Saturday, February 28, 2009
Friday, February 27, 2009
Apparently the answer really is simple.
It is a cash flow problem.
Allowing ALL homeowners and student loan holders to refinance at low rates (for example, below 5% on a 30 year note) would be equitable and eliminate the problem of moral hazard.
But doing so would hurt the banks, financials, and other institutions that hold Americans in perpetual debt slavery through their ownership of mortgages and asset backed securities.
Massive refinancing would lower their interest incomes and further increase the basis point spread in an already illiquid ABS market.
I can already hear the protests from some ABS and fixed income traders reading this site (those few that deign to visit anyway). "But it's all available on my Bloomberg and Reuters terminal! See, there IS a market."
Really. Now who are we kidding.
It's not as simple as punching in a bunch of CUSIP numbers and running a black box model around the theory. ( CUSIP stands for Committee on Uniform Securities Identification Procedures. CUSIP identifies most securities, including: stocks of all registered U.S. and Canadian companies, and U.S. government and municipal bonds. The number consists of 9 characters - including letters and numbers - that id a company or issuer and the type of security. For more information please visit cusip.com).
The ABS market is full of non-conforming, chopped up tranche loans, bits of derivatives, and other junk floating around. I don't pretend to understand the system. JP Morgan, Citicorp, and other big banks have entire operations dedicated to analyzing and researching the ABS market. And THEY don't even know what it means anymore.
The action in Fed funds futures used to be exciting. Now, with short term interest rates close to 0% and the government intent on keeping them at such lows the smart money is betting on a continuance of the status quo.
http://www.clevelandfed.org/research/da ... dex.cfm#Q1
Thursday, February 26, 2009
Now add the desperate pleas for assistance from state legislators and speculative bond vultures.
"The worst financial crisis in seven decades is forcing thousands of previously middle-income workers to seek social services, overwhelming local agencies, clinics and nonprofits. Each month 16,000 people, including many who were making $60,000 to $100,000 annually just a few years ago, fill four county offices requesting financial, medical or food assistance.
“Unless we do things differently, not only will we continue to be on life support, but the power to the machine is going to die,” said county Supervisor Federal Glover, who represents Antioch and the cities of Pittsburg and Oakley about 50 miles (80 kilometers) east of San Francisco.
Meanwhile, in muni bond land prices have fallen and effective yield has risen. The bond vigilantes, formerly confined to Treasuries have emerged into the formerly pristine pastures of highly rated muni bonds. I say "pristine" because until recently muni bonds were considered a "safe harbor" investment for the wealthy. Muni bonds are a conservative investment that pay out relatively low interest w/tax free status. Default rates have remained low but rising fears of i) local governments' inability to repay; and ii) inflation risk are deterring some muni bond investors.
Nothing has really changed for the better since I wrote about muni bonds last year:
In fact, the situation continues to deteriorate. California munis are not trading at CDO level yet but they have suffered significant setbacks in price.
Aside from myself, here are the folks who are in favor of temporarily Nationalizing the banks, and then spinning them back out:
Gordon Brown, UK PM
Senate Banking Committee Chairman Christopher Dodd
Senator Chuck Schumer
Sen. Lindsey Graham
House Speaker Nancy Pelosi
Alan S. Blinder, Princeton
J. Bradford DeLong
Elizabeth Warren, TARP Oversight Panel
Dylan Ratigan (CNBC, Daily Beast)
Jesse Eisinger, Conde Nast Portfolio
Martin Wolf, FT
Aaron Task (Yahoo Tech Ticker)
Paul Kedrosky (Infectious Greed, CNBC)
Nicholas Kristof (New York Times)
Mark Gongloff (WSJ)
Richard Parker (Newsweek)
Michael Hirsh (Newsweek)
David Reilly (Bloomberg)
Paul Vigna (Dow Jones)
Henry Blodget (Silicon Alley)
Willem Buiter (FT)
Adam Posen (Peterson Institute for International Economics)
Calculated Risk (Preprivatize the Banks)
Mark Thoma (Economistsview)
Eddy Elfenbein (Crossing Wall Street)
Aaron Krowne Mortgage Lender Implode-O-Meter
Prieur du Plessis (investmentpostcards)
Roger Ehrenberg, Information Arbitrage
Interfluidity (Nationalize Like Real Capitalists)
And those opposed:
Lawrence H. Summers
Financial Services Committee Chairman Barney Frank
Republican Senator Jon Kyl
Meredith Whitney, Oppenheimer
Deroy Murdock (NRO)
My comments: Nationalization does not solve the root problem behind these banks - that of bad gambling debts. The only solution for the bond issuers -. . . err I mean national taxpayers is if the bad business models are allowed to completely fail.
