May 12, 2021 | This week in The Institutional Risk Analyst, we examine the growing divergence between the various narratives working through the markets and the actual financial and legal risks that are in our collective face. More than anything else, fear-of-missing-out or “FOMO” seems to be the operative term in the financial markets in 2021.
Like small mouth bass, we chase the shiny object. Whether you are chasing alpha in stocks or buying crypto tokens or making non-agency mortgage loans, the maddening crowd is FOMO. The herd chases the shiny object regardless of data or advice to the contrary. Let’s look at some reader comments for inspiration.
One new reader asks if we have free trials for The IRA Premium Service. No, we have monthly subscriptions. Occasionally we publish profiles outside the paywall to provide an example of our work. Please refer to the FAQs or consult your spiritual adviser.
Another manager of a small family office asks if we can offer subscriptions on a delayed basis, perhaps making content available after six months of aging. We’re flattered to hear that our prognostications have such a long shelf life. We’ll suggest it to WIX and let our readers know if and when such functionality arrives.
Several readers of The IRA Premium Service commented on our analysis of the New York Community Bank (NYSE:NYCB) acquisition of Flagstar Bancorp (NYSE:FBC), asking whether the former is not vulnerable to a downturn in valuations for urban multifamily real estate in New York City. Now that is the right question.
Note that the veteran commercial lending team at FBC got full representation in the management of the combined bank. NYCB’s business model is skewed by decades of low or no credit costs c/o the FOMC, but will this benevolent state continue in the future? You still think that’s air your breathing Neo? Our subscribers know the answer.
Another well-placed reader in Washington, D.C., asks about our view of the legal battle between Ripple Labs Inc. and the Securities and Exchange Commission over whether the token XRP is a security. XRP is the world’s fourth-largest crypto token today, with a roughly $70 billion market value, but is ultimately controlled by a single issuer, namely Ripple.
Says another reader: “Thank you for what you said about crypto currencies on RealVision. Proponents do not comprehend that crypto exists because the powers that be allow it. Until they don’t. The world’s most dominant and powerful empire in history will not go down without a fight. That is not a judgement, it’s a fact. When the crypto’s are perceived as a threat, they will be gone.”
The SEC says XRP meets the definition of a security because it’s an investment contract, the test articulated in 1946 by the Supreme Court in a case called SEC v. Howey. “Section 5 of the Securities Act is all embracing,” the agency wrote in the complaint. Ripple says that the SEC took their time blowing the whistle, suggesting there may be a political motive to the agency's actions.
We agree with the SEC on the nature of single-issuer tokens. XRP and other tokens sold by single issuers are clearly securities under Section 5 of the Securities Act of 1933. The fraud provisions also come to mind, but the SEC is deliberately keeping the focus of the complaint narrow.
US lawmakers have introduced legislation to clarify when a crypto token is a security or a commodity. Sorry folks, tokens that convert into nothing are just an electronic form of fraud. The fact that Ripple registered as a money service after its 2015 settlement with the Department of Justice and FinCEN is interesting but hardly relevant. To recall the work of Billy Preston and Bruce Fisher, "Nothin' from nothin' leaves nothin'."
Meanwhile over at the classic FOMO scam known as Robinhood, the tech enabled broker-dealer startup is learning that the “gamification” of investing still carries some big operational hurdles. The idea that you can build a new platform that somehow avoids all of the operational and compliance requirements of the brokerage business is a bad joke, but somehow Robinhood was able to sell that false narrative to the financial media and credulous investors.
Robinhood has filed a confidential S-1 with the SEC. Like Warren Buffett and Charley Gasparino at Fox Business, we’d love the have a look at that document. The IPO bankers are threatening to take this dubious concept public in the next several months, but our question is why? There is so much money sloshing around in private equity land, why take on the duties and risks of public ownership? Because in the time of FOMO, linger time equals risk.
Over in mortgage land, FOMO is also very visible. That gurgling sound you hear is issuers of non-agency mortgages gently choking on a pipeline of lower coupon loans as yields rise and bond spreads widen. Everyone from Rocket Companies (NYSE:RKT) on down the line is jumping into non-agency mortgages, suggesting that a train wreck may be in progress. One reader opines:
“Tons of low coupon (sub 3.125%) mortgages need to clear the PLS market in the coming weeks/months. It takes months to get the loans aggregated and through due diligence / RA process to securitize, so these inventories have seen a lot of widening. Could shake out some of the marginal ‘first time issuers’ and dealers with FOMO.”
Yeah, FOMO. Of course, spreads in the primary lending market continue to tighten, with average secondary market profits falling towards an average of ~25bp vs 150bp in 2020. Meanwhile, the pricing of negative duration assets like mortgage servicing rights is soaring towards 5x multiples of annual cash flow. Of note, on conventional assets, that 5x multiple is 125bp of implied value vs public company comps ~ 90bp in Q1 2021. Most of the mortgage operators we know and trust, BTW, get nauseous when MSR valuations rise much above 50bp.
The FOMO on a record year in 2020 caused a lot of inferior players in the mortgage market to load up on expensive sales talent and operational capacity, a trend that is about to reverse due to falling volumes. Even the FOMO-crazed crowd at Reddit may eventually need to admit that RKT and other lenders are a business that is largely correlated to interest rates.
Not to be outdone, the folks at United Wholesale Mortgage (NYSE:UWM) continue to brag publicly that they will surpass the Rocket in terms of sales -- this after a particularly disappointing first quarter. In the film "John Wick 3," when Mark Dascascos said "I'll catch up with you John," what did Keanu Reeves say in reply? "No you won't."
And speaking of artful FOMO, the folks inside the Biden Administration have apparently decided to tee up their own candidate to replace Federal Reserve Board Chairman Jerome Powell when his four year term ends. Due to FOMO, the Biden people think picking their own Fed chief is their duty and that swerving the central bank leftward will somehow gain them political advantage in 2022. You really cannot make this stuff up.
Along with raising taxes on everyone and increasing regulation on everything and anything, apparently President Joe Biden thinks that making MD socialist and former bank regulator Lael Brainard Federal Reserve Board Chairman will help the Democrats hold onto the White House when VP Kamala Harris makes her run in 2024. Really, we kid you not. And the financial markets need to start believing it too.
We suspect the financial meltdown that occurs when President Biden announces Brainard’s nomination as Fed Chairman will ultimately kill the nomination, but the damage to America's credibility will have been done. Imagine Brainard at the Fed and Janet Yellen at Treasury. The US would be positioned for market crisis followed by a severe economic contraction.
You see, FOMO works both as a buyer and a seller, whether we speak of pretend assets like crypto tokens or tech stocks or non-agency mortgages or even slightly used politicians. It's all about confidence. When the rush for the door truly begins, there will be nobody to stop the flood of selling of stocks or crypto tokens. “The malady of commercial crisis is not, in essence, a matter of the purse," said John Stuart Mill, "but of the mind.”