THE EVERYTHING BUBBLE, PART 1: RETURN OF THE SUBPRIME MORTGAGE
By : John Rubino
LONG-TERM HORIZON, CURRENCIES, GOLD, PORTFOLIO STRATEGY DOLLAR COLLAPSE
This cycle’s main bubble is in government bonds and fiat currencies, with a dash of large-cap tech thrown in for variety. But like a hurricane spawning tornadoes at its periphery, this Money Bubble is creating secondary bubbles like student debt and subprime auto loans that are impressively destructive in their own right.
An example of how extreme things have gotten is US housing, which — as the previous decade’s main bubble — wasn’t supposed to be a problem this time around. But apparently no sector is immune from all that excess central bank liquidity. As today’s Wall Street Journal notes, the subprime mortgage is now being resurrected:
DOES ANYONE REMEMBER HOW TO MAKE A SUBPRIME MORTGAGE?
Brokers willing to learn the lost art of making risky mortgages are in demand again
Brandon Boyd was a high school junior during the financial crisis. Now, the former Calvin Klein salesman is teaching mortgage brokers how to make subprime loans.
Mr. Boyd, a 25-year-old account executive at FundLoans in a beach town outside of San Diego, is at the cusp of efforts to bring back an army of salespeople who once powered the mortgage industry and, some say, contributed to the housing crisis.
Mortgage brokers, who serve as middlemen between lenders and borrowers, used to be a key part of the home-loan process. But some brokers faked loan applications and steered people into debt they couldn’t afford.
Financial regulation has severely diminished their ranks since the housing meltdown. And big banks with national sales teams say they won’t use brokers anymore because they are third-party contractors, making it harder to police loan quality.
Now, small and midsize independent lenders want the brokers back. Nonbank lenders that typically cater to riskier borrowers say they need brokers to fan out across the country and arrange mortgages to people with lower credit scores, or who can’t prove their income through a typical tax return.
Brokers are a key part of a mortgage chain that starts with a borrower going to a broker for a loan. The broker surveys lenders for the best loan to fit the customer. The lender then funds the borrower’s loan.
While brokers before the crisis served banks and independent lenders, today they are working largely for nonbank lenders who make up a critical part of the mortgage market.
In the first quarter, nonbank lenders accounted for about half the mortgages originated in the U.S., according to industry publication Inside Mortgage Finance.
Lenders say there is an untapped market among borrowers with good credit scores like self-employed workers who don’t have proper income documentation, or for responsibly made loans to borrowers with credit problems that have had bankruptcies in the past or had to sell their home for less than it was worth.
If they are successful in recruiting brokers, lenders believe the market potential for both types of loans could reach $200 billion annually.
Housing is late to the credit bubble party because the memory of its 2008 bust is still fairly fresh. So the lure of easy money had to become extremely powerful – and the fear of regulatory reprisal sufficiently weak – for subprime to once again be considered a serious business model.
APPARENTLY THAT DAY HAS ARRIVED.
Long expansions breed this kind of behavior because after five or six years of growth banks find that they’ve used up all their legitimate customers and must – if they want to maintain the deal flow on which their executives’ compensation is based – start scraping the bottom of the barrel. So they replace tried-and-true practices with “innovations” that are actually Ponzi schemes or other cons.
THEN THEY IMPLODE.
The question with housing is whether it has time to travel this road before the Money Bubble bursts, making the secondary bubbles irrelevant.
COST OF ‘BLACK SWAN’ BET ON FALLING MARKETS HITS PRE-CRISIS LOW
Hedge funds could make 25 times their money if S&P 500 falls 7 per cent in a month
BY: MILES JOHNSON IN LONDON .
The cost for hedge funds of taking out “Black Swan” insurance against a sharp fall for US equities has fallen to the lowest level since before the financial crisis as stock markets continue to touch all-time highs.
Months of low market volatility has forced down the price of options allowing hedge funds to place bets that would make them 25 times on their money if the S&P 500 index fell by 7 per cent over the next month.
“The price of constructing hedges against a fall in equity markets are at their lowest levels ever, while equity markets are trading at all-time highs,” said Deepak Gulati, chief investment officer of Argentiere Capital and former head of equity proprietary trading at JPMorgan Chase.
“Historically low levels of volatility in options markets are providing the opportunity to construct long volatility positions with completely asymmetric pay-offs.”
At a time when equity markets continue to grind higher and most investors are betting that volatility will remain low, the potential for big payouts worth many multiples of their cost is tempting a small number of hedge funds to take the other side of that trade.
Options using the so-called one month 97-93 per cent put spread on the S&P 500, which requires the index to fall by between 3 and 7 per cent in a month to be profitable, currently allows a maximum profit of $4 for contracts that cost $0.16, or a 25 times return, according to Bloomberg data.
Expectations of market volatility, which make up an important input into how much options bets cost, have been plumbing new lows this year. Earlier this month, the Vix index, which tracks the implied volatility of the S&P 500 over the next 30 days, closed at the lowest level since 1993.
Last month the Financial Times reported that Ruffer, a $20bn London investment company, had been buying up large amounts of contracts linked to the Vix index priced at half a dollar as part of a hedging strategy for its portfolio, earning it the moniker “50 Cent” among bemused traders.
