We originally published the main body of this story in mid-June this year, and are reprising it now as the chart below from Credit Suisse's chart is making the rounds again, given there is talk that the monetary authorities are considering halting quantitative easing operations (i.e. printing money). We may have gotten through the last 6 months, thanks largely to the Fed's QE induced liquidity, which fuelled a very strong rally off the March lows. The question is, "Has it worked?"
The equity market seems to indicate "yes," and now it remains to be seen in the next two quarters if it has indeed worked.
The passing of a hurricane is quite an event, and a strong one can wreak havoc. In the eye of a hurricane, there is an eerie calm, and quiet, and the sun often shines brightly. The bigger the hurricane, the bigger the eye. This is then usually followed by a secondary lashing as the back end of the hurricane passes. Is this what's in store for the mortgage and credit market over the next 2 years as the banking system faces its next round of resets?
Have the banks hoarded cash for this reason? Is it enough?
According to statistics provided by Credit Suisse, we are in the midst of a mortgage-paper-resets lull (the space between the two humps), as seen by the chart below. Doug Short (dshort.com) has kindly added the S&P500 chart to the one produced by CS. In a nutshell, banks (and the credit market) have gotten a much needed break from the enormous pressure of having to ensure that the liquid assets are available for the re-financings that are in the works.
Given the size of the Option-ARM (Adjustable Rate Mortgages) portion of the scheduled resets, there is much cause for concern, especially for the banking sector, and the credit market in general. This picture of the mortgage reset histogram is reminiscent of the passing of a hurricane. The tail end of the hurricane this time includes not only the Option ARMs but also the Alt-A (better than subprime) mortgages.
The S&P 500 is up nearly 36% from its bear market low on March 9th. Sentiment is somewhat less negative on several fronts. Credit crisis indicators, the ADP employment report, bank stress test leaks, and the market rally itself have all encouraged optimism that the worst is over.
According to Wall Street, the market is forward looking. But has the market really discounted the future impact of continuing mortgage resets? Here's a widely circulated Credit Suisse histogram of resets to which I've added a thumbnail of the S&P 500 matching the timeline from October 2007 to the present. There are a lot more resets ahead — option-adjustable, prime and alt-A — over the next 2 1/2 years.
Click image to enlarge:
