Bond Girl 2010-11-03 19:25
House Senate
Delaware. Now that would be funny.
Pennsylvania. I wonder if Arlen Specter regrets switching parties. I wonder if the Democrats regret taking him.
West Virginia. Of course, the Democrats there are a little… different.
Kentucky. If you liked Rep. Paul, you’ll love Sen. Paul.
Illinois.
Indiana.
Wisconsin. Wow. I thought Feingold was a “lifer”…
Colorado.
Nevada. Looking close.
Washington. Looking very close.
California. Also California. Jerry Brown, Prop 19, record high gold, war with Iran… It really is the 70s again. If you see a “Carter 2012″ bumper sticker, that will be me.
(Drop me a line if I missed any races of interest.)
Christopher Peterson is a law professor at the University of Utah. In a pair of papers, one published last summer and one not yet published, he makes a compelling case that the Mortgage Electronic Registration System (MERS) ought to be illegal — and arguably is already.
These papers are getting some play right now because they anticipate the foreclosure documentation mess currently in the news. I am not even sure how to summarize them, and I strongly recommend you read one or both for yourself (tap “One-Click Download” for the PDF). Prof. Peterson has a very pleasing style, and the historical background he provides is fascinating, particularly in the earlier paper.
But, briefly… In the 1990s, mortgage lenders and servicers decided to bypass centuries of established precedent for tracking ownership of physical land and the related loans, because they did not want to pay fees to county registries that have tracked that ownership for legal purposes since before the nation was founded.
As a result, 60% of all mortgages in the U.S. today are legally “owned” by MERS, a Delaware corporation with approximately zero employees. Now, in order for the owner of a mortgage to perform certain legal actions — like “conveying an interest” in the land — some states require the signature of a “Vice President”.
Imagine for a moment why a state might impose such a requirement, and then read this quote from Prof. Peterson’s new paper (emphasis mine):
As a practical matter, the incoherence of MERS’ legal position is exacerbated by a corporate structure that is so unorthodox as to arguably be considered fraudulent. Because MERSCORP is a company of relatively modest size, it does not have the personnel to deal with legal problems created by its purported ownership of millions of home mortgages. To accommodate the massive amount of paperwork and litigation involved with its business model, MERSCORP simply farms out the MERS, Inc. identity to employees of mortgage servicers, originators, debt collectors, and foreclosure law firms. Instead, MERS invites financial companies to enter names of their own employees into a MERS webpage which then automatically regurgitates boilerplate “corporate resolutions” that purport to name the employees of other companies as “certifying officers” of MERS. These certifying officers also take job titles from MERS stylizing themselves as either assistant secretaries or vice presidents of the MERS, rather than the company that actually employs them. These employees of the servicers, debt collectors, and law firms sign documents pretending to be vice presidents or assistant secretaries of MERS, Inc. even though neither MERSCORP, Inc. nor MERS, Inc. pays any compensation or provides benefits to them. Astonishingly, MERS “vice presidents” are simply paralegals, customer service representatives, and foreclosure attorneys employed by other companies. MERS even sells its corporate seal to non-employees on its internet web page for $25.00 each. Ironically, MERS, Inc.—a company that pretends to own 60% of the nation’s residential mortgages—does not have any of its own employees but still purports to have “thousands” of assistant secretaries and vice presidents.
This is just my personal favorite of the various legally questionable facets of the MERS scheme. There are several others, and again I strongly recommend reading the papers for the rest. It’s great stuff.
I have a hunch the lawyers are just getting warmed up on this one. Should be fun to watch.
One more quote from the new paper:
If the growing line of cases asserting that MERS is neither a mortgagee nor a deed of trust beneficiary is correct, then courts must soon confront profound questions about the very enforceability of MERS’ security agreements. Not merely an ancillary issue, MERS registered loans have fundamental problems related to the very nature of what a mortgage is. There is a compelling legal argument that loans originated through the MERS system fail to create enforceable liens.
Oh, my.
Hey, I did not say which Wednesday… But I do want to finish this up before the Fed embarks on their new M.A.D. policy (Mutually Assured Devaluation).
Let me go back to my original example, supposing I give you a lottery ticket that says: “Nemo will flip a fair coin tomorrow. He will pay $1 to the holder of this ticket if and only if the coin comes up heads.”
