The Latest Bubble?

Subsidies encourage the type of behaviour they are subsidising.

And the Federal Reserve’s QE Infinity is subsidising the market for mortgage backed securities by taking them out of the market at a price floor.

Unsurprisingly, the market for mortgage-backed securities is near all-time highs:

And Wall Street is doing some wild and wacky things.

UBS has just launched a 16-times-leveraged MBS ETN. The ETN, called the ETRACS Monthly Pay 2x Leveraged Mortgage REIT, offers double the return of the Market Vectors Global Mortgage REITs Index – itself an investment vehicle 8x leveraged to mortgage-backed securities.

The idea appears to be that with the Fed acting as a buyer-of-last-resort that prices will take a smooth upward trajectory and that 16:1 leverage makes sense for retail investors as a bet on a sure thing.

Of course, back in the real world, there is no such thing as a sure thing. As Pedro Da Costa recently noted, banks are sitting on the proceeds of MBS purchases, rather than passing on the money to customers in the form of lower interest rates. As the New York Fed’s William Dudley recently noted:

The incomplete pass-through from agency MBS yields into primary mortgage rates is due to several factors—including a concentration of mortgage origination volumes at a few key financial institutions and mortgage rep and warranty requirements that discourage lending for home purchases and make financial institutions reluctant to refinance mortgages that have been originated elsewhere.

Those leveraging up on MBS might want to consider the implications if the Fed were to change its QE3 transmission mechanism — a transmission mechanism that William Dudley is willing to admit is broken — and buy other assets instead of MBS. Without a buyer of last resort with a printing press, prices would seem to be at current levels unsustainable. And those junk MBS products that the market is leveraging up on now in the hope that the Fed will buy them all will be left out in the cold. Such an event would bad news for anyone leveraged 16:1 on MBS.

But such an event would be an ingenious pump and dump, shifting the burden of junk MBS off Bulge Bracket balance sheets and onto the books of not only the Fed — which has already sucked up huge swathes of toxic junk — but also small-time speculators looking to book leveraged gains, but who end up taking the hit. 

43 thoughts on “The Latest Bubble?

  1. @ AZIZ: “But such an event would be an ingenious pump and dump, shifting the burden of junk MBS off Bulge Bracket balance sheets and onto the books of not only the Fed — which has already sucked up huge swathes of toxic junk — but also small-time speculators looking to book leveraged gains, but who end up taking the hit.”


    These small – time speculators are not plentiful enough to ruffle political feathers! But they have capital for the taking.

  2. “…the implications if the Fed were to change its QE3 transmission mechanism..”.

    I realize that I’m asking you, John, to extend — not just elaborate on — this post. But …..
    what odds does your crystal ball offer on this happening, with and without a change of presidents?? How soon at the earliest? And how gradually/surreptitiously might it be?

    • Well if Bill Dudley is admitting that the transmission mechanism is broken and unemployment is still stagnant this time next year, they may change the transmission mechanism and buy other assets…

      • The fed has mentioned that they could change what they purchase. I am relieved that they cannot increase the dollar amount they purchase.

        The issuing banks will also have to buy these junk MBS’s when they mature. The fed is the big bank and will not lose money.

        • They cannot? I was of the impression that they can do whatever they saw fit under QE infinity. That includes amount and type. Doubt they will abandon support for MBS. Too much of the economy is tied to these artificially low rates. Every refinance is putting extra money into the economy. Bank balance sheets are strengthened and bonuses fattened and housing prices are propped up. Too much of a good thing no?

          The problem is that MBS are finite so limits the amount of QE available and contrary to popular beliefs, he can’t air drop fed notes to every man woman and child. You need fiscal policy to do that. Only option to expand QE is by buying other debt instruments with the banks as intermediaries (ie vampire squids) or direct lending which ain’t gonna happen.

  3. Buying up student loans in recognition that the loans are “Toxic” i.e. the education outcomes don’t match the structural needs of the economy, therefore “worthless”?

  4. Hey Aziz! While it may be too dense with sophistication to write an appropriately short blog about, this I would say is probably the most sophisticated thing I have ever read. Particularly when it comes to the sections on rationality and methodology.

    Some snippets:

    “The founders of modern sociology and neo-liberal economics agreed on breaking the link between profits and human labour”

    “Rationality for Weber, therefore, virtually always means actions based on calculation and accountancy. This ignores the most obvious question: what is the calculation and technical control of figures being used for?”

    It’s an easy read, yet profound, and tops the liberty article you once delved into…

    Click to access 20100723173413356.pdf

      • It appears the only thing that extended Britain and Spain and Frabce was massive colonial territories. I don’t believe the uSA has the same territorial support. Influence maybe but not outright territorial support such as Latin Americas or the Commonwealth, or France’s Pacific and African conquests. Thus I conclude that the USA will be short lived. It is imminent for collapse.

        • Are nukes a good substitute for territorial growth insofar as “WE’LL NUKE YOU IF YOU DON’T ACCEPT DOLLARS FOR OIL”?

          Answer: I don’t know (but probably not).

    • Now that I know all about the hypothalamus and pituitary, I am ready to learn what is a Geopoliticas “Green Flamingo” event. Pleaase.

      • The Pink Flamingo is Pink due to a shrimp it eats. What happens if the shrimp eat a lot of copper?

        It could happen.

        Geopoliticas is a fat finger error. Apologies it should be Geopolitical

  5. I’m trying to think of a nicer way to say,”Golly — I’ve always thought that Japan got nuked to end WW II, not because they wouldn’t accept dollars for oil”.

  6. Buddy writes…

    “Thus I conclude that the USA will be short lived. It is imminent for collapse.”

    If you are speaking on of the the dollar being the reserve currency, I disagree. If you are speaking of the U.S. as the predominant world power, then I completely disagree.

    The problems with the dollar can be fixed in five minutes. What’s been going on is outright fraud and theft supported by nearly the entire world.

    As far as the U.S. and its superpower status is concerned, consider what the U.S. has going for itself. Two oceans, and two countries [that are essentially part of the country] as boarders. By far, the greatest food growing capacity in the world. Nearly unlimited energy sources. The best university system in the world. The most stable form of government. A military which can apparently hold its own, ect,, etc., etc…

    Now, this is not to say that this country is not in crisis, but the fundamentals are still in tact. Change [and perhaps serious change] will come and will most likely right this ship, but with the tradition of freedom and individual enterprise deeply embedded in this culture, I would not bet against the U.S.

    The U.S. is the ultimate social paradox, a core of molten urgency for individual expression presently being suffocated under layers of institutional morass. Soon this thing will blow and the U.S. will once again get its shit together.

    One incredible thing about being an American is that you truly believe that anything is possible.

    • Attaboy, Imp! I’m not so confident about the longevity of the US$ as reserve currency, but I agree on the rest (& hope the recovery starts Nov. 6 with a non-Democratic president and congress)!

      Maybe you should share your 5-minute fraud fix.

      • The question isn’t how to fix it, instead, do you want to fix it?

        The solutions are always elementary, as absolute simplicity is Truth. In banking, its using real money, no frl, no inflation, no central banks, competing currencies. That would be a healthy start.

    • Sometimes after all the love and care and advice you give to a loafer relative or family member, and they still continue to drag their heels you have to “bitch slap” them and call them a loser and give up on them for them to finally wake up and get their “shit” together.

      However I disagree with you. The USA is a spent force. Ever since you guys started importing foreign cars due to perceived quality over Detroit, your collective spirit has evaporated. Instead of finding the root cause of the problem and fixing it, people just gave up.

      I know it hurts to hear this, but as a friend I am giving you frank advice.

      Do you remember the Cadillac ads where they used images of WW2 bombers and planes that used GM engines? Well if that did not stir patriotic purchases of Cadillacs over a Lexus (I hit my head on the roof of a Lexus, I am not Japanese) then the USA is out of ammunition.

      The news around the world is reporting the rise of China, and the decline of the USA. It is common knowledge. When citizens around the world can invest in Yuan as opposed to US Greenbacks, why would they use Greenbacks? There is no confidence.

      The US can’t dictate to the world anymore. It is not Fascist Germany with a superior military.

      Walmart was the straw that broke the Camel’s back. It gave the masses a taste of Chinese goods. The products worked and they got more confidence to buy bigger ticket items. Now Chinese goods are as good as US products. I know I repair Chinese lawnmowers (All light engines in general) as a hobby and they go as long as Briggs and Stratton.

      • Who knows what’s going to happen, but I believe you must look at things as a continuum. Yes, all kinds of bad things are going on, but, again, what made this country the powerhouse that it is [was], still fundamentally exists.

        The financial problems can be fixed. Many of the attributes I listed are unique to the U.S. The others have been cultivated over two hundred years. I believe it it silly to suggest that a great country like the United States is just going to dry up and blow away because it is facing some very serious challenges.

        The decisions made over the next ten to fifteen years will, in large part, define the next fifty, but the over all situation will not change until something very fundamental changes. I understand that it seems incredible that so many people can stand by as all this non-sense has come down, but if you look at history, it has always been this way.

        Great Britain was replaced by the U.S. because we could, in every way. I can certainly see a time when China could displace the U.S. in the same way, but this is not going to happen anytime soon. China has enormous problems/challenges.

        In the end, I believe that the U.S. will correct its problems. There are way too many people here that are well-educated and quite interested in preserving this country for future generations. Until a viable alternative is presented to the world, the U.S. stands as leader, as evidenced by the global demand [like it or not] of it culture.

