For those who haven't seen it already, Berkshire Hathaway agreed to invest $5 billion in Bank of America this morning. The pop in stocks lasted all of 30 minutes.
But I wanted to discuss the last Buffett Bailout - of Goldman and what it may portend. My operating thesis is that WB has morphed into a completely political creature and will only make big, publicized investments for propaganda purposes. That certainly was the case with GS in 2008.
But like any actor, he has to receive something in return for the use of his name and image. That something is a political guarantee for his "investment" and the history of 2008 supports this. Buffett's deal with Goldman was announced before the US market opened on September 23, 2008. But behind the scenes a lot of political moves were being made that he obviously knew about but few others did at the time.
The Fed of course was involved. Over the next few days (through 9/29) they established or increased swaplines with a large number of foreign central banks. In effect they lent out $360 billion to foreign banks. The FDIC closed Wachovia and WaMu - pushing them to merge into the already bloated and insolvent Citibank and JP Morgan respectively. Wells ultimately outbid Citi for Wachovia. The Treasury moved to guarantee all money market funds and the TARP bailout was cooked up as a bill and submitted to the House over the weekend prior to initial rejection on the 29th.
The Bottom Line
My point is this. Last time Buffett was part of a full-court press designed to fool people into investing their earned money right along side his borrowed bank credit. Every lever was pulled by Wall Street and the Government in order to "restore confidence" and as the price of his participation, Buffett was given the privilege of front running virtually every central bank and government policy change.
I expect this time will be no different. The Fed is likely to announce something desperate and stupid tomorrow morning. It will likely be accompanied by something out of the Treasury and/or FDIC shortly thereafter if the Fed move proves insufficient to pump asset prices higher and bail out Warren after he stuck his neck out financially for favorable propaganda effect.
Of course the bad news if you're a bull is that it didn't work in 2008 despite truly extreme measures. Stocks, after a short sharp bounce continued to fall for another 6 months and housing prices merely rebounded slightly before resuming their decline. In 2008, stocks had already been falling for a year and had nearly been cut in half before they got that desperate. This time, we are 3.5 months past the rebound high and six weeks from the secondary peak. We are also only 15% off those highs - not 45% like in 2008.
There is probably a trading opportunity on the long side for the next week or two but I'm not going to get greedy or stupid. History indicates that Buffett is likely front-running SOMETHING here. But it sure as hell isn't fundamentals.
Showing posts with label Treasury. Show all posts
Showing posts with label Treasury. Show all posts
Friday, August 26, 2011
Wednesday, August 11, 2010
Bank Debt Spiral
The zero interest rate policy (ZIRP) will kill the banks. Falling interest rates help banks by increasing the value of their bond and loan portfolios. This is the well understood inverse relationship between discount rate and present value of a future sum. But you see keeping interest rates at zero does virtually nothing for the banks as rates cannot fall further. There is a short window where ZIRP is a positive but an "extended period" (in Fedspeak) is just slow death for the banks.
During that short period, the banks are still collecting on portfolios constructed when rates were higher but as those higher-yielding assets mature, there is nothing comparable to replace them. We hear constantly how banks can just borrow at zero and invest in Treasuries - pocketing the difference. That would be fine if yields on Treasury debt were not low and falling along with everything else. The other problem is that this simplistic formula assumes that banks' operating expenses are negligible. Both unstated assumptions fail any sort of reality check.
Back in the real world, T-bills yield virtually nothing. The 2-year note is now at 50 basis points as of today. The 5-year is at 1.43% and the 10-year at 2.68%. Assuming zero borrowing cost (which is overly generous), net interest is equal to gross interest. Large banks generally require a net interest spread of more than 2% to cover their expenses, so they will lose money even buying 5-year Treasuries. If they invest their entire portfolio in 10-year notes, they'll make about a 50 basis point spread on assets pre-tax. But the 10 years is a lot of risk in terms of time for rates to change and also a long time to tie up the money. And banks care BARELY eke out a profit by taking this extreme level of maturity risk. There is a reason why you never see loan portfolios with 10 year average maturities.
For those advocates who think banks can rebuild their balance sheets by buying Treasuries, you might ultimately be correct but there are so many things that can go wrong with that scenario. First consider the size of the hole in bank balance sheets. Recent activity at the FDIC suggests that many troubled banks are overstating the value of their assets by 30% or more - that is the average size of the hit when the FDIC takes them over. At a rebuild rate of 50 basis points annually (with a lot of risk) it would take a literal lifetime to repair the balance sheets via this strategy. It was much easier in the early 1990s when rates for the 10-year started at 9% and never went below 5.5%. There was plenty of room to generate capital gains on bank bond portfolios wit falling rates and still leave a reasonable current yield at the end. Anybody using that era as a template for bank recovery is going to be sorely disappointed. Does anybody still wonder why Japan is trapped despite 20 years of ZIRP?