I asked how much you could get selling that ticket today into a market of risk-averse people. (Recall that risk aversion, by definition, means a preference for certainty over uncertainty; or equivalently, a willingness to sacrifice expectation value for certainty.) Since the expected value of your ticket is 50 cents, I said that no risk-averse person would be willing to pay 50 cents or more for it.
But I was wrong. As it turns out, there is one person — just one person — who can offer you more than 50 cents for your lottery ticket and still be risk averse. Before reading on, can you figure out who?
…
Just as that lottery ticket represents an asset to you, it represents a liability to me. Put another way, you hold a ticket with an expected value of 50 cents, but I hold the corresponding “anti-ticket” with an expected value of -50 cents. If I should buy the ticket from you, that anti-ticket would be canceled and the liability extinguished. Just as your risk aversion will lead you to prefer a certain 50 cents to a possible $1, my risk aversion will lead me to prefer a certain 50 cent loss to a possible $1 loss. And so I can pay you more than 50 cents for the ticket and still be risk averse.
Put yet another way, your risk aversion makes you a natural seller of the ticket, while mine makes me a natural buyer. So how much can you sell it for? That depends on which of us is more risk averse, which of us is the better negotiator, etc… But it could wind up being less than, more than, or equal to 50 cents.
The moral is that risk and risk aversion are meaningless without reference to a portfolio. (Well, the other moral is that sometimes I fail even to get my toy examples right. You want fully-baked analysis instead of some guy thinking out loud, stick with Bond Girl.)
The toy example I should have used is fire insurance. When you own a house, you are exposed to the risk that it burns down. That is a pretty unlikely event, so the expected value of your loss is not very large… But as a risk-averse homeowner, you will be willing to pay somewhat more than that expected loss for an insurance policy, trading the uncertain (enormous) cost of losing your house for the certain (modest) cost of your insurance premium.
In other words, as a homeowner you are a natural buyer of fire insurance. Who are the natural sellers? Well, there aren’t any. Unlike a lottery ticket — for which there is always a corresponding liability somewhere — your house is your asset but nobody’s liability. There is no “anti-house” out there whose value is enormous only if your house burns down. (Good thing, too, I should think.) And that is why the risk premium for fire insurance is always positive.
Which brings me back to inflation swaps. The observation that the nominal fixed payments are actually variable in real terms (and vice-versa) is still valid. But that does not answer the question of whether the risk premium will be positive or negative. To know that, we need to ask whether inflation swaps are more like a bet on a coin toss, or are they more like fire insurance? Who are the natural buyers and sellers of inflation swaps?
Any holder of dollars is a natural buyer of insurance against the Fed “burning them down”. And a dollar, like a house, is an asset with no corresponding liability… Unless you count the Fed’s own balance sheet, which I don’t.
Any dollar creditor is also a natural buyer of an inflation swap, while the corresponding debtor is a natural seller.
My suspicion is that during normal times, the dollar creditors and debtors balance out and inflation swaps act more like insurance with a solidly positive risk premium. But when the expectations become extreme, the pool of natural buyers and sellers can change significantly. For example, as an ordinary working person, I am usually not too concerned about the rate of inflation, because even if the prices of goods and services rise, my salary will rise also. But if I start to worry about deflation or hyperinflation, the equation changes; my concern becomes losing my job entirely (making me a natural seller of inflation swaps) or seeing my salary fail to keep up (making me a natural buyer).
According to those Cleveland Fed papers, the inflation risk premium is generally +50 basis points. And you will find that if you compare their 10-year expected inflation estimate each month with the 10-year zero-coupon inflation swap, they do differ by roughly 50 bps. If expectations become more uncertain — e.g., because nobody knows what the heck the Fed is going to do — that risk premium could rise even if the numerical expected value remains the same. (This may be happening right now.) And if expectations turn negative again, all bets are off… Even a negative risk premium is quite possible, since a deflationary depression makes almost everybody into a natural seller of inflation.
If you just cannot get enough of this “inflation expectations” stuff, check out Using TIPS to gauge deflation expectations, a recent post from an Atlanta Fed economist where he describes how to estimate deflation probabilities from the difference between the yields of on-the-run and off-the-run TIPS. I admit I have not yet tried to follow the math, but if I do and it is interesting maybe I will make a follow-up post.
Hegel on Wall Street. Possibly the most intelligent piece I have ever read in the New York Times.
Are you smarter than an athiest? I am ashamed to say I missed two out of 32 (I am not saying which).
Illiterate Clown Voted Into Brazilian Congress. The jokes just write themselves…
The Return of the Dividend Recap. This is where private equity buys out a business with a nice, low-debt balance sheet, then has the business borrow to the hilt to pay themselves massive dividends. I wonder what tax rate they pay on those.
Poland’s Central Bank Governor Belka on Currency Wars. “The bottom line is devaluations and appreciations change your competitive position temporarily but they don’t change your competitive position for good. If you want to strengthen your competitiveness by devaluing your currency, this is a sign of despair, this isn’t a policy.”
Bond Girl 2010-10-02 17:23
Bond Girl 2010-09-28 23:11
For the record, I have not read Meredith Whitney’s much-hyped report on how the states will present the next bailout-inducing credit crisis. I’ve only seen her interview on CNBC.
Meredith Whitney is obviously a very good bank analyst and has earned her popularity. But it is not difficult to tell that here she has wandered outside her bailiwick. Somehow she goes from complaints about disclosure in the muni market (which would be very valid complaints in another context) to predicting massive bailouts. It actually is not difficult to find information on state budgets. Most states produce volumes of information about their spending habits. The problem with disclosure in the muni market is with smaller issuers (who consider preparing financial statements an onerous activity), and this is complicated by the diverse types of borrowers in that market and the diverse types of revenues pledged. Muni analysts and the SEC have been trying to increase disclosure in the market for many, many years.
Whitney also criticizes the subjectivity involved in muni credit analysis. It impossible to avoid some level of subjectivity in analyzing government credits, because every spending decision a government makes is fundamentally a political decision. (She even makes highly subjective statements herself in the interview in talking about why Texas is a superior credit – it’s a “small government” state.) There is a big difference between modeling how a bank’s loan portfolio performs under certain economic circumstances and the level of services policymakers choose to provide.
Beyond that, the distinction between state and local governments can be of limited use when it comes to evaluating the financial impact of policy decisions. States split the services provided (and the taxes that support them) very differently between the state and local levels of government – this is very important to consider when you are trying to figure out the debt burden that a specific population can support. Some states have centralized taxation and spending. For some it is almost entirely at the local level. The budgets for some local governments in this country dwarf those of many states. While the state may have some discretion to ignore the financial distress of smaller governments, that would be nearly impossible with a larger entity or an entity that provides essential services for a large local government.
If you pay attention to the interview you will see that the “defaults” Whitney is talking about are on “social contracts,” things like reducing spending on education, transportation, health care, etc. (Debt service is not breaking states. It is actually a relatively small percentage of budgeted state revenues. The problem with debt service is that it is a fixed cost that cannot be changed when revenues underperform. The immediate operational stresses on states derive from programs, not debt.) That is a cheap definition of default, and if by bailout, she means “Congress providing states with money so they do not have to make politically unpopular decisions about spending” – um, that’s already happened, twice. It’s just that we like to call it fiscal stimulus or federal aid and not a bailout. It will probably happen again if policymakers get loud enough.
Something that most people do not realize – something that is completely lost in discussions of the amount of muni debt outstanding – is that the federal government and the Federal Reserve have already passed up a number of opportunities to backstop municipal bonds in the face of outright market dysfunction and failure. Take a look at what happened to variable rate debt in the market during the financial crisis. The muni market was the only sector that did not get some sort of liquidity backstop. And it was not for lack of political pressure.
I have to say that the most amusing aspect of the sky-is-falling talk is that Whitney could not provide any actual investment advice. I’m sure we’ll be suffering through many people suggesting credit default swap plays in the virtually non-existent muni CDS market, however.
Bond Girl 2010-09-27 22:54
There has been a lot of discussion lately in the blogosphere about the apparently dramatic increase in Treasury settlement fails (for examples, see Alea and FT Alphaville).
Feel free to disagree with me, but I do not see this as being all that big of a deal. I do not have a lot of time to get into this tonight, but for background on Treasury settlement fails, I would recommend reading this recent report from the FRBNY (pdf) on the introduction and implementation of the TMPG fails charge.
If you look at the current spike in isolation (like the September chart posted on Alea), it may seem like an anomaly (which we are certainly seeing a lot of these days, thanks to the level of borrowing and intervention/potential for intervention). But if you look at fails since the rule was introduced in 2009, you will see periodic spikes but nothing like the chronic fails that preceded the rule (see FRBNY report, Chart 6, on page 24).
The paper makes a number of points that are useful here. First, the new rule was never intended to eliminate fails completely: “fails attributable to miscommunication or operational problems are unlikely to be eliminated by the fails charge – although they may be resolved more quickly [because of it].” Second, the rule is still relatively new, and it could potentially be improved by simply changing the rate.
On an unrelated note… I have set up a Twitter account, for those of you that are into that kind of thing.
Bond Girl 2010-09-26 02:30
I apologize for not having written in a while, but I have been slammed with work at my day job. (Not that I am complaining.)
So I just returned from watching the Wall Street sequel. I suppose going to see it was somewhat obligatory. Like anyone who has landed at an investment bank in the course of his or her lifetime, I have the original memorized. My general impression of the sequel is that while aesthetically arresting at times, the movie was mediocre in general. But I also left thinking that I could talk about it for hours, which I guess says something. (That I am a chatty person perhaps.)
I think the film tries really hard to be a modern Les Misérables, but that is not something that can be accomplished within a couple hours. In that sense, the film mirrors Americans’ handicap in addressing this economic calamity – we have an epic problem and the attention spans that have made Twitter a success.
Like Hugo, the film uses morally ambiguous situations to blend themes of conviction and redemption. But the film somehow lacks any relatable misery. The human costs of the larger crisis remain abstract. The traders that the film revolves around talk about the market crash as if they are spectators and not participants. (This is odd, because the hook of the original was that while it was supposed to be critical of the financial industry and the materialism of the period, it paradoxically left you with the urge to participate in it.)
The main character – who is supposed to be conflicted about the role wealth will play in his life – stares down financial ruin like he is pondering what to eat for lunch. He somehow still cares about his pet project and family melodramas. I distinctly remember the first time it hit me that the market was headed for something truly catastrophic. In late 2007, I was talking to an executive at a nonprofit student lender about a letter he received from the bank serving as the auction agent on their bonds. He told me that the bank wanted to revise the default rate on the bonds because the bank was picking up the bonds at auction. I did not understand this at all, and he explained to me that there was no new investor interest. How could that be – the bonds were AAA-rated, over-collateralized, and the loans were reinsured by the federal government? I understood some hedge funds were sucking wind, but come on, were people really that panicked? No one wanted any kind of ABS. I left that meeting, went to the restroom, and tried desperately not to vomit. (Note: I was not in a position to profit from this information. In fact, no one was.) And that was just the beginning. I cannot even begin to imagine what equities traders felt almost a year later. In the movie, the crisis is really just noise in the background.
Part of the reason that the film seems so detached is that in trying to capture the financial crisis, the film conflates several different real narratives. (Plus the characters namedrop types of financial instruments that are largely unrelated to the plot, as if just mentioning them establishes the storytellers’ bona fides.) You have the old villain, whose only purpose in the movie is to justify the title and provide the periodic information dumps that are required to move the story along, and the new villain, who is clearly supposed to be Lloyd Blankfein. In many ways, it seems like the movie was trying to give Goldman the trial it deserves – or at least the trial that everyone following the mainstream media thinks it deserves. I have certainly criticized Goldman here (OK, that’s an understatement), but that firm should not be the single face of this crisis. Even in the movie, it seemed like the writers were confused regarding what specifically the firm, or its executives, should be held accountable for. But it is clear that even if Goldman has escaped any meaningful legal or financial accountability, the financial crisis will be the firm’s inescapable historical legacy. Lloyd Blankfein has become the new O.J. Simpson, and this movie seems to be trying to give the public some bizarre form of wish fulfillment.
It is striking to think that after all this time, only a relatively small fraction of the population can actually appreciate what happened, and that this is the story that everyone else gets to carry on. But maybe this is true for most of the significant events in human history. We produce some beautiful art, but do we ever butcher the facts.
OK so there’s a fair amount of nonsense in my last couple of posts. (Although I believe the conclusion is still correct.)
But I am about to embark on a much-needed vacation, so I will not have time to post a correction until Wednesday or thereabouts.
Happy Labor Day.
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