miércoles, 7 de mayo de 2014

miércoles, mayo 07, 2014

A Yen for a Mortgage

By John Mauldin

May 03, 2014


For some time I have been saying that I was going to close the mortgage on my new apartment and then hedge it in yen. I promised to tell you the story, including what type of loan I got and how I am doing the hedge. This week I was finally able to pull the trigger. This topic will also let us re-examine why I think the Japanese yen is a screaming short

I am going to make this a shorter letter, as Amsterdam is calling, and it is a beautiful day. This is not a big think piece, but I think many of you will find it interesting. It outlines how I put my economic thinking into actual practice, and names names, if you will, of those who helped me do it.

An ARM and a Leg


But then came the time to get a takeout mortgage. Joe had lent me the total amount at 3.75% for one year.

It soon became apparent I would get only a 70% loan, which would basically take me out of the construction loans. I got lucky in that the appraisals turned out higher than my cost basis, as values have actually moved up. First feelers were not encouraging, so I began to shop.

I wanted a 5-year adjustable-rate mortgage (ARM) with a 30-year amortization. My feeling is that there will be a recession within the next five years (if we do not have one, it will be the longest span on record with no recession in the US) and that rates will once more go way down – and I can then lock in whatever I want, probably a 15-year fixed, at that time. My risk is that we may never again see rates as low as they are today, but that is a chance I am prepared to take. (I really do eat my owncooking.”)

Two personal connections turned up offers in the 4.5% range. Ron was beginning to get feelers in the high 3% range. I called my broker at JP Morgan (more below), and Travis Moss in his office went to work and got me an offer for the 5-year ARM at 2.875%; but it was not clear they could actually do the deal, as high-rise financing is complicated in Texas. About that time, my regular bank, Capital One, changed loan officers. The new guy gave me a courtesy call; and upon finding that I needed a mortgage, he jumped into the process. Rather than a loan that they would securitize, they were looking for a loan to put on the books

They matched the JP Morgan offer and really dropped the closing costs. No points, etc. I sheepishly told Travis (who is a friend) that I was getting a better offer, and within a day he had matched it. We decided to go with JP Morgan, as that is where I am going to do my yen hedge, but it was hard to turn down Clinton Coe from Capital One. He really wanted that loan. When we had our crisis in Texas back in the early 90s, we “lost” our banks to national banks and lost a lot of that personal touch I had known for the first part of my career. It is nice to see bankers like that again in Texas.

I signed the closing papers and had literally just stood up from the table when I took a call from the banker at Capital One, offering to cut the rate to 2.75% and axe a few other costs as well. WOW. Now, in Texas you can cancel a loan commitment for up to three days. I was tempted for a minute, but decided that because I had told Travis I would do the deal, I was not willing to take that back. But I did call Travis and tell him what had happened, joking about it. He saidwait a minute.” He hung up, then quickly called me back and said, “We will match it. Go cancel your loan.” When was the last time your banker tore up your loan and then lowered the rate for you five minutes after you signed the deal?

So I rescinded the first loan and then had to wait another 30 days (the rules) but finally closed on the way to the airport to come to Amsterdam.


A Yen for a Mortgage


Long-time readers know I am a huge bear on the relative value of the Japanese yen versus almost any currency, but especially the dollar. I have been saying for some time that I expect the yen to one day be at 200 and maybe even higher. But that journey is going to take a long time. Forty years ago the yen was at 357 (or thereabouts), and then it rose over time to the high ’70s last year, when it started to fall again. The chart below goes back 43 years. Think, by the way, how your businesses would react if the value of the currency in which you trade rose by a factor of four over 40 years.





Later in the letter I will go more into my reasoning as to why I think the yen will fall over time, but for now let’s look at how I got a “yen mortgage.”

I asked readers to help me find a “pureyen mortgage. I said I thought the market for such a mortgage would be huge, and I would help build it. I must admit, I was somewhat surprised when nothing really turned up. Ten-year government paper in Japan is at 0.6%. You would think that getting 2% for a 15-year mortgage would appeal to someone, but running a few connections still brought me nothing. I even found a US bank that would agree to a takeout and mortgage guarantee, but still no takers. I guess a billion isn’t as big a deal as it used to be.

The basic concept is that if the yen falls by 50% (my bet) and I have my loan structured in yen, then I pay less in dollars. Perhaps a lot less. But since no pure yen loan is available that I can find, a synthetic one will have to do.

