Articles by Tyler Durden

Following this morning’s plunge in new home sales…


After household formation collapsed in June…

It appears Institutional Risk Analyst’s Chris Whalen is spot on with his mortgage finance update: “Winter Is Here”…

After several weeks on the road talking to mortgage professionals and business owners, below is an update on the world of housing finance.  We hope to see all of the readers of The Institutional Risk Analyst in the mortgage business at the Americatalyst event in Austin, TX, next month.

The big picture on housing reflected in the mainstream media is one of caution, as illustrated in The Wall Street Journal. Borodovsky & Ramkumar ask the obvious question:  Are US homes overvalued? Short answer: Yes.  Send your cards and letters to Janet Yellen c/o the Federal Open Market Committee in Washington.  But the operating environment in the mortgage finance sector continues to be challenging to put it mildly.

As we’ve discussed in several forums over the past few years, home valuations are one of the clearest indicators of inflation in the US economy.  While members of the tenured world of economics somehow rationalize understating or ignoring the fact of double digit increases in home prices along the country’s affluent periphery, sure looks like asset price inflation to us.

In fact, since WWII home prices in the US have gone up four times the official inflation rate.

 “Houses weren’t always this expensive,” notes CNBC. “In 1940, the median home value in the U.S. was just $2,938. In 1980, it was $47,200, and by 2000, it had risen to $119,600. Even adjusted for inflation, the median home price in 1940 would only have been $30,600 in 2000 dollars, according to data from the U.S. Census.”

Inflation, just to review, is defined as too many dollars chasing too few goods, in this case bona fide investment opportunities.  A combination of slow household formation and low levels of new home construction are seen as the proximate cause of the housing price squeeze, but higher prices also limit the level of existing home sales.  Many long-time residents of high priced markets like CA and NY cannot move without leaving the community entirely. So they get a home equity line or reverse mortgage, and shelter in place, thereby reducing the stock of available homes.

Two key indicators that especially worry us in the world of credit is the falling cost of defaults and the widening gap between asset pricing and cash flow.  Credit metrics for bank-owned single-family and multifamily loans are showing very low default rates.  More, loss-given default (LGD) remains in negative territory for the latter, suggesting a steady supply of greater fools ready to buy busted multifamily property developments above par value.  We can’t wait for the FDIC quarterly data for Q2 2017 to be released later today as we expect these credit metrics to skew even further.

Single-family exposures are likewise showing very low default rates and LGDs at 30-year lows, again suggesting a significant asset price bubble in 1-4 family homes.  The fact that many of these properties are well under water in terms of what the property could fetch as a rental also seasons our view that we are in the midst of a Fed-induced investment mania.

For every seller in high priced states that finds current prices impossible to resist, there are several ready buyers. But the crowd of buyers is thinning. Charles Kindleberger wrote in his classic book, “Manias, Panics and Crashes,” in 1978:

“Financial crises are associated with the peaks of business cycles. We are not interested in the business cycle as such, the rhythm of economic expansion and contraction, but only in the financial crisis that is the culmination of a period of expansion and leads to downturn.”

One of the interesting facts about the mortgage sector in 2017 is that even though average prices have more than recovered from the 2008 financial crisis, much of the housing stock away from the desirable periphery has not really bounced.  This is yet another reason why existing home sales at a bit over a million properties annually have gone sideways for months.  The 600,000 or so new housing starts is half of the peak levels in 2005, but today’s level may actually be sustainable.

We had the opportunity to hear from our friend Marina Walsh of the Mortgage Bankers Association at the Fay Servicing round table in Chicago last week.  Mortgage applications have been running ahead of last year’s levels, yet overall volumes are declining because of the sharp drop in refinancing volumes.  We disagree with the MBA about the direction of benchmarks such as the 10-year Treasury bond.  They see 3.5% yields by next year, but we’re still liking the bull trade.  But even a yield below 2% will not breath significant life into the refi market.

Though prices in the residential home market remain positively frothy in coastal markets, profitability in the mortgage finance sector continues to drag.  Large banks earned a whole 15 basis points on mortgage origination in the most recent MBA data, while non-banks and smaller depositories fared much better at around 60-70bps.  But few players are really making money.

During our conversations over the past several weeks, we confirmed that the whole residential housing finance industry is suffering through some of the worst economic performance since the peak levels of 2012. The silent crisis in non-bank finance we described last year continues and, indeed, has intensified as origination margins have been squeezed by the market’s post-election gyrations.

Looking at the MBA data, if you subtract the effects of mortgage servicing rights (MSR) from pre-tax income, most of the industry is operating at a significant loss.  The big driver of the industry’s woes is regulation, both as a result of the creation of the Consumer Finance Protection Bureau and the actions of the states.

Regulation has pushed the dollar cost of servicing a loan up four fold since 2008.  From less that $100 per loan in 2008, today the full-loaded cost of servicing is now $250, according to the MBA.  The cost of servicing performing loans is $163 vs over $2,000 for non-performing loans.

Source: MBA

As one colleague noted at the California Mortgage Banker’s technology conference in San Diego, “every loan is a different problem.” But nobody in the regulatory community seems to be concerned by the fact that the cost of servicing loans has quadrupled over the past eight years.  The elephant in the room is compliance costs, which accounts for 20% of the budget for most mortgage lending operations.