All of this assumes that ZIRP is sustainable over decades and that the financial system is sufficiently stable to endure the pressure over the long term. Neither one is proven and the ability to fund the debt implied by ZIRP is particularly shaky. If it works, it will take 60 years As one one of our favorite bloggers Karl Denninger says "the math is never wrong."
During that short period, the banks are still collecting on portfolios constructed when rates were higher but as those higher-yielding assets mature, there is nothing comparable to replace them. We hear constantly how banks can just borrow at zero and invest in Treasuries - pocketing the difference. That would be fine if yields on Treasury debt were not low and falling along with everything else. The other problem is that this simplistic formula assumes that banks' operating expenses are negligible. Both unstated assumptions fail any sort of reality check.
Back in the real world, T-bills yield virtually nothing. The 2-year note is now at 50 basis points as of today. The 5-year is at 1.43% and the 10-year at 2.68%. Assuming zero borrowing cost (which is overly generous), net interest is equal to gross interest. Large banks generally require a net interest spread of more than 2% to cover their expenses, so they will lose money even buying 5-year Treasuries. If they invest their entire portfolio in 10-year notes, they'll make about a 50 basis point spread on assets pre-tax. But the 10 years is a lot of risk in terms of time for rates to change and also a long time to tie up the money. And banks care BARELY eke out a profit by taking this extreme level of maturity risk. There is a reason why you never see loan portfolios with 10 year average maturities.
For those advocates who think banks can rebuild their balance sheets by buying Treasuries, you might ultimately be correct but there are so many things that can go wrong with that scenario. First consider the size of the hole in bank balance sheets. Recent activity at the FDIC suggests that many troubled banks are overstating the value of their assets by 30% or more - that is the average size of the hit when the FDIC takes them over. At a rebuild rate of 50 basis points annually (with a lot of risk) it would take a literal lifetime to repair the balance sheets via this strategy. It was much easier in the early 1990s when rates for the 10-year started at 9% and never went below 5.5%. There was plenty of room to generate capital gains on bank bond portfolios wit falling rates and still leave a reasonable current yield at the end. Anybody using that era as a template for bank recovery is going to be sorely disappointed. Does anybody still wonder why Japan is trapped despite 20 years of ZIRP?
All of this assumes that ZIRP is sustainable over decades and that the financial system is sufficiently stable to endure the pressure over the long term. Neither one is proven and the ability to fund the debt implied by ZIRP is particularly shaky. If it works, it will take 60 years As one one of our favorite bloggers Karl Denninger says "the math is never wrong."
Monday, February 8, 2010
The Non-Comparison
It seems quite popular in these days of crisis for certain commentators to compare struggling individual states within the USA to the troubled Eurozone PIIGS (Portugal, Ireland, Italy, Greece and Spain). ECB President and Apologist in Chief for the Euro Jean-Claude Trichet (and boy isn't that a bunch of Capitalized Words strung together) is a prime example. A couple of weeks ago in a speech about the Greek Financial Crisis his remarks were summarized by Business Week:
For perspective, let's start with raw numbers. The debt of the Greek government hit 300 billion Euros two months ago making headlines around the financial world. At current exchange rates, this is over $400 billion and is surely higher today. The total general fund debt of California is LESS THAN $85 billion as of January 1, 2010. So in absolute terms, the Greek Problem is nearly FIVE TIMES LARGER than California's. In terms proportional to the size of the respective economies, the disparity becomes even more striking.
Implications of Federalism
With a little thought, the reason for this disparity should be obvious. California's state government brings in tax revenue of just under 5.0% of GSP and plans to spend 5.5% of GSP in the FY 2010 budget. Greece taxed 32.2% of GDP and spent 43.0% of GDP in 2009 as estimated by the CIA World Factbook. The state government of California is not the top-level sovereign even within its own borders. Federal taxation and spending within California far exceeds the comparable activities driven by Sacramento. In terms of government impact on the economy, the key is at the Federal level, not the state. So in addition to California's government problems being a much smaller deal overall, the consequences of failure would also be less for the population than would be the case in Greece. We can safely conclude that Trichet's statement, while true at first blush was highly misleading in its implications. There is simply no comparison between the gravity of the current crisis in Greece and the looming one in California.
Having dealt with that nonsense, let's talk about the rest of the PIIGS. These are all similar, top-level sovereign situations. It would appear that Portual is next, with Spain not far behind from the trading activity in CDS and the rising risk premiums being demanded. Italy is not nearly as badly off and it may be unfair to lump them in with the rest of this group; the market appears to be taking note of that as well. And then, there is Ireland.
Celtic Hedge Fund
Ireland is in for a tough time. Their total external debt was 1,637 billion Euros (roughly $2.23 trillion) as of September 30, 2009 with an economy of $177 billion per the CIA. Irish banks alone account for 41% of the debt. Another way to express this is that their banks owe foreigners over 500% of the nation's annual GDP. Many financial institutions are counted in the "Other" category which is nearly as large in terms of foreign obligations. The largest components would be insurance companies and pension funds. In all, Ireland's financial sector probably owes nearly 1,000% of GDP to overseas entities. This is a time bomb comparable in design to Iceland but with many times the explosive power. This is another nation being run like a hedge fund but Ireland currently owes more than 30x as much as Iceland going into their meltdown.
None of this is to suggest that the US doesn't have truly huge problems. But let's not be distracted by specious comparisons involving the states. In the US, the fate of sovereign credit will be determined almost entirely by the actions of the Federal government and the market's reaction to them. In the Eurozone, that same process will be resolved in the national capitals and possibly also in Berlin. Barring a decision by Germany to bail out other members, individual European nations can and will choose austerity or default themselves.
A number of news outlets and blogger have echoed these sentiments so it behooves us to examine the validity of the comparison. On the pure surface level, Trichet is correct: California had a GSP of $1,850 billion in 2008, whereas Greece's GDP was less than one fifth as large at $343 billion. So we can conclude that he in not lying outright but what of the implied statement that California's financial problems are more important to the US than Greece's are to the Eurozone and EU? For this analysis we will leave aside the issue of the rest of the PIIGS.He [Trichet] also played down the importance of Greece's economy on the euro region, which he said represents less than 3 percent of the bloc's GDP, especially when compared with the size of a U.S. state such as California.
For perspective, let's start with raw numbers. The debt of the Greek government hit 300 billion Euros two months ago making headlines around the financial world. At current exchange rates, this is over $400 billion and is surely higher today. The total general fund debt of California is LESS THAN $85 billion as of January 1, 2010. So in absolute terms, the Greek Problem is nearly FIVE TIMES LARGER than California's. In terms proportional to the size of the respective economies, the disparity becomes even more striking.
Implications of Federalism
With a little thought, the reason for this disparity should be obvious. California's state government brings in tax revenue of just under 5.0% of GSP and plans to spend 5.5% of GSP in the FY 2010 budget. Greece taxed 32.2% of GDP and spent 43.0% of GDP in 2009 as estimated by the CIA World Factbook. The state government of California is not the top-level sovereign even within its own borders. Federal taxation and spending within California far exceeds the comparable activities driven by Sacramento. In terms of government impact on the economy, the key is at the Federal level, not the state. So in addition to California's government problems being a much smaller deal overall, the consequences of failure would also be less for the population than would be the case in Greece. We can safely conclude that Trichet's statement, while true at first blush was highly misleading in its implications. There is simply no comparison between the gravity of the current crisis in Greece and the looming one in California.
Having dealt with that nonsense, let's talk about the rest of the PIIGS. These are all similar, top-level sovereign situations. It would appear that Portual is next, with Spain not far behind from the trading activity in CDS and the rising risk premiums being demanded. Italy is not nearly as badly off and it may be unfair to lump them in with the rest of this group; the market appears to be taking note of that as well. And then, there is Ireland.
Celtic Hedge Fund
Ireland is in for a tough time. Their total external debt was 1,637 billion Euros (roughly $2.23 trillion) as of September 30, 2009 with an economy of $177 billion per the CIA. Irish banks alone account for 41% of the debt. Another way to express this is that their banks owe foreigners over 500% of the nation's annual GDP. Many financial institutions are counted in the "Other" category which is nearly as large in terms of foreign obligations. The largest components would be insurance companies and pension funds. In all, Ireland's financial sector probably owes nearly 1,000% of GDP to overseas entities. This is a time bomb comparable in design to Iceland but with many times the explosive power. This is another nation being run like a hedge fund but Ireland currently owes more than 30x as much as Iceland going into their meltdown.
None of this is to suggest that the US doesn't have truly huge problems. But let's not be distracted by specious comparisons involving the states. In the US, the fate of sovereign credit will be determined almost entirely by the actions of the Federal government and the market's reaction to them. In the Eurozone, that same process will be resolved in the national capitals and possibly also in Berlin. Barring a decision by Germany to bail out other members, individual European nations can and will choose austerity or default themselves.
Sunday, August 2, 2009
The Federal Funhouse
Washington DC has now become the linchpin of lies regarding the US economy. When one looks at the numbers, it is easy to see why this must be so. The Federal budget deficit is now running at somewhere between 14% and 15% of GDP. Because the administration has postponed the budget update past the mandatory deadline, we do not have any official figures so we must estimate based on other data but Americans should be quite used to that by now.
The latest Monthly Treasury Statement through June 30 gives us a lot of very useful data. Tax receipts are falling rapidly; for the fiscal year to date, taxes are down from $1,934 billion to $1,589 billion - a drop of 17.8%. The trend has been for the monthly numbers to get worse as the FY has gone on but if that applies to the full year then revenues will be $2,073 billion. The current budget estimate is just under $4,000 billion but will likely be higher as unemployment and related expense rise with a tanking economy. This leaves the US government with a $2 trillion deficit in a $14 trillion economy. In other words deficit spending is on pace to equal 14.3% of the economy.
Looked at another way, approximately one-seventh of the economy should not exist, currently exists only due to Washington spending money it doesn't have and will cease to exist as soon as that spending stops. The spending can continue only so long as creditors are foolish enough to supply more capital for the Federal government to destroy. Once the funhouse mirror of massive deficit spending is removed, we will likely see at least a 10% further decline in the economy within 6 months - taking huge chunks of other nations' economies with it.
Wall Street Wacko
We have also now seen the "confidence" return to Wall Street. What this really means it that speculators have put aside their fully justified fears and returned to blind, stupid buying. The "reasoning" behind this is that they managed to rob the taxpayers to cover their last set of enormous losses so their is no longer any such thing as risk. Heads they win, tails the taxpayer loses. As we have pointed out before, the Fed has aligned themselves with the speculators and is feeding such delusions. But these folks obviously haven't been paying any attention to the political climate at all. Congressmen that voted to bail out Wall Street at our expense are facing hostile crowds in their home districts. Many of them are now cancelling public appearances. Politicians now fear for their safety as their victims are beginning to realize what has happened. Even if the bond market allows this foolishness to continue, there is unlikely to be any support for another bailout when the next bubble bursts - which is likely to be either commercial real estate or commodities (again).
The latest Monthly Treasury Statement through June 30 gives us a lot of very useful data. Tax receipts are falling rapidly; for the fiscal year to date, taxes are down from $1,934 billion to $1,589 billion - a drop of 17.8%. The trend has been for the monthly numbers to get worse as the FY has gone on but if that applies to the full year then revenues will be $2,073 billion. The current budget estimate is just under $4,000 billion but will likely be higher as unemployment and related expense rise with a tanking economy. This leaves the US government with a $2 trillion deficit in a $14 trillion economy. In other words deficit spending is on pace to equal 14.3% of the economy.
Looked at another way, approximately one-seventh of the economy should not exist, currently exists only due to Washington spending money it doesn't have and will cease to exist as soon as that spending stops. The spending can continue only so long as creditors are foolish enough to supply more capital for the Federal government to destroy. Once the funhouse mirror of massive deficit spending is removed, we will likely see at least a 10% further decline in the economy within 6 months - taking huge chunks of other nations' economies with it.
Wall Street Wacko
We have also now seen the "confidence" return to Wall Street. What this really means it that speculators have put aside their fully justified fears and returned to blind, stupid buying. The "reasoning" behind this is that they managed to rob the taxpayers to cover their last set of enormous losses so their is no longer any such thing as risk. Heads they win, tails the taxpayer loses. As we have pointed out before, the Fed has aligned themselves with the speculators and is feeding such delusions. But these folks obviously haven't been paying any attention to the political climate at all. Congressmen that voted to bail out Wall Street at our expense are facing hostile crowds in their home districts. Many of them are now cancelling public appearances. Politicians now fear for their safety as their victims are beginning to realize what has happened. Even if the bond market allows this foolishness to continue, there is unlikely to be any support for another bailout when the next bubble bursts - which is likely to be either commercial real estate or commodities (again).
Saturday, February 21, 2009
The Circle of Lies
Circular Money(TM): at least that's the PG-version of what several correspondents are calling it and we'll explain later. But first a little background. Quite a few folks have expressed concern about the Fed "printing" massive amounts of dollars and putting them into the economy, which will trigger inflation. This is certainly a reasonable fear given the numbers being thrown around and the rhetoric coming out of the Treasury and the Fed. However, we do not believe that the fear is well-founded and our evidence come from the Fed itself. Consider the latest report on reserve balances.
The total balance sheet has expanded by an alarming $1 trillion or 110% in 12 months - very disturbing. But the key question would be is any of this actually printed into existence? To determine this, look at the other side of the balance sheet - the liabilities and capital. Liabilities have expanded by $1,032 billion and capital by $3 billion. Liabilities mean the the assets are funded by borrowing. Real printing would go straight to capital since it creates no offsetting liability. The minuscule increase in capital is easily accounted for by interest on the Fed's bond portfolio so we may safely conclude that little or no actual printing is taking place - much less the monstrous quantities that some would suggest. So the money is being borrowed; now let's look at the liability details to see from where the incremental money is being borrowed.
