patrick.net

I think you are asking the wrong question, given that your purchasing power is increasing much faster than the low interest rate on your bank account might indicate.

The issue is that the Fed is hell-bent on fighting deflation at the moment. However, its harder to do this as one might think, as the Fed can't actually easily get new money into circulation. They have to lend it to a bank, which then lends it you (with interest). That's where the inflation comes from. If we were only allowed to spend the money we have the whole economy would fall apart almost immediately.

What the Fed is doing now is monetizing its debt. Given that banks aren't lending and consumers aren't borrowing, they have no other way to create inflation other than purchasing their own debt with newly printed money. This is *hugely* inflationary, as you may have noticed given the big movement in gold last week and the weakness of the dollar against other currencies.

However, its not that inflationary in the big picture as there are still trillions of dollars that are in the process of being destroyed by bankruptcy and foreclosure. This is quantitative easing and is only a temporary measure, meant to prevent the credit markets from freezing.

Patrick,

you shouldn't really tie your money up in CD. For the little USD balance I have, I keep all of them in cash, ready to be spent, or wired away, or exchanged into something else. I don't mind not making a dime interest on them, because I want to flexibility.

For that pitiful little interest you are earning on CD, you are much better off just keeping your USD as liquid as possible.

I made that mistake myself in 2002, when I had lots of USD (back then 90% of my investable asset) in Fannie and Freddie bonds and CDs with 3-5 years of duration. Then in 2003, I had to dump all of them out of a hurry, losing a bit on principal to get into something else. Luckily I earned far more back than what I lost. But looking back, for that pitiful amount of interest, it was really stupid of me to chase yield like that.

I am in agreement with Kewp. I would also add a comment to the original post. There is a missing component to the balancing act you describe in basically saying your low rate in the CD is subsidizing the homeowner.

Your CD is the safe rate, which is basically the market's perception of inflation. The safe rate never generates real wealth growth. We have commented before about the inflation tax. The higher the inflation, the higher the safe rate, which is taxable. I know you see where I am going with this.

Given that you are looking at this from the richer cash position of a saver the premise that you are getting screwed can't be true since we currently have negative inflation; deflation. Your money at any guaranteed rate of return is actually growing in wealth far more than when rates were a little higher, say 5 years ago.

Now having had a chance to read OO's comment you can see he is a good example of this principle as a real case. The take away is that it isn't even worth putting the money in the bank.

This may sound aggressive but market conditions are clearly encouraging leverage because you can borrow for less than likely future asset deflation.

And obviously I'm saying buy the asset after it deflates with the cash, don't buy a deflating asset.

New supply of jumbo financing in the pipeline
http://www.latimes.com/classified/realestate/news/la-fi-harney22-2009mar22,0,1512078.story

I think you are confusing Treasury Bills (very short term) which are priced as you say and which are a market the fed has always participated in as a way of tweaking monetary policy (repos) or for other reasons.

Treasury Notes and Bonds are different. Pricing has to do with yield there too. If they trade at "par" ie 100, then they will yield what they were issued at. Actually it's bit more complicated.

But the reason that Bonds (30 year maturity) and Treasury notes (10 year maturity) influence Mortgage rates, is that at least in theory, the price discovery which occurs in the market place for these securities reflects the yield that investors want on these securities, which will be very much tied to the yield they want on mortgages (just somewhat lower since the risk is lower on the Treasuries.

Repo,

Yup, but when all the profits go to 3 and 5, the incentive for anyone to do real work disappears, and even the financiers are simply just skimming a fraction of what we borrowed from China. And then it all ends badly.

The essenece of PPIP/PPF: FDIC guarantees the losses

If a bank has a pool of residential mortgages with $100 face value that they are seeking to divest,
the bank would approach the FDIC. The FDIC would determine, according to the above process,
that they would be willing to leverage the pool at a 6-to-1 debt-to-equity ratio. The pool would
then be auctioned by the FDIC, with several private buyers submitting bids. The highest bid
from the private sector – in this example, $84 – would define the total price paid by the private
investors and the Treasury for the mortgages. Of this $84 purchase price, the Treasury and the
private investors would split the $12 equity portion. The new PPIF would issue debt for the
remaining $72 of the price and the debt would be guaranteed by the FDIC. This guarantee would
be secured by the purchased assets

Thanks for the reminder that I'm actually doing very well even with little or no interest because:

1. Houses are getting cheaper compared to my dollars.
2. I'm not being taxed on that increase in relative value.

I feel better now, but I still don't see the exact mechanism by which Fed actions influence CD or mortgage rates.

I see that the "risk free" rate in Treasury bonds is manipulated by the Fed. But mortgage lending is very risky right now, so you'd think that mortgage rates would be very high, and therefore banks would be willing to offer high rates to savers to get that cash to loan out to buyers.

But I guess with the Fed essentially lending to banks very cheaply, banks don't have to give savers anything above that.

That still doesn't explain why banks would lend out to buyers at a low rate of interest. Interest rates should be through the roof right now, given the number of defaults and the declining prices. But instead of high interest rates, what we have is low rates, but very little lending.

Why don't banks offer loans at 15% to high-risk buyers?

The four logical steps that lead to Geithner's plan:

1. FDIC will not or can not take the big banks into receivership.

2. Congress will likely not provide any more direct bailout money.

3. The Fed is already loaded to the gills with toxic securities.

4. Therefore, we must now use the FDIC as a loan guarantor rather than a deposit guarantor, since this can be done congressional approval.

Did I get it right?

>>Why don’t banks offer loans at 15% to high-risk buyers?

Because those buyers cannot afford it? Because the REIC is pushing for "affordable loans"?

>>since this can be done congressional approval.

since this can be done WITHOUT congressional approval.

Here is the question I think should be asked:

For each big bank (TM), what is the lowest average price, as a fraction of face value, at which it could unload all its MBS paper and still remain at least technically solvent?

Now THAT would be a useful stress test.

To answer the original question:

The 10 year note is the benchmark against which other debt/CDs are priced. To oversimplify, say the 10 year rate was at 3% and due to the heavy buying by the Treasury got pushed down to 2.5%. Say mortgages were at the 10 year rate + some margin like 2%. Bonds, Mortgages and CD rates would go down correspondingly also.

For each big bank (TM), what is the lowest average price, as a fraction of face value, at which it could unload all its MBS paper and still remain at least technically solvent?

Did they say anything about more Capital Infusion in case banks are insolvent? I think it was the general belief that Govt would do that. Not sure if that's the case.

sa,

I haven't seen anyone saying that, but I think the general idea is to sell of the waste at a price that leaves the bank somewhat solvent.

Of course, the banks still will not lend out any money after that (against assets dropping in value), but at least the important people will be off the hook (sarcasm alert).

justme,

I think the general idea is to sell of the waste at a price that leaves the bank somewhat solvent.

How can that happen? Don't the private asset managers want the assets at a good price for them? I believe banks haven't taken necessary haircut. For now, it looks like we are having a party.

All loans below the jumbo amount are backstopped by Fannie and Freddie, whose papers are bought by the Fed, ie, backstopped by Fed. There is no need for banks to charge interest rate based on risk, they can turn around and sell to two Fs.

That is why mortgage rate for conforming will stay low and can go lower if Fed goes all the way in.

sa,

>>How can that happen?

By sticking the taxpayer with the difference, naturally.

You're doing one heck'uva job, Timmy (and Larry)

http://www.nytimes.com/2009/03/22/opinion/22rich.html

Fed manipulates mortgage rate directly by buying MBS from F&F directly through open market operations.

So far, the Fed has already announced $1.2T purchase of MBS from the agencies. That is why mortgage rate is capped.

Basically, if you are buying with conforming loan, Fed will make sure your mortgage rate can only get better.

If you need jumbo loan, not so lucky, but obviously Fed is working at it so maybe not too distant in the future, they will come up with something as well.

Mortgage rates will be very good in the coming years. If you are waiting for housing price to tank due to mortgage rate spike, you will be very disappointed. However, one still needs a job no matter how low the interest rate is. Therefore, you will have a much better bet hoping that unemployment rate will go sky high - make sure you stay employed though.

Let's not forget that conforming loans have been upped to ~730k, which used to be well into the Jumbo loan ramge (was ~417k as late as 2008).

The biggest surprise about the Geithner plan:

Complete media silence from Congress this morning.

I really wonder what they are thinking? Perhaps a sigh of releief that the plan does not involve THEM?

justme,

that was a nice link.

I still don't understand how you stick the difference to tax payers. If I am Pimco, I would want to buy assets at lowest price and Govt has to price the same. Banks can decide to sell or not. Is there someway of going around with conflict of interest? like Pimco offering to buy at 60 cents when asset is worth only 40 cents?

Henry Blodget wrote a very good article about what the Geithner plan really means:

http://www.businessinsider.com/henry-blodget-geithners-three-big-misconceptions-2009-3

"But mortgage lending is very risky right now, so you’d think that mortgage rates would be very high"

We saw that before, yes it was the market reaction that the unguaranteed rates were at 8 or 9%. Keep in mind though that as values drop the risk on new loans is actually lower. All of a sudden banks have been infused with very cheap cash and are now competing for quality borrowers on cheaper/safer homes to lend.

Realized I'm just rewording and repeating Justme and OO, seems like we're all on the same page.

sa,

It is because the USG via FDIC is going to give subsidized and non-recourse (as in: they can walk away) loans to the very people that will buy the assets.

http://krugman.blogs.nytimes.com/2009/03/23/geithner-plan-arithmetic/#comments

On top of that there is all kinds of possibilities for conflicts of interest, such as banks lending money to partnerships that will combine their small money with USG big money and BID UP the assets. Because of the huge leverage of the private cash when combined with the USG (about 12x according to some, 6x according to others) the banks can spend $1 in loans to bid up the CDO paper by $12!! It;s insane. Even if the bank lose the money, they get a 12x-1x=11x payoff by gaming the process.

OK, I think I get it for conforming loans. Since the banks are just originators, they pass them on to Fannie and Freddie, who in turn sell them to the Fed, who will accept low interest rates even though the mortgages are likely to default.

So what we have here is the Fed effectively lending to house buyers at lower-than-market rates. But the Fed is so big, and others don't want to lend at those rates (and don't want F&F bonds) so the Fed IS the mortgage market, for now.

And the Fed doesn't give a hoot if the mortgage doesn't get repaid, since it can just print more money anyway. No skin off its nose.

And so the banks don't really need to pay me 7% on my CD. They don't need my deposits at all, really.

But there are probably some good corporate bonds that would actually be willing and able to pay me 7%. The trick is to figure out what those bonds are.

Or has the Fed done its communist price-fixing in the corporate bond market as well?

And the Fed doesn’t give a hoot if the mortgage doesn’t get repaid, since it can just print more money anyway. No skin off its nose

This is why Obama says: "This is America, we can do what ever we want"

The Timing of the plan is also rather suspicious. Diversion baby. Don't let Tax payers settle on one issue.

>> “This is America, we can do what ever we want”

I have to say, I do not think Obama said that.

Patrick,

Yeah, The Fed is the mortgage lender for conforming loans until the 1.2T runs out. Then maybe they will print more.

I know he didn't say that, he just meant that. LOL!

Diversion and obfuscation is definitely the name of the game. The bottom line is that falling housing prices means losses for the banks, and trouble paying back the depositors.

Mish connected the dots. "500 Billion for FDIC" Legislation was basically for this plan.

Watching Geithner and Summers making separate appearances on CNBC and PBS today was quite disturbing.

Geithner is looking like all his dishonesty is getting to him, and his big cranium is about to explode.

Summers is looking like an evil industrialist from a movie based on a Charles Dickens novel.

It is getting bad.

Here's my problem:

Suppose we ditch the whole Geithner plan and instead allow FDIC to take all the big banks into receivership. How much money does the taxpayer stand to lose? Do we have to do a 1T PPIP/PPIF experiment just to fond out?

Shadows on the mountain, and the night begins to fall;
Gather up the children, 'fore the darkness takes us all.
Tribe has come together, standin' naked against the night;
Twenty feet from the fire, the evil waits with zombie eyes.