        If push comes to shove [and it just might], you are going to see 100+ million Americans out on the streets and bankers hanging from the utility poles. Critical mass is coming.

        • The US is fading just like the UK did. The UK was broke after the War, just like the US is broke now (War is war, it still costs)

          Why isn’t the Pound the World reserve currency?

          I am very impartial. I just call it like I see it. If China is going to cement its position it must act how I have planned for. If it does not, it will lose its place. The Communist party knows it and is using this period of US weakness, election and fiscal cliff to deliver its economic deathblow.

          If I am wrong, I am wrong and tapped out. I give up and go about smelling the roses.

        • It’s difficult to compare the U.S. and the U.K. because the U.K. gained most of its wealth through exploiting other countries. This is not the case for the U.S. Look at natural resources, population, geography, food production, technology/innovation, education, corporate sprawl, cultural influence.

          I do agree that the U.S. will eventually wane, I am just not sure when this will occur.

    • @ Imp: “One incredible thing about being an American is that you truly believe that anything is possible”

      This is the problem. Your kind does not think that anymore. All the USA USA USA chants won’t fix the problem. The Soviets used the same patriotic thinking and look what happened. The Oligarchs fled the sinking ship, and left Putin to clean up the mess.

      • You’re not going to compare the U.S. to the U.S.S.R.? The Soviet Union had little chance to survive.

        If the U.S. returns to its roots [as the pendulum swings back to center], the good will once again reveal itself.

        The world is most likely not coming to an end, but, if it is, then all of our problems will be solved! 🙂

        • Impermanence, you are truly patriotic, but there is a time when all powers end. The world will not end when the US wanes. Life WILL go on. In Australia we have been exposed to the decline of the USA and the rise of China ever since the Olympics and the GFC. We just switched customers and kept making money hand over fist. Other countries are in the same boat. Now we are selling raw goods in exchange fro Yuan and bypassing the dollar too. It just makes business sense with less currency exchanges and associated costs.

          I truly feel there will be a massive devaluation of the US dollar after the election. Is this a good thing for the USA? I don’t know. Will it revitalise US manuifacturing? All that I know is with the appreciating dollar versus the US dollar I have been purchasing more US goods (Spam- It stores well, Internet orders, car products etc) Someone in the USA is seeing bigger export orders and sales.

      • Buddy, my information supports this generalization: Commissar/KGB holdover Putin partnered with a few Oligarchs, and imprisoned and kicked out the others after confiscating their assets.

        • The living standards of the poor and lower classes has increased under Putin, and thus in a Democracy his handling has been accepted as moral and in accordance with democratic principles.

          His classic line to the Oligarchs. “You stick to business I will stick to politics”.

          That was a thinly veiled threat (Russian Style) not to attempt any US style, highly financed advertising and paid media campaigns election attempts.

          The Russian people are a little simple (In a good way) and slick marketing would deceive them.

  7. Aziz, I was thinking about this as a much better alternative. Why not just print money and give it to everyone in the form of a tax cut? In this situation, we could just cut the payroll tax in half and finance it by printing money. That way, it won’t have the same negative impact as buying mortgage backed securities. Not only that, but people can either use the spending to either pay down debt or to spend money. Either the debt gets eliminated or demand gets propped up by increased spending which means incomes go up. Therefore, you can systematically wipe out the debt without giving money to the financial sector. Steve Keen had a very similar idea in his QE for the public.

    • I agree. I told Steve Keen about this but his idea was different to mine. Mine was similar to yours but he wants to give money to Mortgage holders. I believe people should get their taxes back to spur demand in areas that have the largest marginal utility. When the economy recovers and inflation surfaces, raise taxes and put the money aside in a sovereign wealth fund, used for spuring demand in future crises.

        • My mathematical model: Sorry I am not a mathemitician perhaps someone can expand and I can take credit.


          S = Supply of goods services

          If D>S = P (Price) increases

          In an attempt to regulate P, C is increased/decreased until P stabilises

          Where A equals income before tax, B equals tax to maintain the government budget, C = income allocated to sovereign wealth fund, D equals income influencing demand on aggregate supply.

          This is radically different to Keynes pump priming theory as the consumer dictates demand, not the government. It assumes perfect utility as the consumer determines, not the government.

          Its paternalistic, but it would work.

        • Sorry to expand, the deduction of C going to the sovereign wealth fund supplements the income of consumers without income, via a flat non means tested weekly payment which covers living expenses. If you are working the deduction of taxes covers future periods of unemployment. So A = Income from working plus the basic weekly supplement which is taxed equal to income and C is expanded/contracted to regulate the economy.

  8. Buddy, I hope you don’t fancy a Nobel PEACE Prize. You aren’t eligible unless you have murdered Israeli school children or enabled him who did, scammed billions and skimmed a hundred million on a bogus environmental panic, or got yourself elected head of a nation’s government after a lifetime dedicated to its ruin.

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