Mortgage Modifications

Obama's foreclosure prevention mortgage modification program is a complete failure. Out of millions of loans, the number of permanent modifications can be counted on two hands. Why? Because the banks have an incentives to drag out the process and deny losses as long as possible. This is a perverse unintended consequence of two things. The first is the bailouts that recapitalized the banking sector. The second cause is various incentives to drag out the admission of losses as long as possible. At the same time, bank regulators are pressuring banks to raise capital. It all boils down to pressure to conserve capital on the one hand, and accounting gimmicks that allow banks to not recognize losses.

The "pressure" applied to banks has no teeth, and consists of bureaucratic nonsense like writing more reports.

The numbers speak for themselves: 16 million households are underwater. 1,711 "permanent" modifications have been made.

The message to consumers is clear: Suckers pay! If you're underwater, walk (or swim) away!

Trying to Devalue Currency

Wednesday's 7-yr Treasury auction was a great success. Foreign central banks (indirect bidders) tendered $26 billion in bids and took $20 out of $32 billion.

The problem with FCB's trying to devalue their currencies against the dollar by buying treasuries is that they're lowering yields and getting blowback on the speculative anti-dollar trade. This completely negates their efforts.

So the anti-dollar carry trade remains in a vicious, out of control cycle. Short-term, it's self-reinforcing, but anyone who takes the time to discover the whole cycle, let alone analyze the implications, can see the obvious self-destructive and unsustainable nature of this imbalance.

Timing is the only question for me. And I think the pressure is starting to make the mine timbers "talk." A Dubai default could cause an unwind, or it could just be another sign of impending collapse.

The Myth of Dubai

The myth of Dubai is over. Default is imminent, as Dubai World seeks to delay payment on $3.52 billion due December 14th, according to Bloomberg. Despite the danger, CDS are only 434 basis points.

My question is who is surprised? Who thought that building man-made islands the shape of palm trees would be a productive investment?

Over the next four months, $9 billion is due. It's crunch time. A default of this magnitude could catalyze a reverse of the dollar/risk carry trade.

Saab is Dead

According to Bloomberg, GM's deal to sell its bankrupt Saab division is dead. Koenigsegg, the Swedish supercar maker was on track to buy Saab, until the European Investment Bank backed out of a $600 million loan for the deal. GM has threatened to just close the company. The sad truth is that unless Koenigsegg is paid to buy Saab, they won't do it. This setback follows GM's failed sales of Saturn and Opel.

Good luck getting that money back, Mr. Obama.

In other news, the FDIC is technically bankrupt, at -$8.2 billion. And the problem is just getting bigger: problem banks now total 552, with $345 billion in assets. Losses could easily total 30-50% of that.

Oh, and guess what? Chinese banks are raising capital because after their lending binge, they're undercapitalized. Whodathunkit? And the plan to do that: sell shares on the stock market. BNP Paribas estimates Chinese banks need to raise over $50 billion. But how will the stock market hold up without a trillion dollars in new credit every year? One old trick for raising capital is beeing taken away. Regulators plan "to tighten capital requirements for banks by capping cross-holdings of subordinated bonds." Gone are the good old days when banks could raise capital by calling across the street and saying, "I'll buy $10 billion of your bonds if you buy $10 billion of mine. Great. Now we can start lending again."

So, if the Chinese economy slows down again, how will that affect the global financial picture?

Chinese Investment Corp.

The CIC is investing in .... drum roll... CHINA!

China Investment Corp. agreed to buy $400 million of stock in China
Longyuan Power Group Corp.’s Hong Kong initial share sale

Now, this is ridiculous. Sovereign wealth funds are supposed to invest outside the country. Looks like just another way to prop up the stock market, or maybe a payback to favored insiders.

In Another Sign

that there is a bubble in the risk carry trade, Short-Term US Interest Rates Turn Negative. Traders and banks are so sure that inflation will pop up that they are crowding into short-term Treasuries. No one want to hold the long term bonds.

It seems that the Fed's zero interest rate policy is restrictive compared to the market. Barron's poll of big money finds 65% of managers bearish on Treasuries, and only 8% on oil. Sounds like somethings already priced in.

Just waiting patiently for the catalyst.

How Cap and Trade "Works"

The WSJ (link from Mish) explains how cap and trade "works" in Europe:

Cap-and-trade programs exacerbate the problem because developed countries (where emissions are putatively capped) get credit for reductions from ethanol—despite the fact that their biofuels are generally grown in developing countries (where emissions aren't capped). So if Malaysians burn down a rain forest to grow palm oil that ends up in German biodiesel, Malaysia doesn't count the land-use emissions and Germany doesn't count the tail-pipe emissions.

In other words, it just shifts environmental destruction in poorer countries. If cap and trade passes, companies will be paid a huge incentive to produce pollution and carbon in developing countries. The best investment would probably be in carbon-producing industries, just as in the ethanol boondoggle, the best thing to buy was the major oil companies.

The problem is not that stopping pollution is a bad thing. As always, the devil is in the details. The bill's authors absolutely refused to take land-use changes into account. So the problem is not the stated intent of the bill, but the dishonesty inherent in it. It is just a hidden tax, and a way of screwing over little people in countries far, far away where we won't hear about it until the damage has been done.