Technology Driving Down Costs

To some degree, technology can be used to address rising costs.  But when it comes to unique events spanning the range from legitimate consumer complaints to a phone call to follow-up on a past request or spurious inquiries, none of these tasks can be automated.  The obsession with the wants and needs of the consumer has led the mortgage industry to some truly strange behaviors, like Nationstar (NYSE:NSM) deciding to rename itself “Mr. Cooper.”

Driven by the atmosphere of terror created by the CFPB, the trend in the mortgage industry is to automate the underwriting and servicing process, and make sure that all information used is documented and easily retrieved. The better-run mortgage companies in the US use common technology platforms to ensure a compliant process, but leave the compassion and empathy to humans.

By using computers to embed the rules into a business process that is compliant, big steps are being made in terms of efficiency. Trouble is, this year many mortgage lenders are seeing income levels that are half of that four and five years ago.  Cost cutting can only go so far to addressing the enormous expense inflation resulting from excessive regulation and revenue compression due to volatility in the bond market.

Avoiding errors and therefore the possibility of a consumer complaint (and a regulatory response) is really the top priority in the mortgage industry today. As one CEO opined: “Sometimes the best customer experience is consistency in terms of answering questions and quickly as possible and communicating in a courteous and effective fashion.”

All of this costs time and money, and then more money.  Our key takeaway from a number of firms The IRA spoke with over the past three weeks is that response time for meeting the needs of consumers and regulators is another paramount concern.

Being able to gather information, solve problems and then document the response to prove that the event was handled correctly is now required in the mortgage industry.  But as one senior executive noted: “Sometimes people are easier to change than systems.”

So in addition to the FOMC, banks and mortgage companies can also thank the CFPB and aspiring governors in the various states for inflating their operating costs for mortgage lending and servicing by an order of magnitude since the financial crisis.  This is all done in the name helping consumers, you understand, but at the end of the day it is consumers who pay for the inflation of living costs like housing.  Investors and consumers pay the cost of regulation.  

Over the past decade since the financial crisis, the chief accomplishment of Congress and regulators has been to raise the cost of buying or renting a home, while decreasing the profitability of firms engaged in any part of housing finance.  We continue to wonder whether certain large legacy servicing platforms — Walter Investment Management (NYSE:WAC) comes to mind — will make it to year-end, but then we said that last year.

Like the army of the dead in the popular HBO series “Game of Thrones,” the legacy portion of the mortgage servicing industry somehow continues to limp along despite hostile regulators and unforgiving markets.  Profits are failing, equity returns are negative and there is no respite in sight.  Even once CFPB chief Richard Cordray picks up his carpet bag and scuttles off to Ohio for a rumored gubernatorial run, business conditions are unlikely to improve in the world of mortgage finance. Winter is here.

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Kim Jong Un is once again showing the US exactly how disinterested he is in negotiating any settlement – particularly one that ultimately forces North Korea to surrender its nuclear weapons: To wit, Kim ordered more rockets and warheads during a televised visit to a local munitions factory just hours after Secretary of Defense James Mattis praised Kim’s “restraint” for not having launched any new missile strikes since the latest round of UN sanctions took effect on Aug. 5. Mattis also reiterated that the Trump administration would be open to talks.

Here’s Mattis (via the Wall Street Journal):

“I am pleased to see that the regime in Pyongyang has certainly demonstrated some level of restraint that we have not seen in the past,” Mr. Tillerson said in a news briefing in Washington. “We hope that this is the beginning of this signal that we have been looking for.”

To be sure, if the “Mad Dog” was looking for signs of a détente from North Korea, he’s bound to be disappointed. Though the date of Kim’s visit to the munitions factory wasn’t disclosed, the North Korean leader could clearly be heard ordering the program to press ahead with its quest to develop a nuclear warhead that could reliably target the Continental US. He also showed off two new additions to his arsenal.

“Mr. Kim’s visit, the date of which wasn’t disclosed by Pyongyang in its report Wednesday, underscores North Korea’s continued investment in its ability to threaten the continental U.S. with a nuclear-tipped long-range missile.”

As WSJ notes, while Kim’s temporary discontinuation of the missile tests has been perceived as an encouraging sign by some, the real issue is the North’s nuclear program, and any progress their engineers might be making. US intelligence agencies believe the Kim regime possess the capability to reach the US with an ICBM.

From Mattis, any statement connoting positivity regarding the relationship between the US and North is indeed rare. The general has typically backed his boss’s aggressive tone when speaking about the isolated nation publicly, like he did during an appearance on Fox & Friends earlier this month…  

“Defense Secretary James Mattis warned North Korea in stark terms on Wednesday that it faces devastation if it does not end its pursuit of nuclear weapons: “The DPRK must choose to stop isolating itself and stand down its pursuit of nuclear weapons,” Mattis said in a statement adding “The DPRK should cease any consideration of actions that would lead to the end of its regime and the destruction of its people.”

Photos published by the KCNA along with Wednesday’s report showed Kim inspecting what looked to be two new missiles.

“Photos published alongside Wednesday’s report by the official Korean Central News Agency showed Mr. Kim and other officials standing in front of diagrams. Missile experts said the diagrams appeared to show at least two never-before-seen missiles, including one that looked to be a variant of a solid-fueled missile that North Korea launched from a submarine last year.


Pyongyang in February launched a land-based version of the solid-fueled missile, known as the Polaris-2. Solid-fuel missiles, unlike traditional liquid-fueled ones, don’t need to be fueled on the launchpad—a laborious process that makes the weapon vulnerable to a pre-emptive strike.”