Wednesday, February 25, 2009
The recent weakness is also due to FUNDAMENTAL fears of Japan's growing trade deficit. In a export dependent island nation w/few natural resources, the shrinking of international trade is signalling alarm bells among both traders and policymakers.
"Exports to Asia slumped at a record pace as manufacturing within Asia, which
had thrived on robust global growth until last year, slumped as Western consumers curtail their spending."
For the foreseeable future, we can expect to see a vicious tug-of-war between
foreigners selling and public funds buying. While the exporter dominated Nikkei has been boosted by recent yen weakness, it seems unlikely that any REAL buying activity is occurring beyond short covering and BOJ purchases of individual stocks.
Yes, you read that last part correctly.
The Japanese authorities have decided that the best use of taxpayer money is to purchase shares of select Nikkei stocks in order to provide a floor on the share prices of stocks.
So much for the free market. And I thought US short sellers liked to complain about the PPT. Imagine being a Japanese short seller and being forced to work in such a manipulated environment.
If the government continues to promote such interventionist policies, then liquidity will simply dry up w/fewer shorts around to cover. This will eventually be wider gaps between bid and ask spreads and possibly ripen into a similar situation like last autumn.
It appears that the Japanese authorities have succeeded in their goal of weakening the yen. But at a steep cost.
Sunday, February 22, 2009
The group consists of two sides: cash rich nations and cash poor nations. China, Japan, Singapore, and (arguably) Taiwan comprise the group w/deep pockets filled w/US treasuries. Everyone else consists of cash poor nations that are prone to political and economic upheaval - which basically includes all of southeast Asia (w/the prior exception of Singapore) and S. Korea.
Why would countries like Japan and China agree to fund the functional equivalent of pan-Asian bailouts?
Remember, the export driven, factory nations of the Far East need weaker currencies against their major trade partners (traditionally a stronger dollar but that has grown to encompass the Euro as well). Funding such bailouts are a hidden way of depreciating their own currencies - even though analysts were quick to defend the new agreement:
“This fund is not aimed at avoiding a region-wide simultaneous depreciation,” said Sebastien Barbe, a strategist at Calyon in Hong Kong, the investment banking unit of France’s Credit Agricole SA. If “the aim is to avoid a currency crisis if one or two member countries are under extreme pressure, then the fund can be used to avoid a currency crisis,” he said.
To be fair, Treasury rich Asian nations are trying to fulfill the traditional role of Western money, that is to support capital flows that had been abruptly slowed or even cut off last autumn. Southeast Asia and S. Korea were hit particularly hard as foreign investors began withdrawing funds from the sovereign debt (mutual funds), corporate equity markets (mutual funds again), and individual project finance deals (hedgies).
Sovereign reserves declined substantially in attempts to defend the currency from speculative attacks and led to increased demand for dollars (the international reserve currency of choice remains the dollar). The stronger dollar in turn negatively impacted trade deficits and led to further weakening of export driven sectors - particularly in manufacturing and shipping. This is a vicious cycle that is still ongoing but finance ministers apparently believe this new economic framework can lead to regional stability.
On a more practical level, the implementation of such a reserve currency scheme means that the yen is no longer the attractive safe haven it used to be. Instead, the flight to safety has found new legs in other asset classes such as precious metals.
Friday, February 20, 2009
In March 2008, I was finishing my final year in law school and taking a class in "International Corporate Legal Environments." It was a class co-taught by one business school professor and one law school professor. This was one of the questions on the mid-term exam:
Q) How do multinational firms exploit the value chain on a global basis?
A) My answer:
This is a broad question with a necessarily broad answer. My answer is leverage. Recent events in the financial markets have given leverage a bad name and it remains to be seen whether firms in these businesses will be able to wield the enormous amounts of power they once controlled. However, outside of financial services the concept of leverage remains a potent force in international business.
Multinational firms leverage aspects of their value chain to achieve incredible economies of scale. The concept of a value chain was first advanced by Michael Porter in his book, "Competitive Advantage: Creating and Sustaining Superior Performance". Under Porter's theory, a value chain is a broad spectrum of business functions that managers can use to achieve higher efficiencies in production, sales, operations, etc. However, I expand upon Porter's theory by adding to the value chain and make an abstract concept real through the discussion of three prongs: money, time, and distance.
