Consumers rewarded for defaulting on mortgages

Eleven banks, including Bank of America, Citi, and Morgan, have begun sending checks to "victims" of the robo-signing scandal, by which banks foreclosed on mortgage defaulters without observing proper procedures.  The cost to the industry, and therefore their shareholders and depositors is $9.3 billion.  Of the $9.3 billion settlement, $3.6 will be distributed to the victims in the form of cash payments. There are 4.2 million of these victims; a case-by-case review has found that only 53 of the 4.2 million were not actually in default.  (Yes, the number is 53.)  So the others (4.2 million minus 53) were in default.  This is why they are being compensated.

It's a little sad that people who actually paid their mortgages are not being compensated.  But such is the way of the world.

"Frustrated central banks move into riskier assets"

This is the title of an article on page 2 of today's Financial Times. Central Bank Publications and RBS have surveyed 60 central banks and these banks expressed dissatisfaction with artificially low interest rates on reserves currencies and fear for the consequences of unbridled monetary expansion as practiced by the Fed and others.  These banks hold $10.9 trillion dollars, most of which reserves are in Asia and the Middle East.  They have been diversifying into non-traditional currencies like the Canadian and Australian dollars, the Chinese renminbi, and the Scandinavia currencies.  Here is a quote: "The response to the crisis by these monetary authorities has had a profound effect, the poll found: more than four-fifths of the respondents said the aggressive monetary easing of the US Federal Reserve and the European Central Bank had altered their behaviour."

The chance of a dollar crisis is rising, but it is hard to see where central banks will go.

Chairman Ben and the lost boys (and girls) in Neverland

Each year, when it releases its full transcripts of the Federal Open Market Committee (FOMC) from five years ago, the Fed invites us to cast our minds back to a place long ago and far away. The conversation around the conference table at the Fed's Washington headquarters on January 30 and 31, 2007¹ seemed to take place in Neverland rather than on the verge of the worst financial crisis since the Great Depression.

Housing starts had fallen steeply from almost 2 million (annual rate) in early 2006 to about 1.1 million at year end, just before the FOMC met. The Feds were not worried however (there are few worries in Neverland) because their model predicted that the rate would soon rebound to a normal 1.3 million level. Problem solved! (But in fact, starts fell to 400 thousand by the end of 2008.) The FOMC did fret pleasantly about inflation, however.

In fact, only a relatively few paragraphs of the 200+-page transcript were devoted to the housing crisis. Here is a sampling. Moskow of the Chicago Fed said that that “the economy is clearly showing more underlying strength than we thought in December.” Lacker of Richmond commented that “each batch of housing data has bolstered my confidence in the trajectory we sketched out last fall – namely, that a drag from housing will mostly disappear by midyear with spillover having been relatively limited.” Gov. Bies said, “we feel very good about overall credit quality.” Gov. Mishkin commented, “we're not seeing anything out of the ordinary or a persistent pattern, and that gives me more confidence that nothing bad is going to happen here.” (Mishkin had co-authored a study proving that nothing bad could happen in Iceland either.) Bernanke summarized: “The general view was that housing would cease to subtract from growth later this year.” Yellen of San Francisco agreed: “Housing remains a concern, but I think the prospects for a really serious housing collapse that spreads to consumer spending have diminished substantially. . . To me the upside risk to inflation seems palpable, especially because labor markets have tightened.” (Yellen is the reputed front-runner to succeed Bernanke, assuring a continuation of .. . ah . . continuity; the magical Veil of Nescience that Dr. Greenspan bequeathed to Chairman Bernanke seems to sit well on her brow.)

The Fed GDP forecast at the meeting was a cheery 2.2% rate in the first half of 2007, 2.4% in the second, and 2.5% for 2008, not the 2% for 2007, 0% in 2008, and -4% in 2009 that actually befell the world outside of Neverland. Back on planet earth alarm bells were ringing non-stop.² Barrons had suggested in August 2006 that housing prices could drop 30%. At the Davos conference just before the Fed meeting, Nouriel Rubini made dire predictions, and the Bank for International Settlements warned of a deepening crisis. Despite these warnings, the Fed stuck to its rosy scenario because in Neverland every time someone says “I don't believe in fairies” a fairy dies.

Even Euromoney seems to have got it right! In the January 2007 cover story, “The world on the cusp,” which was well-illustrated by a drawing of a world on a cusp, Clive Harwood introduced a series of articles that presented “the view that the state of global imbalance must come to an end soon, and with painful consequences.” Charles Dumas predicted “a hard landing followed by poor recovery,” that would “likely cause severe deflation.” Brian Reading followed by stating that “the world is suffering unprecedented financial imbalances” and that “their inevitable reduction . . . will dominate global growth prospects. . .”

But even in Neverland where all stories have happy endings, drama exists. Think of Hook and the crocodile. At the Fed meeting, drama came in the form of the interim president of the Atlanta Fed, Mr. Pat Barron, a practical, energetic, and brilliant man who rose from auto mechanic at Buckhead Chrysler Plymouth to COO of the Atlanta Fed. He is a practitioner not of mathematical economics, like Dr. Ben, but of “descriptive economics,” which is now derided in academe and defined as explaining “economic phenomena as they are without making any statements about how they ought to be.” He expressed a “contrarian view” that the housing market was in deepening crisis. The Lost Boys (and Girls) listened politely to this real world Wendy and moved on.³

History suggests that investors should assign a correlation of -1 to the forecasts of certain central bankers. Ben says the exit from QE will be orderly. Where is he leading us? “Second star to the right and straight on till morning.” That's where you'll find Neverland.

1http://www.federalreserve.gov/monetarypolicy/fomchistorical2007.htm

2See Tee,Gillian, Fool's Gold, Free Press, New York, 2009, especially chapter 10: “Tremors.”

3 According to Tett's book, Geithner was also worried, but ever the good subordinate, he kept his peace.

Reserve Bank of NZ claims it's "not a bimbo."

New Zealand's Reserve Bank is putting in place a bank rescue plan that would include forfeiture of deposits. It denies, however, that these deposits are like Cypriote deposits. The bottom line, however, is that bank deposits have entered the mix of assets available to government to solve government problems.

Here is a report from Fairfax New Zealand News:

The Reserve Bank is rejecting suggestions that its new policy for banks facing a collapse is anything like rejected plans to sort out the present banking crisis in Cyprus.

The RBNZ plans that will mean a "haircut" or partial loss on all deposits if a bank fails, are due to come into force in New Zealand at the end of June.

Reserve Bank Deputy Governor Grant Spencer said today that the RBNZ "Open Bank Resolution" (OBR) policy would mean a quick and orderly resolution of a bank collapse.

"It is markedly different from proposals to resolve the banking crisis in Cyprus," Spencer said

Depositors' money in banks here had never been guaranteed, apart from temporary periods, such as under the Deposit Guarantee Scheme from late 2008 to December 2011.

"If their bank fails, depositors have always needed to understand that deposits are not guaranteed," he said.

The perception and reality of deficit spending.

Perception can diverge from reality for a considerable length of time.  Here are two comments that reflect this:

Mayor Bloomberg on the radio:  "“We are spending money we don’t have,” Mr. Bloomberg explained. “It’s not like your household. In your household, people are saying, ‘Oh, you can’t spend money you don’t have.’ That is true for your household because nobody is going to lend you an infinite amount of money. When it comes to the United States federal government, people do seem willing to lend us an infinite amount of money.… Our debt is so big and so many people own it that it’s preposterous to think that they would stop selling us more. It’s the old story: If you owe the bank $50,000, you got a problem. If you owe the bank $50 million, they got a problem. And that’s a problem for the lenders. They can’t stop lending us more money.” (Observer.com)

Warren Buffet on CNBC:  "If the Fed bought $3.5 trillion of Federal debt a year then we would have no deficit and would not have to pay any taxes at all." 

Buffet was being ironic but Bloomberg was not, or was it the other way around?

As goes Venezuela, so goes Germany: A run on the Fed's gold reserves?

Germany is withdrawing its gold from the Bank of France and the Federal Reserve and stocking it in their own vaults in Frankfurt. This follows Bundesbank board member Thiele's visit to all global storage sites.  The German central bank says its move is designed to "build trust and confidence domestically" in its gold reserves.  The statement also suggests that auditing, or lack of it, is an issue.

Are doubts building about the security of reserves held at the Fed by other central banks?

http://www.bloomberg.com/news/2013-01-16/bundesbank-to-repatriate-674-tons-of-gold-to-germany-by-2020.html

Hyperinflation or deflation?

Hyperinflation or deflation? It depends on your standard of comparison. We have had huge inflation since 2008 when measured in shares of RIMM (Research in Motion,) for example. Today it costs 10x as many RIMM shares to buy a McDonald's burger than it did four years ago, but has the price of a burger increased that much? In Latin America, we saw in the late eighties prices doubling each month in some countries in local currencies while they were dropping in terms of dollars. Were they experiencing inflation or deflation? As Einstein pointed out, it is relative to your terms of reference. I think we will eventually have hyperinflation measured in US dollars accompanied by deflation in real terms.