Incite -- (v) 1: give an incentive; 2: provoke or stir up; "incite a riot"; 3: urge on; cause to act
Friday, May 07, 2004

"We confirm that flight - repeat - engine one is on fire"
Written by: Speculator

The first Friday of every month is one of the more enjoyable for financial market volatility fans. It is the day when monthly payroll figures are published by the Dept. of Labor.

Today's number may prove to be huge - for more reasons than most know. This plays well into what Beck published earlier about the troubles with Fannie Mae (FNM) and with Greenspan's verbal jaunt down to Arcane Land on Tuesday.

First, the numbers - Payrolls increased net 288K jobs in April - well above the consensus number of 177K. On top of this, March's numbers were revised upwards from 308K to 388K. All in all, this was a big, if not huge, number.

This is extremely bearish news for the bond market. Following the Feds FOMC meeting on Tuesday, where they agreed to keep the keg party running - but announced that Alan had just about had his fill, any significant outsized positive econ news will only serve to force the Fed's hand quicker. Rates are going up. This brings all sorts of questions into play for our extremely interest rate sensitive economy.

So, for the immediate possibilities - the 10-year treasury yield surged 12 basis points (bps) from 4.6% to 4.72%. In this range (the upper-fours), it is opined that applications for home-mortgage refinancings (refis) will be cut in half for 10 bps move upward in the 10-year note. The key here is, mortgage investors, like FNM, have serious problems matching their liabilities with their assets (this the crux of what they do , they effectively collect 0.50% of interest income on $1.4 Trillion dollars worth of assets (securitized mortgages, which are financed with $1.4 Trillion dollars worth of liabilities (their own corporate bonds, also known as "agencies"). As rates move quickly, and volatility surges, they have a very difficult time adjusting their portfolio to "match". By "match" I mean that they are in the business of matching the duration of their liabilities with their assets. To go into the details of what DURATION is would take far far far too much time - but the idea is simple: they want to match the net timing of their receivables (assets) with the timing of their payments (liabs). As the number of refis plummets, the DURATION of their assets is extended (less people repaying their mtgs early). That means they've got to extend the duration of their liabs commensurately, which means that they need to sell US Treasuries.

As these yields move very quickly, as they have this morning, FNM and others must move quickly to keep things "matched". Funny thing is, as they sell their liabilities - they actually accentuate their problem, for they add to the supply of treasuries, which serves to increase the yield, which means they need to sell more. Isn't this fun??

So, here is the gig - we are quite possibly into the first act of the housing bubble meltdown. The only thing that will prevent it from going thermonuclear is that houses are not speculative assets for most people, and they are extremely expensive to sell, compared to other assets (you have to live somewhere). So, people are not inclined to sell just because of price depreciation. But, this will mean that many many many banks will have equity-refi loans that will have principals that are well above 100% of the "current" value of the collateral backing it.

It will be very interesting to see how all of this plays out. I contend that this is possibly the most interesting time, due to this dynamic, in all of financial history.

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John Beck

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