On Kyle Bass Master Fishing for Non-Agency RMBS ~ The Risk Averse Alert

Saturday, January 05, 2013

On Kyle Bass Master Fishing for Non-Agency RMBS

In his fourth appearance at AmeriCatalyst, J. Kyle Bass, founder and principle of Hayman Capital Management, takes the stage with a compelling keynote address offering candid views on the state of crippled sovereigns and the global economy, the state of the U.S. economy and sovereign debt, the bottom of the U.S. housing market, and his favored investment opportunities today.

Bass' hour long presentation is well worth your time. Unfortunately, the YouTube video could not be embedded in this post, so you will have to click the above link to view Bass' address. Let's just say his outlook is not the least bit rosy. As he is anticipating a wave of sovereign debt restructuring to correct what he identifies are profound financial imbalances, the crucial question this likelihood raises really centers on how this restructuring will come about, as well as what might come to pass over the interim prior to that fateful moment.

Truth is these considerations—not at all touched upon during Bass' presentation—call into question his view claiming the U.S. housing market has bottomed, which assumption likewise plays part in his conclusion that, non-agency residential mortgage-backed securities (RMBS), held to maturity, present a favorable investment opportunity to those who know how to analyze these securities (which at the time of his presentation on October 1, 2012 were yielding in the range of 6-12%).

One might conclude Bass is assuming sovereign debt restructuring will occur along lines we have seen in various places throughout the world over the past fifteen years, most recently, for example, in Greece. However, as the necessity for sovereign debt restructuring reaches nations at the core of the global economy—Japan, China, major EU countries, the United States—considerations today purposely left out of mainstream dialog will be difficult, if not impossible, to ignore any longer. The destruction of societies with weak, parliamentary representation, sold out to unchecked criminality insisting on the supremacy of a mountain of illegitimate, unpayable debt, soon in kind will visit nations at the core of the imperial scam called "globalization," and test political marionettes upholding this arrangement, and this in a fashion unlike anything yet experienced. The fact the American Revolution is neither dead, nor even anywhere remotely near tragically dormant, is a functional reality we might rightly suppose is well recognized by those, for example, at the Financial Times of London who persist to this day with insistence Glass-Steagall be restored. More power to these folks. Friends of the American Revolution could not be more proud to have earned this alliance. Likewise, no shortage of this nation's citizenry could use this valuable lesson in humility from a former enemy.

So, with growing likelihood sovereign debt restructuring will be a vital necessity sometime during the next two years—this is Bass' conclusion—the battle to reinstate Glass-Steagall is likely to become more pitched. Even the current moment's manufactured attack on the viability of the U.S. Treasury's liabilities should see recognition increasing for the need to reorganize the banking system along Glass-Steagall lines. Weak deferments to the U.S. Constitution made this past week by unpenetrating media mouthpieces woefully blind to acts of criminal fraud rampant throughout the financial system—first, defending the debt ceiling and, second, denying the legitimacy of legal means Treasury has available to it to honor its outstanding obligations—rather sets the stage for political dialog moving far outside the box constructed by trapped, glorified gamblers otherwise representing imperial forces serving to wreck sovereign nation states the world over. Confirming this viewpoint, we saw during this week's start of the 113th Congress representatives Kaptur (D-OH) and Jones (R-NC) promptly resubmitting legislation venturing to reinstate Glass-Steagall (the former H.R. 1489 is now H.R. 129).

Now, don't get me wrong. Kyle Bass could be spot on regarding his favorable outlook toward non-agency RMBS. Yet I will argue Glass-Steagall reform of the banking system positively will be necessary if his fundamental viewpoint assuming the housing market is near its historical, cyclical bottom is to bear out. If, on the other hand, his analytical assumption accommodating his conclusions is founded on the idea that, reigning in the U.S. Treasury's outlays will assure a stable climate conducive to economic recovery otherwise foundational to an improving real estate market, then his thesis finding non-agency residential mortgage-backed securities an attractive investment alternative is at grave risk of being blown out of the water. In suggesting a sovereign debt restructuring is likely to occur sometime over the next two years Bass likewise is indicating the present day's financial and economic limbo mimicking the Japanese experience of the past 20+ years will not persist. Therefore, one of only two mutually calamitous outcomes will win the day. Either a decidedly deflationary debt write down crushing the economy, and thus the real estate market, will follow, or a massively hyperinflationary, Weimar Germany-like central bank deluge all too likely will occur. This latter outcome, too, not only will crush the real estate market, as labor will be further marginalized by a collapsing employment climate precipitated by circumstance destroying business profit margins, but it will make today's 6-12% yields on non-agency RMBS a woeful pittance in fact. Hyperinflation being a most undesirable outcome, yields making the likes of Paul Volcker blush rather would become our certain, tragic reality.

In the face of much confusion over how we got to a point where debt burdens are so great that, sovereign restructuring is widely considered likely we simply must come to terms with the mechanisms whose operation has led to mere symptoms being blamed as causes of the present day's calamity-threatening dilemma. National treasury outlays parabolically increasing over the past 30-40 years in fact are but the consequence of a hyperinflationary policy blessed by central banks the world over, with the U.S. Federal Reserve under Alan Greenspan being a most aggressive advocate. What Alan Greenspan did specifically was to relegate control of the Fed's "money printing" capacity to leveraged speculators operating throughout the private banking sector, this being accomplished through the deployment of an over-the-counter derivatives marketplace whose functioning the former Fed chairman sophistically rationalized to Congress over and over again, claiming this was serving to allocate capital more efficiently on account of some magic of the market capable of mitigating risk. How many times did we see that man dazzle his audience during appearances before various congressional committees playing up the "risk mitigation" capacity of modern, securities-based credit markets? Trouble is—and Greenspan has been forced to admit this—rather than mitigate risk, markets were serving to concentrate it.

Per ballooning Treasury liabilities, the credit-creating capacity the Greenspan Fed relegated to private sector credit markets required debt securities that were used both to synthesize derivative securities, as well as dynamically hedge the growing risk exposure financial institutions were taking on (which, of course, they were handsomely profiting from, as well). No small part of the game played in a securities-based financial system whose evolution created a veritable casino of historic dimensions employed schemes whereby physical assets were seized using various financial operations, leveraged using debt of dubious quality, then sold off—stripped—and in the process compromising the fortunes of millions of workers who, having formerly possessed the wherewithal to save, became fodder for a massive expansion in unsecured credit. Likewise, too, were many whose savings had been effectively raided relegated to the public dole. Yet this was but a small price to pay for a banking system profiting hand over fist. A Treasury nursing the game's victims likewise was forced to increase its outlays, which consequence in fact was most desirable to a banking system unquestionably needing the Treasury's wares to facilitate its endless leveraging of physical assets of every sort the world over.

Greed being what it is, though, the unending need for physical assets to be profitably leveraged—keep in mind there are upper limits to what can be made available—ushered in circumstance even conducive to expanding war, which, itself, effectively placed the U.S. military in the service of a glorified casino euphemistically called a banking system. Not only was the physical asset that is the U.S. military "leveraged," the banking system's voracious appetite for U.S. Treasury securities was quite spectacularly satisfied. Military machines don't come cheaply, particularly those that need be transported half way around the globe. Think about it. The events of September 11, 2001 might have been in no small part something of a "one step back, two steps forward" affair—this among other nefarious things—meant to satisfy the banking system's voracious demand for U.S. Treasury securities.

Now, granted, changes in demographics finding so-called "baby boomers" aging, and thus increasing demand on Social Security and Medicare, likewise have been a feature of our contemporary experience. Yet these programs are self-funding. They have nothing directly to do with the U.S. Treasury's liabilities. Notwithstanding this, on a regular basis over recent decades these so-called entitlement programs have been pilfered by congressional acts wherein inability to facilitate the U.S. Treasury's issuance of debt needed to finance legislative imperatives was overcome by raiding the piggy bank, so to speak, effectively serving to "paper over" Treasury's legal liabilities and disastrously compromise Congress' fiduciary duty. And now, the criminal enterprise that is the U.S. banking system would have everyone believe entitlement spending is threatening the U.S. Treasury! Good lord, what will they think of next? Maybe place the blame for this on Iran? No, more likely China.

All silliness aside, increases in entitlement spending are barely an indirect symptom, and certainly not a cause of the U.S. Treasury's parabolically ballooning liabilities.

Truth is Wall Street has had an undying love for U.S. Treasury securities. Indeed, were this not so, would yields on U.S. Treasury securities have been so surely set on a decades-running contraction?

In fact, though, this love affair now has reached a point where one of the parties in the marriage is the wiser to seek a divorce. That is the simple reality of this moment. The debt ceiling, the Satan sandwich's mandated sequestration, and the broader attack on the U.S. federal government's spending are ample reason for a rational citizenry to come to terms with how this circumstance came to be and seek divorce with unrelenting demand for a Glass-Steagall reform of the banking system.

If we need be finance geeks in order to defend rational demand for Glass-Steagall's reinstatement, then some better sense of traditional notions associated with the issuance of debt might be regarded a valuable commodity in this era of dangerously trapped casino operators who might go to no end attempting to deny their present, woeful state. A most desirable effect of Glass-Steagall's restoration would be far greater assurance that, every debt contracted will in all probability be satisfactorily extinguished. This is more than just a side benefit from imposing a hard-and-fast separation of commercial and investment banking activities. Rather it is the essence of the rationale for the separation! The Greenspan era's delusional claim that, modern credit market mechanisms would serve to mitigate risk have proven an abysmal failure, as near-term concerns driven by the profit motive served to cast to the wind effective concern over whether new credit created would be usefully deployed in endeavors rather certain to generate new wealth—that is create something out of nothing, so to speak. This fundamental aspect of debt whose encouraging enshrines the beneficial nature of capitalism wherein debt might be regarded a blessing is the substance of universal principle a Glass-Steagall reform would serve to uphold.

And so we come full circle and return to Kyle Bass' positive outlook toward investment opportunities in non-agency RMBS. Sovereign debt restructuring by itself will not ensure his view pans out, and this not even if a Glass-Steagall reform, indeed, is implemented. It is not enough to only have the framework in which debt can be widely agreed a blessing. The ends to which debt is applied, that new wealth created will serve to make debt's extinguishing a virtual certainty, likewise need be institutionally devised. This is where our old boy Hamilton comes in with the Third Bank of the United States whose primary purpose would be to finance the build out of a state-of-the-art physical economic platform worthy the 21st century. Upon this, alone, will new wealth beyond most everyone's wildest imagination be created by agents of capitalism whose actions bring private enterprise to flourish like never before. Prerequisite to this possibility is certainty the platform created will increase productive efficiencies to a degree making debt required to finance its build out easily extinguished (and this many times over at that). If we go this route, then I can endorse Bass' view toward non-agency RMBS. If we resist, then I believe unequivocally his is a crap shoot and you might be better off shorting Herbal Life and/or Apple... 

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