Dollars Backed by Mortgages, Fed Gives Away Billions, Why OPEC Isn’t Happy, Gas Spikes 5 Cents, and More!

by Addison Wiggin & Ian Mathias

  • Fed exchanges billions more CDOs for IOUs… how the U.S. dollar is now 20% mortgage-backed securities
  • Home prices showing no signs of a bottom… which famous investor just tripled his stake in the U.S. housing market
  • Gold holds firm despite market chaos… Ed Bugos on what to expect next
  • Oil backs off a few bucks… why $135 oil does NOT make OPEC officials happy
  • Gas spikes 5 cents overnight… states tell cops to drive less, walk more

The Federal Reserve handed out another $46 billion to U.S. investment banks yesterday.

The Fed conducted its ninth TSLF Thursday, exchanging Treasury notes for unwanted mortgage- and asset-backed securities. While it may be a “good” sign that struggling investment houses didn’t borrow ALL of the $75 billion the Fed made available, it’s still worth noting that these big brokerages have dumped around $160 billion on the Fed since these weekly auctions began in March.

As such, “Illiquid collateralized debt obligations — including mortgage-backed securities,” says our government stats watchdog John Williams, “now total in excess of 20% of the collateral backing the Federal Reserve Notes.”

Yikes. One-fifth of the U.S. currency is backed by fetid CDOs. Think about that.

“According to the Fed,” John explains, “U.S. dollar currency in circulation is estimated at $818 billion, the better portion of which circulates outside the geographic confines of the United States. While the U.S. currency has been a fiat currency for decades, the Federal Reserve Notes presently in circulation are collateralized by securities held by the Fed.

“Those securities traditionally are U.S. Treasury securities.

“Since the onset of the banking solvency crisis and the establishment of various new lending facilities by the U.S. central bank, however, an increasing portion of the U.S. Treasury securities held as collateral has been lent to troubled financial institutions in exchange for largely illiquid collateralized debt obligations.”


And that’s not all the Fed’s been up to this week. On Tuesday, the Fed doled out another $75 billion in short-term loans to banks. In these Term Auction Facilities (TAFs), the Fed’s lent over $510 billion since the TAF was introduced, in December 2007.

Also, the discount window, an extra-cheap source of overnight loans for commercial banks, pumped out an average of $13.5 billion a day this week. Lest we forget, in the post-Bear Stearns world, investment houses can now visit “the window” too… such firms borrowed an average $14 billion a day this week.

“I think the tidal wave that hit various financial institutions since last August,” opined Warren Buffett yesterday, “has largely been recognized and felt. In terms of the effect on the economy in the United States, we don’t know, but I think it will be longer and deeper than many people do. There could well be a lot to come.”

Right on cue, U.S. home prices fell 3.1% in the first quarter of 2008, a record decline. The year-over-year fall, according to a report from the Office of Federal Housing Enterprise Oversight released yesterday, was the largest in the 17 years of recorded government observation.

First-quarter home prices fell 1.7% from the last quarter of 2007, also an OFHEO record.

Sales of existing homes in the U.S. fell again in April, this time by 1%. Homes were sold at an annual rate of 4.8 million… slightly better than expectations, but still down 17% from the same time last year.

According to the same report from the National Association of Realtors, the median home price was $202,300 in April, down 8% year over year, but up 1% from March. Supply continues to expand… as home prices increase ever so slightly while lending standards tighten, a sickening 11.2-month supply of homes sits on the market.

Here’s a speculative bet that will be worth watching. Bill Gross, head of PIMCO, the most revered bond biz in the U.S., tripled his company’s investment in mortgage debt. His $130 billion Total Return Fund, the world’s largest bond fund, is now composed 61% of mortgage-backed securities.

Gross told the Financial Times that his decision to expose such a huge portion of the fund was not based on his faith in U.S. housing, but rather the U.S. government’s unspoken guarantee of Fannie Mae and Freddie Mac.

In other words, the world’s biggest collection of bonds is riding on the hope that if Fannie and Freddie bite the dust, the government could, and would, bail ‘em out. It’s probably a safe bet to say they’d try. But at what cost to you or your currency?

For now, Gross has played the credit crisis masterfully. The Total Return Fund is up nearly 4% this year, twice the returns of typical bond funds, and TRF’s best start in eight years.

Major U.S. stock indexes regained their balance yesterday after taking some big hits this week. Trading was choppy, and in the end, stocks finished just slightly on the upside.

The Dow and S&P rose a huge, breakout 0.3%. The Nasdaq climbed 0.7%.

After rallying to $925 early in the week, gold is holding the ground it gained.

“What a difference a week makes,” notes Ed Bugos, keeping an eye on the gold markets for us from his perch in Vancouver. “It may be early to call it, but the gold market sure is making a helluva comeback. The seasonal low and the idea of a bounce in the dollar are already factored in the gold market.

“What I like about the recovery this week is that it has blown through heavy resistance points in the $890-920 range in just four days. In a normal advance, the bulls should want to lay off here and let the market backfill a little — to sucker some shorts in and test support underneath them — before pushing through that resistance.”

We’ll keep you abreast of Ed’s technical observations for gold. But if you want his favorite ways to play the resurgent bull — including his favorite junior mining companies — check out Gold & Options Trader.