There are lots of ways to do it. Futures are the obvious waysimply selling the yen short. But I have no way of knowing timing on the yen, and in my view there will be some significant correctionsalong the way, so using futures would be a constant battle of margins, rolling into forwards, paying commissions with every new contract, etc. And given the new Dodd-Frank rules, it is #$%W$#$ hard to simply tell a broker to execute a trade. To do the trade I ended up doing (see below), I had to be on the phone in the middle of the Amsterdam night to verbally confirm that I was sane and really, really did want to do the trade. But given my travel schedule and possible technological issues, updating my futures trade could have been problematic.

So I elected to keep it simple and do a 10-year put option. I want Abe-san and Kuroda-san to pay for about half my mortgage. I will gladly pay the other half. All they have to do is print yen to fulfill their part of the transaction – and they seem pretty committed.

Warning: Don’t try this at home, kids. This is a VERY risky bet, even though my losses are limited to my entire investment. And while my logic might be compelling, at the end of the day I am trading/betting/gambling (all essentially the same thing) that politicians in a country and a culture I don’t live in and don’t truly understand are going to act in a certain way. They might choose another path with different disastrous results that would make the trade go against me. They have no good choices, only disastrous ones, because they have overleveraged their government and cannot possibly meet their obligations without some kind of default. Rather than outright default to their own retirees, I think they will print and inflate and monetize away that debt. But that’s just me making a trade to counter what I think they will do (and what they tell us they will do). With that preface, let’s look at what I am doing.

To execute the trade, I went to The Plumber. That is my rather affectionate name for Erick Kuebler, a JP Morgan broker here in Dallas. Darrell Cain introduced us, with a rather effusive (for Darrell) endorsement. Having met a few brokers over the years, including some really good ones, I just listened and watched. But as Erick is part of that downtown TCU-grad mafia (a local thing – he was in the same frat with Kyle Bass and a group of guys), he kept showing up at places where I was.

Over time, I realized that Erick understood the workings of the market better than anyone I personally knew. Not the normal things you and I think about, but what really happens when you execute a trade. I simply want to go to a screen and buy or sell, in much the same way that I go to a faucet and turn it on and get water. I expect water to come out when I twist the handle.

The Plumber knows what happens when I do that. He knows where the water comes from, who purifies it, what tank it was stored in before it got to me, whether it will be hot or cold, and what the pressure is. He knows whether to use copper or PVC pipe in the construction. He knows who charges what at each step along the line. I have learned a lot from The Plumber. (Simple ETF trades, for instance, are not all that simple. Especially in size.) For the record, I am a registered broker with my own firm, and you would think I would know this stuff. I kind of knew but had no real idea how many toll gates there are if you are not paying attention. Erick specializes in larger trades for clients trying to avoid those tolls. He laughs at the HFT guys.

Plus, Darrell chose Erick and JP Morgan to handle my self-directed defined-benefit pensions plans (which deserve a whole letter – for the right small business they are a marvelous tax preference vehicle), so Erick was the logical choice to help me do this yen trade.

Buying in-the-money” or close-to-spot options is expensive. While I have no way to know what the yen will be one or two years from now, I truly think that over ten years Japan has no choice but to print massively. So, if I think the yen will eventually get to 200, I can buy an option that allows me to exercise the put at a strike price of 130. If I do a million dollars notional, that means if the yen goes to 200 I make about $700,000. The rules keep me from disclosing how much that put option costs me, but let’s just say that I end up with a nice multiple if I’m right.

Of course, if the market is right (in its current state of unwavering faith) and the yen doesn’t even top 130, I lose all of my option premium. ALL OF IT. 100%.

I will eventually add two more trades, one option at 140 and another at 150, but as I am notoriously bad at timing, I am going to “featherthose trades in over the next few months. I can see the yen dropping below 100 or going above 105 quickly (it is at 102 and change today); but since I don’t know, it just seems better to me to take some time to put the whole trade on. I now have until May 5, 2024, for the yen to rise above 130 … or I take the loss.

Given that I think 200 is where we’re going it doesn’t really matter all that much if we start at 98 or 105; but I think that in general it’s good practice to pace your investments when it’s practical to do so.

A Bug in Search of a Windshield


I wrote about four years ago that Japan was a bug in search of a windshield. In January 2013 I actually started to invest personal assets in the “short Japan story (mainly through funds), and with this week’s action I’m doing so more aggressively. The position represents an outsized portion of my personal portfolio, and it’s one I would not suggest that most people take in such size. But then, you ask, why am I doing it?