Money is of course the compensation that firms give to its employees and suppliers as well as the value it receives for the sale of its goods and services. A simple way of explaining the power of money is that it is an instrument of cash flow that fuels a business empire. However, it is more complex than that.
Wages and supplier payments are debt instruments. Debt instruments are by definition obligations to repay today's production with a promise of tomorrow's revenue. This necessarily leads to my next point, time. In North America, the typical time between paychecks is two weeks. The margin for supplier contracts is even greater, often consuming 30 days at the shortest with 60, 90, and even several year periods not unheard of. Moreover, when dealing with consumer markets, firms are generally paid immediately. Shrewd captains of industry realized long ago that by tinkering with the balance between production and payment that they could exploit a wonderful arbitrage opportunity by maneuvering in the gray space of obligatory payments and necessary receipts of income. However, it was not until the Industrial Age that managers discovered the third and final element of their toolbox, distance.
Distance refers not just to physical distance but also a mental separation. When societies transition from one age to another, there is a cognitive dissonance, or gap in thinking, as the humand mind struggles to adopt to new circumstances by continuing to use old gestures to substitute for the new. This transition is especially jarring when the change comes suddenly. For large companies, the dawn of industrialization meant not just increased economies of scale at home but also possibilities abroad to market their wares and possibly find new production sources. Cunning capitalists engaged in a game of logistical and economic warfare against each other as they sought to exploit new markets by creating the first multi-nationals. Those who could not, or would not, grasp the concept of accelerated technological and capital access were consumed. In 19th century America, the iconic image of the industrialist was that of the "robber baron" standing triumphant over his foes in the steel, railroad, and banking industries. However, this transition found its expression earlier in the Civil War as Northern industrialists waged an economically driven war against an agrarian South.
The newly formed multi-nationals also used the power of distance against their workers, many of whom were still reeling from the rapid shift in societal and economic changes. Besides the time distance between paychecks, managers borrowed a new tool, but this time from the government: retirement plans. Following FDR's reforms, shrewd captains of industry realized that they could manage growing worker unrest by once again leveraging the power of distance. Retirement plans gave management the opportunity to co-opt employee dissent by offering the surface appearance of caring for their workers' welfare. However, the financial obligations for these plans would not come due until many years in the future. Now, instead of just relying on a two week distance, management could focus on delivering today's revenue at greater levels of efficiency. As for the retiree obligations, they were destined to become someone else's problem.
There is one last element to distance and one which has become increasingly critical in today's business environment, risk transfers. By transfering risk away from their operations, multi-nationals could insure against business downturns by creating a financial and operational separation. Indeed, the extremely liquid market in futures and options of today has its origins in the same time frame as the Industrial Revolution. Moreover, industrialists discovered the power of lobbying (which also has its roots in the Industrial Revolution) to enable these risk transfers.
Highly skilled actors armed with guile, charm, and numbered trust fund accounts have always been an unofficial part of government. These mercenaries act as representatives for America's corporate constituency by pressuring politicians to implement favorable laws and regulations. However, the modern age turned the industry into a profession. In the United States, lobbyists even have their own code, the Administrative Procedure Act or APA.
It is important not to think of money, time, and distance as discrete elements but parts of a synergistic whole. I presented them separately for narrative ease in showing a historical progression. Elements from one section have always overlapped into the territory of another.
The best international managers are aware of these elements - even if only implicitly - and knows when to apply the appropriate amount of leverage. However, there is always the potential for multi-national managers to lose control of the process. In that case, they should not worry. If the company is large enough, the government will be there to offer support. Then it will become someone else's problem - the taxpayers.
Hey, I got an A in the exam and the class. Thank you Profs. Kowzlowski and Dean Thomas. If either of you are reading this thank you for the words of encouragement!
Like a nasty poltergeist, the auction rate security market (or lack of it) continues to haunt investors, issuers, regulators, and other interested parties.
Auction rate securities are bonds or preferred stock that have rates set by reverse auctions. They were frequently issued by parties that wanted to engage in long term financing but take advantage of short term interest rates. Auctions were typically held every 7, 28, or 35 days to reset the interest rates as the securities are passed on to new holders.
Wall Street banks were responsible for soliciting bids so that the securities could be sold successfully at auction. In turn, the banks charged lucrative fees for managing and soliciting the bond auctions. Many banks also decided to hold these assets on their own books as well in order to fatten their bottom lines.
