Careful, there’s Pepper in the air. But first, let’s finish off yesterday’s lamentations on a more positive note.
By Jove, they’ve got it! After we’d harped on about it in Markets and Money endlessly, the Reserve Bank of Australia has finally figured it out. The economy drives the currency, not the other way around.
It might not seem like a big deal at first. But if imports and exports set the exchange rate instead of the other way around, a lot of economics is a load of rubbish and the budget could return to surplus just from firing treasury and academic economists.
If the real economy’s imports and exports dominate ‘jawboning’, money printing, and interest rate fixing, then all that interfering is a load of hogwash. And it also means that the currency is reflecting the state of the economy, making it neither a headwind nor a tailwind but an indicator.
A high Australian dollar means we’re doing well at exporting. A low one means our trade balance is low. You can’t say they’re good or bad, because the balance is self-correcting via the exchange rate mechanism. Interference just messes with this correction.
So what did the RBA actually say? Well, the Australian Financial Review paraphrased board member John Edwards, saying, ‘The biggest surge in export volumes on record may be holding up the dollar even though commodity prices are falling…’
So the Australian dollar has been rising because we had a trade surplus of $2.6 billion in the first two months of the year. That’s the ‘best’ start to a year since 1971. Hurrah for the mining boom, which is supposedly gone according to former editions of the AFR.
Actually, you shouldn’t call trade surpluses good or bad. As we explained yesterday, you produce things to be able to consume yourself. So consuming less than you produce isn’t inherently good. Then there’s the fact that international borders, which determine which region has a trade surplus or deficit, are arbitrary. East Germany went from being a bottomless economic pit for imports to a global export powerhouse overnight in 1989 simply by redrawing a map.
Economic cycles specialist Phil Anderson reckons currency markets aren’t the only thing not actually driven by money printing. Central bank intervention is old news and ‘if it’s in the news it’s in the price’. He claims the US stock market isn’t going up because of QE, but sales and profits. Indeed, corporate profits and margins are at unnatural highs. Analysts like John Hussman have been writing about how they will fall back to reality eventually.
That also fits in nicely with Anderson’s call for equity market moves for the next year and a half. He points out in this video that the US stock market always goes up for four years after the US housing market bottoms out. We’ve had that rally. Now it’s time for a breather. To find out what Phil’s latest trade ‘campaign’ is, as he likes to call it, you can sign up for free to The Anderson Project hotlist here.
While the US might be progressing nicely along Anderson’s ‘property clock’, we’re worried about the local mortgage market.
What’s this Pepper that made us sneeze? Well, Aussie firm Pepper Home Loans raised $500 million by selling Residential Mortgage Backed Securities (RMBS). They were ‘non-conforming’ RMBS, meaning they’re full of sub-prime loans. Self employed borrowers and borrowers who had previously got into trouble make up the bulk of the loans in the RMBS.
Remember how Australia doesn’t have sub-prime loans? Heh.
Here’s the remarkable part. Assume your memory takes you back more than seven years. How much return would you require to invest in a sub-prime RMBS?
We’d demand about 5% margin on top of the benchmark. Our desk buddy Shae would want 4%. Pepper will pay investors a margin of 1.1% for the AAA rated tranche and a mind boggling 0.35% for US$200 million worth offered to US and European investors. (The ‘margin’ you would demand is quoted above a benchmark rate like Australia’s bank bill rate or the UK’s LIBOR.)
These people are lunatics. They’re getting a pathetic return for the same securities that blew up the financial system just years ago, full of dodgy mortgages sourced from a country with a housing bubble.
Are we exaggerating? Nope. Pepper Home Loans is the name that consistently pops up in Loan Application Form manipulation cases we research. In case you’ve missed out on this story, the short version is as follows. There is evidence that some unscrupulous mortgage brokers often manipulate Loan Application Forms (LAFs) by adding income, assets, professions and more to get loans past lending standards. Denise Brailey of the Banking and Finance Consumer Support Association has seen hundreds of non-conforming loan LAFs and couldn’t find a single one without some manipulation.
In other words, Pepper’s RMBS is possibly full of loans to borrowers who are really 80 year old pensioners and not lawyers and stock brokers on six figure salaries, as their LAFs claim.
There’s no point in denying that anymore now that the court cases are out and Denise did a document dump online showing hundreds of manipulated LAFs. So now the financial industry reckons ‘sub-prime is a small problem’. Just $2.3 billion out of a $1.4 trillion mortgage market. We’ve heard that one before. Besides, according to Denise, about 10% of prime loans feature the same kind of LAF manipulation anyway.
As soon as all those sub-prime borrowers default and house prices fall, all hell will break loose in the RMBS market. Any investor who was fooled twice by the same investment, shame on you.
for Markets and Money