Is there a correlation between the 2003-2007 Miami condo market and today’s Treasury market?
David Zervos with Jefferies notes that during that time period “regulatory arbitrage” in the mortgage market was taking place wherein faulty correlation assumptions allowed risky loans to be pooled so that 60 to 70 percent of the assets were deemed zero risk weight AAA securities.
“As such, banks could lever these assets ad infinitum with no capital charge – and they did. A few years of massive levered spread collection, along with some very large bonus payouts, were followed by the mother of all bailouts.”
As the securitizers looked for more and more loans to pool, in order to feed the voracious bank balance sheet arbitrage monster, they reduced lending standards and drove house prices to record heights – in other words, government induced non-economic buying of an asset. In sub-prime it was a government induced regulatory arbitrage that led to non-economic buying of Miami condos.
“The prices were driven up for short term gain, even though the longer term valuations were absurd. Folks got paid huge within this short time frame via the arbitrage, while the long term time bomb ticked. And when the bomb went off, anyone with levered inventory was properly gutted! The US Treasury market has also been affected by a government induced regulatory arbitrage – it is called ‘QE’.”
Traders and investors, instead of buying & flipping condos, are buying and flipping long dated Treasury and Agency MBS securities.
“The opportunity to get in front of a non-economic, federally backed, arbitrage induced buyer of duration is a gift from heaven.”
And we can guess how it might end … last week’s mid-week rate spike died down to end the week but has resumed today.
This also peripherally leads to a note about the world’s stock markets. Last week, in Japan, the Nikkei was flattish but closed out the week up about 2%. It is now up nearly 20% for year – the best performing stock market in the world! But in Hong Kong the Hang Seng is up over 15%, China is +9%, Brazil is +19%, Europe +12%, and our S&P 500 is up over 11%.
Stocks and bonds don’t always move in opposite directions, but remember that many components of what pushes stocks higher can also push rates higher – primarily expanding economies. For loan agents and their clients, the bad news is higher rates, but the good news, in theory, is that an improving economy will help more borrowers (and properties) qualify.
At least the markets quieted down Friday after a week of rate worsening. The 10-yr T-note closed at 2.30%, with a renewed focus on gas prices for anyone who has filled up recently. This week is an odd week for economic news in this country – mostly housing news.
One interesting thing to note is the growing price gap between new vs. existing homes.
As of January, median existing home price was about $155k and median new home price was about $217k – 40% higher. There is a standing joke about driving a new car off the lot drops the value by 50% – but is that the case with a home?
Are there so few new homes that people are really paying a 40% premium for one?