A significant amount of weight is being placed on the upcoming pullout of the Federal Reserve from the mortgage-backed securities (MBS) market.
The success of such a move must be largely underpinned by the necessary emergence of a solid third-party investor base, be it Europe's institutional investors or Asia-based sovereign wealth funds. When dealing with MBS the best investors are those who buy to hold the bonds to maturity, reducing volatility on both the buy and sell sides.
Essentially, the Obama administration appears poised to rely on long-term investors for a long-term recovery, though I doubt we will see either.
In conversations I had at the American Securitization Forum (ASF), one source mentioned that European investors are some of the most skittish, having bailed in the third quarter of 2007 in large numbers as subprime began to break down. And with the very future of the European union in doubt, due to the recent debt troubles in Greece (next stop Italy, Spain, Portugal), it has become hard to see a hugely supportive investor base emerging.
Especially when faced with scary (European) bond stability.
Hamilton College political scientist Alan Cafruny, who has questioned the logic of the European Union (EU) since 2003, sums it nicely: "The Greek debt crisis has exposed the underlying contradictions of Europe's economic monetary union-- a single currency and market absent a single government--at a time when the EU is beset by growing conflicts among the member states," he said. "Any resolution of the debt crisis is likely to exacerbate these conflicts, calling into question the underlying logic of Union."
Another report, this one from Reuters that deals with ultra-rich European investors, is showing a flight to commodities, so don't count on them, either.
Indeed, a Bank of America Merrill Lynch global survey of 200 fund managers reveals that "investors have scaled back their growth expectations, retreated into cash and are increasingly skeptical that the European Central Bank (ECB) will increase interest rates in 2010."
The report also finds that the proportion of European investors expecting the region’s economy to grow in the coming 12 months has fallen to 51% from 74% in January, and the proportion expecting no rate rise by the ECB in 2010 has soared to 45% from 19%. Globally, 42% of respondents now see no rate hike by the Federal Reserve before 2011, up from 27%. Hedge funds have scaled back leverage to less than one times from 1.33 times.
"Investors are questioning whether this is a pause in growth or a trend reversal. We believe it’s the former," said Gary Baker, head of European Equities strategy at BofA Merrill Lynch Global Research.
Even more suspect is the fact that the recent offerings of US Treasuries yesterday showed waning Chinese interest in the bonds. Japan actually outstripped China in its total purchases: $768.8bn compared to $755.4bn, respectively.
At any rate, why buy bonds when the actual real estate is more tempting? Hedge funds, private wealth funds, etc. are all snapping up distressed assets, in a continuing trend since 2008. Will MBS prove to be tempting enough to pull them into the market in larger numbers?
It's not likely, considering - in another report from Reuters - that "client dissatisfaction with badly-performing investments has made them tougher negotiators on price for private banking services, squeezing profit margins and making greater efficiency at the banks all the more urgent."
But will there be buyers for MBS, almost certainly. At the ASF, a panelist anticipated that 80% of new issuance in the larger ABS market is absorbed by 20% of the investor base. While those numbers hint at a diminished investor base, they also indicate it is not completely decimated.
"This was also supported by the results of a survey released at the conference showing that a number of investors had not returned to the market as they are still worried about residential market loan modification making their cash flow modeling too uncertain," said Société Générale analyst Jean-David Cirotteau, who for the record, disagrees with my view.
"They require a higher premium, which has so far meant that issuance is too expensive," he adds. "The situation of the US investor base gives rise to some concern, but it still looks much more comfortable than the current situation in European markets."
But there is one thing Jean-David and I agree on. In the United States there will likely be government support for any fledgling and flagging programs. So I won't be surprised when Bailout 2 follows the double-dip.
And, for the record, I hope that I am completely wrong.
I just hate it when I'm right.