Thursday, August 5, 2010

The Debts of the Spenders: The Stock Bulls Do Have a Case. Kind Of.

The stock bulls have a fair value case. I know its not trendy to talk fundamentals anymore but bear with me. With interest rates so low, the P/E values don't look so bloated anymore.

If interest rates are double digits, the present value of a dollar that you're going to receive in the future from an investment is not nearly as high as the present value of a dollar if rates are 4% (which happens to be the rate of a 30 year treasury). In other words, a dollar of future profit becomes that much more valuable.

There has also been much talk about Bernanke restarting the bond purchase program again. This is synonymous with steady low rates.

And many companies are sitting on cash hoards. That means they wil either have to invest in plant/equipment, labor (hah!), or start giving out bigger dividends.

In fact, with bond yields so low and some asset classes like mortgage securities trading above par, then it seems buying a bunch of blue chip stocks that yield consistent divvies is the way to go. Just stuff them in your IRA and wait for capital appreciation. Few financial advisors will tell you this because they can't make any commissions off this strategy.

I also urge readers to look at this article for some historical context. Note the year it was published:
*Credit goes to Kauneongal for the IRA strategy.

Tuesday, August 3, 2010

The Debts of the Lenders: China on the Soapbox Again About US Treasuries

More harsh rhetoric about US fiscal profligacy. Chinese buyers, represented mostly by the state, are growing increasingly vocal in their criticism for the US to follow a European style austerity plan. . . . or else.

“I do not think U.S. Treasuries are safe in the medium-and long-run,” Yu, a
member of the state-backed Chinese Academy of Social Sciences, wrote yesterday
in an e-mailed response to questions. China is unable to sell the securities in
a “big way” and a “scary trajectory” of budget deficits and a growing supply of
U.S. dollars put their value at risk, he said.

“China has to depend more on demand and supply in the foreign exchange
market for the determination of the yuan exchange rate,” Yu wrote. “Only God
knows how much value that China has stored in the U.S. government securities
will be left in the future when China needs to run down its reserves.”

“The U.S. government has strong incentives to reduce its real burden of
debt through inflation and dollar devaluation,” he said. “Whichever way it is,
the yuan-recorded market value of Treasuries will fall, causing huge capital
losses to China’s central bank.”

Sunday, August 1, 2010

The Debts of the Lenders: China's Silk Road to Latin America

Great article from Bloomberg.

“The potential for inter-emerging market trade is ginormous,” said Jim
, chief economist at Goldman Sachs Group Inc. in London, who coined
the term BRIC in 2001 to describe the rising role of Brazil, Russia, India and
China. “That makes it quite difficult to see how you get a sustained global
recession because of what’s going on in the west.”

Saturday, July 24, 2010

The Debts of the Spenders: The Dodd-Frank Wall Street Reform and Consumer Protection Act (“WSRCPA”)

Just a quick overview of the recent US financial reform laws. The changes are sweeping and this is not meant in any way to be comprehensive. Updates will be posted as changes are made.

The law is formally known as the Dodd-Frank Wall Street Reform and Consumer Protection Act (“WSRCPA”). Readers interested in the Too Big To Fail aspect should focus on Title 2 (see below).

The Banking Lobbyists' perspective:

For a timeline of when the rules will be effective:

The other ABA (American Bar Association - which is not to be confused with the American Bankers Association) also has its own views and is having several upcoming programs:

One of the biggest changes is the introduction of the OLA, or Orderly Liquidation Authority, which REPLACES Bankruptcy Court under the auspices of the FDIC (the OLA is part of the FDIC) under Title 2. The OLA will be responsible for probating the "living wills" of too big to fail institutions. All legal challenges will fall under the APA (Administrative Procedure Act) which governs nearly all federal agencies - (you can be sure there will be plenty of legal challenges being filed in the coming months).

Also, many of the aspects covered in the Cadwalader (a major white shoe law firm) legal memo made it to the final law.

Saturday, July 17, 2010

The Debts of the Lenders: How Much Further Can the Yen Rally?

The Yen has been on a wild tear in recent days, notching impressive gains against the dollar on safe haven flows. Additionally new laws on Japanese leverage limits are imposing margin calls on speculators.

The introduction of leverage caps on foreign exchange margin trading in Japan in the coming month is likely to place pressure on the Australian dollar/yen cross rate, according to research by the Royal Bank of Canada.

The Japanese regulator will impose a cap of 50 times leverage on collateral for margin trading at the start of August to curb currency speculation by retail investors. The cap will be further lowered to 25 times from August 2011.

So, where does support and resistance lie? There is still further room for a rally. Up to 85 or 118 on the corresponding $XJY index which closely matches the CME and Globex price quotes. This represents the currency's 14 year low which was reached late last year.

At these levels, it is likely that the BOJ will take steps to intervene. The bank has already released official statements that they are watching the situation closely.

July 15 (Reuters) - Bank of Japan Governor Masaaki Shirakawa said on Thursday he was continuing to watch currency and stock price moves carefully.

"Yen rises hurt exports short-term while stock price falls have a negative impact on capex and consumer spending," Shirakawa told a news conference.

"While the yen's rise and stock price falls may affect Japan's economy I expect it to remain on a recovery trend."


Tuesday, July 13, 2010

The Debts of the Spenders: Chinese Rating Agency Downgrades USA

Along came a Beijing-based rating agency--Dagong International Credit Rating Co. Its first order of business is to downgrade sovereign debt ratings on some major Western nations, while slamming its Western counterparts.
"The reason for the global financial crisis and debt crisis in Europe is that the current international credit rating system does not correctly reveal the debtor's repayment ability."
Dubbed as the world’s first “non-Western” sovereign credit rating agency, in its debut international report, Dagone (means Big Justice in Chinese) downshifted the US to AA with a negative outlook, while UK and France were given AA-; Belgium, Spain, Italy with A-.

Wednesday, July 7, 2010

Correction on Prior Post

*Credit: Tjemme

I confused yield chasing with the effects of inverted yield curves.

The economics textbook explanation was a bit dry so I went and looked at a multi-year chart of the 30 year bond instead. If you go back to the early 1980s, the 30 year yield was hovering around 10% and hit a high of 15% in September 1981. Then it went progressively lower past 1984.

So, those investors who bought at double digit yields reasoned that rates were going even lower in the future. They bet that was their last chance to lock in rates before the bottom fell out. Past 1984, they turned out to be right.

So far, the current scenario does not look like a repeat of the early 1980s. Right now, the Fed is intent on keeping low rates for a while longer instead of tightening. This is not the correct environment for an inverted yield curve.

The 'move up the curve' does not put upward pressure on short-term rates. Chasing yield only in this way only works when long-term yields are higher. Chasing yield effect works by slowing pushing down the yieldcurve starting from the beginning. Inversion contradicts chasing yield.

The Debts of the Spenders: The Dangers of an Inverted US Yield Curve

Economists and traders believe that inverted yield curves are a sign of impending recession. It is possible but rare for the longer end to have lower yield than the front end of the curve. Potential causes include direct US Federal Reserve intervention, Chinese and Japanese sovereign buying, and finally yield chasing by funds. It is this last point that I want to bring my attention towards.

In theory, lower yields are supposed to push businesses towards renewed economic activity by lowering their borrowing costs. The private sector is then able to finance expenses like plant and equipment, back office updates, and labor costs more cheaply than if rates were higher.

Unfortunately, reality is a different story. Generally, the US business sector remains leery of renewed spending and has instead slashed costs to the bone by enacting their own fiscal austerity measures - firing unnecessary workers, gutting expense accounts, and deliberately slowing payment to creditors while pushing for timelier payments towards their own customers. This is a normal reaction to a recession.

