We were heartened by news yesterday that Standard & Poor’s (S&P) had given an AAA rating to $920 million worth of residential mortgage-backed securities issued by Westpac Banking Corporation [ASX: WBC].

According to S&P:

“The preliminary ratings reflect our opinion of the transaction’s credit support, collateral pool, servicer, and other features based on our current criteria and assumptions.”

But let’s make one thing clear, the mortgages backing these securities are – apparently – ‘prime.’ In other words they are not ’sub-prime.’

Based on the details in today’s The Age newspaper:

“The weighted average loan-to-value ratio (LVR) of the mortgage pool is 58.3 per cent and less than 1 per cent of the loans have an LVR greater than 80 per cent. The average life of the loans is three years. There are no low-documentation loans in the pool.”

That’s alright then. But Westpac did also take the opportunity to throw some rubbish out as well. It’s flogging $55 million worth of AA rated securities, and $25 million worth of unrated stuff as well.

So, what does this all mean? For a start this $1 billion issue of residential mortgage backed securities (RMBS) is a mere drop in the pond of the total RMBS market. According to the Reserve Bank of Australia there is over $128 billion of RMBS outstanding.

Of that amount, about $7.7 billion is owned by the Commonwealth Government through the Australian Office of Financial Management.

And it’s just a drop in the ocean compared to the $12.9 trillion worth of off-balance sheet business the banks have floating around in OTC forwards, OTC swaps, credit derivatives and other tasty morsels.

But what this RMBS issue also means is that the bank is desperate to get its hands on more cash.

You can see that from the banks’ advertising. If you look at the interest rates being charged on loans and compare it to the rates being provided on term deposits it’s a revealing picture.

Take out a variable rate home loan with Westpac and you’ll pay around 6.11% in interest.

Take out a 12-month term deposit and you’ll receive up to a 6.8% interest rate.

But even if you compare the term deposit rate with the fixed mortgage rate Westpac is still running it at a loss for the first year. Its 1 year fixed rate is currently 6.54%.

Clearly the banks would only do this if they believe interest rates are going to rise further. You can take that 6.8% term deposit rate as the low-ball figure of where mortgage interest rates will be by the end of next year.

In fact, you should try something closer to 8%.

The issuing of the RMBS means that Westpac gets to flog off a bunch of mortgages and in return it will get cash from the investors in those securities. Naturally, it can dish the cash out to provide even more home loans.

And so the lending glut continues. It can never stop.

Although there could be trouble on the horizon if lending by the banks does drop by 9% next year as forecast by Market Intelligence Strategy Centre (MISC).

It believes the value of new home loans will be $14.4 billion lower through the year to September 2010.

If there’s one thing that events over the past twelve months have shown you, it’s that banks are as far from being stable and conservative investments as you can get.

Their actions truly are a sign of desperation. Now, don’t get me wrong, I’ve got no problem with the banks putting up interest rates. They never should have been slashed so low to begin with.

The very reason the banks are so desperate for cash now is because they’ve gorged themselves on giving out ultra-cheap money over the last twelve months.

While the mainstream press slams the banks for increasing interest rates just in time for Christmas, we slam the RBA and the banks for enticing borrowers to load up on cheap debt. Cheap debt which they know full well will lead to pain for borrowers twelve months from now.

And we slam the mainstream press for supporting them with their “Houses set to boom forever” headlines.

But it’s not just Westpac. It’s all of them. It’s the entire framework of banking that’s rotten. You may recall we likened the ANZ retail share offer earlier this year as being like taking “Lambs to the slaughter.”

At that point ANZ Bank [ASX: ANZ] shares were being offered to the market at $14 per share. Don’t touch them with a barge-pole was our general advice.

Since then ANZ Bank shares have risen by 50% and those investors that bought at $14 would have done quite nicely.

Do we regret missing out on that price action? Are we embarrassed that we got the call so wrong?

Nope.

