As I stated back in 2009 that US debt would be $13.5 trillion by the end of 2010, it is now $13.9 trillion today. Here is a plot based on US treasury data for total debt:

Notice the gradual increasingly slope with shortening timeframe. This is a typical behavior of a super-exponetial function that is destined to “collapse” in the future. The debt obviously won’t collapse due to payback, but possibly “collapse” through massive inflation or repudiation. This is the chart that any US citizens should keep an eye on. If the chart continues its own pattern of increasing slope with shortening timeframe for slope change. Then one definitely be prepared.

To put 20 trillion debt increase for perspective, the entire global stock market valued at $49.1 trillion in March 2010. When USA run out of other people’s money to use, the only way left is obviously to simply print more (as if USA hasn’t done it yet through two rounds of quantitative easing).

I’m not changing my current projection for a US debt/currency blow-up in 2016/2017, unless the above debt chart changes its super-exponential pattern, and/or that the time has gone beyond 2022 without any problems. Let’s see if Tea Party & Ron Paul who just took the helm of Domestic Monetary Policy Subcommittee can effect a direction change in the coming years.

Using the data taken from Mish’s article:

The tranche breakdown shows total deal size. Total size is 519.159M, “A” Tranches are 476.069M total, “M” Tranches are 30.112M total, “B” tranches 7.788M total and “C” tranche is 5.19M total.

As of today, tranches A1 through A5 are all still rated AAA . Those 5 tranches constitute $476.069M out of an original pool size of 519.159M. In other words, 91.7% of this entire mess is still rated AAA even though REOs are now up to a whopping 10.48% and 60 day delinquencies are 32.69%. Moody’s and the S&P should be embarrassed by this.

The following is just an estimate based on my understanding and guesses on the bond markets: Based on my observation from going to home auctions, REOs are being sold at prices of about 50% to 75% previously valued. Let me use an average of 60% from previously valued after all the fees and expenses, and that’s only assuming 5% or less are fraudulent loans where the property values can be just 10% to 30% of the loan. Assuming that the average loan-to-value LTV ratio was 92.5%, midway between 5% and 10% down payment, the loss on the loans for REO will be (92.5% – 60% recovered)/(92.5%) = 35% loss. Furthermore, it’s probably safe to assume that 90% of those 60 day delinquencies will go into REO. Assuming the rest of the loan do perform, you will be looking at a total loss of 32.69% * 90% * 35% + 10.48% * 35% = 14% of the principal. Let’s say the average interest rate is 6%. The performing loans are 100% – 32.69% * 90% – 10.48% = 60%. With 60% earning 6% divided for all the A tranches (476.069M/519.159M = 91.7%), the A tranches will only be getting an average of 3.9% interest instead of maybe 5.5% that they “deserve”. To get back to 5.5% yield on a 30-year mortgage bond for the same absolute cash flow, the bond prices must fall by about = (1.039^30/1.055^30) or to 63% of its original value. Of course, that does not include any future decrease on the cashflow. Obviously, when all of those REOs are recovered at 60%, the bottom tranches will experience 100% loss. It will wipe out 100% of all the non-A tranches, and more. A tranches will on the average experience a (91.7%-(100%-14%)) / 91.7% = 6.2% loss. Therefore, that will be a 6.2% forced principal loss, and a (100%-63%)=37% marked-to-market loss. Yeah, and that’s for the terrific AAA mortgage bonds that you buy into.

Here is price chart for a AAA bond maturing in 2038 (30 years) from the ABX-HE-AAA 07-2 series at MarkIt.com. It already has a loss of (70-45)/70=36% since this January 2008.

Very unfortunately, real estates will get worse, not better. I expect that these AAA bonds to experience a horrendous loss, something that if you ever put your retirement money into such “fixed income” investment, you would want to forget about it, and will vow to never buy a single US dollar again in your now shorten retirement life and a shorten lifetime possibly due to the financial stress.

