Global Carry Trade Begins To Unwind…in Mortgages

“The Great Unwind May Be Here,” says the Wall Street Journal. We did not read the article. We didn’t think we needed to. We’ve been asking the same question already.

When people talk of ‘unwinding’ they are usually referring to the carry trade – speculations involving borrowing in a low-interest currency and placing the money in higher-yielding investments. Typically, the carry trader borrowed yen and bought New Zealand bonds…or maybe U.S. dollar collateralised debt obligations.

So far, the New Zealand bonds are still making their coupon payments as promised, but other things have begun to go wrong. Mortgage backed securities, for example, have proven no more valuable than the flakey mortgages that backed them. And the yen (JPY) has begun to move up. Having borrowed yen to gain leverage, the carry trader is, effectively, short the Japanese currency. If it goes against him, he can lose big. So many speculators are faced with unwinding their positions.

But there is a larger unwind going on. It is what happens at the end of the credit expansion. Little did they know it, but ordinary Americans were conducting a carry trade of their own. They borrowed from mortgage lenders at 6% or so…and invested the money in houses, which they thought were going up at 10% to 20%. The trade was a good one as long as houses kept rising. When housing stopped rising, they went into ‘negative carry’ and many soon found the burden just too much for many of them to carry at all.

By the way, we reported that the big hump in mortgage resets would occur in October of this year. Not so, says our old friend John Mauldin. Instead of peaking out at $55 billion worth of mortgages subject to upward adjustment in October of this year, John says the total gets bigger…reaching $110 billion worth of mortgages to be reset in March of ‘08. Thereafter, the numbers go down.

Not surprisingly, a lot of housing speculators are eager to unwind their positions before the carry gets any more negative. Others wait…and have their burthens reduced, courtesy of the bankruptcy courts and foreclosure proceedings.

The U.S. housing industry may be insignificant to the worldwide economic mega-boom, but it is hardly insignificant to the U.S. economy. As we mentioned yesterday, a substantial decline in housing is like a substantial leak on a big ship. Once she starts taking on water, the whole boat sinks lower. As long as seas remain calm, she can stay afloat for a long time. But as soon as a storm brews up – it’s every man for himself.

Sauve qui peut!

Bill Bonner
Markets and Money

Bill Bonner

Bill Bonner

Since founding Agora Inc. in 1979, Bill Bonner has found success and garnered camaraderie in numerous communities and industries. A man of many talents, his entrepreneurial savvy, unique writings, philanthropic undertakings, and preservationist activities have all been recognized and awarded by some of America’s most respected authorities. Along with Addison Wiggin, his friend and colleague, Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. Both works have been critically acclaimed internationally. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind Markets and Money.
Bill Bonner

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