Keep in mind, this is Circular Money(TM) only to the extent to which the entries offset and that is not a perfect match but very close. TAF loans increased by $388 billion and "other loans" (the rest of the alphabet soup) by $139 billion for a total of $527 billion vs $599 billion the banks lent to the Fed. The remainder comes from assets the banks sold to the Fed to raise cash. Clearly a large portion of the $34 billion in agency bonds and $65 billion in mortgage-backed securities (MBS) also was sold by banks. The money comes from the Fed and goes right back to them. Here again we see the Fed's actions in light of their attempts to maintain the deception. They started to pay interest to the commercial banks on required and excess reserves in October 2008. They are currently paying the banks 25 basis points (0.25%) on all reserves deposited with the Fed. Note that the Effective Fed Funds rate is a nearly identical 22-24 basis points. The ability to pay interest on the reserves was critical to offset the interest cost of borrowing. This way the imaginary accounting entries can be maintained nearly indefinitely with interest paid neatly offsetting interest received as well. The interest differential on huge sums of non-existent money would have unmasked the deception fairly quickly otherwise.
The Big Con
This game has no effect in reality, so what is the purpose of the Circular Money(TM) deception? It is yet another con game by the Fed to convince people that dead banks aren't really dead because Ben Bernanke says so. As long as a critical mass of people continue to buy the party line, the zombie banks will continue to lurch about spastically. We have long contended that the Federal Reserve is a very weak entity in reality and it's greatest power is that people THINK it is powerful. They announce things intended to influence the behavior of those under this illusion. They threaten to "print" in order to stoke fear of inflation and get people to act accordingly - they seem to be hoping to restart financial speculation by scaring people into draining their savings or taking on debt. But if the Fed could actually induce inflation, then we should already have it already as they've been taking radical action now for over 18 months. When the current threats fail to become reality, the already damaged credibility of the Fed will be severely compromised.
The concerns about inflation would be very serious if any actual printing were taking place but that would destroy the banking system - which is the last thing they want. As things stand, the money exists only in theory and cannot be lent outside the banking system since it doesn't really exist. In order for it to exist outside this circle of lies, the Fed would have to find a large funding source beyond the banks themselves to replace any funds the banks lend out to the economy rather than back to the Fed. They would have to compete for that funding with the Treasury who needs to borrow over $1 trillion in short order. Now do you see why the Fed prefers this deception to going to the market and trying to get that funding? If they tried and failed, it would reveal the Great Oz as the helpless little man behind the curtain that he really is.
The total balance sheet has expanded by an alarming $1 trillion or 110% in 12 months - very disturbing. But the key question would be is any of this actually printed into existence? To determine this, look at the other side of the balance sheet - the liabilities and capital. Liabilities have expanded by $1,032 billion and capital by $3 billion. Liabilities mean the the assets are funded by borrowing. Real printing would go straight to capital since it creates no offsetting liability. The minuscule increase in capital is easily accounted for by interest on the Fed's bond portfolio so we may safely conclude that little or no actual printing is taking place - much less the monstrous quantities that some would suggest. So the money is being borrowed; now let's look at the liability details to see from where the incremental money is being borrowed.
- $78 billion worth of Federal Reserve Notes has been issued - increasing the amount in circulation by 10%. This is a function of demand for cash, not Fed policy. Increasing distrust of banks naturally leads to an increased preference for cash instead of deposits.
- $32 billion of reverse repos - that is the Fed borrowing from other financial institutions using its Treasury holdings as collateral
- $917 billion of "deposits" - now a deposit is a loan so this is the Fed borrowing once again. Let's break this down further:
- $216 billion is borrowed from the US Treasury - through the general and supplemental accounts
- $699 billion is from "depositary institutions" - i.e. banks.
Keep in mind, this is Circular Money(TM) only to the extent to which the entries offset and that is not a perfect match but very close. TAF loans increased by $388 billion and "other loans" (the rest of the alphabet soup) by $139 billion for a total of $527 billion vs $599 billion the banks lent to the Fed. The remainder comes from assets the banks sold to the Fed to raise cash. Clearly a large portion of the $34 billion in agency bonds and $65 billion in mortgage-backed securities (MBS) also was sold by banks. The money comes from the Fed and goes right back to them. Here again we see the Fed's actions in light of their attempts to maintain the deception. They started to pay interest to the commercial banks on required and excess reserves in October 2008. They are currently paying the banks 25 basis points (0.25%) on all reserves deposited with the Fed. Note that the Effective Fed Funds rate is a nearly identical 22-24 basis points. The ability to pay interest on the reserves was critical to offset the interest cost of borrowing. This way the imaginary accounting entries can be maintained nearly indefinitely with interest paid neatly offsetting interest received as well. The interest differential on huge sums of non-existent money would have unmasked the deception fairly quickly otherwise.
The Big Con
This game has no effect in reality, so what is the purpose of the Circular Money(TM) deception? It is yet another con game by the Fed to convince people that dead banks aren't really dead because Ben Bernanke says so. As long as a critical mass of people continue to buy the party line, the zombie banks will continue to lurch about spastically. We have long contended that the Federal Reserve is a very weak entity in reality and it's greatest power is that people THINK it is powerful. They announce things intended to influence the behavior of those under this illusion. They threaten to "print" in order to stoke fear of inflation and get people to act accordingly - they seem to be hoping to restart financial speculation by scaring people into draining their savings or taking on debt. But if the Fed could actually induce inflation, then we should already have it already as they've been taking radical action now for over 18 months. When the current threats fail to become reality, the already damaged credibility of the Fed will be severely compromised.
The concerns about inflation would be very serious if any actual printing were taking place but that would destroy the banking system - which is the last thing they want. As things stand, the money exists only in theory and cannot be lent outside the banking system since it doesn't really exist. In order for it to exist outside this circle of lies, the Fed would have to find a large funding source beyond the banks themselves to replace any funds the banks lend out to the economy rather than back to the Fed. They would have to compete for that funding with the Treasury who needs to borrow over $1 trillion in short order. Now do you see why the Fed prefers this deception to going to the market and trying to get that funding? If they tried and failed, it would reveal the Great Oz as the helpless little man behind the curtain that he really is.
Friday, September 19, 2008
Frederick the Great vs. Hank Paulson
This is total panic time. They're now firing off everything that they have after the first several attempts at an options expiration week stick save failed badly. Basically, the Treasury is guaranteeing virtually everything now with backstops for money market mutual funds and a new super SIV for bad assets. But as Fredrick the Great said: "He who defends everything, defends nothing!" This was a simple acknowledgement of military reality - concentrate on protecting the most important assets. Spreading yourself too thin invites defeat in detail and the destruction of your forces. Then the enemy can loot at leisure.
The government seemingly doesn't understand this but they will. There simply isn't the money to do everything and in their arrogance the Fed and Treasury have over-reached badly. By trying to save all of the bankrupt financial companies, they are weakening the defenses of the strategic key - Treasury debt. The bond market is already demanding 50 basis points more in interest than just days ago. Another way to look at it is that 10-year government bonds have lost 3.5% of their value in that time. The Treasury is the logistics depot from which the army defending every other target is being supplied. If it falls, the war is over and our enemies win.
One shot wonder, long-term consequences
The SEC, erstwhile market watchdog is barking up the wrong tree again. They sat on their hands and did nothing while the disaster built all around them and now they are attacking the group pointing out the problem, not the ones who caused it. In banning short-selling, they also increase the probability that there will be no bounce when the next decline occurs since short-covering is the one thing that has kept our stock market from collapsing like much of the rest of the world's.
The fact that they feel the need to use this one-time guaranteed short-squeeze now ought to tell you everything you need to know when the cost is so high for so little gain in terms of time. This tells me that election politics are paramount here since there is at least a chance (maybe 50/50) to delay the crash by 6 weeks. There is little prospect that we make it 6 months. With so little difference, I'd prefer it occur before the election to guarantee an Obama presidency. Whichever party holds power over the next 4 years will be discredited for a generation (after Hoover and GD 1.0, the Republicans were unable to build sustainable majorities for two generations). Though I'm disgusted with both political parties, there is at least some chance that the Republicans will return to their Reaganite roots after a time in the wilderness. I have no hope at all where the Democrats are concerned. The fundamentals are positively horrific and much depends on sustaining the illusion of control. Short-sellers overwhelmingly profit from disparities between perception and reality - as such, they are always among the first to point out that the emperor has no clothes. Given the stakes, anyone who sees through the deception must be punished and silenced.
There isn't even enough tax money to cover the normal operations of our bloated government, much less this madness. But the bond market was willing to make up the difference as long as there was a high probability of repayment. But the checks that Paulson is writing with his mouth right now are guaranteed to bounce and some bond buyers are noticing. From a low beneath 3.30% this week, the yield on the 10-year Treasury bond has skyrocketed by 50 basis points. The fact that the bailout silliness has more than doubled that deficit doesn't help at all. Like any fool who continues to spend far beyond his means, the creditors will charge us more and more to borrow until insolvency.