I don’t know who else is holding all these losses besides banks. But eventually someone will find out and puke, and will come back and sue all the credit rating agency and bankers for jail time. Even then, it won’t give you back the lost paper money. Don’t let AAA cheat you out of your retirement. Protect your nest egg carefully. For the first time in history, you could be beter off investing your money in stock markets, rather than “fixed income” in a bear market. And where on Earth and when in human history can someone buy a highly rated bond and experience such a big loss? That is USA under Greenspan & Bernanke’s realm.

Bill Cara recently opined that maybe he had missed the first part of the trade of generation, which is to short the bond. I myself have also been a little surprised too.

The recent bond market actions have not been good at all. Whenever stock market falls, bonds tend to rise. But NOT this time. Stocks fell, and bonds fell too. While it is still too early to tell based on just a few days of trading, the trends seemed to be broken already.

Here is the chart for the 30-year treasury bond:

As you can see above, long term interest rates have risen. And with the recent tumbling of stock markets, the yields break new high instead of falling back down. Whatever it is I think for the intermediate term, the yields are probably going up. And that probably means more selling in the bond markets, which probably means that $US will continue to face pressure in the future.

If you want to refinance, probably you should look to lock your interest rates whenever the rates dip again (if it dips at all). I am also referring people to my own mortgage broker, so that you can get $100 cash back in addition to matching the really good rates at www.absolutemortgageco.com. If you are interested in getting a loan, you can email me, and I can forward you the details on the broker.

Certainly I think the best time to refi or getting a loan may be behind us. The implication from the rising interest rates for housing markets is obviously negative.

Bloomberg reports:

Feb. 13 (Bloomberg) — Bonds sold by U.S. municipal borrowers with rates set through periodic auctions failed to attract enough buyers as banks including Goldman Sachs Group Inc. and Citigroup Inc. that run the bidding won’t commit their own capital to the debt.

Rates on $100 million of bonds sold by the Port Authority of New York and New Jersey, with bidding run by Goldman, soared to 20 percent yesterday from 4.3 percent a week ago, according to data compiled by Bloomberg. Presbyterian Healthcare in Albuquerque and New York state’s Metropolitan Transportation Authority also experienced failures, officials said.

What began three weeks ago with too few bidders for auction-rate debt backed by relatively small entities, such as Georgetown University and Nevada Power, has widened in recent days to include large issues of state governments, such as New York state’s Dormitory Authority. The auction failures provide new indication of Wall Street’s unwillingness to commit capital amid $133 billion in credit losses and asset writedowns.

Recall that I exited my closed-end muni fund positions (NXZ in particular) the day after MLK day. Well, NXZ been trending up ever since and I had a great deal of self-doubt. Today it gave back 3.86% which was an enormous move for a bond fund. It’s still above where I sold it but I’m beginning to think that my conservatism may be vindicated.

Despite Warren Buffet’s offer to provide a back-stop to the monoline insurers, the credit crisis is far from over. First of all, it’s clear that if the monolines give up their muni business they may as well sign their own death warrant. The way I see it, the muni business is the only bargaining chip they have, as in “If we go down, we take the system down with us. So how about a few billions to help us out?”

That said, I’m sure eventually most of the muni bonds will find a high quality insurer. Their yields are very attractive now. Even more so should the dividend rate cut expire in 2010. The way things are going, soon I may even have a chance to go back in for less.

I have discussed before that for my asset allocation, I had chosen to have muni bonds in taxable accounts instead of taxable bonds in tax-deferred accounts. In fact, I purchased some NXZ at the beginning of the year. I got out of them last Tuesday, after the big panic. Although I managed a small profit, the selling price was below Friday’s close. I wasn’t too happy about the move at first, but my prudence may still be rewarded.

The motivation was of course the imminent downgrade of the bond insures Ambac and MBIA, which has been all over the news. To be fair, the muni insurance business is profitable, serves a useful purpose and will never be allowed to fold. However, some has suggested a figure of 200 billion! is needed to bail out the bond insurers. That may be too steep a price even for the billionaires who are circling around the (soon to be) carcasses. In all likelihood the 200 billion figure stems from the write-downs from CDS’s (Bill Gross doesn’t appear to be that far off), and you can bet that the bond insurers are clutching to their muni business like a lifeline. Barclays is now saying that if the bond insurers’ rating are cut too deeply, banks faces additional 143 billion in write-downs. A hundred billion here, a hundred billion there, and pretty soon, we’re talking real money!

Judging by the price action of those closed end funds, muni investors are nonplussed about all this ruckus. However, a little prudence may not be a bad thing. It’s not unreasonable to assume that while Ambac and MBIA are drinking from the CDS cool-aid, some of that good fun got spilled over to the muni insurance side, and the default risks got under priced in some issures. At the least one would expect the balance sheets of municipalities hard hit by the housing crisis not look as sound. So while as the muni insurance business as a whole will never go away, it’s not clear that all the muni bonds will keep their existing ratings in a re-shuffle.

I could pour over the latest quarterly reports of those muni funds to see what may be affected, but given the size of my investment that hardly worth the effort. I’ll keep the cash and jump back in after this brouhaha is over.

I’m very surprised that bond market has actually gone up (bond yield coming down) along with the stock market. The ^TNX (10 year treasury) has come down to 4.383%, and ^TYX (30 year treasury) has come down to 4.663%. Regardless of how the bond yields are coming down, whether via direct monetization through Fed’s printing, or bond market forecasting economic slowdown, the lower yields will definitely bring some stablizing effect to the housing market fallout.

Although I would like to say that it makes more sense to me that the bond market actions are due to Fed monetization, I cannot find any evidence in their Fed operations of permanent repo. In any case, assuming that Fed can fake everything else, the only thing that it cannot fake is the $US exchange rate with other foreign currency. Furthermore, under normal circumstances, bond yields should have risen when the stock markets go up. Although such weird episodes have happened before, the recent occurrence of synchronous rising is the first one since many months.

If the 30 years treasury yield fall further, it will be on track to match its all-time low at about 4.25% in June of 2003, and June of 2005. That’s just roughly 12% =(4.66%-4.25%) * 30 yr away from the current level. I don’t know how it could possibly make sense to any of the bond buyers, but a 30 year bonds yielding at 4.66% is simply too low. Investing money in a farm will probably bring a much better yield.

This week Fed is supposed to cut interest rate by another 0.25%. I think Bernanke going forward is more likely to surprise the market on the upside (meaning cutting more than less). His philosophy has always been that aggressive cutting can stave off crisis. The only thing that I see however is that there will soon be another bubble in either foreign markets or commodity markets or both, due to these aggressive rate cutting. It’s very important for investors not to sell out completely in the energy/precious metal sectors.

If Fed can successfully bring long term interest rates down to a very low level, then it may actually make sense to start buying real estate at the lower priced area. Although initially I was estimating that the bear market in housing will last all the way to 2012, if bond markets behave irrationally than my original thinking, then the buying time of real estate could be sooner at least for the lower priced area.

Government has been pushing lenders to work out terms with the homeowners by modifying the loan terms. However, only 1% or less of the loans were modified. It is not happening for several reasons:

1. Work load on modifying the loan term is additional on a shrinking workforce in mortgage industry.
2. Most of the loans have been sold to different investors, and to modify one loan, you must get all the investors to agree to a loss on the mortgage bond (while homeowners get the gain).
3. Who is going to want to take the loss?

Congress has also passed a law to help out these “poor” homeowners (not sure if all the renters want to cry out FOUL). The forgiven debt by lenders to the homeowners from the “short sale” of the home, normally counts as a taxable ordinary income, will no longer be counted as income, and therefore, tax will not need to be paid.