As we’ve written before, with over 1,800 shares listed on the Australian stock market we just don’t see the need to take such a massive risk on four rotten companies (ANZ, Commonwealth Bank, NAB and Westpac) that claim to be ’safe as houses’ but which are nothing more than super leveraged bets on themselves and the housing market.

As far as I’m concerned, investing in bank stocks is no less risky than playing Russian Roulette. An investor may have been lucky over the last few months, but soon enough the banking crooks will deliver a ‘bullet’ to investors’ heads.

Besides, when we looked at the issue of the RMBS by Westpac, something else struck us.

It was this comment by S&P:

“This will be the first issuance of securitized mortgage loans originated by Westpac Banking Corp. (AA/Stable/A-1+) for 2009.”

We won’t claim to be an expert on the workings and theories of ratings agencies. I’m sure they’ve got all kind of fancy models that gives them guidance on the rating level.

And we’re sure there’s a bit of subjectivity in there as well.

But here’s the thing that amused us. It’s the fact that S&P considers a bunch of home buyers to be a better credit risk than Westpac. In fact it considers a bunch of home buyers to be a better credit risk than all Australia’s banks.

After all, the best rating the banks can get is AA. Whereas ‘moms and pops’ in the suburbs can get themselves an AAA rating – providing they’ve got a mortgage!

I know we’re only talking the difference between AAA and AA, but the difference is perhaps somewhat symbolic and telling.

It’s a good indicator of how leveraged and risky the Australian banks are. Let’s look at this comparison. If you’re a lender and you had the choice of lending to Party A that was leveraged by about 12 to 1 or to Party B that was leverage by around 2 to 1, you’d see that Party B provided the lower risk.

And that’s exactly the conclusion S&P have made. Banks are leveraged to the eyeballs. Sucking in cash from sucker depositors and then lending it out to anything with a pulse.

That’s what makes the rating so bizarre.

Normally you’d expect investors to have greater faith in a big company to repay than you would in individuals.

Especially when the big company – the bank – has a diversified range of assets at its disposal whereas the home buyer has most of his/her assets concentrated in just the home.

I mean, if BHP Billiton sold securities against individual assets to investors, you’d think that most of those assets would attract a lower risk rating than that given to BHP.

But look, maybe I’ve got all this wrong. Maybe it’s normal for individuals or groups of home buyers to have a better credit rating than a multi-billion dollar bank.

Maybe this is just how things work in the banking and finance sector.

Who knows? On this occasion perhaps the ratings agencies have got it just right.

But for your editor it’s another reason to give banks a wide berth and allow other investors to ‘enjoy’ the returns they’re getting from those ’safe and dependable’ 4 Pillars.

Cheers.
Kris.

60-Second Market Round Up
by Shae Smith

The S&P/ASX200 finished up slightly yesterday to 4,654, higher by 18 points. The news of the Dubai debt relief lifted the market higher at the end of the day.

The Dow Jones Industrial Average added 29 points to close at 10,501.05. Citigroup has come up with a plan to repay the bail out money.

Overnight in the UK, the FTSE finished higher to 5,315.34, up by 1.02%.

The Nikkei finished the day at 10,105.68, up by a tiny 2 points.

The price of spot gold in Australian dollars is trading at $1,230.20 while in US Dollars it is trading at $1,126.99. The price of silver in Aussie dollars is $19.00 and in US Dollars it is $17.41.

The Aussie dollar versus the US dollar is trading at USD$0.9173, and against the Japanese Yen JPY81.27

Crude oil has continued its downhill run, closing at USD$69.59.

For the biggest movers on the market yesterday click here…

Do you remember it was only a few weeks ago that the mainstream press was telling you that the major banks were winding back their reliance on the government wholesale funding guarantee?

Well, maybe they are, but they still can’t help themselves.

According to the Sydney Morning Herald, the Commonwealth Bank has raised USD$1.25 billion last week, every last cent guaranteed by the taxpayer. And the week before Westpac raised $1.1 billion guaranteed by you and other taxpayers.

Even that wasn’t enough to get us riled this morning. It takes more than that these days.

