All Things in Moderation

Vital Statistics:

Markets are generally flat this morning after the release of Q1 GDP, which came in light. The economy expanded at a 2.2% annual rate in Q1 vs expectations of 2.5% and lower than the 3% number in Q4. This more or less confirms the slowdown we have been seeing in other data as well. Yesterday, initial jobless claims came in at 388k.

Yesterday, the National Association of Realtors released their March Pending Home Sales Index, which is a forward-looking index of housing activity based on contract signings. The first quarter’s activity was the highest in five years. Supply and demand are becoming more balanced.  It will be interesting to see whether the banks start letting more REO go to meet the increased demand of if they continue to drip out inventory gradually.

Bill Gross continues to bet that Operation Twist continues as a mortgage play. Further, he believes that QEIII is a possibility, especially if the employment numbers weaken. Interestingly, he is also looking at this trade as a volatility bet – if you are long mortgages, you are short bond volatility – and is betting that the 10 year has more or less found its level for the next couple of years. 

A pet peeve of mine is this whole idea that the repeal of Glass-Steagall somehow caused the financial crisis. It turns out that Tim Geithner agrees with me that GS didn’t play a material role. No other country in the world (EU, Japan, UK, Canada) separates commercial and investment banking, or even draws a distinction between the two for that matter. Glass-Steagall was instituted because investment banks were stuffing their sister commercial banks with poorly underwritten bonds after the market crashed in 1929. If the investment bank couldn’t sell the paper to public at par (or close to it), they sold it to their captive banks who bought it at par and marked it there until bank runs exposed the fact that these bonds were worthless. The investment banks did the same thing with the insurance companies, which is why insurance companies were included. The point of G-S was to prevent this sort of thing and to ensure that these transactions would be arm’s length.

The financial crisis didn’t occur because JP Morgan was selling suspect bonds to Chase at the end of a gun barrel. Or Citi selling worthless paper to Travelers for that matter. The cause of the financial crisis was a deflating real estate bubble, which hit banks with large derivatives exposure (Bank of America and Citi) as well as small community banks that were in the very ordinary business of making mortgages, car loans, and business loans. It turns out that the smaller banks are the ones who can’t repay TARP. If we didn’t have a real estate bubble, we wouldn’t be having this conversation.Why did we have a real estate bubble?  There were a lot of contributing factors, but the biggest was the Fed and a psychological belief on the part of the public that real estate was a one-way bet.

People forget the reason why we repealed Glass-Steagall in the first place. The main reason was that the big international investment banks like UBS and Deutsche Bank were able to undercut the US investment banks because they were able to borrow at zero, while Goldman and Merrill had to fund their balance sheets at LIBOR. “Wall Street” was turning into Nomura, Barclay’s, Credit Suisse, and ING. Second, there were a couple of commercial banks who had become hybrids – JP Morgan and Bankers Trust – with Citi and Bank of America close behind. Glass-Steagall was becoming irrelevant anyway and the repeal was more or less an acknowledgment what had already happened.

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Markets are higher this morning on Apple’s earnings. Hard to believe a half-a-trillion dollar company could move up 10% in a day, but there you go. Bonds and MBS are lower as we await the FOMC decision this afternoon. No one anticipates a change in policy, but the market will focus on clues about QEIII. 

Speaking of the Fed, Krugman has some advice for Ben Bernake. Hint:  He’s not doing enough.

Durable Goods orders fell 4.2% YOY in March, the biggest drop in 3 years. Ex transportation, they fell 1.1%. This was far below expectations. There was also a marked buildup in inventories in the last 6 months, which portends a manufacturing slowdown. There has been nothing in the economic data in the last couple of months that indicates the economy is accelerating – everything points to a deceleration. This is mainly due to overseas weakness. The UK is officially in recession, while Europe and China are slowing.

Mortgage applications fell last week after a huge jump the week before. The 10-year spent all of last week below 2%, so maybe the refi activity is starting to dry up – meaning everyone who can refi at 3.75% has already done so.

Lender Processing Services has released its first look for March foreclosures and delinquencies. The total US loan delinquency rate is just over 7%, which is down almost 9% YOY. The number of properties in foreclosure totaled 2.06MM, the number 90D+ was 1.6MM and 30D+ was 3.5MM, for a total of 5.6MM delinquent. The full report will be released on May 1.

FWIW, Mark Zandi thinks the bottom in real estate is in. Bob Schiller isn’t so sure.

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World equity markets are recovering slightly after yesterday’s sell-off on the back of a couple of good bond sales out of Spain and the Netherlands. The Netherlands is another potential worry spot, as Prime Minister Rutte’s ruling coalition collapsed over austerity disagreements. Bonds and MBS are down slightly.

The S&P / Case-Schiller index fell to new post-bubble lows, with the index dropping 3.5% YOY. Five of the 20 MSAs showed increases – Detroit, Denver, Miami, Minneapolis, and Phoenix. Remember, Case-Schiller is a very lagged index, as the number reflects the market in December ’11 – February ’12. We are seeing the correlation between different MSAs break down, which should be good news for the homebuilders. Overall punch line of the report: Prices are still falling, albeit at a slower rate.

Shelia Bair warns of a bond bubble in the US. She raises an interesting question – Are we Europe?  Or Japan? She thinks we are Europe. I think we are Japan, personally.

United Technologies, 3M, and AT&T all reported better than expected earnings. Former highflyer Netflix is down 15% on future growth worries despite a better than expected quarter. Apple reports after the close.

Lawrence Yun of the National Association of Realtors weighs in on the future of Fan and Fred. Punch line:  Privatizing Fan and Fred in the 1970s created an untenable situation, where management took risks to maximize shareholder return with an implicit government backstop. This was an untenable situation, and almost guaranteed to end badly. It did. The question is what to do now. If you fully privatize Fan and Fred, you can expect volatility in mortgage rates and occasional market freezes. Say goodbye to the low-cost 30 year fixed rate mortgage, a uniquely American product that we almost consider our birthright. Pre-privatization, Fan and Fred performed a boring job very well. Perhaps it is time to make it official and fully nationalize them.

Chart:  S&P / Case-Schiller 20-city index:

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