The POMO Show-mo: If I could animate, it would be in Slow Mo, but that’s a WordPress No-No.

Permanent Open Market Operations.  POMO.

That’s government-speak for the Fed buying gobs of Treasuries and Agency Mortgage-Backed Securities (MBS).

I’ve used this tiny podium in a handful of older posts to present my opinion of the grand experiment known as POMO.  Repeat readers will recall that my pet peeves generally fall into two main categories of fully-intended (but oft-denied) consequences:   1) Financial Repression – punish savers until they move into risk assets, and 2) Market Distortion – levitate the stock market to create a wealth effect and consumer confidence.  As to point #1, it’s self-explanatory and not worthy of much deeper analysis.  As for #2, I’ll let the following graph do the talking.  The orange line is the S&P 500 while the white line is POMO. (Click on chart to enlarge)


Today, however, I’m adding #3.  Witness the mREIT.  An mREIT is a mortgage-based Real Estate Investment Trust.  In simple terms, they borrow money at low rates (usually via repo) and invest the borrowings in higher yielding long-term mortgage securities and profiting from the spread.  mREITS come in two flavors:  Agency mREITS and non-Agency mREITS.

The distinction is huge.  We’ll circle back to it in a minute.

Monetary policy is holding down the cost of short-term borrowing at nearly zero – an advantage in the borrowing costs for both Agency and non-Agency mREITS.  With such cheap borrowing, mREITS have bloated the amount of mortgage assets on their books.  The bloat allows huge dividend payments to mREIT investors – a cool drink of water in an otherwise yield-parched world.   And the short-term kicker for Agency mREIT’s specifically was the amount of Agency MBS the Fed would be purchasing as part of POMO.  To provide some perspective, they will be buying $26 billion this month.  These purchases increase the value of MBS which, in turn, resulted in increases in the stock price of Agency mREIT’s.

What more could a yield seeking investor want?  Big dividends, rising share price, and an implicit government guarantee on the underlying investment.

Then came the AGNC earnings report.  AGNC is a large Agency mREIT.  During the first quarter, AGNC had a huge earnings miss driven by two factors; both of which are related to Fed activity and POMO.  First, the high-priced MBS on AGNC’s books (higher due to POMO buying) tumbled by $837 million ($2.21 per share) as the market began to anticipate an end to QE and POMO due to stronger economic reports.  Second, spreads fell from 1.63% in 4Q2012 to 1.52% this quarter.  Despite the market pricing down MBS, the constant buying by the Fed via POMO continued to compress the spreads.  Viewed YOY, spreads declined from 2.31% in 1Q 2012 to 1.52% as mentioned above.

The impact of these dynamics was further expansion of financial repression.  Investors needing yield who moved into Agency mREITS were delivered these returns for the day:

AGNC                                    -7.3% (it was down 9% at its day low)

NLY                                        -2.6%

CYS                                         -1.5%

ARR                                        -1.7%

And this on a day when the S&P 500 closed up 1.05%

To paraphrase the most interesting man in the world, “I don’t always seek yield, but when I do it’s always hedged.  Stay cautious my friends.” – LL


The Mouse That Roared

By now, most everyone is familiar with the weekend bail-in of the Cyprus banks.  Cyprus…  that little mouse of an island with about 1 million citizens.

From Goldman Sachs, here is a bullet-point summary of the action:

  • Over the weekend, Cyprus and Troika agreed on a rescue package with the following key points:
  • €10 billion total rescue package.
  • A tax on deposits, expected to yield €5.8 billion, which has the following characteristics:
    • 6.7% tax on deposit amounts < €100, 000.
    • 9.9% tax on deposit amounts > €100, 000.
    • Deposit amounts are recorded as of Friday close (March 15) and apply to all deposits in Cypriot Banks in Cyprus (across currencies, type of customer account). They do not apply to customer deposits of Cypriot banks held outside of Cyprus (the two large Cypriot banks both have a presence in the UK, for example).
    • Cypriot bank operations in Greece will be taken over by Greek banks, at no cost to the Greek tax payer. This is important as the large Cypriot banks operate a substantial portion of group assets in Greece.
    • In exchange for the tax, the impacted depositors will be granted shares in the Cypriot banks.
  • Tax changes, where (1) the corporate tax rises to 12.5% from 10% and the income from deposits to be taxed at 20-25%.
  • Bail-in of junior debt is expected to take place, however overall impact is limited by a low balance of outstanding securities.
  • Commitment to downsize local banking sector towards EU average size (in relation to GDP) by 2018.
  • A privatization program which is expected to contribute €1.4 billion.
  • Russia will participate, but to a small extent (exact amount / type unclear).

As a result of these actions, even deposits falling below the deposit insurance maximum will be taking a haircut.  ATM’s in Cyprus are empty and the banks are on holiday until Thursday at the earliest.

General reaction in the media has run the gamut from moral indignation to righteous rage.

  • How can government force savers to disgorge a large chunk of their savings?
  • What do you have left when the rule of law can be overturned by edict?
  • What are the implications for property rights of the individual?
  • How can we accept this financial repression of middle and lower class savers?

Feel sorry for the Cypriots.

Except the above questions were not intended to apply only to Cyprus.  They should have been asked years ago when the US Federal Reserve decided to hold interest rates at zero.

Zero nominal rates means negative real rates; forcing savers to disgorge their savings to inflation.  Artificially forcing interest rates to zero is an edict by an unelected central bank.  Hardly the rule of law.  And what are the implications for property rights when inflation backhandedly chips away at your property’s value? Finally, here, in the good-ol’ US it is the lower and middle class saver that is being financially repressed by being paid nothing on their savings.  Think of the retiree trying to make his savings last for the rest of his life.

I somehow missed the moral indignation and righteous rage when these policies were implemented on our shores.

I guess if you implement financial repression quietly and over time, few people notice or care.  Yet, if you overtly and immediately bring about the repression, you make global headlines and become the target of global derision.

So Cyprus is the mouse that roared.

Pay no attention to the whispering gorilla.