No, there were two other things that came to our attention over the weekend that made us stagger uncontrollably about the house.

But before I get onto that, a quick follow up to last Friday’s Money Morning. Thanks to all the climate change induced rain over the weekend we were stuck inside and so managed to have a glance at the Money Morning message boards.

It seems that some readers believe we misrepresented the “Property Professor” by claiming that he believes property doubles in values every ten years. Apparently what he was really saying is that property provides you with a hedge against inflation compared with renting.

Of course, he didn’t say that at all. It’s typical of the property spruikers trying to cover each other’s tracks when their nonsense and fallacies are exposed.

Naturally, we don’t blame the spruikers for trying. They’ve had it easy for so long, where no-one has ever dared challenge their property investing falsehoods.

Anyway, for fear of being accused of misrepresenting the Property Prof, how about this snippet of financial advice from the emeritus professor of debt:

“If you could, rather than buying one $400,000 property with a principal and interest loan you’d be better getting two $400,000 properties with two interest only loans. When they double in value, sell one and the other one’s freehold. If you keep that principal and interest loan, it’s going to take you 25 years to do that. You hold two and you only need one property cycle, seven to 10 years, and the other one’s freehold.”

That little gem was from an investing round table held by The Advertiser in Adelaide.

But the argument that somehow the Property Prof was misrepresented doesn’t stack up when you read an article he wrote for Realestate.com.au:

“I have calculated capital growth of about 7% per annum, which means it doubles in value every 10 years.”

Click on the link here for the rest of the mind-bogglingly simplistic calculations. Calculations which fall apart if interest rates are higher than 6.5% and collapse completely if property turns out not to double in value every 10 years.

But never mind. As I say, that’s not what got us revved up over the weekend.

Something that did make us sit up to attention was an email from one Money Morning reader who suggested we look at an article on Ratecity.com.au which quoted Westpac CEO, Gail Kelly as saying:

“We are a very highly indebted country – on average we borrow twice what we save… we need to incentivize and drive additional savings as a nation.”

Hmm. What do we make of that? We’re not going to argue against savings. Saving money is a good thing.

The trouble is under the current banking system, saving money in a bank account only makes the problem of excess borrowing worse.

In a perverse way, people who saved money in a bank are partly to blame for the collapse of the banking system and the expansion of borrowing in the Australian market.

And it’s what makes the comments from Kelly all the more troubling. She’s making the right sounds “savings are good”, it’s just that like every other banker, when she’s got her paws on your savings, it’s just used to leverage themselves up to the housing market.

Don’t forget that around 50% of all bank lending goes towards residential real estate. The money that you tuck away in a bank account for a rainy day is used as security so house buyers can get 100 to 1 leverage on a house.

That’s the real reason Kelly and the others want you to save more, so they can lend more.

If Kelly really was concerned about the amount of borrowing then all Westpac would need to do is tighten their lending criteria.

That’s not hard is it?

Only doing so would mean the collapse of the housing market and that wouldn’t do much of the banks’ balance sheets.

And besides, now that the government has given the banks a free kick with wholesale and deposit guarantees there is no need for the banks to tighten their lending. They know they can push things to the extreme.

Which brings us to the other story that made us wince.

We tuned into the Barefoot Investor on CNBC yesterday afternoon. Hosted by Scott Pape, it’s a ‘family friendly’ investing show. He talks about budgeting and paying off debt, and all that sort of thing.

Anyway, it was the opening item that disproved all of the pap that we hear about the banks making it harder to borrow. And how the Australian banks have a much healthier balance sheet than overseas banks.

Scott interviewed a young lass from Sydney, the short story is that she had a $200,000 home loan which she took out now to qualify for the first home buyers debt.

But that’s not the half of it. The young lass looked as though she had barely graduated from high school, yet had a $200,000 mortgage which she had secured with a deposit of…

$2,000.

That’s right, two grand. In other words, 100 to 1 leverage.

Oh, and by the way, she didn’t have a full time job at the time she applied for the loan, and still doesn’t!

