Tuesday, November 25, 2008

The Debts of The Spenders: Financial Leverage Ratios

We are not out of the woods yet. Plenty of hungry bears remain lurking. Unfortunately, it looks like the taxpayer will be eaten while the ones responsible for this whole mess get to run away.

But what happens if the mark to market rules are changed? Banks have been lobbying regulators for the past few months to change the accounting rules to reflect financial modeling valuations. Numerous banks and industry analysts are writing non-performing assets down to zero and this is reflected in their share price.

The asset writedowns are also angering government regulators because it allows the banks to qualify for free taxpayer money from the TARP and various other federal assistance programs.

IF the government waives the rule changes this could spark a large bear rally in financials and the greater market. Savvy traders would merely fade the rally though. When market valuations are completely abandoned opacity increases and confidence decreases.


Sunday, November 23, 2008

The Debts of the Lenders: The End of the Carry Trade Part 6 (PRDCs and Japanese bond markets)

Power Reverse Dual Currency bonds are a type of structured bond that were created by Japanese market makers to take advantage of the arbitrage opportunities between low domestic interest rates and higher rates overseas.

They are structured in such a way that when a certain exchange rate level is breached, for example Y95 in dollar/yen, the coupon disappears but the note is still valid. Unfortunately for the Japanese market makers, these instruments amount to DE FACTO SHORT POSITIONS on the yen. The money managers are now faced w/the prospect of either buying yen on the spot market (hideously expensive) or buying yen calls. In either case the Japanese bond desks are being forced to contribute to the further unwinding of the carry trade. This in turn will result in only more bearishness for global equities markets.

Potentially, the Japanese government COULD step in to buy all those bad bonds. But the cost would be astronomical, time consuming (months to plan and weeks to implement), and extremely complicated to oversee. And that is just speaking from the domestic angle. Foreign traders would also have to be consulted or else the ripple effects of policy decisions in Tokyo would quickly make their way felt in global markets. Don't believe me? Just look at how well the US government's TARP program has been implemented.



The Debts of the World: Bulls Are Not Dead - They Moved to Treasuries

This is one of the oldest trading correlations:

bullish treasuries = bearish equities

and vice versa: bearish treasuries = bullish equities.

When yield starts to get negative or close to 0 then you have a turning point (13 week or 3 month note). After all traders can't give the govt more money than they're already lending out for very long. The same thing happened one month ago in October when TED was above 4.0.

This time the catalyst is not TED but rather the fear of collapsing CRE (commercial real estate) and the rapid decline in Citicorp's share price. I'm seeing dividends on commercial REITs at nearly 100%! That is ridiculous. And completely oversold. Citicorp however is anothe story.

Wednesday, November 19, 2008

The Debts of the Spenders: The Coming Collapse of Commercial Real Estate

The perception of value in US commercial real estate has completely evaporated in November as this chart from CMBX illustrates. The chart maps the staggering jump in CDS insurance or the cost of using credit swaps to protect corporate bonds and loans from default.

Interest rates on U.S. commercial paper also rose to the highest in almost two weeks, according to yields offered by companies and compiled by Bloomberg. This is reflected in the yield (aka borrowing costs) in terms of basis point increases. Traders are pricing in higher yields as paranoia now rules the day.

To be fair, a contrarian viewpoint is that these elevated levels are not based on reality but rather pure fear. A short term turnaround - if not capitulation - could be around the corner.


Wednesday, November 12, 2008

The Debts of the Lenders: Russian Default Risk Rises Exponentially

I think an oil supply shock, in a critical and volatile region, would be of great help to Moscow and other exporters.

"To say Russia has quickly been humbled would be an understatement.
After a brief period of complete shock, expect a sudden outburst of
absolute rage from the Russian people and Russian politicians as they
squarely lay the blame for their instant fall from grace on 'the
West'. Unfortunately Russia's regional neighours are likely to bear
the brunt of that blind rage."


Tuesday, November 11, 2008

The Debts of the Spenders: Storm Clouds Gather Over Treasuries Pt 2

Treasury bond investors - such as pension funds and other institutions - stand to lose billions and potentially trillions of dollars in the coming months.


Higher interest rates on future bond issuances will lower the value of existing treasury holdings. This is unlikely to be a problem w/shorter term issuances such as the 3 year or lower maturities. However, it spells big trouble for bonds that have longer dated maturities.