At the same time, low expected volatility also allows traders to make cheap bets using options on the US stock market also rising in value.
The so-called 3 month 105-110 per cent call spread on the S&P 500, which needs the index to rise by 5 to 10 per cent over three months to be profitable, would generate a profit of up to 38.5 times. This compares to an average pay-off ratio for an identical call spread of 5.6 times over the past decade.
THE GLOBAL AGE OF COMPLEXITY
By : Andrew Sheng ; Xiao Geng
NEW YORK – Every century, it seems, has its “age.” The Renaissance, from a philosophical perspective, has been called the Age of Adventure. The seventeenth-century Age of Reason was followed by the Age of Enlightenment. The nineteenth and twentieth centuries were ages of ideology and analysis, respectively. As for the twenty-first century, I would argue that it is the Age of Complexity.
On the one hand, science and technology have progressed to the point that humans can create life and, through ultra-advanced genome-editing technologies, even engineer new species.
Futurologist Yuval Noah Harari anticipates the imminent rise of Homo deus: a species of humanity that can “play god” by manipulating nature in myriad ways, including delaying and ultimately even conquering death. Most of the technological trends identified by the US Department of Defense as crucial in the coming years were unheard of just 30 years ago.
On the other hand, much of humanity is besieged by feelings of helplessness and frustration, owing to the challenges we seem unable to resolve, from pollution and climate change to unrelenting radicalism and terrorism. Economic inequality – reinforced by job losses from automation, deeply entrenched social orders, and damaging political power dynamics – has contributed substantially to this sense of powerlessness.
At a time when our power of creation, matched by our power of destruction, has reached unprecedented levels – when one weapons launch could change the course of history – the development of a more equitable and effective system could not be more urgent. In this new age of complexity, we need a new paradigm for thinking about the world, and thus for guiding our efforts to advance peace and prosperity.
A prevailing worldview has always been essential to shaping human destiny. Alexander the Great would not have conquered most of the known world of his time without the influence of his philosopher-teacher Aristotle. And he was not unique: behind every great empire has been a great philosopher or historian whose worldview imbued the imperial drive with legitimacy and even sacred significance. (Were history written by the victims, not the victors, empire-building would look a lot less glorious.)
As we move to develop a new worldview to guide our future, we must embrace a truly global perspective. In the past, analysis of the evolution of humanity’s worldview has tended to focus on the West, following the European and, later, American progression from exploration, colonization, and empire-building, to industrialization, the diffusion of market relations, and technological innovation.
In the twenty-first century, however, this narrative is being revised. The global economic crisis that originated in the United States in 2007 exposed the fragility of the advanced-country model, giving rise to a new, more multipolar worldview, in which the emerging economies, led by China, India, and Russia, have increasingly challenged the status quo.
Meanwhile, the challenges countries are facing have become increasingly interconnected, with global mega-trends, from climate change to financialization, playing out beyond the purview of individual governments. As the physicist-turned-ecologist Fritjof Capra and the chemist Pier Luigi Luisi remarked in their 2014 book The Systems View of Life, “the major problems of our time are systemic problems – all interconnected and interdependent.” Accordingly, “they require systemic solutions.”
In this context, the world needs a more holistic worldview that accepts the pluralism and diversity – in terms of geography, tradition, and governance models – that reflect and reinforce the complexity of today’s global trends. Such an approach must recognize not just the need for countries to work together to shape the world, but also the limits of our ability to shape it at all.
Humanity has long operated within a paradigm of determinism; we believe we can predict and manipulate outcomes. But we have not discovered any natural laws or equations that explain how life evolved into its current state, much less indicate how it will evolve in the future.
Determinism has run its course, and must be replaced by a paradigm in which uncertainty is accepted as an irreducible fact of life.
In the natural sciences, this is already happening. Quantum mechanics, general relativity, and uncertainty have been accepted as the way forward in physics and mathematics. In biology and neuroscience, there is a growing acceptance that life emerges through cognition (self-awareness and self-generation) and changes constantly, meaning that there is no “prestatable becoming,” in the words of the biologist Stuart Kauffman.
Yet in the social sciences – from economics to politics – this transition has yet to take place.
Economics continues to operate in a largely linear manner, guided by the deterministic eighteenth-century Newtonian framework. But simple mechanistic theories cannot deal with living, complex, and often quantum systems. Indeed, the reductionist logic, based on simplistic assumptions, that dominates economics today is at best incomplete, and potentially fundamentally wrong.
Similarly, in politics, we continue to struggle to reach systemic solutions, not least because we often cannot agree on the nature of the complex problem we face. This partly reflects the global nature of today’s challenges and the diversity of perspectives that therefore must be reconciled.
More fundamentally, it reflects the fact that humans are not always rational – a fact that a new “complexity economics” would do more to acknowledge.
More broadly, a new “complexity worldview” must appreciate that human behavior is driven by everything from politics and economics to culture and psychology – even by technology itself. In an age of complexity, the institutions we build and sustain demand a system-minded approach that evolves alongside the rapidly progressing natural sciences.