The photos represent a clear message to the US: North Korea has no intention of halting its nuclear weapons program.

“’Pyongyang’s release of photos indicating yet two more new missiles in development shows it has no intention of halting its continuing quest to threaten the U.S. and its allies with nuclear weapons,’ said Bruce Klingner, senior research fellow for Northeast Asia at the Heritage Foundation.


“A two-week adherence of North Korea to U.N. prohibitions against missile tests hardly counts as a significant indicator of benign intent by the regime,” he added, referring to the United Nations Security Council’s newest round of sanctions earlier this month.”

Another of the WSJ’s “expert” sources said the missile program is probably “untouchable” for now, but that diplomacy could still be worth pursuing.

“’The missile-building program is unstinting,’ said Patrick Cronin, senior director of the Asia-Pacific Security Program at the Center for a New American Security.


“Diplomacy cannot touch that for now.”


But Mr. Cronin argued that the U.S. should continue to pursue diplomacy with Pyongyang, and encourage any signs of progress — including the recent dearth of missile tests.


North Korea hasn’t launched a missile in 26 days, though the launch of its first ICBM on July 4 came after a 35-day pause.


“North Korea has shown glimmers of restraint for now and the U.S. seeks to encourage more, but is ready to move in the opposite direction as well,” Mr. Cronin said.”

In summary, the Pyongyang report was of a kind with what North Korea has said from the beginning: It will not give up its weapons. End of story.

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Authored by Mohamed El-Erian via,

Persistently low inflation, or “lowflation,” is vexing lots of people. According to the recent minutes of policy meetings of the Federal Reserve and the European Central Bank, central banks on both sides of the Atlantic have been trying to identify the causes — but with limited success so far. This complicates monetary policy decisions and undermines the range of institutional solutions that have been proposed by academics. Until this changes, central banks may need to think more holistically about the objectives of monetary policy, including the unintended consequences for future financial stability and growth of being too loose for too long.

Four facts stand out in reviewing recent inflation data:

  • Inflation rates have been unusually and persistently low.
  • This is primarily an advanced-country phenomenon.
  • Inflation has not responded to the prolonged pursuit of ultra-low interest rates and huge injections of liquidity by central banks through quantitative easing. 
  • This has coincided with a period of notable job creation, especially in the U.S., thereby flattening the “Phillips curve” that plots unemployment and inflation rates.

Many economists worry that such lowflation frustrates the relative price adjustments that are critical to a well-functioning market economy. And if the inflation rate, and related inflationary expectations, flirt with the zero line for too long (as had occurred in Europe), there is an increased risk of actual price declines that encourages consumers to postpone their purchases, weakens economic growth, and undermines policy effectiveness (as had been the case in Japan).

The many reasons that have been put forward for the lowflation phenomenon range from benign measurement errors to worrisome structural drivers, with a host of “idiosyncratic factors” in the middle. Indeed, the Fed minutes released last week contain a list of possible drivers. These also note that a few central bankers are questioning the usefulness of traditional models and approaches in explaining and predicting inflation behavior. The recent ECB minutes also refer to “a number of explanatory factors” for lowflation and the importance of monitoring “the extent to which such factors could be transient or more permanent.” (And that is not the only issue vexing central bankers and economists more generally — productivity and wage formation have also been puzzles to an unusual extent.)

Turning to solutions, some economists have suggested that central banks increase their inflation targets, typically set at 2 percent currently. Others have proposed that the monetary authorities should pursue a price level target so that shortfalls in meeting the desired inflation rate in one year would require aiming for a higher rate in the subsequent year.

As attractive as they may sound to some, these solutions are operationally challenged, particularly if structural factors are depressing inflation. 

Having failed to meet the 2 percent target despite aggressive monetary policy, it is far from obvious that central banks would be able to meet a higher objective. And no one is quite sure how the political system would respond to a central bank that pursues much higher inflation as it tries to offset the shortfalls of prior years. Indeed, until we have a better understanding of how the transmission mechanism has evolved, there is no guarantee that a change in policy approach would do anything more than threaten even greater collateral damage and unintended consequences.

Already, economies on both side of the Atlantic must contend with the risk that a loose monetary policy approach may have overly repressed financial volatility, excessively boosted a range of asset prices beyond what is warranted by economic fundamentals, and encouraged too much risk-taking by non-banks. Indeed, in the Fed minutes, the central bank staff noted that “since the April assessment, vulnerabilities associated with asset valuation pressures had edged up from notable to elevated.” Robust job creation, financial conditions, and the overall health of the economy should guide monetary policy formation rather than the excessive pursuit of a still-misunderstood lowflation.

The lowflation demon is real and, in the case of the U.S., the market now believes that it will likely dissuade the Fed from delivering on the next signaled step in the gradual normalization of monetary policy, including an interest rate hike in the remainder of 2017. Yet a lot more work is needed to understand the causes and consequences of persistently low inflation. Until that happens, central bankers may be well advised to stick with the demon they know rather than end up with one of future financial instability that undermines prospects for growth and prosperity.

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Unveiling a novel, if oddly circuitous attempt to shut up President Donald Trump on his favorite social network, former undercover CIA agent Valerie Plame Wilson has launched a crowdfunding campaign in hopes of raising enough money to buy Twitter so she can then ban Trump from using it.

The blonde ex-spook launched the fundraiser last week, tweeting: “If @Twitter executives won’t shut down Trump’s violence and hate, then it’s up to us. #BuyTwitter #BanTrump.”

If @Twitter executives won’t shut down Trump’s violence and hate, then it’s up to us. #BuyTwitter #BanTrump

— Valerie Plame Wilson (@ValeriePlame) August 18, 2017

The GoFundMe page for the fundraiser says Trump’s tweets “damage the country and put people in harm’s way.”

From the campaign:

Donald Trump has done a lot of horrible things on Twitter. From emboldening white supremacists to promoting violence against journalists, his tweets damage the country and put people in harm’s way. But threatening actual nuclear war with North Korea takes it to a dangerous new level. 


It’s time to shut him down. The bad news is Twitter has ignored growing calls to enforce their own community standards and delete Trump’s account. The good news is we can make that decision for them.


Twitter is a publicly traded company. Shares = power. This GoFundMe will fund the purchase of a controlling interest in Twitter. At the current market rate that would require over a billion dollars — but that’s a small price to pay to take away Trump’s most powerful megaphone and prevent a horrific nuclear war.

And the punchline: “Let’s #BuyTwitter and delete Trump’s account before he starts a nuclear war with it. The whole world will thank us when we do!”

Plame’s pitch is simple: raise enough cash to buy a controlling interest of Twitter stock. If, on the “odd chance” Plame is unable to raise enough to purchase a majority of shares, she said she will explore options to buy “a significant stake” and champion the proposal at Twitter’s annual shareholder meeting.

Considering that her campaign’s stated goal is only $1 billion, a (very) minority stake is the best the former CIA agent can hope for. As of Wednesday, a majority stake would cost just over $6 billion (TWTR’s market cap is $12.33 billion). Still, a billion dollars of TWTR shares would make her Twitter’s largest shareholder (or rather bagholder) and give her a dominant “activist” position to exert influence on the company. Of course, whether kicking Trump off Twitter is worth the hassle is a different question, especially since anyone who wishes not to follow Trump can do so for free.

Another problem is that almost a week into the campaign, it has raised just under $8,000, meaning it is about $999,992,000 shy of its lofty goal.

The White House responded to the campaign, and in a statement to the AP, press secretary Sarah Huckabee Sanders said the low total shows that the American people like the president’s use of Twitter. “Her ridiculous attempt to shut down his first amendment is the only clear violation and expression of hate and intolerance in this equation,” the White House read.

As a reminder, Plame’s identity as a CIA operative was leaked by an official in former President George W. Bush’s administration in 2003 in an effort to discredit her husband, Joe Wilson, a former diplomat who criticized Bush’s decision to invade Iraq. She left the agency in 2005.

Some cynics have dared to speculate that Plame’s campaign is just a (not so) veiled attempt to regain social and media prominence. It is unclear if their Twitter accounts will also be banned by the up and coming CEO. It’s also unclear what happens to the raised cash once the campaign fails to reach its target, although we are confident Jill Stein has some ideas

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Authored by Tho Bishop via The Mises Institute,

Ever since entering the Senate, Rand Paul has continued his father’s work in advocating for an audit of the Federal Reserve. This week, writing for the Daily Caller, Senator Paul renewed his efforts, illustrating how the recent era of unconventional monetary policy has made an audit all the more important:

In 2009, then-Fed Chairman Ben Bernanke was able to refuse to tell Congress who received over two trillion in Fed loans, and it took congressional action and a Bloomberg lawsuit to force the Fed to reveal the details of what it did in more than 21,000 transactions involving trillions of dollars during the 2008 financial crisis.  A one-time audit of the Fed’s emergency lending mandated by Congress revealed even more about the extent to which the Fed put taxpayers on the hook.

When pushed to defend the lack of transparency for the Federal Reserve, officials like Janet Yellen and Treasury Secretary Steve Mnuchin point to the myth of the Fed independence – a position that requires outright ignorance of the history of America’s central bank and the executive branch. Of course it’s quite usual for the Senate to base the merits of legislation entirely off of fallacious arguments, so they have continued to be the legislative body holding up a Fed audit with little indication they are prepared to move.

Given that reality, it is time for Senator Rand Paul to change his approach and introduce another piece of legislation from his father’s archives: the Free Competition in Currency Act.

While not as catchy as “End the Fed”, this piece of legislation – inspired by the work of F.A. Hayek – was perhaps Ron Paul’s most radical pieces of legislation. The idea was quite simple: eliminate legal tender laws mandating the use of US Dollars and remove the taxes Federal and State governments place on alternative currencies – such as gold and silver. While the original legislation did apply to “tokens,” an updated version should explicitly include the growing market of cryptocurrencies as a good with monetary value that should not be taxed.

What this would do is create a more even playing field between the dollar and alternative currencies, allowing an easy way for Americans to safeguard their wealth if they ever have reason to doubt the wisdom of the Federal Reserve’s policies. Just as Senator Paul advocated for the ability of Americans to be able to opt-out of the failing Obamacare system, this bill would grant Americans a lifeboat should the weaknesses inherent with the Fed’s fiat money regime expose themselves.

Unlike most examples of monetary policy reforms, which tend to be the products of ivory tower echo chambers, competition in currency would reflect active political trends. In recent years, states like Texas, Utah, and – in 2017 – Arizona have passed laws allowing the use of silver and gold for use in transactions. Meanwhile, other countries have looked to embrace the potential of cryptocurrencies for their monetary regimes. This makes this not only an idea that is good on paper, but one whose time has come.

As alluded to before, simply because a policy makes sense does not mean the Senate will act on it. That doesn’t mean the conversation and debate isn’t worth having. While it may still be on the horizon, there has been a steady drumbeat in Washington for the Federal Reserve to face some sort of reform. For two Congressional sessions in a row, the House has passed legislation explicitly calling for the Fed to embrace a “rules-based monetary system.” While this approach may sound better than today’s PhD standard, it doesn’t solve the problems inherent with central banking and fiat money.

Monetary rules such as “NGD Targeting” – which has the support of a rare coalition including the Cato Institute, Mercatus Center, Christina Romer, and Paul Krugman — should never be seen as a “reasonable compromise” for those skeptical about the Fed. Instead it’s simply another way of disguising central planning in a way to make it more palpable to the public, and therefore more difficult to stop. By putting this bill out there, Rand Paul can help frame the debate and bring a real solution to the table. Something that wouldn’t force the Fed to change a single thing, only making them compete on the market like the producer of other good or service. 

After all, as is the case with healthcare, or shoes, the best sort of “monetary policy” is competition on the market. Not one dictated by government. 


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Over the weekend, Morgan Stanley reminded its clients that the biggest threat facing markets over the coming weeks is the “three-headed policy monster” inside Washington: raising the debt ceiling, passing a budget and embarking on tax reform. As MS cross-asset strategist Andrew Sheets noted, “none are easy, but we see the debt ceiling as the most immediate test.”

He then cautioned that while the most likely outcome is that, after some tension, the debt ceiling gets raised “we don’t think it will be easy, or smooth, and it may require some form of market pressure to get different sides to fall in line. I’ve spoken to investors who are comforted by FOMC transcripts from 2011 that discussed prioritization of debt payments in order to avoid default. I am not. First, I worry that this reduces the urgency of what remains a serious issue. Second, this prioritization would require delaying payments to programmes like Social Security and Medicare, with real human and economic cost. And third, while the mechanics of this prioritisation may work, it is untested in a live environment.”

As reported earlier, the market’s concerns about a potential debt ceiling crisis, so far mostly contained, have once again started to bubble to the surface, with the Oct. 5 T-Bill rate rising to the highest level since August 1st, suggesting that bond traders see rising odds of a “worst case outcome” and partially answering our question from Monday whether “Markets Are Sleepwalking Into A Debt Ceiling Crisis: Mnuchin Issues Another Warning.

Additionally, the yield spread between the Sept 28 and Oct 5 Bills is now the widest on record:

The blowout has come after the latest warning by Treasury Secretary Steven Mnuchin, who on Monday said that “we need to raise the debt limit and it’s my strong preference is that there’s a clean raise of the debt limit.”

However, as of this morning, it’s not just the debt ceiling that traders have to worry about, because as discussed overnight, a new potential problem emerged last night when Trump told a Phoenix rally that he is commited to securing funds for a border wall, even if it results in a government shutdown.

While last night’s rally audience loved the threat, Democrats promptly blasted it: on Wednesday, Chuck Schumer ripped Trump for threatening to shutdown the government: “If the President pursues this path, against the wishes of both Republicans and Democrats, as well as the majority of the American people, he will be heading towards a government shutdown which nobody will like and which won’t accomplish anything,” Schumer said on Wednesday. Including funding for a physical wall is considered a non-starter for Democrats, whose votes will be needed to get a government funding bill through the Senate.

We doubt a warning from the Senate Minority Leader, or any other Democrat or Republican for that matter, will have much of an impact on Trump’s decision-making if he has indeed set his mind on procuring border wall funding. Which is also why in a note from Compass Point released this morning, strategists Isaac Boltansky and Lukas Davaz warn that not only is the risk of a government shutdown bigger than the debt limit, but that Trump’s commitment to securing funds for a border wall, together with Trump’s “injurious relationship” with GOP leaders – best demonstrated by last night’s NYT bombshell article laying out the open war between Trump and Senate Majority Leader Mitch McConnell – “dramatically raises the spectre of a shutdown in October.” Here are the highlights of their note, courtesy of Bloomberg:

  • The prospect of a govt shutdown “still poses a potentially serious downside risk for investors,” even as “our firm belief that the debt ceiling will be lifted removes a profound political risk from the landscape”
  • Trump’s commitment to securing funds for a border wall “dramatically raises the spectre of a shutdown in October” and his “injurious relationship” with Congressional Republican leadership “further complicates the underlying calculus”

Compass Point adds that four factors increase the potential for an equity market sell-off as government shutdown risks intensify:

  • Further delays confirmations, which would affect Trump’s deregulatory agenda;
  • Delivers a “psychological blow” to markets, serving as a “concrete symbol” of Washington’s inability to govern;
  • Delays legislative progress on tax reform;
  • Alters Fed’s policy normalization trajectory

In summary, while Compass Point says that lawmakers will promptly raise the debt ceiling in mid-September, or less than a month from now – something which Morgan Stanley and others find hard to believe – a government shutdown in October suddenly all too likely.