10 year Treasuries still offer yields below 4% (roughly 3.75-3.8% the last time I checked). Throw in several more trillion dollar bailouts of the financial, auto, insurance, and other industries currently begging at Washington's doorstep and you have the formula for a meteoric rise well north of 4-5%.

Rising inflation is also a problem in the future as the US government continues to run their printing presses 24/7.

Ironically, a steep yield curve has been beneficial to banks as it reduces their borrowing costs while raising the return on their loans. This is yet another example of Paulson and Bernanke's unintended consequence of unlimited bailouts: robbing Peter to pay Paul.

The Debts of the Spenders: US Is Already Bankrupt

The US dollar is a monetary fiction. But that pretense will persist as long as there is no other reserve currency alternative to the dollar.


Thursday, November 6, 2008

The Debts of the Spenders: Everyone's a Billionaire in Zimbabwe

Inflation expectations can turn even your average person into a billionaire. Zimbabwe reported an official inflation rate of 231 million percent this year.

The Debts of the Lenders: The End of the Carry Trade Part 5

Wall St trading desks on leverage are contributing to their own demise!

First, a lot of them bet on $200 oil and $9 corn. Second, they betted on each others' demise through CDS. Third, they betted on a strong euro. And finally, they're betting on a strong yen.

Ironically the yen is at the heart of all the prior bets since a cheap yen fueled easy borrowing. Now, you have the currency trading desks bidding up a strong yen while the arb and prop desks frantically try to unload their losing trades. And this is going on in the same house!

``An intervention to change the yen's rising trend would be like trying to stop a tsunami with one hand tied behind your back,'' Toru Umemoto, chief currency analyst in Tokyo at Barclays Capital, said in an interview on Oct. 28. The unit of London-based Barclays Plc is the third-largest foreign-exchange trader.


Wednesday, November 5, 2008

The Debts of the Spenders: Federal Reserve Continues To Pay Banks

And banks STILL refuse to lend. No surprise there as the only people w/credit have always been able to get credit while those w/poor credit. . . have poor credit for a reason.

WASHINGTON (MarketWatch) -- The Federal Reserve on Wednesday said it has raised the interest rate paid to banks on reserves that banks keep with it. The Fed said the latest formula for excess reserves sets the interest rate at the lowest FOMC target rate in effect during the reserve maintenance period. The previous formula set it at the target rate minus 35 basis points. The rate on required balances will be set at the average target fed funds rate over the reserve maintenance period. The previous formula set it at minus 10 basis points. The Fed said these changes would help foster trading in the funds market at rates closer to the FOMC's target federal funds rate. In recent weeks, trading has been below the Fed's target. The Fed said the new formula for paying interest on reserves -- an authority the Fed received as part of the Congressionally approved $700-billion bailout program for financial firms -- will be effective from Thursday, November 6.

Saturday, November 1, 2008

The Debts of the Spenders: Storm Clouds Gather Over 10 Year Treasuries

The bond markets rarely lie. I find them to be a reliable indicator of medium-long term economic sentiment.

Medium term government paper is another canary in the coal mine. Traditionally, 10 year notes occupy the middle ground between the extremes of short term (13 week - 2 year) and long term (30 year) paper. The fact that they are veering towards bearish sentiment is troubling for the US government.

The short term paper has seen yields driven down to below 0 at several points in October because of a flight to safety. Meanwhile, the longer term paper continues to maintain an upwardedly biased yield curve (despite some minor down movements also based on a flight to safety). This is no surprise as interest rate risk rises to match uncertainty when the time horizon expands.

Some commentators believed that medium term paper yields were supposed to fall. Instead the opposite happened. Rates rose.

I believe this is an ominous sign. EVERY SINGLE world government is flooding the bond markets w/paper. EVERYONE. Foreign Treasuries are doing this to finance the gigantic budget deficits arising from new bailouts and existing social spending programs.

The US government has to compete w/these new issuers for bond buyers' attention. While rates here are relatively low, they are sure to rise in the future.

Short term paper is continuing to offer low yields because they are the extension of central bankers' wills. However, central bankers are powerless to determine longer term interest rates. No. Long term rates remain under the domain of the markets.

Treasury Auction Schedule: