Random Musings

Just some various random thoughts, none of which is really long enough to make a full post on its own.

My wife and I were watching the E*Trade baby ad the other night - the one that first aired during the Super Bowl, where the baby, captured on webcam, is talking about E*Trade. (You may or may not be aware that E*Trade was the poorest-performing stock in the S&P 500 last year.) He clicks his mouse, buys a stock, says, "Whoa - I just bought stock," then spits up. (That always cracks me up.) And my clever wife looks at me and says, "Maybe he just bought E*Trade." Just keep 'em coming, babe. You're my muse.

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This week we learned that mortgage foreclosures and delinquencies are at record levels. Who'da thunk it? The conventional wisdom has always been that the home loan was the last debt a borrower would default on. But that was before we started making loans to people who should have remained renters. With plummeting real estate values, once people see they own less than they owe, they're just dropping the keys in the mailbox and walking away, thinking, "Why make payments on a house that's worth less than the balance?"

Exacerbating this problem is the fact that these people thought real estate would go up forever (like the fools who thought tech would go up forever back in '99). Now that they see it ain't so, they don't want to be homeowners anymore.

And lest anyone's been drinking Hillary's (and, to be fair, many others') "this-problem-was-caused-by-predatory-lenders-taking-advantage-of-honest-hardworking-Americans-who-just-wanted-a-piece-of-the-American-dream-so-the-best-option-is-to-freeze-their-rates" kool-aid, consider this. Accompanying the forecosure data was a comment by an economist for the organization that published the numbers:

"We're seeing people give up even before they get to the (rate) reset because they couldn't afford the home in the first place." (Emphasis added.)

Sorry. I do not feel sorry for those people, not one iota. The American dream, insofar as it pertains to home ownership, is a roof over one's head. It doesn't have to be an Italian slate roof, topping an expanse of 4,000 square feet.

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Related note: now, increasing numbers of Americans are saying the mortgage is the first thing they'll default on. Why? The answers are frightening: "I need my car to get to work to make money to make my other debt payments, and I need my credit card to buy groceries, but I can live anywhere." Wow. I guess nobody cares about equity anymore. I just hope my daughter's not stuck supporting these people in their retirement, when they find they have nothing. It's a brave new world.

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Five-year TIPS (Treasury Inflation-Protected Securities) have a negative yield these days. What does that mean? First, I'll define TIPS. Then, I'll explain.

TIPS were introduced a few years back to help investors hedge against (or bet on; always remember that one man's hedge is another man's bet) inflation. Traditionally, investors would just buy or sell straight Treasury notes and bonds, and the difference between their yield and the inflation rate was deemed their "real," or inflation-adjusted, rate of return.

The rate of interest TIPS pay is lower than regular Treasuries. But, unlike the vanilla version, TIPS don't pay a fixed principal amount. Instead, their principal can go up or down based on changes in the Consumer Price Index, or CPI. When inflation is higher, the principal goes up more. In the event of deflation, the principal can go down. TIPS still pay principal at maturity, but the Treasury pays you the CPI-adjusted principal amount, not what you bought. And, each semi-annual interest payment is based on the prevailing principal balance and the interest rate.

So what does a negative yield on five-year TIPS mean? Does the investor pay the Treasury interest? Not quite. Yield is a function of the interest rate a bond pays, and its current price relative to "par," or 100% of the amount originally bought. So you still receive interest, but the traders have basically bid the price of the TIPS you own up to a level where the premium you pay over par wipes out the interest you're going to get over the bond's life.

Why would the traders do that? It's simple, as Ross Perot used to say. TIPS traders - the inflation-bettors of the bond world - are betting that inflation's going to take off to the point where they're not getting paid for the inflation risk. Hence the negative yield on TIPS.

The moral of the story: there is significant inflation risk in our economy right now, especially with Fed Chairman Ben Bernanke (who's a pansy, by the way) throwing money on the problem, like so much gas on a fire.

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Speaking of gas - fill 'er up - quick! Oil's trading over $106 a barrel today.

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And speaking of the Fed, and inflation, and mortgages ... well, mortgage rates keep going up even as the Fed pushes short-term rates down. Why? Two reasons.

First, traders and buyers of long-term assets, like mortgages and the ten-year Treasuries they're priced off of, are concerned about the future purchasing power of their investments. When the Fed's throwing money at the economy, their concern is that future inflation will be higher. This is due in part to the fear that all that easy money will overheat the economy and people will go on a borrowing and buying rampage that will increase demand for everything, thus bidding prices up.

And if that sounds familiar, it's because that's what happened in real estate after Bernanke's predecessor, Alan Greenspan, practically gave money away for a year, keeping the Fed funds target at a ridiculously low 1.00% much longer than he needed to.

So, long-term Treasury traders and originators of mortgages, concerned over the future purchasing power of the dollars in their investments, are keeping rates high to ensure they're compensated for future inflation.

The second reason for higher mortgage rates is that, with rising foreclosures, and given the brave new world of attitudes about responsibility for debt, lenders are realizing that risk is still underpriced in the mortgage market. That's why spreads on mortgage-backed bonds (the yield they offer relative to the yield on Treasuries, which are supposedly risk-free) widened about 50 basis points, or half a percent, in three days this week.

The bottom line: the Fed can ease all they want, but mortgage rates are staying put. That means the subprime crisis continues unabated, and the Fed just tanks the dollar and fuels inflation with their careless easing.

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In a story related to the widening of mortgage spreads, a couple of comments by traders and money managers indicate just how ugly this is getting: the markets are "utterly unhinged," and "Everything is telling you the financial system is broken," and "The Fed can't really save the mortgage market." I've been playing in the world of mortgage-backed bonds since their early days, in the 1980s, and I've never seen anything remotely like this.

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Two signs of the times: first, I got a postcard in the mail from a local realtor, offering a $500 discount off the commish if I listed my house for sale. Things must be getting pretty bad. (By the way, the Kansas City market isn't nearly as volatile as places like Vegas, Florida and SoCal, so if things are getting bad here, they're really ugly in those spots. I also know of two area real estate partnerships that folded recently, and that's just anecdotally.)

Second, even CNBC is now lambasting the Fed for its easy money policy, with a story headlined, "Fed's Rate Cuts May Do Long-Term Dollar Damage." Yeah, no kidding. But this is the same network that loves a rally and will start any rumor to spark one, the network whose poster boy, Jim Cramer, likes to scream at Ben Bernanke on-air, "Mr. Chairman! Cut the rate! Cut the rate!" What does Jim care if we inflate another bubble? To him, it's just a buying opportunity. He won't starve when it bursts.

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I leave you with this final story. My daughter, who plays the viola, was selected to the Kansas State Orchestra, and last weekend they played their concert in Wichita, which is a three-hour drive. I drove to hear her, and her boyfriend rode with me, so I had ample time to bond with the lad.

Now, some fathers might face this prospect with dread (and some lads as well). But we had a very nice time. He struck me as a thoughtful, caring, mature young man.

One comment he made stood out in particular. He was telling me about a youth mission trip to Mexico that he went on, and how he was struck by the poverty there. And he said ...

"Those people are just so thankful for things that we'd complain about not being good enough."

Wow. Would that I had had that insight at 18. Would that all those who bought more house than they could afford had had that insight, however old they are.