Then, shortly after the note was released, rating agency Fitch also chimed in and warned that if the U.S. debt limit is not raised in a timely manner, it would review the U.S. sovereign rating, with potentially negative implications. In other words, Fitch is warning that a repeat of August 2011 – when S&P infamously downgraded the US to AA+ after the failure to raise the debt ceiling resulted in a brief technica default0 is now on the table. The silver lining: Fitch said that a government shutdown following a debt ceiling increase, such as the one envisioned by Compass Point, would not direct affect on U.S. AAA rating.

Finally, for those who are still on the fence about the likelihood of a shutdown and are otherwise unhedged, one month ago Bank of America put together a “costless” spread collar trade, should volatility surge in the coming weeks as a debt ceiling/government funding deal emerges as unlikely. Here again is how to make money should the US government shut down in just over a month.

Trade idea: VIX Oct 12/14/19 call spread collar for zero-cost upfront


We are comfortable selling VIX puts to leverage a likely floor in volatility, particularly ahead of the debt ceiling, and using the premium collected to the cheapen the cost of portfolio protection. For example, investors may consider selling the VIX Oct 12 put vs. the 14/19 call spread, indicatively zero-cost upfront with a net delta of +54 (Oct fut ref 13.35).


The trade leverages the facts that (i) VIX 3M ATMf implied volatility, while low, is not necessarily cheap compared to the level of the VIX 3M future (Chart 14), and (ii) VIX 3M call skew is currently very steep, in the 92nd percentile since Sep-09 (Chart 15).


More critically, while VIX call spread collars have been challenged by recent sub-11 VIX settlement values, they can be successful, low-cost hedges when there are defined macro catalysts on the calendar to provide support to volatility, as seen from the US election and more recently the first round of the French election.


Lastly, we are comfortable capping upside via the call spread as the VIX 1M and 2M futures have not closed above 20 since Brexit over one year ago.


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Authored by Daniel McAdams via The Mises Institute,

Like me, many of you watched President Trump’s train wreck of a speech on Afghanistan earlier tonight. It’s nearly midnight and I am still reeling.

I guess it was too much to ask to hear him admit the obvious and draw the obvious conclusions:  

After 16 years – the longest war in US history – no one even remembers what we are fighting for in Afghanistan.


The war is over.


Not another American (or innocent Afghan) life for one of the most convoluted and idiotic wars in history!

Trump of 2012 and 2013 said just that. Candidate Trump said just that.

Then tonight he told us that once you sit in that chair in the Oval Office you see things differently.

What does that mean?

Once elected you betray your promises so as to please the deep state? Here’s the truth that neither President Trump nor his newfound neocon coterie can deny:

1) A gang of radical Saudis attacked the US on 9/11. Their leader, Osama bin Laden, was a CIA favorite when he was fighting the Soviets in Afghanistan. He clearly listed his grievances after he fell out with his CIA sponsors: US sanctions in Iraq were killing innocents; US policy grossly favored the Israelis in the conflict with Palestinians; and US troops in his Saudi holy land were unacceptable.


2) Osama’s radicals roamed from country to country until they were able to briefly settle in chaotic late 1990s Afghanistan for a time. They plotted the attack on the US from Florida, Germany, and elsewhere. They allegedly had a training camp in Afghanistan. We know from the once-secret 28 pages of the Congressional Intelligence Committee report on 9/11 that they had Saudi state sponsorship.


3) Bin Laden’s group of Saudis attacked the US on 9/11. Washington’s neocons attacked Afghanistan and then Iraq in retaliation, neither of which had much to do with bin Laden or 9/11. Certainly not when compared to the complicity of the Saudi government at the highest levels.


4) Sixteen years — and trillions of dollars and thousands of US military lives — later no one knows what the goals are in Afghanistan. Not even Trump, which is why he said tonight that he would no longer discuss our objectives in Afghanistan but instead would just concentrate on “killing terrorists.”

Gen. Mike Flynn had it right in 2015 when he said that the US drone program was creating more terrorists than it was killing. Trump’s foolish escalation will do the same. It will fail because it cannot do otherwise. It will only create more terrorists to justify more US intervention. And so on until our financial collapse. The US government cannot kill its way to peace in Afghanistan. Or anywhere else.


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Even before Ray Dalio doubled down on his warning that the US has become as dangerously fragmented as during the pre-World War II days of 1937, prompting him to “tactically reduce” risk, some of the biggest names on Wall Street were selling.

Two weeks ago, T.Rowe Price made waves when it said that it had cut the stock portion of its asset allocation portfolios to the lowest level since 2000. The Baltimore-based money manager said it also reduced its holdings of high-yield bonds and emerging market bonds for the same reason. Roughly at the same time, in its mid-year review, Pimco said that “with the macroeconomic backdrop evolving in the face of potentially negative pivot points and considering asset prices generally are fully valued, we are modestly risk-off in our overall positioning” adding that “we recognize events could still surprise to the upside, but starting valuations leave little room for error.”

This followed a similar preannouncement by DoubleLine’s Jeff Gundlach who not only said that he is reducing his positions in junk bonds, EM debt and other lower-quality investments, but predicted – correctly – the volatility spike in the first week of August. 

Then it was Guggenheim’s turn to make a similar warning: in its Q3 Fixed Income Outlook, the asset manager said that “the downside risk of a near-term market correction grows the longer volatility
remains depressed. Asset prices are at record highs while volatility has rarely been lower. Our Global CIO and Macroeconomic and Investment Research team believe these indicators point to a dangerous level of complacency in the market, which has shrugged off the Fed’s guidance that economic conditions support monetary tightening… given where asset prices are, they would have a long way to fall.”