But when the banks realized that liquidity was beginning to dry up (and leaving them w/illiquid "Level 3" assets on their books), they began marketing the same toxic assets as safe, conservative investments to ordinary retail investors. Troubles began to surface in late 2007 and began to rear its head in early 2008 with allegations surfacing against Lehman Brothers and Bear Sterns.
Indeed, it was Lehman Brothers that eventually epitomized the full extent of Wall Street's fraud. But other banks are equally liable: Goldman Sachs, Merrill Lynch, and other hallowed names were involved in the ARS game.
Even after state and federal regulators settled a number of actions against these firms (typically by forcing them to re-buy the auction rate securities back), yields continue to remain low because the Fed's actions to slash interest rates to record lows gives issuers little incentive to refinance. Moreover, the return of the auction rate securities continued to burden the banks with the same problem of illiquid assets on their books that they faced last year.
When times were good these banks were all too happy to keep mark to market value of these assets on their books since they were yielding up to 18-20% interest. But now when the rates are below 2% (at best), the enthusiasm for m2m has waned noticeably.
Bloomberg published a recent update:
“I have lost all faith in bankers and Wall Street,” said Stelzer, who invested the proceeds from the sale of his ranch in the securities through San Francisco-based Wells Fargo & Co.
A year after collapsing, the one-time $330 billion market for debt with rates typically set every 7, 28 or 35 days is still claiming victims. Investors are stuck with as much as $176 billion of the securities even after regulators forced banks to buy back more than $50 billion of auction-rate debt that was marketed as safe, cash-like instruments.
The market’s meltdown, the result of the seizure in credit markets, initially left investors with bonds they couldn’t sell, though the securities paid interest at rates as high as 20 percent. Now, rates on securities auctioned every seven days pay an average 1.36 percent, according to an index from the Securities Industry and Financial Markets Association, after central banks slashed borrowing costs.
Investors are stuck because interest on auction-rate securities is lower than what issuers would have to pay on new borrowings, giving them little incentive to refinance.
Thursday, February 19, 2009
The net amount of space leased will fall by 47.8 million square feet this year, one of the steepest drops in occupied space on record, excluding the loss of space from the 2001 destruction of New York’s World Trade Center, said Reis in its quarterly outlook. Asking rents will fall 5.4 percent and actual rents will fall 7.4 percent this year, Reis said.
Demand for commercial real estate of all types -- office, retail, apartment and industrial -- is weakening as companies slash payrolls and consumers cut spending in the recession. The Bloomberg Office REIT index has dropped 54 percent in the past 12 months on concern landlords will see income decline as tenants abandon space. Office building owners Maguire Properties Inc. tumbled 91 percent and SL Green Realty Corp. dropped 85 percent.
Wednesday, February 18, 2009
Just think of it as the private sector model for TARP funding (regulators chose to go along the preferred stock route last autumn).
Because of leverage the yields were very fat ...as long as the debtors paid on time. But that isn't happening anymore.
In fact, properties are barely able to meet their 1st mortgages let alone the mezz debt. Even if the mezz firms try to take over the assets they face a lengthy ct battle as well as the prospect of owning empty office shells bereft of tenants and full of back taxes.
Then compare it to this article:
and this one:
Woori Bank, a South Korean bank chose NOT to exercise its option to call in a bond ahead of its 2014 maturity. Perhaps because they don't even have the money to do so:
"Indeed, it isn't even clear that Woori would have been able to raise debt to pay off the existing notes. Many banks in Korea and throughout Asia have been shut out of the global credit market amid the credit crisis."
"Woori's announcement caused a sharp rise in the cost of protecting against defaults on its U.S. dollar bonds. Credit-default swaps covering the bank's subordinated bonds widened 0.75 percentage point to 7.75-8.75 percentage points. Swaps covering its senior bonds widened 0.15 percentage point to 5.25-6.25 percentage points."
In a system based on trust, banks paying off their callable bonds is an IMPLICIT promise that is baked into their note offerings. In this kind of market it is cheaper for the bond issuer to delay payment until maturity even though this hurts the bond holders. The immediate effects are twofold: 1) the bond issuer gets to save cash but at the expense of 2) the bond holders will demand higher premiums in the future to compensate them for the risk of such repeated actions.
The Koreans' actions in turn sparked wider fears that E. European borrowers (who are particularly strapped for cash) would also follow similar practices. The yields among E. European borrowers, which are already under pressure, soared higher. In turn, Central European banks which hold the E. European debt exposure on their books face the risk of imminent downgrade. This was not a particularly surprising development as some academics pointed out earlier in the decade:
It is unfortunate when some academics have pointed out potential trends or risks years in advance only to be ignored by the financial and/or greater academic community. Often we tend to be relegated to the "Cassandra" camp because we lack the necessary credentials (e.g. Ivy League degrees, wealthy peers, or just plain unpopular ideas) to be heard among policymakers. Instead, such academics (like myself) must be content w/proving ourselves through market actions.
Tuesday, February 17, 2009
"the current basis point spread that the indices are trading at. So, as fear (and liquidity, and credit problems, etc.) increases, spreads increase (and prices go down)."
Well, at least I got one thing right they do measure the fear among institutions! I have kept the original description for comparison. Hey, this is a learning process and I do not claim to get everything right.
These graphs measure the spreads between the bid and ask prices in CMBS (commercial mortgage backed securities) linked to commercial real estate financing. They represent the FEAR among institutions of impending default. Each graph is separate for individually rated securities. The top shows AAA and the last shows BBB grade.
Monday, February 16, 2009
Like Silicon Valley on steroids, apparently, with real estate prices now down between 40 and 50 percent over just the last month...And no, the worst has yet to come.
For the social ramifications please see my older post.
Saturday, February 14, 2009
1) Averaging down - strategy used by novice traders to lower cost basis of their trade.
Govt application - strategy used by novice bureaucrats who know nothing about market dynamics to increase the cost basis of bank bailouts.
2) Margin call - When brokers liquidate positions and cut off credit.
Govt application - When China or foreign nations liquidate treasuries and cut off credit. (*Note - unlikely to happen but all bets are off if an official bad bank is declared).
3) Stop Loss Order - Orders that savvy traders use to limit losses.
Govt application - Orders that govt bureaucrats use to increase losses.
4) Arbitrage - The simultaneous purchase and sale of 2 different (but closely related) securities to take advantage of a disparity in their prices.
Govt application - the simultaneous spending and taxing of different generations to take advantage of disparities in age to benefit the oldest generation at the expense of countless future ones.
5) Back Testing - tests run on historical data and then applied to new data to see if the results are consistent.
Govt application - tests run on historical data and then applied to real life regardless of consistency.
6) Breakout - The point when the market price moves out of the trend channel.
Govt application - The point when Congress breaks for lobbyist lunch hour.
7) Volume - the number of contracts or shares traded between different parties over a certain period of time.
Govt application - the number of contracts traded between the same parties over and over again (even if it is the same body) to create the illusion of supply and demand.
8) Slippage - The difference between the price a trader expects to be filled at and the price they are actually filled at.
Govt application - the difference between subsection 2) paragraph 103(b) and subsection 2)paragraph 103(b)i-c. Not even CPAs, lawyers, and judges can agree on what this means.
9) Efficiency - Getting the most bang for your buck (runup/drawdown)
Govt application - Unions.
Given the flood of horrible fundamentals some traders have wondered - as have I - just where do those rallies come from? Well, look no further.
The President's Working Group or Plunge Protection Team ("PPT"), as it is lovingly called by short sellers, is a cabal of institutional insiders working in collusion with government regulators to promote "market stability". Their actions are a daily reality in bear markets and are responsible for the wild swings in equity, futures, bond, and options markets.
Regulators and their corporate constituency (ever notice how they are often one and the same) cannot abide economic reality and have to resort to cheap tricks to pump the markets higher so that insiders may sell at a better price.
Such tricks PRECEDE the release of major news events.
The PPT and market insiders often telegraph their moves to those savvy enough to know what to look for. Because of the immense volumes of money being moved around, the PPT often gives advance warning signals.
Such signals may include any or all of the following:
a) Large index futures orders (buy orders usually)
b) Sharp jumps in out of the money calls among the insider Wall St banks such as Goldman Sachs and Morgan Stanley. This activity can become glaringly obvious around options expiration week for same month options.
c) Sudden weakening of the yen/usd cross.
d) Steady withdrawal or decreases of liquidity from the repo market (withdrawals are enacted to increase bond demand at the expense of equity bulls) as seen through FOMC operations. This action runs concurrent with marked increases in failures to deliver among the primary credit dealers. (Theoretically the opposite can hold true if the Fed increases liquidity but since the US is in a refinancing binge interest rates must be kept low).
Except for option D the PPT maintains a decidely bullish bias. Famous examples of PPT intervention and insider profiteering include the advent of the short selling bans last July and September. PRIOR to the announcement of the short bans, open interest and volume suddenly spiked in Goldman Sachs and Morgan Stanley same month calls. It was almost as if some market participants knew something in advance. . . . .
For more background information:
Thursday, February 12, 2009
*Editor's note: The American way is live rent free for several months at the expense of the taxpayer (and indirectly at the expense of foreign creditors) and that's before this new program even started.
Instead, a compromise fiscal stimulus bill was passed in Congress ***[Correction - As of this writing the bill is scheduled for debate. The House debate is scheduled for Friday and the Senate's over the day or possibly the weekend].***
It was not as big as the Democrats would have liked but all that proves is China retains some leverage (pun intended) over US spending habits although that power has been severely diminished.
The banks couldn't get free bailout money directly so they decided to suck that money out through a free bailout of mortgage holders. Apparently US policy makers mistook reluctant Chinese purchases of Treasuries to go on a spending binge. . . again.
However, a true "bad bank" remains unlikely because the debt burden would be so prohibitive that it would destroy any intrinsic value of Treasuries overnight (let's not even get into the European problems which I covered in my January posts). And that is something the Chinese - indeed any creditor - will probably not stand for.
Remember, a nation borrowing and issuing notes in its own fiat currency is highly unlikely to suffer default. But inflation risk definitely exists. And the bond market remains - extrinsic of gold - the one place that serves to check fiscal profligacy.
"Except for US treasuries what can you hold? Gold? You don't hold Japanese government bonds or UK bonds. US treasuries are the safe haven. For everyone, including China, it is the only option."
Comment: See what I mean about watching the UK for signs of hyper inflation? In fact, if one is particularly adventurous, shorting gilts could be a good trade. Once the BOE cuts rates to 0% then there is not much they can do except buy their own debt back. The BOE and Exchequer can also play similar games to what Bernanke is doing w/control of the repo market. But such moves are illusory and also highly inflationary. Just look at gold's surge since early 2009.
"We hate you guys. Once you start issuing $1 trillion-$2 trillion we know the dollar is going to depreciate, so we hate you guys but there is nothing much we can do."
Comment: Jim Rogers is right. The USD continues to be the last man standing... but only because there is a lack of viable alternatives.
"There will be no bottom fishing of financial institutions, particularly in the US, because there is a lot of uncertainty about the quality of the books."
Comment: Well, there you have it. The Chinese have single handedly destroyed Wall Street's attempts to obfuscate things through a suspension of mark to market or "fair value" accounting as it is referred to in some circles. Banking chiefs and fixed income vultures must be disappointed that America's biggest foreign creditor remains reluctant to re-enter the private debt or equity markets.
Tuesday, February 10, 2009
The U.S. “should make the Chinese feel confident that the value of the assets at least will not be eroded in a significant way,” Yu, who now heads the World Economics and Politics Institute at the Chinese Academy of Social Sciences, said in response to e-mailed questions yesterday from Beijing. He declined to elaborate on the assurances needed by China, the biggest foreign holder of U.S. government debt.
“The government will be a net buyer of Treasuries in the short term because there’s no sign they have changed their strategy,” said Zhang Ming, secretary general of international finance research center at the Chinese Academy of Social Sciences in Beijing. “But personally, I don’t think we should increase holdings because the medium- and long-term risks are quite high.”
“The biggest concern for China to continue buying U.S. Treasuries is that if Obama’s stimulus doesn’t work out as expected, the Fed may have to print money to cover the deficit,” said Shen Jianguang, a Hong Kong-based economist at China International Capital Corp., partly owned by Morgan Stanley. “That will cause a dollar slump and the U.S. government debt will lose its allure for being a safe haven for international investors.”
“We are facing hyper-deflation, so we need a policy to create hyper-inflation. We have to do something to undermine the central bank and government’s credibility or else we won’t be able to halt the yen’s rise. So, while we know this is drastic medicine, we will do it,” said Koutaro Tamura, an upper house Diet member who will chair the new group.
The plan for the government notes came as Atsushi Mizuno, a board member of the BoJ, warned that the central bank, needed to take “extraordinary” measures to counter Japan’s deepening recession.
Warning that the Japanese economy would remain in a “severe” state, Mr Mizuno said it was “important to be ready to act promptly and consider taking policy action that may be considered extraordinary under normal circumstances”.
Thursday, February 5, 2009
It is simply impossible for any one government - even the US government - to sustain support for both a bad bank and lower interest rates. There is a fallacy among central bankers today. They believe they can set interest rates at all ends of the yield curve spectrum. That is just plain wrong.
Policy makers are slowly realizing that adding a bad bank in its "purest form" would result in the sudden transfer of loss from the private sector banks to the public balance sheet. This would result in a sudden shift from deflation into inflation. Potentially overnight. The reason has to do w/interest rates and the bond markets.
Governments wield immense power over short term lending rates (e.g. the well tracked "interest rate cuts" followed by market traders). However, this capability diminishes the further out the maturity on their notes. At this end of the spectrum, traders - not the government - wield the ability to set rates through their collective actions of buying and selling. Governments TRY to wield influence over the longer end of the curve by buying bonds either directly or through indirect means such as the primary credit dealer facility (see below).
This is all connected to ZIRP or zero interest rate policy. The US and Japan are already at ZIRP. The UK is headed there and so is the EU whether they want to or not (stubborn buggers).
BUT to keep interest rates down, they must issue LESS BONDS...not more. Hmmm. Since we know that's not going to happen, world govts will be buying their own bonds in an effort to keep rates down. (The more they "stimulate" the economy the greater the bond issuance has to be to pay for it).
It's the case of 1 arm buying from another in the same body (fed or equivalent quasi-govt body is buying its own national debt).
This gives the PERCEPTION of higher demand and lower supply. The Fed can get away w/this Ponzi scheme short term b/c it has more firepower than any other single bond buyer and will CRUSH any one bond short in the near term. The Fed is assisted in this activity by the primary credit dealers, or a cabal of chosen banks that get first dibs on cheap treasuries:
At strategic junctures, the Fed instructs the primary dealers to withold liquidity through the early return of repos. The earlier return of treasuries artificially lowers the supply and causes the yields to lower.
The system worked wonderfully last fall in stimulating a massive rally in treasuries.
Here we have Bernanke, saying one thing before Congress and then doing the exact opposite. He wasn't even trying to hide it at the time - the data is publicly available on the Fed and Treasury's web sites through the FOMC and capital flows data.
But then I realized that the ponzi scheme had to end. And that end would be when Obama came to office and pushed for "change".
Unless there is some actual REAL demand by other non-government bidders, central bankers risk becoming the only buyer left standing at the end of the day. The result? Rising interest rates. Of course, the more of their own debt the central bankers have bought. . . the higher the interest rates will be. Simply put, the chief market manipulator has undone itself through its own short sighted, market actions.
As deflation drags on and the West continues to bailout bad actors, completely innocent 3rd parties like China, Japan, Taiwan, Mid-East arabs, etc. that had nothing to do w/Level 3 accounting and other banking games will decide to save themselves instead of the US and Europe.
Just keep in mind that the more stimulus programs the West enacts, the more it will cost the foreign creditors. And they are getting very tired. Very fast.
So, in the end it really is about the taxpayer.
Or rather the PERCEPTION of the taxpayer being (un)able to repay the mountain of debt that governments have shifted onto their population. Remember, a bond is nothing more than an income stream of future promises to repay. And the West's ability to repay grows more doubtful with every bailout of bad actors and the resulting transfer of risk calls into question their ability to refinance current and future debt loads.
Monday, February 2, 2009
Some readers pointed out that I failed to properly define a clearinghouse. Ok. I thought I did but here goes:
A clearinghouse is a central party that nets trades. It is the equivalent of the plumbing or maintenance crew working inside the bowels of a building. They handle the boring, mechanical back office work of "netting trades" or making sure that for every buyer there is a seller.
A clearing member is a member of a clearing house. You can find out who they are on the bottom of your brokerage slips or elsewhere in the tiny disclosure agreement that you signed. Most traders and investors don't even know (or care) whom their clearing firm is unless there is a problem (like a margin call or federal securities investigation). That is the way the industry prefers it. Nice and quiet.
There are 4 groups out there jockeying for position in the CDS clearing market:
A) CME Group and Citadel
C) NYSE Euronext, Liffe, LCH. Clearnet
D) The Clearing Corporation (since sold to Intercontinental Exchange or ICE)
The NY Fed Reserve - formerly headed by one Timothy Geithner - is pushing for a US solution. But they are encountering problems w/the recalcitrant Europeans who are advocating a European standard. The trans-Atlantic spat is an issue over sovereignty, e.g. which political body would have jurisdiction over any clearinghouse(s).
The issue also revolves around the elimination or marginalization (depending on who you talk to) of the OTC (over the counter) CDS market.
