Monday, October 12, 2009

Where The Debt Lies (..and Happy Columbus Day Mr. Krugman)

Apropos of Columbus Day and before the main topic, a comment on Mr. Krugman's editorial on monetary policy, appearing in today's NY Times ("Misguided Monetary Mentalities"). Please read it before proceeding.

When Christopher Columbus sailed west from the Old World he was merely trying to discover a faster, more profitable way to reach the well-known trade riches of India and China; he had no notion of America or the New World's vast potential. In other words, he was clueless, if also lucky.

Just like Columbus played it safe with his royal backers and their establishment groupthink, so is Mr. Krugman today calling for known and accepted palliatives for our economy's troubles: more loans, low interest rates, a weaker dollar, more government deficit spending. Not surprisingly, he points his arrows at the Wall Street Journal and selected Federal Reserve members for their sotto voce remarks on raising interest rates, soon.

Well... what if both establishmentarian views are misguided? Should we be following our outdated Neoclassical and Keynesian maps to exit the crisis, or should we strike out in a new direction? Aren't new problems calling for novel solutions? I certainly think so and will soon come back with a post on Green Finance.

Meanwhile, on with today's post.

Like the oracle of Delphi, today's post title may be interpreted in two ways: the location of debt, or the untruth of debt. In fact, this post is about both.
  • Let's start with where the debt is. The chart below (click to enlarge) breaks out marketable debt (i.e. bonds, bills, notes, commercial paper, ABS and MBS, etc., which trade on the open market). The total comes to $34 trillion and excludes loans held directly by banks and other financial institutions, plus the Treasurys in the Social Security trust fund.
Lies, Damned Lies and Debt

Until 2000 all types of marketable debt were growing more or less at the same rate; the slope of all lines is similar. One notable exception was Treasurys; because of the short-lived Clinton surplus, borrowing needs for the federal government came down. But after the year 2000, mortgage-related debt started racing ahead and finally exploded spectacularly by 50% within a mere three years. In the 2004-07 orgy of new loan origination and securitization mortgage-related securities went from $6 trillion to $9 trillion. And we all known what happened after that...

What is happening now is that Treasurys are rushing in to fill the void (a.k.a. socializing losses).
  • But wait a minute... what void? Look at the red line in the chart above: Mortgage securities are still valued at $9 trillion, after a full two years of record delinquencies, defaults and charge-offs (see chart below, click to enlarge).

Since the beginning of 2007 charge-offs for all real estate loans directly held by commercial banks come to a total of 9.5% (adding two years' quarterly rates). One would presume that mortgage lenders held on to the most attractive loans for their own books and securitized the rest, resulting in higher delinquency and charge-off rates for mortgage-related bonds. Indeed, we know that credit default swaps prices (CDS) to insure such securities against default went through the roof. Markit's various ABX indices of mortgage-related CDS collapsed anywhere from 60% to 95% (reverse scale to CDS pricing).

But even if this is not so, even if credit quality is identical between banks' own loans and those they securitized, shouldn't the value of real estate securities at the end of the second quarter 2009 be lower by about 10% to around $8 trillion, at most? And that's just face amount, never mind market value.

Therein, therefore, is where lies the lie on debt, the pretension that all's well in finance balance-sheet land. This "missing void", as it were, has been filled by no one other than the Fed itself, which last year bought $700 billion in mortgage-backed paper for its own account. Coincidence? Of course not...


  1. Smoke and Mirrors comes to mind, which is exactly what green shoots are made of.

    Hell has already captioned the end of this financial fiasco as, "The Great Reset".

    He made a comment a couple of days ago that we will default on our debt. Taken together it means one thing.

    The end of US Empire. Period. If you can't see it now, you never will, till it happens.

    Joe M.

  2. Hell, I am confused...
    In that first graph, you say that... mortgage debt is "VALUED" at 9 trillion.
    Yup, I sure can see that when you add up all those numbers, they must come to about 9 trillion, which has been "spent".
    Um, isn't there a difference between "valued" and "spent" ? I thought so, at any rate...
    I suppose that I'm just... nitpicking.

  3. Another little nitpick, Hell...
    The Sibyll would NEVER NEVER have announced that there were two ways of interpreting her oracles.
    For the simple reason that...
    there may be MORE...
    She would have maintained an... oracular silence on the subject.

  4. I don't know ... I think I just realised that:

    As long as property prices does not rise by much so people begin to refinance & cash out,

    And interest rates remain low,

    And not too many people default,

    Then "they" can just keep buying and re-buying all the mortgages forever so the mortgage rates will never rise and the debt will never go away.

    "They" control the first two variables.

    Maybe the third also if "they" just stick defaults in "Level 3 Assets".

  5. A little off topic:

    Student Loans are the New Indentured Servitude; and

    Student Debt and The Spirit of Indenture

    I have brought this issue up before, but these new articles renewed the issue.

  6. Hell,

    Here's the mortgage data that I follow:

    The securitization markets froze up before banks could unload all of their toxic trash. No worries though. The Fed & CONgress were ready, willing and able to take the junk mortgages off their balance sheets.