The only solution is immediate cuts in government spending and the repudiation of all the backstops that have been proposed. Getting within shouting distance of a balanced budget is the only thing that can prevent an imminent spike in Treasury rates. The entire game depends on the willingness of foreign savers to fund the now gaping chasm of the Federal Deficit. If they balk, the whole structure is endangered. By taking on the toxic waste of the financial industry, all the US government has done is place itself at risk in the inevitable implosion. This is too large for any government or even all of them together to solve. Remember how Congress sent the GSEs out to save a drowning housing market and the "lifeguards" not only failed the rescue but also got pulled to the bottom right along with everybody else? That is precisely what is going to happen to the US government if they don't extricate themselves now. A blowout in borrowing costs was a precursor to the demise of Fannie and Freddie; we appear to be seeing a super slow-mo, reverse-angle replay with the Treasury right now.
One reason the US survived GD 1.0 without the political damage in the rest of the world (think Hitler, generals in Japan, Peron and petty dictators from Pilsudski to Metaxas) was the fact that the our government's finances never reached a state of existential crisis. The deficit (what there was of it) and government bonds were always sure to be paid back. That assurance is not present today and the government's actions are making ultimate repayment ever less likely. The Argentine example is particularly poignant. In the early 20th century, that country had a higher per capita income than the USA. After decades of socialist and corporatist policies under the Perons, they became the ongoing basket case and borderline Third World country they are today.
I hate to paraphrase anything from the Star Wars series but it is too apropos: This is how freedom dies - to thunderous applause.
The government seemingly doesn't understand this but they will. There simply isn't the money to do everything and in their arrogance the Fed and Treasury have over-reached badly. By trying to save all of the bankrupt financial companies, they are weakening the defenses of the strategic key - Treasury debt. The bond market is already demanding 50 basis points more in interest than just days ago. Another way to look at it is that 10-year government bonds have lost 3.5% of their value in that time. The Treasury is the logistics depot from which the army defending every other target is being supplied. If it falls, the war is over and our enemies win.
One shot wonder, long-term consequences
The SEC, erstwhile market watchdog is barking up the wrong tree again. They sat on their hands and did nothing while the disaster built all around them and now they are attacking the group pointing out the problem, not the ones who caused it. In banning short-selling, they also increase the probability that there will be no bounce when the next decline occurs since short-covering is the one thing that has kept our stock market from collapsing like much of the rest of the world's.
The fact that they feel the need to use this one-time guaranteed short-squeeze now ought to tell you everything you need to know when the cost is so high for so little gain in terms of time. This tells me that election politics are paramount here since there is at least a chance (maybe 50/50) to delay the crash by 6 weeks. There is little prospect that we make it 6 months. With so little difference, I'd prefer it occur before the election to guarantee an Obama presidency. Whichever party holds power over the next 4 years will be discredited for a generation (after Hoover and GD 1.0, the Republicans were unable to build sustainable majorities for two generations). Though I'm disgusted with both political parties, there is at least some chance that the Republicans will return to their Reaganite roots after a time in the wilderness. I have no hope at all where the Democrats are concerned. The fundamentals are positively horrific and much depends on sustaining the illusion of control. Short-sellers overwhelmingly profit from disparities between perception and reality - as such, they are always among the first to point out that the emperor has no clothes. Given the stakes, anyone who sees through the deception must be punished and silenced.
There isn't even enough tax money to cover the normal operations of our bloated government, much less this madness. But the bond market was willing to make up the difference as long as there was a high probability of repayment. But the checks that Paulson is writing with his mouth right now are guaranteed to bounce and some bond buyers are noticing. From a low beneath 3.30% this week, the yield on the 10-year Treasury bond has skyrocketed by 50 basis points. The fact that the bailout silliness has more than doubled that deficit doesn't help at all. Like any fool who continues to spend far beyond his means, the creditors will charge us more and more to borrow until insolvency.
The only solution is immediate cuts in government spending and the repudiation of all the backstops that have been proposed. Getting within shouting distance of a balanced budget is the only thing that can prevent an imminent spike in Treasury rates. The entire game depends on the willingness of foreign savers to fund the now gaping chasm of the Federal Deficit. If they balk, the whole structure is endangered. By taking on the toxic waste of the financial industry, all the US government has done is place itself at risk in the inevitable implosion. This is too large for any government or even all of them together to solve. Remember how Congress sent the GSEs out to save a drowning housing market and the "lifeguards" not only failed the rescue but also got pulled to the bottom right along with everybody else? That is precisely what is going to happen to the US government if they don't extricate themselves now. A blowout in borrowing costs was a precursor to the demise of Fannie and Freddie; we appear to be seeing a super slow-mo, reverse-angle replay with the Treasury right now.