For years, the large investment banks such as JP Morgan, Goldman Sachs, Deutsche Bank, HSBC, RBS, and the other members of the Libor cartel (see Sept 2008 article) were content to gamble away the world's economy among themselves on private, bi-lateral computer networks using Bloomberg and Reuters terminals. When THAT trade started to implode last fall, regulators (most of who did not even know the difference between a stock and bond) swooped in and demanded a clear way of settling the mess.
The futures exchanges, who had been observing the crisis all this time, decided this was their chance to score the big money. Unlike OTC markets (where the participants were free to play "hide the trading losses" through offshore subsidiaries and other accounting shells), exchanges mark to market trades on a regular basis - daily or semi-weekly depending on the trade.
Transparency is a given - well as much as you can get in the financial trading world.
The exchange lobbyists arrived, faces thoughtfully grave and fingers rubbing chins, to "advise" the regulators that this entire mess could be solved. . . through routing AND clearing the trades on THEIR networks through THEIR members. The OTC market participants have their own clearinghouses - but most of these tend to be basically vestiges of the same parent w/no real independence (and thus their accountability was suspect to say the least).
The investment banks are loathe to give away their business to the exchanges. This is about more than just money. It is also about maintaining privacy (e.g. hiding their true losses from the public)! But they are not in a particularly advantageous bargaining position right now (to say the least). Politicians are screaming for their heads. So is the public. And laughing quietly among themselves are the exchanges.
I am not an expert on the clearinghouses or the exchanges. Nor am I privy to the high stakes poker game going on behind closed doors.
BUT I do know that the first 3 groups -
A) CME Group and Citadel
C) NYSE Euronext, Liffe, LCH. Clearnet
are about as pure an exchange interests as you can get. A) represents the Chicago traders partnering w/reclusive private equity. B) represents the German and Swiss traders C) is a loose gathering of NY, London, and various European trading firms unaffiliated or disgruntled w/B).
D) The Clearing Corporation
was formerly owned by several prominent NY firms (such as Goldman Sachs and Morgan Stanley) before being sold to ICE. Although the transfer has already been effected, it is likely that some old banking affiliated staff (e.g. investment bank allies) remain behind to unofficially represent the investment banks' interests.
Sunday, February 1, 2009
All those fancy canapes, martinis, and presentations are nothing more than a giant dressed up sales pitch to continue buying the equivalent of timeshares in America, the UK, and the EU. Calls for "international cooperation" are really disguised pleas for more bond purchases.
Western nations continue to pontificate about how essential (their) consumers are to the world economy. But w/interest rates already at record lows, Western central bankers have resorted to unorthordox measures like buying their own bonds as evidenced by Bernanke's numerous alphabet programs to buy commercial paper (the UK has also announced a similar program). However, nothing is free.
The bond markets WILL reflect this added burden on borrower nations' balance sheets in the form of higher interest rates sooner or later. This is the last thing Bernanke, Alistair Darling, or other Western central bankers want. After all, there is a limit to how much debt nations can issue before supply overcomes demand.
And these measures do not even include the added cost of any "bad bank" bailout.
In order to maintain low interest rates the West MUST convince the Middle Eastern oil producers and the East Asian factory nations to stand behind their bond purchases. Otherwise the facade will collapse and these central bankers will be exposed as the only buyers in the room. The bond markets already saw some of this last Thursday after China signaled its displeasure at US comments regarding "currency manipulation."
However, the West faces a sceptical and jaded audience. Emerging market sovereign wealth funds have already been badly burned by prior investments. CIC (China Investment Corporation) and Temasek Holdings (Singapore) are estimated to have lost 50-60% of their investments in Morgan Stanley and private equity houses. Exact figures are hard to come by since the government arms have not been forthcoming w/their true losses. Instead the losses are estimated from current market prices compared to the purchase price and general market conditions.
While the sovereign wealth funds have publicly commented that their investments are "long term" stakes, there are already clear rumblings of discontent as evidenced by China's Premier Wen Jiabao's comments last Thursday that sent the 30 year long bond soaring to 3.6%.
Indeed, the problem extends further than many realize. Sovereign wealth funds are the public face of foreign investment. Emerging market nations face immense public pressure to focus investment INWARDS on domestic infrastructure projects. Their central banks face pressure to initiate their OWN quantitative easing programs (e.g. buying their own bonds).
Why should they lend more money to spendthrift Western gamblers who have already blown several trillion $ worth of taxpayer revenues?
Only time will tell what measures ultimately come out of Davos. Indeed, the Davos meeting is a stepping stone or bridge of sorts to the next major international conference: the G20 meeting in April where President Obama will be attending.
He can't afford to miss it. Literally.
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