However, I don’t think Wallstreet and Congress understand the magnitude of the credit crunch. In one sentence, the biggest credit and housing bubble in the human history has BURSTED. It just can’t be reversed anymore. In the capitalism (which tends to generate BIG up and BIG down), the mortgage bond market went crazily up, and now it is simply imploding. Many of the loan products can no longer exist, or at least exist in the same prevalence as before, simply because such loans cannot be sold to investors anymore, who are sitting on a huge loss, and are the main losers in this credit/housing implosion. Definitely homeowners are not the biggest losers. Mortgage bond investors are.

The following quote from FDIC head shows the ignorance of our government officials:

…most likely affect loans that have a low starter rate for two or three years and reset to much higher rates. Many of those loans are adjusting now and have helped push a record number of homeowners into the foreclosure process.

“Keep it at the starter rate,” Ms. Bair said at the Clayton Annual Investor Conference. “Convert it into a fixed rate. Make it permanent. And get on with it.”

Ms. Bair and other federal regulators likely couldn’t force servicers to make these changes, but her message might be interpreted as a warning to loan servicers about potential legislation, said Howard Glaser, an industry consultant based in Washington.

[Boldface, my emphasis]

Now, tell me, if the loan is kept at the starter rate, who is going to keep that loan on their book, since obviously such loans cannot be sold anymore most likely. Ms. Bair, do you want to volunteer and put up your own money to invest in these speculating homeowners?

At the end of the day, it is still about money. Only those loans that make sense to be modified with a minimal loss will be modified. And if the government make laws to force loan term conversion, expect more capital flight out of this increasingly capital-unfriendly country. If I were the investors, I will sell everything when the government force me to eat a substantial losses on my mortgage bond investment and hand it over to the homeowners.

But given the precedence in the oil industry where government repeatedly threaten big oil companies for additional taxes, I suppose that such scenario is definitely a possibility.

Incidentally Mark Hulbert is posting another bullish post “Ahead of the (yield) curve – Commentary: Post-Fed curve much steeper, a good sign for the economy”. I must say that everything of what he said about a smaller chance of recession based on the steepening of yield curve is correct on paper. However, I cannot agree that one can simply use only the yield curve to determine the odds of recession.

For one thing, because the long term bond markets are not collapsing or dropping dramatically after Fed raising interest rate, while the short term interest rates are falling, it appears to be a good sign that Fed still having everything under control for now, except on US dollar index cutting through multi-years support at 80. But based on Bob Hoye’s historical analysis (pg.2 at this link), such post-bubble yield curve steepening is more ominous rather than a bullish sign. Bob’s recent forecast has been quite accurate, and I would trust his words as a market historian rather than Mark Hulbert’s who has been putting out 8 to 9 bullish articles out of 10 this year. Such yield curve steepning according to Bob Hoye is simply part of the post-bubble credit contraction process. Certainly, if long term bond yields start to go up much more, they will simply deepen the housing recession. Now, I don’t care about how accurate the predicative power of yield curve. It is simply a black-and-white matter that housing markets will get worse if the bond yields go up. With the housing bubble unfolding, my only attention would be the absolute level of the long term bond yields, rather than whether the curve is inverted or not.

By the way, if I didn’t make it clear in my yesterday’s post on “is it 1998 or 1970?”, I will now. I believe that more of the emerging markets will be in the 1998-style progression, while more of the senior markets will be in the 1970-style. I think US stock market will be going thru an extended period of sideway with possibly a bullish slant, with $US falling gradually. The best thing for US dollar holders should be trading in this sideway market to make up the $US fall in purchasing power. But you do need to wait for a round of cleansing before jumping into it.

Best luck, and have patience.

It’s interesting to see how media has played the news. And how gold bulls have taken the news in stride. Here is what has taken from Forbes:

The ECB injected a further 61 billion euros ($83.8 billion) Friday morning, while the U.S. Federal Reserve later announced a three-day repurchase agreement to inject liquidity into the market.

The Fed said it would accept $19 billion in mortgage-backed securities after its Fed Funds rate, the rate that banks charge each other for overnight loans, ticked above 6 percent – well above the Fed’s target of 5.25 percent.

You can get the temporary repo market operations from the New York Fed site directly. However, these repo operations are temporary only for 1 to 7 days. The cash needs to be paid back, while the supposedly sold mortgage assets are only serving as collateral during this temporary period.

Regardless, major media plays this as Fed & ECB coming in without stating any of the facts related to the temporary nature of these operations.

So does that mean Fed is not printing money after all? The answer is obviously NO. At the minimum, Fed has printed 0.78 trillion of dollars via its treasury securities holdings. You can get the data at this link. Fed holding these securities is a method of printing money directly for the use of US federal government. It’s one branch issuing IOUs, and then “another branch” taking up the IOUs and giving back and authenticating the new cash as an electronic ledger. These new cash obviously dilute the buying power of the existing $US and create inflation. If US budget deficit continues and foreigners refuse to take more new US debt, the new IOUs will either force the interest rate on treasury bills to go up (which will also make the mortgage rates to go up further) or Federal Reserve can come in and absorb the excessive supplies of treasury bonds via printing of more US dollars which eventually will drag down the currency exchange rate of $US due to more supply versus demands.

So don’t let the orderly liquidation of securities liquidating into your hands via your buy order. Someone needs to take the losses. Don’t partake a portion of it.

As the credit risk increases at all spectrum, and more lenders going out of business, guess what? You and I will be paying much higher interest rates.

I just checked out the mortgage rates offered by the two cheapest mortgage sources that I relied on (only for quoting purpose):
Mtgcapital.com: 15 years fixed at 6.000%, 30 years fixed at 6.375%. Lender’s fee is $1250.
Absolute Mortgage: 15 years fixed at 6.125%, 30 years fixed at 6.375%. Lender’s fee is $399, and both are zero points.
The above rate is based on ^TNX or 10 year treasury at 4.77%, and ^TYX or 30 year treasury at 4.92%.

You won’t find out the effects of increased risk premium + decreased competitions if you don’t have a history. Fortunately, I had a previous post with the exact information that I need:

at Mortgage Capital.com:
1. 30 years fixed: 5.75% APR.
2. 15 years fixed: 5.5% APR.

Both are zero points, $1250 lender’s fee.

at Absolute Mortgage:
1. 30 years fixed: 5.75% APR.
2. 15 years fixed: 5.5% APR.

Both are 0.125 points, $399 lender’s fee (lower interest and/or lower fees). When you make a loan as big as 680K (exceeding conventional conforming loan of $417K already), the 0.125 point will cost you more fees compared to MtgCapital. Therefore, Absolute Mortgage should be cheaper in all cases.

The above rates are quoted when 10 year treasury yield was at 4.509% and 30 year treasury was at 4.65%

So let’s see how much more expensive you need to pay now. From mtgcapital.com, it appears that every 0.50 point will give you 1/8 lower in interest rate. I’m going to use that to adjust the interest rates wherever applicable. The 10 year treasury was 0.261% lower and 30 year treasury was 0.27% lower.

So at mtgcapital.com, the 15 years fixed is now (6.00% – 5.5% – 0.261%) = 0.239% more expensive. The 30 years fixed is now (6.375% – 5.75% – 0.27%) = 0.355% more expensive.

At absolute mortgage, the 15 years fixed is now (6.125% – 5.5% – 0.261% – 1/8% * 0.125/0.5) = 0.333% more expensive. The 30 years fixed is now (6.375% – 5.75% – 0.27% – 1/8% * 0.125/0.5) = 0.352% more expensive.

Conclusion: you and I will be paying about 0.25% to 0.35% more in interest rate for the same loan as before. On the 30 years, the risk premium is higher now also because there is a yield curve steepening effect. If Fed starts to cut interest rates, it may pin down the lower end of the curve, but the longer end (15 and 30 years fixed) may or may not come down in relative terms. Until the inflation appears subdued, the longer end will not come down as much.

Good luck to anyone who wants to get a loan, or refinance their ARM time bomb.