Trying to Fit the Pieces Together

Michael Pettis' new blog post makes for some interesting reading. At the very bottom, he has a footnote showing the similarities between the US in the late 1920's, Japan in the late 1980's, and China today. Which begs the question, "How will the US of the future, being a deficit country today, be different from these previous historical examples?"

Will long bond rates stay low, like they did in the US for two decades, and still are in Japan? How much GDP growth can be gained from tariffs and dollar devaluation?

Oh, and one more bit of news. In a stunning development, US home construction "unexpectedly" dropped by 10.6% in October. No surprise here. Before reading the story, I knew it was due to multi-family construction. The home buyers credit has removed renters from the market, rents have been falling for a while now, and so there goes apartment building.

US vs China

I can't prove it, but I think I know what the US strategy with regards to China is. It's a simple devalue the dollar until China's economy overheats and inflation runs rampant. This will be interesting to watch.

Because there will be no inflation in the US. In fact, Costco just ditched Coke because Coke wouldn't cut prices enough in this story. And employment? Employment won't exert inflationary pressures for years, maybe even decades.

Where's the Bubble Coming From?

Here's the chart from Bloomberg showing dollar lending in China jumping from $250 billion to $350 billion in.

Why the dollar loans in China? Simple. It's a bet on the Yuan against the dollar. The bubble is getting frothy. Look at today's 130 points on the DJIA. Low volume again.

And by the way, do the Chinese realize the irony in their admonition to Obama that the dollar carry trade is creating asset bubbles? Do they remember buying hundreds of billions of MBS from 2003-07, contributing to the US housing bubble? Also, do they realize that as soon as they opened their mouths, the dollar dropped 1% against the Yen, Euro, and Pound, Gold jumped 1.3%, and the DJIA popped up 150?

Global assets and equities are most clearly in a humongous bubble.

Trade!

Well, I decided to do only one trade today. The reason is that a bubble needs something to pop it. Also, credit tightening is bad for equities. With ANF, consumer credit is contracting and job losses continue. This is not good for spending. Also, banks and retail credit lenders like CIT will be cutting back and therefore charging more. So financing inventory will be more expensive. So, here's the trade:

short 5% ANF @ $37.31

And Gold is clearly acting like a bubble, as the media has proclaimed new highs at: $1,100, $1,105, $1,110, $1,115, $1,118. What's next? $1,119? $1,119.50?

And since China's started cutting back on lending and stimulus, that should kick in soon. So, here's the next trade:

long 1 FXI Jan. 2011 $30.00 put @ 1.86.

Can't short FXI, so I have to do it with the option.

The Hits Just Keep on Coming!

It seems that in addition to Chinese pig farmers storing their wealth in copper instead of Yuan is not the only market distortion coming out of China. Tim Iacono's blog links to a story that parking lots full of new cars are reported to have been "sold." Somehow, China is supposed to have become a bigger car market than America, yet gasoline sales are flat? Who'da thunk? Sounds like it's time to short China, with a smaller short on copper.

And in U.S. news, SURPRISE, SURPRISE!!! Home prices fell in the third quarter! Just as housing was undergoing its fourth or fifth recovery, according to the media.

The valuations I've been seeing lately are in bubble territory: ANF, 70 X earnings, PCU, 67 X, SBUX, 40 X. Are you kidding me?

Trade!

short 5% position in PCU @ $34.71.

David Rosenberg today is reporting that the current commitment of traders data shows record long positions in Gold and Oil. Copper is at a cycle high. Huge long positions have been taken in the Aussie, Loonie, and Euro. The S&P also is hugely bearish.

The only shorts are in Dollars and 10-30 yr. Treasuries.

I'm going to lever up here. Possible moves for the rest of the week are to take a 5% short position in FCX. FXI is hard to borrow, so I may try an option on them, as well as a 5% position in FXP. ANF is no longer hard to borrow. The shorts have been covered, which probably caps the stock. Earnings come out on Friday.

My ideas are: short 5% FCX, buy 5% FXP, short 5-10% of ANF, and buy an FXI put.
I can buy a Jan. 2011 put that prices a 4% chance of falling 38%, or 7% chance of falling 30%. In my opinion, China is a huge bubble, and there's a 50-50 chance of rising or falling by at least 50%. The chance that things stay the same are very low, in my opinion.

Copper and China

The looming oversupply in copper is getting too large to ignore. Bloomberg is reporting that buyers for copper in China can't be found, as Xi'an Maike estimates 985,000 tons is in storage. Sounds like a looming crash to me. It's time to buy FXP, short FXI, or maybe even both. Such a collossal mispricing cannot be ignored, as copper trades at 120% higher than a year ago. 350,000 tons sits in duty-free warehouses and may be re-exported to avoid paying the import duty. Another way to play this would be to short FCX, Freeport-McMoran Copper and Gold, or PCU (Southern Copper) which has an outrageous P/E of 67. FCX doesn't have one because it lost $31/share over the last year.