Instead of pushing business borrowing up, the current easy monetary stance is pushing speculators to borrow money at lower short-term interest rates and invest it in higher return assets - either in equities (which is Bill Gross' latest argument) or higher yielding debt (such as private sector high yield, emerging market bonds, or Greek government debt). However, because the buying mandates of many institutional funds require managers to buy investment grade only, they will inevitably turn towards longer dated US government debt. This effectively puts upward pressure on short-term rates and downward pressure on long-term rates.

The end results will not be pretty when rates do rise. Whoever bought all this high yield debt will lose a lot of money . . . even comparatively speaking if they were to hold until maturity.

My final cause of concern is that Bernanke himself believes that inverted yield curves are nothing to worry about. Bernanke has been wrong about a lot of things so whenever he's championing a particular idea I tend to be suspicious about it. When Bernanke made this speech it was in 2006 - then the height of the credit bubble. Well, we both know what happened in the 4 years since then.

The Debts of the Spenders: European Stress Tests A Joke But Fiscal Austerity Measures Are Working

Apparently, EU ministers believe that CDS traders and European bond desks are stupid. Their stress tests do not account for any sort of default scenario. This is ironic considering how a potential Greek default has led to a freeze on interbank lending among the PIIGS. Besides the more obvious triggers of outright bankruptcy and delays, please also note that the legal language of most CDS contracts states that a debt restructuring CAN lead to a default. Such catalysts are referred to dryly by lawyers as "credit events" and WILL drive the CDS spreads wider.

Of course, when the market tries to act efficiently traders will somehow be blamed for lower prices and higher yields.

FRANKFURT (MNI) – Planned stress tests for European banks will cover their resistance to a crisis in the market for European sovereign debt, but not the scenario of a default of a Eurozone state since the EU would not allow such an occurrence, a German newspaper reported Wednesday.

But not everything is bad in Europe - for one thing, the British, Greeks, and Germans seem able to pass an austerity budget - a fact that forex markets have noted with optimism by driving up the value of the GBP and Euro in recent days. If only the US could learn that lesson. Unfortunately, our politicians' bad behavior is being subsidized by the Chinese, who continue to buy treasuries blindly.

While default risk remains virtually non-existent at the federal level, the same cannot be said of state and local finances. The US muni market which consists of state and municipal finance is facing severe funding problems.

"Commercial lenders added more than $84 billion to their holdings since 2003, according to the Federal Reserve, pushing total investments to $216.2 billion at the end of the first quarter. Bank regulators and ratings companies are ramping up scrutiny of banks most at risk of being forced to raise more capital should debt prices slide.

“There is a huge untold problem here,” said Walter J. Mix III, a former commissioner of the California Department of Financial Institutions who closed 30 banks during the last banking crisis in the 1990s. “The economics lead to the conclusion that there will be downward pressure on these bonds.”

Default speculation and a move by investors to the safest securities drove municipal bond yields to a 13-month high relative to U.S. Treasuries in the first half of the year. Now, the Federal Deposit Insurance Corp. has asked analysts to look into the issue, according to spokeswoman Michele Heller.

U.S. states are likely to face $140 billion in cumulative budget gaps in the coming year, according to the Center on Budget and Policy Priorities. Last year, 187 tax-exempt issuers defaulted on $6.4 billion of securities, the most since 1992, according to data from Distressed Debt Securities in Miami Lakes, Florida.

“It’s a market where it’s clear that the underlying fundamentals are lousy,” said Michael Aronstein, chief investment strategist at Oscar Gruss & Son Inc., a New York- based brokerage. “People can say fundamentals don’t matter but I’ve been doing this for 32 years. They do.”

Tuesday, June 29, 2010

The Debts of the Spenders: PIMCO Blasts Fannie and Freddie for MBS Manipulation

And here I thought PIMCO would be happy with these high prices. . . Oh wait, they sold most of their MBS months ago. For more irony, compare this story against the backdrop of strategic home defaults where 1 in 5 or 20% of homeowners (err...isn't that the wrong term?) choose to default on their mortgages even when they have the funds to meet payments.

"The 30-year 5.50 percent coupons are insanely expensive," Scott Simon, head of mortgage and asset-backed securities at Pimco, manager of the world's biggest fixed-income fund, said in an interview with Reuters. "If they (Fannie and Freddie) could make the most money selling agency MBS, they should."

The global financial turmoil has benefited not only U.S. Treasury securities, but also agency MBS as foreign and domestic buyers have sought the relatively safe-haven investments.

But Simon also said prices on the MBS are too rich for his taste.

"Even if this coupon cheapened a full point, I would still not like them and we are not even close to levels where I would consider buying them," he said.

"We have to assume that somebody must have been telling them not to sell," Simon said. "They are not supposed to be running a business where they lose money holding on to their positions."

Thursday, June 24, 2010

The Debts of the Lenders: Bill Gross Claims Stocks Will Outperform Bonds Within the Next Few Years

Continuing on the bond vein, Bill Gross of the famed PIMCO bond fund, came out today and said that now is the time to go long equities (when has he ever said that?). His argument is that the bond rally of 2008-2010 is at its peak and we'll see bonds lose their value as interest rates slowly climb.

I think he's got the right idea about the eventual return on assets but I have my doubts about his timing - especially after the Fed confirmed low rates again at this week's meeting. Continuing distress in European and US credit markets means that the 10 year yield may see 290 or lower. (The last time that occurred was in the dark days of Fall 2008 and early spring 2009).

Note - the right chart is of the 10 year yield which is inverse to price. The left chart is of the US corporate bond returns from July 2009 to the present.

If you are curious to know more information about bond returns click here to sort bonds by total return, yield, price, and volume.

The king of bonds is now talking up stocks as a better long-term investment. He says that as U.S. Treasury returns fall, investors will have to take more risk with high-yield bonds, equities and, eventually, real estate.

“If you're talking about the next 10, 15, 20 years, there's certainly the recognition that assets will grow faster in those categories,” he says. “Over the long term, stocks return more than bonds when appropriately priced at the beginning of an investment period.”

The Debts of the Lenders: Mortgage Bonds Rally On Irony

Several months after Bernanke ended his purchase of MBS securities, the market is seeing even loftier heights. The reason?

Speculators are betting that since the housing market remains weak so too will mortgage refinancings. (Lending standards are a lot tougher and so are the supply of mortgage brokers). Combine that with a limited supply of bonds and you have a recipe for bonds trading well above par.

Even PIMCO, the fixed income giant that spearheaded the initial MBS purchase drive in late 2008/early 2009 was stunned by the rally in prices.

The average price of $5.2 trillion of bonds guaranteed by government-supported Fannie Mae and Freddie Mac or federal agency Ginnie Mae climbed to 106.3 cents on the dollar yesterday, according to Bank of America Merrill Lynch’s Mortgage Master Index. That’s up from 104.2 cents on March 31, when the Federal Reserve ended its program purchasing $1.25 trillion of the debt.

“It’s gotten insane,” said Scott Simon, the head of mortgage-backed securities at Newport Beach, California-based Pacific Investment Management Co., manager of the world’s biggest bond fund. “This is rarefied air.”

So, what could cause the rally to end? If the government were to figure out a way to force lenders to re-finance (profitably).

Here is some historical perspective:

Tuesday, June 15, 2010

The Debts of the Spenders: Greece Attracts Chinese Investment

Earlier this year, China had rebuffed efforts by the Greek government to invest (e.g.bailout its moribund banking sector). But apparently all that has changed now. China is apparently realizing its responsibility to the rest of the world as a key pillar of economic stability - even if such efforts may lead to months or even years of initial losses.

A delegation led by Zhang Dejiang, a Chinese vice-premier, will seal a series
of agreements on Tuesday with local companies, a Greek government official

“These concern maritime affairs, telecoms and a project to renovate a
landmark tower building in Athens’ port of Piraeus,” the official said.

Deals for joint ventures, charter agreements and shipbuilding deals worth
€500m ($615m) with Greek shipping companies will also be signed.

China’s state shipping company Cosco already controls a container terminal at Piraeus under a €3.4bn long-term concession deal. Cosco is expected to make a joint bid later this year with Greece’s state ports company to create a €150m-€200m logistics hub near Athens to distribute goods for China in the Balkans.

Friday, June 11, 2010

The Debts of the Spenders: The Continuing Greek Tragedy

Here's the problem. Greece cannot devalue its currency.

Since the beginning of the euro, Germany has become some 30% more productive than Greece. Very roughly, that means it cost 30% more to produce the same amount of goods.

Labor costs must fall by a lot. And not by just 10 or 15%. But if labor costs drop (deflation) then that means that taxes also drop. The government takes in less and GDP drops.

It looks like Greece will have to eventually leave the Euro someday. Just imagine the legal bills involved because all the contracts are in Euros. That will be a great day for the lawyers.

So in the meantime, banks that have pledged to refinance (e.g. are holding Greek government bonds) are stuck in a game of Prisoner's Dilemma where each side is waiting for the other to engage in mutually harmful retaliation.

(Prisoner's Dilemma is a popular Economics/Political Science stratagem taught to university students. It is a study of BEHAVIORAL economics rather than RATIONAL economics and was popularized during the Cold War to study the effects of Mutually Assured Destruction). The emphasis on behavioral economics is not accidental - studies have repeatedly shown that actors rarely act in their best, or rational, interest.

Here is how one analyst describes the current situation:

“From an individual bank’s perspective, it would be great to get rid of the sovereign debt,” Hoffmann-Becking said by telephone. “However, if everybody did it you’d have a rapid collapse of the government bond market and then you’d have the default. And in the default, the fact that you have no sovereign debt actually doesn’t help you at all.”

The Debts of the World: Where Do We Grow From Here? Part II

A history of US federal interventions (bailouts):

A) Late 1970s - US bails out municipal bonds by guaranteeing state and some local (NYC) bonds.

B) Early- Mid 1980s - US bails out third world nations and Latin America via Brady Bonds.

C) 1989 - US bails out commercial real estate via the Resolution Trust Corporation

D) 1997-1998 - US bails out emerging markets in Asia via IMF.

E) 2008 - US bails out investment banks (except Lehman Bros) via TARP and sovereigns holding housing finance agency bonds (Fannie and Freddie Mac).

F) 2009 - US bails out municipal bonds (again) by underwriting the Build America Bonds (BAB) which covers interest payments for the states.

G) 2010 - US pressures EU to bail out itself while granting hundreds of billions dollars in currency swap guarantees

Notice a pattern here?

The current crisis is not materially different from past crises (except in the scale). America's net worth is TRILLIONS of dollars. We are the world's biggest consumer and driving engine. A few trillion here and there will not destroy us.

The formation of the EU itself would not have been possible without America's help. A continent that had been at war with itself for hundreds of years has endured 60 years of peace because of a US taxpayer funded NATO. European nations that were used to, on average, one war every generation suddenly found quiet. Even the Balkan conflict in the 1990s has been (largely) resolved through American military power.

Debt is fine as long as there is productivity growth behind it. The EU's formation was supposed to usher in a period of productivity. Instead, it produced a stagnant continent that has grown used to some of the highest living standards in the world. But how can governments pay for it?

Let's look at productivity gains. Growth from the last generation of innovative American companies (there is a distinct lack of start-ups in Europe due to business cultures and government tax regulations - Indeed, the tax burdens behind the EU bailout will stifle growth even more.) is falling.

The Microsofts, Dells, and Intels of the 1980s and 1990s have turned into moribund mega-corporations with smaller profit margins. Generally, past innovations are already factored into equity share prices. Maintaining the past pace of productivity will be difficult. Which is why the world is looking to the India's, Brazil's, and China's for the next big gains.

The Debts of the World: Where Do We Grow From Here?

Growth is only one factor. The more important thing to examine is PROFITABLE growth. Let us examine a country that is always on the lips of pundits - China.

Much of China's growth is real but whether such growth is strengthening the economy is questionable.

Chinese growth, much like Japan in the 1970-80s, is living off the legacy of cheap, government controlled money and low prices. While the entire world was lauding the "Japanese economic miracle", the entire structure was rotten from within. The number of NPLs (non performing loans) grew steadily. Instead of writing off losses, the corporations - with the connivance of the state - covered up the losses with even more losses to keep the system alive. More alarmingly, the demographics began to shrink. All this came to a head on December 29, 1989 when the Nikkei reached an intra-day high of 38,957.44 before closing at 38,915.87.

The following 20 years were not pretty.

We are beginning to see the same things in China. Except China's 1 child policy will only make things worse.

Smarter people than me have already written volumes about this. But I'll put things in recent perspective. The spate of suicides in Chinese sweatshops is a symptom of a systemic problem - a corporate culture wedded to near term profit and nothing else.

Besides cheap labor do you know what the other Chinese competitive advantage is?

"Quality Fade."

Quality Fade is a term made by Paul Midler, an old China hand who is an importer agent stationed in southern China.

Made in China may be more expensive than you think. There are many reasons why a manufacturer would agree to make merchandise for next to nothing. One reason is that "switching costs" in manufacturing are high. It was important to many manufacturers to catch the order first. Later, once the importer was relaxed and the orders were assured, the factory could raise prices bit by bit, and then quality could be cheapened. After winning the initial order, many Chinese suppliers systematically degrade the quality of their production in order to cut costs.

I highly encourage all to read "Poorly Made in China" which covers this in more detail:

Or for those with less time:

Thursday, June 10, 2010

The Debts of the Spenders: EU Pledges Unlimited Support for PIIGS Bonds

June 10 (Bloomberg) -- Jean-Claude Trichet said the European Central Bank will extend its offerings of unlimited cash and keep buying government bonds as it tries to ease tensions in money markets and fight the European debt crisis.

“It’s appropriate to continue to do what we’ve decided” on purchases of sovereign and corporate bonds, Trichet, who heads the ECB, said at a press conference in Frankfurt today. Earlier, the central bank kept its benchmark interest rate at 1 percent. “We have a money market which is not functioning perfectly.”

The ECB is buying state debt and pumping unlimited funds into the banking system as part of a strategy by European policy makers to stop the euro region from breaking apart. While Trichet refused to bow to some investors’ demands for more details on the bond purchases, he said the ECB plans to offer further help to banks struggling to raise cash in money markets.

Friday, June 4, 2010

The Debts of the Spenders: US Homeowners Walking Away From their Mortgages

A growing number of the people whose homes are in foreclosure are refusing to slink away in shame. They are fashioning a sort of homemade mortgage modification, one that brings their payments all the way down to zero. They use the money they save to get back on their feet or just get by.

“Instead of the house dragging us down, it’s become a life raft,” said Mr. Pemberton, who stopped paying the mortgage on their house here last summer. “It’s really been a blessing.”
This type of modification does not beg for a lender’s permission but is delivered as an ultimatum: Force me out if you can. Any moral qualms are overshadowed by a conviction that the banks created the crisis by snookering homeowners with loans that got them in over their heads.

Sunday, May 30, 2010

The Debts of the Lenders: Chinese Bond Holders Demand Higher Interest Rates

In a sign that bond holders of Chinese property developers are growing impatient, the market raised rates as the prospect of risk appetite diminishes.

Yields on the $3.9 billion of bonds issued by Kaisa Group Holdings Ltd., Country Garden Holdings Co. and seven other developers since January widened by an average 2.26 percentage points relative to Treasuries as of last week, according to data compiled by Bloomberg. That’s more than the 2.05 percentage- point increase in spreads for the seven dollar-denominated bonds sold by other companies in Asia outside Japan.

Investors are demanding greater yields to lend to China property firms, a sign they expect borrowers will have a harder time meeting debt payments amid a government clampdown down on lending. Goldman Sachs Group Inc. and Credit Suisse Group AG cut their profit estimates for Chinese real estate companies after a 12.8 percent rise in real estate prices in April from a year earlier spurred the state to increase regulation.

Friday, May 28, 2010

The Debts of the Spenders: An Interesting Look at the US Stock Market

Is the smart money always right? Take a look for yourself with the Commitment of Traders report as published by the CFTC and released every Friday. Note the large drop in OI in mid-March as small specs went bullish and big players reversed or just dropped out of the game altogether.

This hearkens to a point that popular Zerohedge blogger has repeatedly made - the stock markets are run by hi-fi trading machines and not real volume.

Monday, May 24, 2010

The Debts of the Spenders: British Austerity Package - 300k Jobs to Be Cut

There was a time when the British Pound was considered a flight to safety "haven" trade. With measures such as these, perhaps it may regain that status once again. Will Greece have the courage to take such measures? Recent evidence shows that it alas does not.

Thursday, May 13, 2010

The Debts of the Spenders: ECB Cuts Back on Bond Purchases

After last weekend's pan-European bailout more details are beginning to emerge. Faced with internal dissent over rising inflation concerns, the central committee trimmed purchases of Spanish and Italian bonds. Most of the ECB’s bond purchases seem to have been made on May 10, the first day the rescue plan was in force, and buying has diminished since then.

Further details on exactly how they plan to sterilize or keep monetary purchases from spilling over into the broader market will be released later.

Sunday, May 9, 2010

The Debts of the Spenders: EU Agrees To Print Almost $1 Trillion and Buy Government Bonds

"Death to speculators!" was the rallying cry heard round the weekend as European leaders struggled to contain the Euro from crashing. One wonders where exactly they will get the money to do so. The answer of course, is the printing press, or more accurately off balance sheet transfers to ensure a smooth flow of liquidity (e.g. credit moving around the world). Nearly all of these transfers will be done at the institutional level and between psuedo government agencies such as the IMF and World Bank. This measure is critical as it prevents runaway inflation from entering the wider economy. . . .at least temporarily.

The Debts of the Lenders: Turkish Growth in Stark Contrast To Greek Shrinkage

The whole irony behind the Greek drama is the concurrent rise of its age old rival, Turkey. A large part of the fiscal imbalances were brought about by military spending in preparation for a potential war in the Aegean over Cyprus.

But this conflict was ages ago and the political situation has calmed down quite a bit with the Turks routinely begging for entry into the EU zone every few years. The Turks have a dynamic, growing economy that is poised to overtake every other nation within the EU bloc. Indeed, the perenially high interest rate banking sector is finding itself enjoying a period of relative calm amid the chaos being wrought just a few kilometers away from its borders.

Perhaps nothing is more ironic than Turkey turning away the IMF at the very same time that its neighbor is begging for foreign intervention.

In March this year it sold $1 billion of 11-year dollar-denominated bonds at the lowest yield on record, after the government decided it did not need help from the International Monetary Fund.
If Turkey had joined the EU then its fortunes would've been tied to a moribund political economy with decisions made by bureaucratic vote instead of the independence necessary to launch itself upwards.

Additionally, the larger and more youthful demographic make for a more appealing picture than the image of aging Greek pensioners burning rubber tires or firebombing their local banking branches.

Finally, its close proximity to Iraq may be considered a boon instead of a burden. The security situation has calmed down considerably since the martial law era of the 1970s and 1980s when Kurdish insurgents ran amok throughout the countryside. While a de facto Kurdistan exists in northern Iraq, the US presence in the region has actually stabilized the situation instead of inflaming it. While Turkey may not be able to benefit directly from the oil wealth in Iraq, its economy may experience secondary bonuses such as improved trade links via a land route that was formerly closed off during the Sadam years.


The Debts of the Spenders: UK Rejects EU Bailout Fund

More to come later. This is a developing story.

EU leaders are worried that financial markets will continue to lack confidence in countries with high deficits.

Officials and diplomats in Brussels hope that a stabilisation mechanism will calm the international markets' fears about default in Europe.

But the loan guarantees are too much for the UK to swallow, and the UK Treasury will have nothing to do with them. Without the UK onboard the package looks pretty thin.

Friday, May 7, 2010

The Debts of the Spenders: EU Nations Establish Emergency Fund to Defend the Euro

Faced with a total collapse of the Euro, Eurozone leaders vowed to create a stability fund to save their currency. The bureaucratically stodgy institution was shocked to its core after months of haggling over the Greek bailout turned out to be for naught. Leaders believed the 110 billion Euro bailout package for Greece would be the backstop required to return confidence to the markets.

The ECB's normally placid meeting on Thursday failed to create confidence after ECB President Trichet refused to discuss the "nuclear" option of pulling a Bernanke (e.g. having the ECB buy sovereign debt). The lack of any meaningful price action in PIIGS market debt has forced 2 year yields to double digits this week. While attractive at first glance to junk buyers, the high yield reflects the market's concern that the Greek government will be forced to re-structure - e.g. pay less than face value - on government debt.

Instead, their actions served only to produce the largest rise in implied volatility ever - exceeding 2008 levels.

Now, Eurozone leaders are working furiously over the weekend to create a continental bailout package. Notably absent from the table however was any mention of buying government bonds. Failure to do so would result in European financial institutions - banks, pension funds, and insurance companies - facing enormous losses. There are no easy solutions here. Even a re-structuring of government debt obligations would result in further write offs. But at least it would be amortized over time instead of vanishing in a blink of an eye (e.g. kicking the can down the road for another generation to handle).

Some notable quotes:

“We will defend the euro, whatever it takes,” European Commission President Jose Barroso told reporters early today after the leaders met in Brussels.

“When the markets re-open Monday, we will have in place a mechanism to defend the euro,” French President Nicolas Sarkozy said. “If you don’t think that’s significant, you haven’t been to many EU summits.”

Europe will send “a very clear signal against those who want to speculate against the euro,” Merkel said.

All agreed on “the need for a clear, timely and strong response,” Canadian Finance Minister Jim Flaherty, who chaired the call, told reporters in Ottawa. “We hope to see a strong, early policy response in Europe.”

Europe’s unprecedented lending pledge has “proven insufficient to stop market contagion to the rest of the euro- zone periphery,” Michael Saunders and other economists at Citigroup Inc. said in an e-mailed note before the summit.

Thursday, May 6, 2010

The Debts of the Spenders: LIBOR OIS Spread Widens to 2008 Levels

Markets are pressuring Trichet to pull a Bernanke and have the ECB buy European government bonds (Bernanke was responsible for structuring the agency debt MBS program under the Federal Reserve).

May 6 (Bloomberg) -- Money markets show banks may be increasingly reluctant to lend to each other on concern that quality of collateral backing short-term loans is diminishing as government finances in Europe worsen.

The spread between the three-month dollar London interbank offered rate, or Libor, and the overnight indexed swap rate rose to the most in more than five months, reaching 13.4 basis points today. The so-called Libor-OIS spread has increased from 6 basis points on March 15.

Tuesday, May 4, 2010

The Debts of the Spenders: Bond Vigilantes Call IMF's Bluff

After pledging over 100 billion euros to bail out Greece, the IMF and ECB thought that the Greek contagion was over. They could not be more wrong. CDS on the other non-Greek PIIGS countries (Portugal, Italy, Ireland, and Spain) have expanded wider in anticipation of further bailouts while the Euro continues to sink like a rock. Fiscal stability, it seems, is irrelevant as the market is pricing in further bailouts.

Of course, the lenders of last resort, the US Federal Reserve, is always ready to step into the pipeline as a guarantor with swap lines (a la 2008).

Some questions that need to be answered before the Americans can step in:

- Will European MPs (members of Parliament) approve the package?
- What is the final bailout sum?
- What form will the aid arrive in?
- Will the IMF Completely Change the Rulebook because of Europe?

Thursday, April 29, 2010

The Debts of the Spenders: Is the EU's Collapse Imminent?

Greece's fiscal problems are weighing down the rest of the EU as fund managers ponder the potential end of monetary union.

Thursday, April 22, 2010

The Debts of the Spenders - Dollar Strength Correlated with the Market

Time for some technical analysis talk.

As you can see here, the US dollar has been making higher highs and higher lows on the daily chart. Additionally, the MACD and RSI have stayed above the water line. The dollar has also moved back above its 50 day MA.

Note the similarity to the S and P 500 chart.

Sunday, April 18, 2010

The Debts of the Spenders: Bill Clinton Regrets Repeal of Glass Steagall

Former US President Bill Clinton admitted to bad judgment in a tv interview. Specifically, Clinton blamed Robert Rubin and Larry Summers for deceiving him about the risks of unregulated derivatives products. Under Clinton, the Depression era Glass Steagall Act that separated banking activities from trading was dissolved.

Provisions that prohibit a bank holding company from owning other financial companies were repealed on November 12, 1999, by the Gramm-Leach-Bliley Act, named after the influential senators who were bought and paid for by the banking community. As for Robert Rubin, immediately after his term as Treasury Secretary expired, he was appointed head of Citigroup Travellers with a $1 billion/annual paycheck. Completely coincidental? You decide.

Clinton also said that Republicans who controlled Congress would have stopped him from trying to regulate derivatives. “I wish I had been caught trying,” Clinton said. “I mean, that was a mistake I made.”

Saturday, April 17, 2010

The Debts of the Lenders: China to Curb Real Estate Bubble

Affordable housing in China is a joke. Instead, the real estate market - along with the stock market - has turned into a giant casino. Fund flows from Chinese investors are contributing to the bubble because of strict capital controls that remain on where, what, when, and how (regular) native Chinese can spend their funds. Thus, this news is encouraging - even if it appears to be yet another round of mere talk instead of more substantive action.

Surging Prices

Property prices in 70 major cities surged 11.7 percent in March from a year earlier, the most since records began in 2005, government data showed last week.

In an April 15 statement after the release of first-quarter numbers for gross domestic product, the State Council said that local governments have failed to control speculation. Besides limiting the risk of price bubbles, policy makers want to keep housing affordable.

Monday, April 5, 2010

The Debts of the Spenders: Bond Buyers Demand Protection Against Downgrades

Step-up bonds are bonds whose interest increases if a borrower is downgraded (but not defaulted). According to a report by Bloomberg, sales surged to $37.3 billion in March, or 12.4 percent of all debt issued.

Please note that most of these bonds are issued by PRIVATE companies as opposed to sovereign entities such as national and/or local governments (Greece and various American cities/states/local governments come to mind).

Moreover, it is important to distinguish step-up bonds from credit default swaps as they focus on interest rate increases as opposed to an outright insurance payment (which is usually triggered only by default. This response is not unusual considering that the greatest inflow into bond funds by investors occurred in 2009. There is not much room left for additional gain so those corporate issuers late to the refinancing party must offer additional incentives to attract increasingly discerning lenders.

Friday, April 2, 2010

The Debts of the Spenders: More on Negative Swap Rates

This post is a continuation of the immediate prior post. Here are some questions that I received.

Q) Wasn't the credit crisis driven in part by low interest rates that made investors search for higher yield (risks receiving too little attention)?

A) Yes. But this is part of the West's "Extend and Pretend" recovery rally. If a bank wrote down $40 billion loss in 1 year, they could theoretically break even by making $10 billion/quarter for 4 quarters. Obviously this enthusiasm is not reflected by emerging market nations like India and China which have tried to reign in their own markets by raising rates and/or withdrawing liquidity.

Unlike 2004 (when the markets were also preparing for the end of Quantitative easing) there is a coordinated movement among Western governments (US, Canada, UK, and the Eurozone) and Japan to keep rates low.

Q) Can it be that the negative swapspread partially reflects a credit concern in Treasuries (if cannot be good that Buffett borrows at lower rates than Treasuries - )?

A) Yes and no. It is not so much credit concern as it is the supply issue. Many bond traders (myself included) believe the 10 year will break 4% by this summer. Temporary factors contributing to a rate rise include Obama's Health Care monster bill. But a weak economy driven by deflation and labor figures should drive the 10 year yield below 4% again by December.

Additionally, the Europeans look very weak. Where are traders going to park their money? In pounds and euros? Ha.

The US certainly is not suffering from the same legitimacy questions as Greece, the UK, or Eurozone. That is because the US has 2 magic bullets to refinance its needs - China and Japan.

Q) Why are companies hedging all their long-term interest-rate risk exposure? Doesn't that increase their risks if short-term rates rise again? Do they have too much of a short-term focus?

A) See my answer regarding coordinated Western govt action on rates. The Japanese are also doing their part to fuel the carry trade. So long as they borrow in dollars or yen then there should not be a problem. The market seems confident about the remainder of 2010 but is unsure about the next few years. Hence the need to hedge.

I am also looking at the options volatility for the tone of the market.

The following is a direct quote from

"We seem to be at a crossroads with options these days. On one hand, most
options have an implied volatility near 52-week lows. Who would want to sell
options when they are this cheap?

On the other hand, the only important aspect of an option's volatility is whether it is too high or too cheap relative to the volatility of the underlying instrument itself going forward. Spreads tend to work best as they have the defined risk and defined reward. You can make the same risk case with a straight buy though. All things considered, I prefer taking in credit."
I slightly disagree with the author to some extent and believe that sometimes it makes sense to lay out some debits at these low volatility points. He is championing an iron condor strategy - something that can be very expensive for traders to take on.

Q) It is a sign of confidence that investors are willing to buy long-term credit. But will these turn out to be good investments? The term 'wall of debt' has been used (e.g.

A) The best bond deals are over. Gone are the days when you could buy at vast discounts to par and make 400%-500% in a bond (no, I am not making those figures up - see the preferred/ hybrid offerings for US financials in 2009). The nature of Wall Street is a herd driven mentality. These are the latecomers who are trying to sell their offerings to investors. For the past few months, bond fund inflows have beat equity inflows. That is why forward thinking traders are shifting focus to equities again and commodities. Just look at oil's rise. Corporate coffers are full of cash again and CFOs may commit to stock buy backs this summer (but probably not at these technicals).

Wednesday, March 31, 2010

The Debts of the Spenders: Explaining Negative 10 Year Swap Rates

The yield inversion is a sign of hedging risk against more volatility in the coming months as desks are worried about a potential rise in rate risk.

One possibility behind LIBOR being less than the 10 year yield is that major banks are not positioned properly for it and will lose heavily. But this is not the same thing as a "Black Swan" type event that some commentators are calling for. Certainly not as bad as when the TED spread >4 in Fall 2008. Eurodollar forward contracts are not pricing in disaster as they continue to reflect a belief in ZIRP through the end of 2010.

Indeed, the Fed has stated it has no intentions to raise interest rates soon as they are still testing ways to withdraw the quantitative easing policy that was initiated.

There are three Fed meetings between now and the expiration of the Sept Eurodollar contract (9/13).

Apr 27-28

June 22-23

Aug 10

The job and housing market remain very weak. Inflation remains in check.

In fact, the negative swap rate seems to be NORMAL given the search for yield among fund managers (e.g. demand for higher-yielding assets such as corporate bonds and emerging market securities). A bond is a contract that involves at least two parties. The fund manager buyers are one party. The other is the bond issuer seeking to hedge risk (primarily interest rate risk) .

With low interest rates projected to stay (and the majority of corporate deals still dollar denominated) at ZIRP for the remainder of 2010 and all these corporate borrowers (bond issuers) seeking to sell their debt it is no wonder that swaps turned negative.

But what of the timing you ask at the end of March? The timing can be explained by the end of Bernanke's TOMO MBS program. With the Fed seeking to exit the agency debt market, there are players eagerly waiting to enter the private market again (agency debt market dried up by Q3 2007). There are even NEW private securitization deals happening again (my colleagues at the NY Bar say there are signs of greater deal flow again in the pipeline). The nature of corporate America is to shy away from risk so while they are all eager to make some money they are also reluctant to make the first move. All this explains the heavy demand for swaps.

Tuesday, March 30, 2010

The Debts of the Spenders: Will the Private Sector Replace the Fed as a Buyer of Cheap Mortgages?

This is the thought provoking question asked in a recent Bloomberg article that posits the possibility of private investors returning to the mortgage bond market after the Federal Reserve is due to end its agency TOMO buying programing of Fannie and Freddie linked debt. The Fed's program has been instrumental in keeping long dated (10+ years) fixed rate mortgages below 5%-7% for over a year but is due to expire within a few days. It seems like such a long time ago but the Fed's intervention in the agency debt market was designed to be a temporary measure

The article's writer cites the narrowing spread as indication of just such a transition:

In December 2008, two weeks before the start of the Fed bond-buying program, the spread between the 10-year government bond yield and the average U.S. 30-year fixed mortgage rate was 3.07 percentage points, the widest since 1986, as investors demanded higher payment to compensate for risk. Last week, the difference was 1.14 percentage points, narrower than the 20-year average of 1.65 percentage points.

“Private buyers are going back into the market to pick up where the Fed is leaving off,” said David Berson, chief economist of PMI Group Inc. in Walnut Creek, California. “Credit spreads have narrowed significantly, and not just for mortgages, because investors believe the worst of the financial crisis is behind us.

Fed policy makers have made it clear in statements following the end of rate-setting meetings that they will restart the mortgage-bond buying program if needed, according to Pandl. That “backstop” has reassured investors and encouraged them to re-enter the market, he said.

Much of the demand for mortgage bonds is coming from money managers seeking to diversify their portfolios, said Berson, of PMI Group.

“Investors are full up with Treasuries,” he said. “They haven’t been able to diversify into mortgage bonds because the Fed has been buying the bulk of them. Give them an opportunity to diversify into that market, and they will.”


Additional reading:

Monday, March 29, 2010

The Debts of the Spenders: The US Health Care Bill

Much of the significant tax impact appears to be delayed, but some of the current highlights include:

- An additional 0.9% Medicare payroll tax on income in excess of $200,000 for singles or $250,000 for married couples.
- An additional 3.8% Medicare "unearned income" tax on investment income to the extent it exceeds the same $200,000 for singles and $250,000 for married couples threshold - calculated as a 3.8% tax on the LESSER of investment income or the excess of the taxpayer's income over the aforementioned thresholds.
- A 40% nondeductible excise tax on insurance companies and plan administrators on high cost ("cadillac") insurance plans, if the premiums exceed $10,200 of individuals or $27,500 for families (limits adjusted for inflation).

Saturday, March 27, 2010

The Debts of the Lenders: China's Growing Bubble

The US - China relationship used to be marked about hand wringing recriminations about human rights and Taiwanese arms sales. Those still exist but have been relegated to the backburner before the realpolitik of economic change. China's insistence on keeping a yuan-dollar peg has resulted in a growing amount of inflation and speculative bubbles building up within the country's borders. Shut off from access to Western capital outlets (and after the events of 2008 can you really blame the country's regulators for being suspicious of US-British style finance), Chinese speculators have instead poured money into the country's dual vehicles of wealth acquisition - the stock and property markets.

Indeed, these market malinvestments have resulted in some pretty distorted changes:

SHANGHAI, China — In what may be the hottest real estate market on the planet, one fact of life seems extra cruel. In Shanghai, young women expect their boyfriends to buy a home before proposing.

“There’s a joke that goes Shanghai women can’t find husbands because they want a house, a car and a RMB1 million [$150,000] income,” said 28-year-old (male) sales rep Su Bei.

In truth, choosier women even go as far as to require that a spouse-to-be have paid off the mortgage entirely before popping the question.


HONG KONG—One is a China state tobacco company. Another, a Japanese ramen chain. And finally, there is an obscure Hong Kong semiconductor maker.

What they have in common: They are some of the latest companies to jump onto the real-estate bandwagon as prices soar to gravity-defying levels in Hong Kong and mainland China. Some experts see the growing involvement of nontraditional players as yet more troubling evidence of froth in both property markets.

Last week, a small maker of diodes and transistors called Sino-Tech International Holdings Ltd. shocked investors by announcing that it was "diversifying into the property sector," buying a luxury three-story residence in Hong Kong's swank Peak district for more than HK$280 million (US$36 million) in cash, one of the biggest sums ever for a property here.


The Debts of the World: Low (US) Interest Rates Continue to Dominate Discussion

It's been a while since I last posted because I have been busy with other things in my life. Like focusing on passing 2 state bar exams and working full time. Anyway, I have certainly not been idle on the investment front.

The ongoing credit driven events in Greece and China have driven government yield premiums to higher highs as can be seen here in this dynamic yield curve chart that is overlaid with the benchmark US S&P stock market index:

Is this signs of a normalization?

Late last August, the markets were driven by the inverse dollar - risk premium trade where a lower dollar was directly correlated with higher asset prices in risk related trades such as commodities (and commodity linked currencies like the Aussie Dollar) and equities (particularly emerging market equities). Now, that correlation seems to have weakened with the dollar rising in tandem with benchmark interest rates.

Indeed, markets are continuing to price in a market driven by low US interest rates through the end of 2010 as evidenced by the Eurodollar futures contract (there are 3 more contract dates left in 2010 - June, September, and December. All 3 show that traders expect a continuation of low rates. For brevity purposes, the nearest contract date, June, is listed here).

Friday, February 19, 2010

The Debts of the Spenders: Cities Weigh Chapter 9

Chapter 9 is a seldom used term to describe municipal bankruptcy provisions (re-organizations) if a city or other local government branch falls behind in its financial obligations; e.g. where its cash flow has turned substantially negative. This is not new. Similar fears afflicted the muni debt market in fall 2008 when nearly every financial sector turned south.

But savvy players like PIMCO's Bill Gross saw a chance to buy muni debt and those managers who followed made a tidy return on the severely marked down bonds. Their surge in price was part of a greater tide lifting all boats in the 2009 fixed income rally where HY (high yield; aka junk bonds) outperformed every other sector - equities, commodities, and FX. Munis have historically been considered "safe" as their default rates are a lot lower than private sector actors. The wealthy also use muni's as tax shelter vehicles because many states and jurisdictions make their bond returns tax free for local residents.

Is there another opportunity available here?

Maybe. Maybe not. The environment of fear that led to a technically and fundamentally oversold market does not exist today. Or at least not yet.

Tuesday, February 16, 2010

Agricultural Update: El Nino Waning in 2010?

The widely followed Australian Bureau of Metereology issued its report that the risks of El Nino are lessening. This is important because it means that regular rainfalls will return, which is bearish for agriculture prices since there is less uncertainty over crop yields. But on the other hand, the end of El Nino's warm water effects indicate that the ever volatile energy markets for crude and natural gas may spike in the coming months because of an increase in hurricanes.

Indeed, contracts for active CME grains (May contracts) and Nymex crude (August) are already beginning to display this seasonal effect.

You can click here to see a dynamic stop action map of Pacific sea temperatures from November 2009 to the present:

Australian Bureau: Pacific Indicators Suggest El Nino Waning

Temperatures in the Pacific Ocean suggest an El Nino event is waning, though current patterns are typical of such an event, the Australian Government’s Bureau of Meteorology reported Tuesday.
Surface and sub-surface temperatures remain warmer than average in the equatorial Pacific, but climate models suggest these will cool in the coming months but remain above El Nino thresholds
until April or May, according to the bureau’s weekly tropical climate note.

El Nino events are typically associated with above average sea temperatures in the eastern and central tropical Pacific and are usually but not always associated with below normal rainfall in the second half of the year across large parts of southern and inland eastern Australia. An El Nino can have a disastrous impact on agricultural production in eastern Australia, particularly for non-irrigated crops such as wheat.

The bureau’s Southern Oscillation Index, another indicator of an El Nino, measured minus 23 for the 30 days ended Feb. 14, falling sharply from minus 10 in January. An El Nino typically is associated
with strongly negative values for the SOI, sustained for several months around minus 10 or lower.
The recent rapid decline in the SOI can be partly attributed to several tropical disturbances affecting French Polynesia, it reported.

Source: CME News For Tomorrow

Monday, February 15, 2010

The Debts of the Lenders: Chinese FDI Surpasses US Overseas Investment

In the 1992 US Presidential campaign, Independent candidate Ross Perot famously stated that ratification of the NAFTA treaty would lead to the "giant sucking sound of thousands of US jobs" to foreign locales such as Mexico. Fast forward to today and the focus has shifted from Mexico to another cheaper locale, China.

For years, most attention on China focused on FDI or foreign direct investment. In the 1990s, low interest rates in Japan drove investor funds to the mainland in search of higher yield (This trend is still continuing). These investors were later joined by adventurous Western (mostly American) funds in search of investment potential. Growth really took off though with the death spiral of US manufacturing as firms continue to offshore manufacturing away from North America.

But, 2009 marked the year when investment flows went the other way - from China towards the US. Does this mean that the dividends of globalization are finally starting to pay off for Washington lobbyists? Apparently not.

While Chinese investment remains very diverse, the focus of the political leadership is all too apparent:

. . .Chinese outbound investment (whether in the US or elsewhere outside of China) is still predominantly focused on securing natural resources and forward integrating into sources of critical raw materials deemed integral to China's manufacturing infrastructure and industrial capacity.

Meanwhile, US workers continue to wait for the long promised fruits of global integration. With real unemployment at record highs and no economic recovery in sight for the average American, they may have to wait a while longer. So far, it looks like Ross Perot may have been right.

Friday, February 12, 2010

The Debts of the Lenders: India's Central Bank Faces Stark Choices in Raising Rates To Avoid Food Inflation

I first discussed India's problems with food shortages last summer here.

But here is a more recent update:

The Financial Times also reports:

Spiralling food prices have provoked debate about whether the Reserve Bank of India will be forced to raise interest rates to try to cool the economy. Already the bank has begun to exit its loose monetary policy by raising banks' reserve needs

This problems is endemic to not just India but nearly all the emerging market nations. Ministers face different challenges from their Western peers. Instead of asset deflation and shrinking/aging population pools, emerging markets in Asia, Latin America, and the Middle East are confronted with a young workforce that needs to remain steadily employed and fed. Any sort of contribution towards domestic issues is going to indirectly affect the fiscal sustainability of Western governments reliant on fund flows to maintain record borrowing deficits.

Monday, February 1, 2010

Agricultural Update: US Corn Crop Faces Possible Mass Spoilage

Questionable Quality Of US Corn May Bring Masses To Market Soon

The prospect of warming weather in coming weeks could subject millions of bushels of stored U.S. corn to spoilage, resulting in waves of farmer selling and even lower prices, even though cash values are already at three-month lows.

Farmers won’t be able to wait out higher prices because damaged corn in storage could easily spoil as temperatures rise, making it all but worthless. Some suggest prices could tumble as much as a dollar per bushel from current levels, if farmer selling overstocks the supply pipeline. Much of the U.S. corn crop was stored with higher-than-usual moisture levels because a wet fall didn’t allow the crop to dry properly, making molds and the toxic
byproducts they produce a problem.

Farmers sold immediately what they could not store, but most of the crop
remains in bins or piled on the ground. January’s freezing weather halted the quality decline, but the snowy weather also has kept some farmers from getting to bins and marketing corn. A sharp break in prices since Jan. 12, when the U.S. Department of Agriculture said the U.S. corn crop was much bigger than expected, also has limited farmer selling. Benchmark Chicago Board of Trade March corn prices are down about 15% since Jan. 11 and Monday traded around $3.59 a bushel. The national-average cash-corn price was $3.18 entering Monday’s trading session.

“I am sure the sharp break will stop some of those bushels moving in the short run, but they will eventually have to come to market before planting season arrives or run the risk of being junk,” said an Iowa corn processor.
The Iowa processor said that, of the farmers that are selling now, about onequarter are bringing high-moisture corn that is prone to deterioration and difficult to store. If quality is poor, farmers will inevitably get less money for their corn. Dockage discounts imposed on corn of extremely low quality can total nearly $2 to $3 per bushel, providing heavy incentive for elevators and farmers to market it before such damage occurs. “I am hearing reports that up to 75% of on-farm stored grain is suffering from at
least some condition issue. This will only get the temperature warms,” said West Bend, Iowa, commodity trade adviser Karl Setzer. “The last time we had storage issues in corn was in 1992, which caused corn deliveries to increase 5% during the second quarter of the marketing
year. This would equate to roughly 500 million bushels of corn this year.”

During the second quarter of 1992, CBOT nearby futures prices fell 6%, but
Setzer said prices this time around could drop even more than that, depending on what farmers do. He added that some cash grain market advisers are telling their clients to wait to sell on general ideas corn prices could rally later this year, but “this is a very risky move, however, given this
year’s quality issues.”

Source CME News For Tomorrow

Friday, January 29, 2010

Agricultural Update: Corn's 2010 Outlook

For agricultural reports on this blog, I will drop the "Debts of the. . ." title and replace it with the Agricultural Update title instead. It seems more fitting.

Corn Set To Rebound On Ethanol Demand, Economic Recovery

A flailing economy and record crops have worked to pull corn prices some
20% off their 2009 peak, but analysts say the move is only a temporary setback, with an economic recovery under way and ethanol demand on reliable footing. “Nearly a third of the domestic corn output in the U.S. is being used for ethanol production and this volume is set to expand even further,” Commerzbank analysts wrote in a recent research note. “This should push up prices.”

Ethanol—made primarily from corn in the U.S., since the nation is the world’s largest producer and exporter of the crop—is a fuel additive used in reformulated gasoline.

“This year, 12.95 billion gallons of renewable fuels are mandated to be used
in fuels sold in the U.S., up from 11.1 billion gallons in 2009,” said Brian Milne, refined fuels editor at Telvent DTN. While that mandated demand will not be satisfied exclusively by ethanol, “demand for ethanol will continue to rise with the mandate, which runs to 2022.”

Corn for use in ethanol production has already increased nearly fivefold from the year 2000 to 3.6 billion bushels in 2008, according to the National Corn Growers Association, which used preliminary data for 2008.

It wasn’t too long ago that ethanol demand was actually outgrowing corn
and risked—maybe even succeeded in— sending prices for corn and its byproducts, including feed for cattle, to unreasonable levels. Renewable fuels got a “bit ahead of themselves in the public eye in 2008 when gasoline was over $4 a gallon and the race to biofuels was on,” said Chris Kraft, president of “High fossil fuels lead to high demand for ethanol, which lead to historically high grain prices, which made ethanol as expensive as gasoline.”

In 2009, corn continued to be supported by expectations of increased demand for ethanol, as well as difficult growing and harvesting conditions that year—”too much rain followed by early cold and snowfall before all the crops were harvested,” said Milne.

Forecasts of a bumper corn crop have combined with the downturn in the
nation’s economy and falling oil prices to withdraw some of that support.
On Jan. 12, the U.S. Department of Agriculture raised its estimates on the
nation’s corn crops by 2% from its November forecast to a record level of
13.2 billion bushels. That’s 1% above the previous record set in 2007, the USDA report said.

Prices sank more than 7% the day the report was released and posted subsequent declines in eight of the 11 sessions thereafter. “Corn has been the darling of the funds and the focus of reallocation of moneys ... in the first week of January,” according to a report from commodity broker and researcher Linn Group. “Stats had been mildly supportive also—at least
a bull case could be built.”

But with the latest USDA production and usage report, “that story has evaporated,” the report said. “We ... look for a year of deteriorating corn prices with only strong energy prices to help stabilize this market at reasonable levels.”

Year-to-date, corn has posted the weakest returns among the major commodities, with returns of -10.3% as of Jan. 22, according to Deutsche Bank.

Corn futures prices have dropped from a $4.50-a-bushel high in June 2009
to trade recently at $3.60 on the Chicago Board of Trade.

Source: CME News For Tomorrow

Tuesday, January 26, 2010

The Debts of the Spenders: US Supreme Court Rules Corporations are People Too

Here are the views of the ABA Task Force on Financial Markets Regulatory Reform. It was presented to Congress this week.

For those who do not know, the ABA (American Bar Association) is an extremely influential and powerful lobbying group in Washington DC. The ABA is dominated by the interests of Big Law firms, most of whom have vested interests in the promotion of the status quo from their wealthy clients (e.g. maintaining lucrative contracts with Wall Street) and who themselves are big donors to US politicians.

Before reading this, I'd like readers to consider the comments in this context. The US Supreme Court (the highest court in the land) recently passed a decision that effectively ruled Corporations are people with the same powers of speech reserved for individuals when it comes to making political donations.

WASHINGTON — Overruling two important precedents about the First Amendment rights of corporations, a bitterly divided Supreme Court on Thursday ruled that the government may not ban political spending by corporations in candidate elections.

The ruling, Citizens United v. Federal Election Commission, No. 08-205, overruled two precedents: Austin v. Michigan Chamber of Commerce, a 1990 decision that upheld restrictions on corporate spending to support or oppose political candidates, and McConnell v. Federal Election Commission, a 2003 decision that upheld the part of the Bipartisan Campaign Reform Act of 2002 that restricted campaign spending by corporations and unions.

The ruling represented a sharp doctrinal shift, and it will have major political and practical consequences. Specialists in campaign finance law said they expected the decision to reshape the way elections were conducted. Though the decision does not directly address them, its logic also applies to the labor unions that are often at political odds with big business.

Translation: US corporations may spend an UNLIMITED AMOUNT OF MONEY on politicians.

Monday, January 25, 2010

The Debts of the Spenders: FDIC Considers Granting AAA Status to Mortgage Bonds

*Credit Gato.chan

Take special note of the last line in this article. Is this going to shape up as yet another "extend and pretend" solution to the credit crisis?

Or will this be a juicy opportunity for arbitrage traders to take advantage of the yield between low interest treasuries and higher yielding assets.

Do I hear another Bill Gross play on MBS?

“The FDIC is going to be a big issuer in the securitisation markets this year,” said Christopher Whalen, managing director of Institutional Risk Analytics. “This could lead the way in terms of recreating the securitisation market, as the FDIC deals could end up being the new template.”

Friday, January 22, 2010

The Debts of the Lenders: Why China Cut Bank Lending

Very informative. Please watch the whole video. A city built for 1 million people. And virtually unoccupied.

This is the most (in)famous project. But multiply similar projects like these all throughout the country and you will begin to get an understanding of the scale of the problem. Macro-economic slack has resulted in the government force-feeding the low wage light manufacturing and infrastructure sectors.

This is great news for exporters but poor news for consumers - few of which can afford the shiny new things in their midst. Until China focuses on building its consumer class and relying on low wage serf labor, there is no way that the country can pick up the global slack from the West.

Wednesday, January 13, 2010

The Debts of the Lenders: China Allows Short Selling

Although it is only a trial run, the Chinese authorities have taken a much needed step in the right direction by allowing freedom of capital to migrate in both directions instead of only up. The move is aimed at increasing arbitrage opportunities between the mainland A shares market vs the H shares in Hong Kong.

Short sellers add much needed breadth and scrutiny to a market by increasing liquidity. Lower brokerage fees and commissions are just one byproduct. Most importantly, short sellers act as an external check on corporate malfeasance and weakness by exposing dark deeds to sunlight.

The Debts of the Spenders: Bernanke vs the Taylor Rule

Was the Fed too accomodative? Not enough? Have no idea what I'm talking about?

Read here:

A bit wonkish but a good read nonetheless.

Sunday, January 10, 2010

The Debts of the Spenders: How the USA is Becoming More Like the Eurozone

The number of US government employees has grown steadily over the past 70 years since the end of the Great Depression. The same cannot be said of the private sector. Another way to examine the situation is to realize that as private productivity increases, the workers in those respective industries inevitably pave the way forward for their own eventual layoffs.

Saturday, January 9, 2010

The Debts of the Spenders: 50 States of Disunion?

*With credit to Jeff Bernstein of Urban Digs.

I have added a few of my own comments below in the last section.

So, just how bad are individual state finances in the USA? See for yourself here and here.

According to the National Conference of State Legislatures "Ironically, a contributing factor to future state budget gaps is the end of federal stimulus funds provided by the American Recovery and Reinvestment Act (ARRA). Those additional funds supported state budgets in FY 2009 and, to an even greater extent, in FY 2010. That money recedes in FY 2011 and, when it is gone, will leave big holes in state budgets—what many state officials are calling the “cliff effect.”"

Despite this bearish data ISM data is improving. And the numbers have been growing steadily for the past few months of 2009. In fact, we are already back to 2006 levels!

I am going to say a few heretical things here. Long time readers will note a departure from the traditional bearish tone on unemployment and personal consumption which are lagging indicators. But we've got bullish data coming in from inventory re-stocking. Of course a lot of this is federal money but it looks like Keynesian spending may work - short term at least. Let us also not forget the Census 2010 hiring spree ongoing. It's going to give a big bump to NFP in Q2.

Tuesday, January 5, 2010

The Debts of the Lenders: 2 Year Note Recovers in Mid-Week

I went in too early and got hit - still underwater - but this was a nice rally in bonds (yield is inverse to price).
Bloomberg covers the story here. The short trade got too crowded.
A JPMorganChase & Co. survey showed that investors who are short the Treasury market was at its highest level since March 2007. The pending home sales data show housing may be at risk of weakening when homebuyer incentives, which were extended in November, expire later this year. Unemployment close to a 26-year high and weaker consumer finances remain hurdles to a sustained acceleration in home sales that would help fuel the economy.

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