Guggeneim CIO Anne Walsh also warned that “high-yield corporate bonds are particularly at risk due to their relatively rich pricing, so we have continued to significantly reduce our exposure to that sector. The high-yield corporate bond allocations across our Core and Multi-Credit strategies are now at the lowest level since their inception. The bank loan allocation has also been reduced as a majority of the market is trading at or above par with some loans trading at negative yields to call.”

The list above is by no means exhaustive: according to a Bloomberg calculations, investors overseeing a total of over $1.1 trillion have been cutting exposure to junk bonds amid growing concerns about rising rates, central bank policy and general geopolitical uncertainty.

Below courtesy of Bloomberg, is the list of money managers who have recently cut holdings of junk debt:

JPMorgan Asset Management; AUM: $17 billion (for Absolute Return & Opportunistic Fixed-Income team)

  • In early July told Bloomberg they have cut holdings of junk debt to about 40 percent from more than half.
  • “We are more likely to decrease risk rather than increase risk due to valuations,” New York-based portfolio manager Daniel Goldberg said.

DoubleLine Capital LP; AUM: about $110 billion

  • Jeffrey Gundlach, co-founder and chief executive officer, said in an interview published Aug. 8 he’s reducing holdings in junk bonds and emerging-market debt and investing more in higher-quality credits with less sensitivity to rising interest rates.
  • European high-yield bonds have hit “wack-o season,” Gundlach said in a tweet last week.

Allianz Global Investors; AUM: $586 billion

  • David Newman, head of global high yield, said in an interview his fund has begun trimming its euro high-yield exposure because record valuations make the notes particularly vulnerable in a wider selloff.

Deutsche Asset Management; AUM: 100 billion euro ($117 billion) in multi-asset portfolios

  • Said earlier this month it has reduced holdings of European junk bonds.
  • The funds are shifting focus to equities, where there is more potential upside and higher yields from dividends, according to Christian Hille, the Frankfurt-based global head of multi asset.

Guggenheim Partners; AUM: >$209 billion

  • Reduced allocation to high-yield corporate bonds across core and multi-credit strategies to the lowest level since its inception, according to a third-quarter outlook published on Thursday.
  • Junk bonds are “particularly at risk due to their relatively rich pricing,” portfolio managers including James Michal say in outlook report.

Brandywine Global Investment Management; AUM: $72 billion

  • Fund has cut euro junk-bond allocations to a seven-year low because of valuation concerns, Regina Borromeo, head of international high yield, said in an interview this month

Who knows if these marquee names are right: if it’s them against the central banks, all their sales will do is forego potential profits as the world’s central banks push yields and spreads to levels that are beyond laughably ludicrous, but such is life in a centrally planned world where nothing makes sense. We do have one question: if asset managers with more than $1.1 trillion in AUM are all selling junk bonds, i) who is buying, and ii) how is it possible that the yield on the Barclays global HY index has barly budged from all time lows?

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Authored by Robert Colvile via,

  • The struggles of Provident Financial have fuelled concerns about a new sub-prime crisis
  • Buyers of Provident’s car loans are up to their eyeballs in debt
  • Regulation has discouraged big banks from offering affordable credit to the poor

A decade on from the financial crisis, the reports today about the sub-prime lender Provident Financial have given us a nasty case of déjà vu.

Within the space of a year, its loan repayment rates have fallen from 90 per cent to 57 per cent – leading to profit warnings, the departure of its chief executive, and a collapse in its share price.

It feels like a frighteningly familiar story. Overstretched customers at the bottom of the economic food chain rack up unaffordable loans from greedy financiers. When the music stops, the credit failures cascade upwards, bringing down lender after lender until the whole financial edifice comes apart.

So are we facing a new sub-prime crisis? There are two conflicting narratives.

The first is that Provident’s problems are unique to Provident. The firm operates in what is euphemistically known as “the non-standard credit market” – ie providing loans to people who are woeful credit risks. It does this via Vanquis Bank, which sells credit cards; Provident, which sells domestic loans; Satsuma, which does short-term online loans a la Wonga; and Moneybarn, which provides car finance.


The one-line explanation for what went wrong with the business is that Provident moved from collecting what it was owed via “self-employed door-to-door agents” to full-time “customer experience managers”. In other words, rather than outsourcing the business of debt collection it would bring it in-house.


The move followed followed claims, for example by Citizens Advice (£), that the agents of some doorstep lenders were engaging in illegal cold-calling, irresponsible lending or naked intimidation – though Provident denied that its own agents engaged in such behaviour, and said they would be sacked immediately if they did so.


The problem was that, as soon as the firm told the existing collection agents that they were being fired, they walked out rather than stay through the transition. Hence the plunging rates of debt collection, which the new staff haven’t been able to get back up.


But there’s another narrative – which is that Provident’s entire business model is evidence of a serious and potentially systemic financial problem.


The alarm here is particularly focused on the sub-prime car-finance industry, in which Provident (via Moneybarn) is the biggest player. Across the sector, the credit checks are incredibly swift and (according to many reports) rather cursory. That’s led many people to worry that the market is getting out of hand – including the Financial Conduct Authority, which has launched an investigation. There’s a particular echo of the sub-prime crisis in the increasing popularity of personal contract plans (PCPs) – clever financial innovations which offer very poor people access to very nice cars, because they are effectively leasing them rather than owning them.