I guess I’m a true believer. Japan has a government debt-to-GDP ratio of at least 221% and perhaps as high as 245%, depending on your data source and how you account for certain securities. The interest rates on the Japanese 10-year bond is at 0.6%, yet interest-rate expenses eat up some 23% of total government revenue. (Debt service accounts for 46% of government tax revenue.) If interest rates were to rise to OECD levels, or another 2%, interest-rate expense would eat up 80% of government revenue. That is not a workable business model.

My friends over at Hayman Advisors (Kyle Bass’s fund) sent me the following pieces of data: Added together, Japanese debt service and social security (nondiscretionary spending) exceed government tax revenue and have done so for each of the last five years. The fiscal deficit has been greater than 10% of nominal GDP in each of the last five years. Japan has ~¥1.1 quadrillion of total government debt (~¥1,100 trillion) compared to nominal GDP of~¥481 trillion (a 221% ratio).

Japan has consumed the savings of multiple generations through the sale of government bonds. Japan now has less than 5% of its government debt sourced outside Japan. But the country does notowe it to itself.” It owes it to the tens of millions of savers and retirees who have played the game correctly, worked hard and saved all their lives, and now want to use those savings in retirement.

The largest pension funds are no longer net buyers of Japanese bonds (JGBs). They are now selling, and that tide will swell with a vengeance, since Japan is rapidly aging. Further, the largest pension funds are starting to roll out of JGBs and into equities. Which makes sense, as who wants to own a 10-year JGB at 0.6% if inflation rises to 2%? What rational investor would choose to do that?

Japan cannot afford interest rates to rise all that much. So there must be a good market for JGBs. But who will buy?

Two weeks ago, there was a day and a half when the Bank of Japan was not in the market for 10-year JGBs. Even though they are buying in size every month with their latest aggressive round of QE, there are times when they are notin the market.”

During my recent speeches, I have been asking the room how many JGBs they think traded during the period when the BoJ was out of the picture. Make your guess now.

No one gets it right. For that day and a half, the bond market had zero trades. The Bank of Japan is now the market. Think about that! (See: reuters.com/japan-jgb.)

Given the reality of Japanese finance, I think they BoJ will continue to “hit the bidin order to hold interest rates down. They will space out their buying more to keep those no-trading days out of public view. They will give us a song and dance from time to time to try and keep the valuation of the yen from rising too fast, but in the end they are going to monetize more in absolute terms than the US did in an economy three times Japan’s size. Perhaps as much as $8 trillion over an extended period. That’s the relative equivalent of the US Fed buying $30 trillion and putting it on its balance sheet. If you thought the Fed was going to do that, what would you do now?

What do you think Japanese investors will do when they realize what is happening? Buy equities, of course, but also diversify internationally. This move is going to play havoc with cross-border capital flows into all sorts of markets.

This is a brief synopsis of the Japan story. For a much fuller read, I point you to some of my past letters, or better yet, the full story in chapters two and three of Code Red.

I urge you to be cautious about putting on a “yen hedge” for your own mortgage. It is hard to do and more expensive for options with a notional value of less than $1 million, so it might not fit into your portfolio all that well. Talk with your financial advisor or broker, and really do your own homework. There are very smart people who, like me, are yen bears but who think that 140 or 150 is about as high as the yen will go. When I start talking 200, they think I’m smoking some of the stuff sold in the coffee shops here in Amsterdam. If they’re right, my trade will be in the money but not all that good over time, considering the risk and use of capital.


Eddy has a somewhat different view of the problems facing Europe. He and I see the same issues (debt, impossible-to-keep government promises, no fiscal union, banking capitalization woes, etc.), but he thinks the euro will break up, not in just a few years but much further down the road, in ten years, perhaps. It is his view that the dream of a unified Europe will be chased by politicians all the way to the bitter end. They will kick the can down the road much further than some of us think possible. He believes they can hold it together longer with promises and halfway measures, promises to fix things at the next meeting, etc. I admit to wondering just how they can accomplish that, and we spent a few pleasant hours over lunch on the canals as he explained his views.

Ten years? Wow. A lot of things will change in 10 years, but Keynes is right about this: the markets can stay irrational longer than you can remain solvent. I find it hard to believe that France can stall that long; but then again, we are talking politics, not economics.

It really is time to hit the send button. Have a great week. I am off to ponder how human beings could pile into such small ships and dare the oceans. (I get seasick relatively easily and find a storm at sea to be such an awful idea that I have a hard time even thinking about getting on a boat.) I therefore find it fascinating that it seemed like a good idea at the time and that so many did it. But then again, I am shorting the yenwho knows what craziness true believers will get up to?

Your still trying to think about Europe in 10 years analyst,

John Mauldin

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