rent free span a foreclosure "victim" can expect to get? One YEAR seems to be about right. This is insane and it colors the entire universe of housing related statistics. Until this question can be resolved, I will refrain from entering judgement. One may wonder why so many much smarter than I have paid no notice to this phenomena. It would be a great question to ask Ben Bernanke at confirmation hearings if he condones this kind of activity.

Repudiation of US Financial Engineering
I always check in over at the site Housing Doom on Friday's for the weekly charts of foreign central bank holdings of US debt. Over time I have been watching a particular trend that smelled bad to me, and today both Zero Hedge and Jesse's Cafe Americain jump me on the story. I would add this is a good thing as they offer finer analysis than I could have.

First off, the relevant chart (via Housing Doom August 21, 2009):

Please note that foreign appetite for treasuries was strong, but then the better returns of agency debt during the ramp up of the housing bubble (agencies; think FNM, FRE) caused a cross over in demand right at the bubble froth peak of mania in August 2005. Chasing the bubble as it trended down, many had seen enough and a huge dump of agencies ensued in August 2008. It seems banks do their business directional plays in August, who knew?

Zero Hedge cover yet another bond market story by Chris Martenson which tries to delve further into the morass of what is getting swapped for what and how. The entire piece is a must read, as the details are many and all are important.

Tyler offers this summation:

As more and more people dig behind the Fed lustrous facade, increasingly more troubling discoveries are made. On one hand you see POMO auctions that repurchase recently auctioned off securities; on the other - potential capital rotation via custodial accounts of which there is no mention in mainstream media venues. If this analysis is in fact correct, the Fed is monetizing not only the Treasuries it purchases via POMO, but effectively also the indirect bidders' treasury interest, which is represented by their rolling out of agencies purchased by the Fed, and the newly raised cash used for UST purchases. Has the Fed essentially monopolized the entire Treasury Auction process?

This is a key question that demands attention.

Jesse covers a potentially ugly reality as it relates to foreign investment in the US today as well, namely there is not much:

"...The sad truth is that US collateralized debt packages and their derivatives have become toxic in the minds of the rest of the world, and there is little being done to change that, except an orderly winding down of the bubble, with the remaining assets being divided largely by insiders, and not price discovery and capital allocation mechanisms centered by the 'invisible hand of the markets.'"

A chart from the site showing "Foreign Assets in the US - Net Capital Inflow":


I would urge all readers to spend some time on the 3 articles shown tonight, as I think they are key to understanding where we are going.

My own personal thinking on this entire picture is thus:
Foreign buyers of US debt no longer want anything to do with exotic instruments, many of which were sold under less than honest marketing. This is a repudiation of US financial engineering products.

It is not clear to me as of writing if foreign holders are a) swapping agencies for treasuries, b) selling agencies to the FED for treasuries in return, c) some combination of the two or other. What is clear to me is that this makes no sense. Spooked by agencies because they were not tied to assets that reflected any real value, treasuries are accepted instead? I would ask how US treasuries will be paid off if the US gets stuck holding the mortgage paper that is worthless, as this may dent a balance sheet!

For now a rotation into treasuries may make many feel better. The end game is that the US will have to stomach losses, unless we can hold off until things improve (and you wondered where the banks got the "pretend and extend" plan of action). In any event, the US monetization of debt across the board continues, and now I see a way where the quantitative easing can be "ended" in October, yet continue on in other forms.

The final piece that is missing here is why foreign banks would take treasuries in place of agencies when the US dollar MUST suffer as a result of balance sheet destruction. This would only make sense if you could use treasuries to buy other asset classes (other currencies, gold, oil, etc) before anything goes wrong, or you think the US dollar will not get killed as bad.

Plenty to think about here, and I look forward to watching this particular topic. Closely.

Have a good night.