One reason the US survived GD 1.0 without the political damage in the rest of the world (think Hitler, generals in Japan, Peron and petty dictators from Pilsudski to Metaxas) was the fact that the our government's finances never reached a state of existential crisis. The deficit (what there was of it) and government bonds were always sure to be paid back. That assurance is not present today and the government's actions are making ultimate repayment ever less likely. The Argentine example is particularly poignant. In the early 20th century, that country had a higher per capita income than the USA. After decades of socialist and corporatist policies under the Perons, they became the ongoing basket case and borderline Third World country they are today.
I hate to paraphrase anything from the Star Wars series but it is too apropos: This is how freedom dies - to thunderous applause.
Wednesday, September 17, 2008
The Fed is Broke
Three months ago we published Why Bennie Can't Lend, detailing the Fed's balance sheet and the limitations they were up against. We contended that they were out of cash and unable to sell their bond holdings without serious consequences. That is why their incremental actions have been limited to the TSLF, where they loan out the actual bonds rather than cash. Today, the Fed admitted that we were right all along by arranging for the US Treasury to raise more money for them so they can keep lending via the alphabet soup of liquidity facilities.
Basically, this is simply another holding action by the Fed to prevent the "fire sale" (actual price discovery) of assets held across many financial institutions. Yet the implications are profound. This would have been a perfect opportunity for the Fed to print money if it had any intention of actually doing so. Yet they did not, even under the extreme pressure of Lehman failing and AIG bailing. Instead they chose to stay within the framework of fractional-reserve banking and they BORROWED instead. If they were going to conjure money out of thin air, this would have been the time to do it and they demurred.
We believe that this is a shock to the market in a number of ways. It clearly demonstrates the limitations of the Fed's power when many market participants believe that power to be virtually unlimited. It shows that the Fed is no different than any commercial bank in this regard - they have to be able to borrow and lend to expand the money supply. They have the advantage of being able to turn to the Treasury in a pinch but they are trying to support asset prices (promoting asset inflation) and they need cash to do it. The Fed either won't or can't create that cash by decree.
Ironically, just as the weaknesses of the Fed's inflationary program are being made clear, the herd is stampeding back into the inflation trades. This appears to be based on the assumption that today's Fed action is inflationary (true on a very small scale) and demonstrates some new power on their part (not true at all). What has been demonstrated is the INABILITY of the Fed to inflate asset prices without the willing cooperation of the market. With sentiment having turned, the best they can hope for at this point is to slow the crash in prices of risky debt used to fund credit expansion. This is a desperate rear-guard action by the Fed
The Federal Reserve has announced a series of lending and liquidity initiatives during the past several quarters intended to address heightened liquidity pressures in the financial market, including enhancing its liquidity facilities this week. To manage the balance sheet impact of (ed. - ie. pay for) these efforts, the Federal Reserve has taken a number of actions, including redeeming and selling securities from the System Open Market Account portfolio.http://www.ustreas.gov/press/releases/hp1144.htm
The Treasury Department announced today the initiation of a temporary Supplementary Financing Program at the request of the Federal Reserve. The program will consist of a series of Treasury bills, apart from Treasury's current borrowing program, which will provide cash for use in the Federal Reserve initiatives.
Basically, this is simply another holding action by the Fed to prevent the "fire sale" (actual price discovery) of assets held across many financial institutions. Yet the implications are profound. This would have been a perfect opportunity for the Fed to print money if it had any intention of actually doing so. Yet they did not, even under the extreme pressure of Lehman failing and AIG bailing. Instead they chose to stay within the framework of fractional-reserve banking and they BORROWED instead. If they were going to conjure money out of thin air, this would have been the time to do it and they demurred.
We believe that this is a shock to the market in a number of ways. It clearly demonstrates the limitations of the Fed's power when many market participants believe that power to be virtually unlimited. It shows that the Fed is no different than any commercial bank in this regard - they have to be able to borrow and lend to expand the money supply. They have the advantage of being able to turn to the Treasury in a pinch but they are trying to support asset prices (promoting asset inflation) and they need cash to do it. The Fed either won't or can't create that cash by decree.
Ironically, just as the weaknesses of the Fed's inflationary program are being made clear, the herd is stampeding back into the inflation trades. This appears to be based on the assumption that today's Fed action is inflationary (true on a very small scale) and demonstrates some new power on their part (not true at all). What has been demonstrated is the INABILITY of the Fed to inflate asset prices without the willing cooperation of the market. With sentiment having turned, the best they can hope for at this point is to slow the crash in prices of risky debt used to fund credit expansion. This is a desperate rear-guard action by the Fed
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