The dollar has hardly budged since we wrote you last. The index tracking the greenback remains right at 72. Ditto with its major competitors: The euro, pound and yen are all hanging in there at $1.57, $1.98 and 103, respectively.

“The Aussie dollar has had quite a week,” notes our friend Chuck Butler. The Australian currency is up to 96 cents, a 24-year high.

“I find this to be very exciting,” says Chuck, “the Aussie dollar played second fiddle to the New Zealand kiwi for six years. But the tables are turned now. Australia has the ability to fill the raw material needs of China, which in turn gives it the ability to reduce its deficit situation. Interest rates are high there, and aren’t going anywhere, except maybe up. The markets are waking up and smelling the coffee on this one too: As I said yesterday, some LARGE BANKS had talked up the Aussie.

“We’ll see more of this as we go along. They’ll all want to jump on my bandwagon now!”

Chuck, by the way, will be making a surprise announcement in Vancouver. It involves the Aussie dollar, we’re told. But you’ll have to be there to find out what it is… see you there.

The Aussie didn’t receive any help from oil yesterday, though. Light sweet crude backed down a few bucks. After touching a record high of $135, crude has retreated to the super-cheap price of $133 this morning.

“We are not very happy with this increase in oil prices,” said OPEC chief Abdala El-Badri yesterday. “Volatility has nothing to do with the fundamentals. It has nothing to do with world demand… The price was at $130 and today is at $135, so it’s really a crazy market.”

El-Badri, if you think about it, is rightfully nervous. While dollar weakness contributes to $135 oil, the last ten bucks have been driven mostly by supply-and-demand speculation. As the man who almost entirely embodies the supply side of the oil trade, El-Badri shouldn’t be happy that the world is collectively announcing that supply might fail to meet demand. For example:

The outlook for global oil supply “is a dangerous situation,” warned Fatih Birol, chief economist to the International Energy Agency. Birol and his crew just finished a study of about 400 oil fields across the world, and he announced yesterday that the IEA will lower its oil supply forecast in its next annual report. As far as we know, that’s never happened before.

“We are entering a new world energy order,” Birol continued. “The prices are very high, and demand did not respond in the last few years as much as one would have expected. The growth in terms of production was not great. We did not see enough investment… The oil investments required [to meet future demand] may be much, much higher than what people assume.”

Next Tuesday, the Dubai Gold & Commodities Exchange will begin hosting crude oil futures trades. Good timing, considering the abuse of oil execs by Congress this week and the likelihood of U.S. government regulating speculators in the commodity markets.

“If this environment keeps up,” our Kevin Kerr told this morning, “more and more hedge funds will flee for more friendly shores.” You can check out the full interview here.

Gas prices shot up full 5 cents a gallon overnight, to a record high $3.87. The average gallon over Memorial Day weekend 2007 was 65 cents cheaper…still planning on driving to the beach this weekend?

Gas has gotten expensive enough that municipalities across the country are beginning to tighten their belts.

Cops, for example, are seeing all sorts of odd new regulations thrown their way, reports the AP this morning: Turn off the engine if stopping for more than one minute, no more taking patrol cars home, pair up whenever possible, walk the beat when the situation permits and – by far the most emasculating suggestion – consider using one of these bad boys:

Sorry, armed or unarmed, uniformed or undercover, cop or citizen… no one can be taken seriously riding that thing.

Oy. As I.O.U.S.A. stumbles, we note again today that our border nations are doing their damnedest to catch up. Yesterday, we showed you Canada. Today, we look southward.

According to GDP data released this morning, Mexico is on track to grow between 2.6-3.2% this year. Mexico is making the case that the U.S. and Mexican economies are not inextricably entwined — for the time being anyway.

And a quick glance at Mexico’s IPC shows similar bravado. Since the height of the credit crisis earlier this year, it’s easy to see where money’s being treated best in North America, and where it isn’t:

“How can there be any consternation,” writes a reader, “about what the problems are with the cost of oil and all other commodities, not to mention the U.S. economy as a whole.

“Since 2002, the U.S. dollar has lost 50% of its purchasing power, and the mathematics of this is that the dollar will now have to gain 100% of its existing buying power to return to the 2002 level.

“Just let the Fed keep dropping more empty dollars out the window for everyone and eventually, we’ll all have none.”

The 5 responds: To paraphrase Jim Rogers,
sell the dollar, you’ll be helping the Fed… it’s the patriotic thing to do.


Addison Wiggin,
The 5 Min. Forecast

P.S. We just learned our screening time for the Silverdocs film festival in Silver Spring, Md., just outside D.C. It’s Sunday, June 22, at 3 p.m. Here’s the link if you’ll be in the area:

If the Maryland Film Fest here in Baltimore a few weeks ago was any indication, you’re bound to see a few sitting and ex-senators in the audience… and you’ll feel their angst in the Q&A afterward. Heh.

P.P.S. The protagonist of our film, former Comptroller General David Walker, was on CNBC for two hours this morning, along with Blackstone CEO Pete Peterson. The headline given to the segment was eerily “similar” to the Baltimore Sun article written about the film just prior to the Maryland Film Fest. Check it out:

An Inconvenient Debt

An inconvenient debt



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