So how did the bank lend her $200,000? That’s simple, they got her old man to go guarantor for her.

Yep, don’t worry about income or a deposit or job security or the ability to repay a debt, as long as someone else is prepared to hock their home, the banks will give anyone a loan.

It’s a fairly sad state of affairs. And it proves that despite the propaganda from the mainstream press and the mainstream analysts, Australia’s banks are going to extraordinary lengths to make sure the lending and borrowing binge continues.

And it’s all built on the false premise that property values double every 7-10 years. The banks believe it’s true, the property spruikers believe it’s true and the home buyers believe it’s true.

The trouble is, it’s not true. When the mist clears all that will be left is a pile of bricks and mortar that’s worth 40% or 50% less than the loans covering them.

Until then, thousands more suckers will be convinced to buy into property at inflated prices under the false belief of it being an inflation hedge and a guaranteed path to millionaire status.

Cheers.
Kris.

60-Second Market Round Up
by Shae Smith

The S&P/ASX200 finished down on Friday, by 1.33% closing at 4,685.80. An ordinary trading session on Wall Street has seen a pretty flat start to the Australian trading day.

The Dow Jones Industrial Average dropped off 23 points, finishing at 10,318.10. While traders are being told the ‘recession’ is over, they still shied away from speculative stocks. Traders chose to stick with stocks that can withstand economic uncertainty, like Coca-Cola Co [NYSE: KO] and Merck & Co [NYSE: MRK].

In the UK, the FTSE100 saw a sell-off of energy and mining stocks which forced the index to close at 5,251.41, down by 16 points.

The Nikkei had its first four week losing streak since in over a year, finishing at 9,497.68, down by 0.54%. Overall, last week the Nikkei lost 2.8%

The price of gold in Australian dollars is trading at $1,259.07, while in US Dollars it is trading at $1,151.20.

Currently the price of silver in Aussie dollars is $20.23 and in US Dollars it is $18.50.

The Aussie dollar versus the US dollar is trading at USD$0.9142, and against the Japanese Yen JPY81.21

Crude oil closed at USD$77.47

For the biggest movers on the market yesterday click here…

As you know, we’re more than happy to admit when we get something wrong, and on this occasion we have. What did we stuff up? Well, for that you’ll have to wait until tomorrow.

Until then…

Your editor laughed heartily this morning on reading the following paragraph from News Ltd:

“ASIA-Pacific powers, including the United States and China, have vowed to overhaul the crisis-stricken world economy, rejecting protectionism and touting plans for a gargantuan free market.”

Our laughter only increased further when we reached the following paragraph:

“Leaders of the Asia-Pacific Economic Cooperation (APEC) forum, who together steer more than half the global economy, have also said they will maintain hefty stimulus spending ‘until a durable economic recovery has clearly taken hold’.”

We wonder if these journalists ever actually read what they’ve written. If we’ve got this right, governments have “plans” for a “gargantuan” free market that will be supported by “hefty” government stimulus spending.

How on earth can that be described as a free market?

It can’t.

In fact their comments are no different to any other comment you’ve heard from politicians over the last twenty, thirty or fifty years.

They all claim they support free markets while simultaneously introducing more and more rules and regulations to ensure markets are under more government control than ever before.

For a start you can’t “plan” any free market let alone a gargantuan free market.

Free markets aren’t planned they just, well, they just are.

And that’s why politicians hate the free market. A free market works without interference and meddling from governments.

In a free market there would be no need for a bunch of megalomaniacal pen pushers (politicians and bureaucrats) to swan off to Singapore for meetings on how to plan a free market.

There would be no need because under a free market they would have no influence on markets. Their meetings would be redundant. There would be nothing to discuss.

In fact, dare we say it, they would be redundant.

But central planners can rest at ease. And free marketers like your editor and cry into their beer.