Moneybarn, to be fair, doesn’t focus on PCPs: it’s more about old-fashioned lending. But that lending is going to people who are often heavily indebted already. Back in July, Liberum Capital published a research note explaining why it had put a SELL rating on Provident. The most startling figure was an estimate that “a typical Moneybarn customer spends 66 per cent of after-tax income on rent, car loan and credit card payments”. These, in other words, are people who are already drowning in debt – and the slightest rise in interest rates, or economic slowdown, or spike in inflation, could see them go under completely.

In America, it was fears that another bubble was forming in sub-prime loans that prompted the big banks to pull back from the car market in particular. So are we in for a repeat of 2008?

Personally, I’m optimistic. We’re talking about fewer borrowers and lenders: Moneybarn, for example, has only 41,000 customers. Also, regulators are now hyper-aware of the dangers of excessive lending, and have taken a whole series of steps to make sure that the dominos cannot (or should not) topple into each other as they did back then.

In fact, the real message of the Provident story is very different – because it’s about the unintended consequence of those same regulations, and the people who have suffered because of them.

If you read Provident’s annual report, there is an awful lot in there about social responsibility – to the point where the opening dozen or so pages could essentially be boiled down to the phrase “We’re not Wonga!” in 144pt bold caps. But there’s not a lot of stuff in there about interest rates.

You can get an idea of just how profitable Provident is, however, by looking at its component businesses. Last year Vanquis made £204.5 million from its 1.5 million credit card customers. Provident and Satsuma, which are part of the same unit, made £115.2 million from approximately 850,000 customers. And Moneybarn made £31.1 million from those 41,000 customers.

In other words, each customer for Provident’s credit cards, and home or online loans delivered approximately £135 in profit. For Moneybarn, it was a staggering £758.

So where are these profits coming from? Not, as you might think, from those at the very bottom of society. The average customer for Vanquis is 35-45, living in rented accommodation but with a full-time job paying £20k to £35k. Because of their “thin or impaired credit history”, the maximum line of credit is no more than £4,000, with a representative APR of 39.9 per cent. The statistics for Moneybarn are similar: £20k to £30k in income, with an APR of 33 per cent.

For Provident and Satsuma, the income is lower and the interest is higher – a lot higher. These are people on £10k-£15k, paying interest rates of 535.3% for Provident and an eye-watering 991% for Satsuma, although the loans are usually smaller and shorter-term.

How, given these statistics, can I argue that the regulations are a problem? Don’t we really need more regulations to protect people from these greedy, unscrupulous loan sharks?

The problem here is actually pretty simple.

Before the financial crisis, the big banks lent to all sorts of people they really shouldn’t have. In order to prevent the same thing happening again, the rules were tightened up – now you could only get a loan for a house, or a car, or pretty much anything, if you had the sort of credit rating that would make your bank manager (if they still existed) beam with approval.

Yet this process had a very important consequence: the mass withdrawal of blue-chip financial institutions from the lower end of the market. Barclays, for example, used to be well known as a place that bankrupts could go to for a second chance. Now, such customers often find themselves locked out of the credit market.

Britain, as the official Financial Inclusion Commission points out, has a pretty comprehensive banking system: only 1.5 million people are officially “unbanked” (although a great deal more are not all that happy with the service they’re getting…).

But even those with bank accounts often struggle to get access to credit. According to Provident, there are between 41 and 43 million Britons in the “standard” credit market, and between 10 and 12 million who are locked out of it – plus approximately two million who flow between the two depending on the health of their finances.

Thanks in large part to the banks’ and regulators’ flight from risk post-2008, those 10 to 12 million – and their counterparts in foreign countries – have been left to the likes of lenders like Provident. Or to those who are far less scrupulous: since the crash, payday lending has grown massively, but so has the number of illegal moneylenders and pawnbrokers.

As Provident’s profit figures suggest, this is an incredibly profitable niche. Last year, Provident’s return on equity (ROE) across the group was 45 per cent – in other words, every £1 in assets delivered a 45p return in profit.  By comparison, Metro Bank – a challenger bank serving a more conventional market – is aiming for an ROE of 18 per cent in 2020. At the height of the boom years, Barclays’s ROE only reached 20 per cent – in these staider times, it is now barely 3 per cent.

What’s happening, in other words, is that the poorest in society are paying more – much more – than they should for credit and lending, or even for access to the banking system. Syed Kamall MEP has written powerfully on CapX about the damage this causes.

Access to credit is one of the things that lets people climb the economic ladder, in the developed and the developing world. But access to too much credit – or to credit on the terms that are generally now on offer – keeps them trapped in debt.

No one wants to open the floodgates in terms of lending – lord knows we’re all indebted enough already as it is. But encouraging the banks to expand their services, or coming up with new ways to help the unbanked and deliver low-cost, low-risk credit, would directly benefit the poorest in society. Such people will never be able to borrow on the same terms as those with unblemished credit records. But the more players there are in the market, the lower the premium they will be charged.

As it is, in attempting to protect the financial system from another crash, we’ve left millions of people with no option but to turn to the likes of Provident – which may often end up being a very improvident move indeed.

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We’ll preface this post by saying we have never heard of the Alternative Money Fund – which “Specializes in Returning Freedom and Value” – and very well may never hear of it again, however it is notable for two things: i) it is a “hedge fund” invested …

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