Because there will be no gargantuan free market. Instead there will be the same old gargantuan state interference, corruption and incompetence. If you skip past the waffle about free trade in Leaders’ Declaration:

“But our common goal remains the same – to support growth and prosperity in the Asia-Pacific region, through free and open trade and investment…”

You’ll see that encouraging free markets and free trade is the last thing on their mind:

“We will leverage APEC’s traditional strengths of voluntary cooperation, capacity building, sharing of best practices, and working with the private sector, to implement necessary reforms in infrastructure development, agriculture/food management, social security, education and workforce training, and regulatory frameworks. We will work with the International Financial Institutions and Multilateral Development Banks to facilitate these efforts. Given APEC’s diversity, these reforms must take into account individual economies’ stage of development, demographic trends, factor and institutional endowments, and comparative advantages.”

A free market isn’t a free market when you have government telling you they will become even more involved in an economy.

It just isn’t possible.

And as for the statement that:

“We firmly reject all forms of protectionism and reaffirm our commitment to keep markets open and refrain from raising new barriers to investment or to trade in goods and services…”

Well, we don’t think we’ve come across a bigger lie since the Australian banks claimed they hadn’t received a single dollar of bail out money.

You only have to compare that statement with the previous one I’ve quoted above. On the one hand they claim to reject protectionism, and on the other hand they claim they’ll support reforms in infrastructure development, agriculture/food, social security, education and regulations.

And you can bet the “reforms” won’t involve less red tape and regulation it will mean more red tape and regulation.

When you look at each one of those topics again you’ll realize each one is the antithesis of free markets.

A free market in infrastructure development? I wouldn’t have thought so. When was the last time any infrastructure project happened on the basis of free market competition or supply and demand? Never.

Agriculture and food is one of the most manipulated and corrupt markets there is. Domestic producers receive numerous ‘free-kicks’ thanks to import regulations, or because of state approved monopolies.

Social security. A free market in social security? Are you kidding me? Social security is one of the biggest drains on the taxpayer wallet. Billions of dollars is stolen from taxpayers each year, swilled around in Canberra and then redistributed to the politicians favourite causes.

We’d love to see a free market in social welfare, but we know it ain’t gonna happen.

And as for education, again, where is the free market there? Nowhere. State schools get complete government funding and even private schools get handouts. How is that a free market when every school gets cash regardless of performance?

It’s clear the politicians either have no idea what free markets are, or more likely, they know exactly what a free market is and are afraid of it.

Because in a truly free market their powers to influence, bribe, threaten and meddle disappear. That’s why they need to maintain as much control over the economy as possible.

But the outcome of the APEC summit makes us realize one thing. It makes all the talk from Lord Monckton of Brenchley about a ‘world government’ all the more plausible.

Have we turned all conspiracy theorist? No. But as I mentioned at the beginning, we’ll have more on that tomorrow.

Cheers.
Kris.

60-Second Market Round Up
by Kris Sayce

Shae has taken a long weekend, which included dressing up as an Oompa-Loompa. We believe it was for a fancy dress party but that is yet to be confirmed!

So we’ll step into the breach for today until she returns tomorrow.

The S&P/ASX200 closed at 4,706.40 down by 41 points.

The Dow Jones Industrial Average closed at 10,270.47, a 73 point gain. In Europe the FTSE finished higher by 19 points to 5,296.38.

The Nikkei was down 34 points to 9,770.31.

In Australian dollars gold is trading at $1,198.79, while in US Dollars it is trading at $1,118.90. And the price of silver in Aussie dollars is $18.68 and in US Dollars it is $17.43.

The Aussie dollar against the US dollar, currently trading at USD $0.9340. The Aussie dollar against the Japanese Yen is trading at JPY 83.60.

Crude oil closed at USD$76.35.

For the biggest movers on the market yesterday click here…

THE big banks have been slow to react after the Reserve Bank cut interest rates by a larger-than-expected 0.75 percentage points yesterday.

The Commonwealth Bank was the first of the major banks to move after the Reserve Bank board’s announcement yesterday, chopping its rates by 0.58 per cent.

This was despite repeated warnings from Treasurer Wayne Swan to pass on the rate cut quickly, and in full.

more…