JasonC

Bond Expert Tuesday Outlook: Meeting the Treasury

The threat in the near term remains deflation and there is no reason for the Fed to tighten yet. The economy could not take it, it would be a 1938 style mistake and Bernanke is not going to make that one, he knows the history too well.

Longer term the trade on the board is to go short the 2 to 10 year spread. It won't stay this wide forever. Likely the short end moves upward as the economy recovers, along with an overall upward shift of the curve. Possibly the long end breaks downward on significant additional weakness, though I would put the chances of the first at 3-4 times those of the second. But here is what won't happen - 2s staying under 1% while 10s go to 5%...

Today in Commodities: Dollar Up, Again

Hey, someone noticed that the dollar went up! No fair! No one on the planet is supposed to be able to notice when that happens! Everyone screaming in chorus that it is toilet paper is supposed to make it so, and make everyone's overcrowded commodity bets pay off at infinite, wipe away all debts, and make every doom monger whole.

Monday FX View: The Dollar Stands Still

Um, the dollar just went vertical, up 1% against the Euro in less than an hour, and not one news organization, website, or commentator has a story covering it.

Is anyone watching the actual markets, or does everyone just make things up to fit their political world-view or trading book and just hope it turns out to be true?

Why Everyone Is Wrong About the Inflation/Deflation Debate

The no-risk trade is so crowded it is clearly doomed.

Gold is up because it is perceived as a safe haven.
Treasuries are bid at tiny yields because --- same.
Commodities - same.
Cash yielding zero - same.

All of it is Pavlovian investing in reaction to last year's pain. As usual with rear view mirror anything, it is precisely wrong, 180 degrees.

There is no inflation and there is no prospect of any.

The dollar is about where it was a year ago. Everyone talks about its decline over 9 months and not the huge spike it had in the 2 right before that, in the crisis peak. In case everyone just forgot, the entire world being short dollars (for debt, to fund real anything, etc) and unable to cover *was* the bubble.

It will be a long slow recovery, with GDP growth positive but below peaks in both GDP for a while and asset values for longer. Unemployment will decline only slowly. Deleveraging is a long slow slog and not over quickly. But there will be no inflation to speak of during it.

Everyone thinking they have to play the next shift in the exchange value of money to get ahead is exactly focused on the wrong issue. Where can capital earn reasonable returns with moderate safety in the present environment? Anywhere it can, it will be paid handsomely because credit is ridiculously cheap and will stay so. Anyone willing to take the slightest risk will be paid. Except those betting the house (again...) on outlier monetary movements --- which is approximately the entire financial pundit class, plus every populist fad-chaser on the planet.

Think stable income producers. Think credit, utilities, preferreds. Add modest leverage at near-zero cost, and carry. Don't pay any attention to all the heavy breathing scare mongers peddling their ridiculous washboard fantasies of hyperinflation or great depression reruns -- they are a total crock, start to finish.

10 More Reasons Why the Recession Will Last Forever

What an idiotic article.

Wanna bet this recession ends like every other?

No it is not different this time, it never is. What goes around comes around, it is a cycle. Grow up.

BofA and Stating the Obvious About Bank Profits

The real story in the B of A report is they remain cash flow positive as they have throughout. They added another $2.1 billion to their loss reserves, matching the loss to the common pretty much. There was also the $1.8 billion item from writing *up* the value of debt issued by Merrill because its credit improved.

Trust me, they won't go bankrupt through an improving credit rating.

They tick over around break even until the credit loss rate turns, then they pop upward. The net cost of the entire crisis will be a dilution a bit under half, from being forced to issue lots of stock at lousy prices to maintain capital at the bottom. In return they will have Merrill and be a $2.5 trillion bank in the next up cycle.

Everyone reacting to it as some disaster is smoking something, it was a non-event report...

BofA and Stating the Obvious About Bank Profits

The Fed isn't going to lose anything buying agencies MBS securities. It is going to make somewhat more profit than it makes in treasuries.

Even Alan Greenspan Thinks the Banks Have Become Too Large

Um, the idea that banks can be allowed to fail if only they are small enough is a delusion.

We can let banks under $100 billion in assets fail these days because they are a tiny portion of the entire financial sector. But if you slice Citi and B of A and the rest into $100 billion pieces, can you let each of them fail when credit weakens?

You cannot. They own the same stuff, and 25 $100 billion banks going down the same week is no more livable than one $2.5 trillion bank going down. You have to stop them from failing if the event gets large enough, full stop.

Authorities save little ones by selling them to bigger ones and then only worry about keeping the big ones afloat, and the true small fry can just be liquidated. Check. Then the "burn it all down" liquidationists imagine they'd get their way if only all the banks were small enough. Um, no, not remotely.

The whole reason $2.5 trillion banks can't be allowed to fail is the real economy can't take the money supply collapsing like that. But exactly the same money supply collapse is threatened by multiple failures of medium sized banks. The saving effort is just more complicated, that is all.

Everyone deludes themselves that the authorities can get out of paying by just refusing to save failing banks. That too is a delusion. Widespread bank failure sticks the whole bill for the mess on the authorities' desk, it does not avoid a dime of it. In fact, the longer you wait and the more reluctantly you pay up, the more you get to pay because the lower confidence has gone and the higher risk premiums have soared.

You cannot make capital cheaper by refusing to pay for it. Grok already. Capital is paid for, in full, or is evaporates. In a world in which vast quantities of capital value are allowed to evaporate, you pay more not less for capital because it is scarcer and riskier.

The Dogma of Low Interest Rates Is Wrong

ETFs are not the United States. They are preferred vehicles for speculators who play fads and momentum.

There is a giant flow of capital to the US. It is called the trade deficit. It is less giant than it was a year ago, but real capital continues to leave Asia and land in the US.

People who simultaneously want to run up currency balances and attract and use real capital do not understand basic accounting, and want to eat cake and have it.

Whether it makes economic sense for Americans to run trade deficits depends entirely on whether the future return from holding dollar bonds at near zero interest rates will be greater or less than the returns from investing real capital in the US. Those simultaneously moaning that the dollar is certain to implode while real everything must soar, and that the trade deficit is ruinous, do not understand basic accounting either. Foreign savers are the ones going long the dollar by accumulating our bonds; we are the ones going long real assets by buying things for issued debt.

As usual, the doom mongering press and pundit set looks at one half of each transaction and predicts horrors from a selected side of it, while pretending the other side does not exist.

The reality is there is no inflation in the US, it is a deflation, and the world has yet to get used to Americans saving for their own capital needs instead of outsourcing it. Interest rates at zero reflect the complete lack of bargaining power of our foreign creditors, who simply do not see how or where to invest their own savings.

If they learn to, fine, we save to fund our own investments and the trade deficit disappears. They've got a giant pile of dollar claims, we've got tons of real stuff already delivered and worth every cent paid for it, to a free consumer.

Everyone is trying to tell other men what to do with their own wealth...

Recession Is Over; Depression Has Just Begun

The article has followed a few true points in Minsky to a ridiculous conclusion that capitalism inherently self destructs, which is nonsense.

There is nothing remotely incompatible about a positive private savings rate and balanced government and trade budgets. The accounting identity misread comes from ignoring the income side of savings. Savings do not disappear into a black hole, sucking the economy into nothingness after them; nor are they mere transfers to those who borrowed those savings (first order, first year cash flow statement effect). Debt service isn't paid to a black hole in the sky either. Instead, they are intertemporal transfers.

Attempting to understand intertemporal trades by looking at the balanced current income statements of the counterparties only, and then pretending this is a complete picture if repeated through time, is the underlying error. You can't understand any intertemporal credit transaction without using all 3 statements of modern accounting, balance sheet, income, and cash flow.

The Minsky stabilizer point that is sound, is that government deficits deliberately run in a recession do enable private sector actors (households and business) to improve their own balance sheets. The private sector savings rate rising, is recessionary yes, and government decifit spending allows a larger upward move in the private sector savings rate for the same drop in current output.

But only while the savings rate is increasing. At any level of that rate, the accounting is dead-stable with a government budget in balance. There is no need for a perpetually unhinged deficit merely to sustain a non-zero savings rate. The reason the article misses this, is it notices only the savings-allocation income-statement side of the credit transactions, and not the raised-later-income from repayment side of them, that necessarily follows from the improvement the former brings to private balance sheets.

Government deficits run in the recession enable an increase in the private savings rate. Once economic growth resumes, there is no further need for the private savings rate to ratchet endlessly higher to infinity, and this need is over. Sure, the withdrawal of government stimulus should be gradual and moderated to the actual pace of the recovery, and wait for actual voluntary stabilization in the private savings rate. But that is quite completely all that is required.

The next misconception in the article is that the debt service levels of the private sector are horribly high, or that the populace in general is in some deep financial hole. The net worth of the US household sector is positive $53 trillion. It's leverage level is 5 to 4.

Somebody owns every scrap of that debt, you see. It isn't a liability without counterparty, of wealth disappearing into a black pit in the sky. When involuntary debt restructuring occurs, when $2 trillion in debt defaults, yes that draws down asset values - but of course it does so precisely while reducing net indebtedness and future debt service payments. A transfer has occurred from creditors to debtors, and both sides have shrunk their sheets on both the asset and the liability side.

Under ordinary conditions of ongoing growth, debt rises in line with the economy, as a portion of the new asset value being continually created is financed by debt rather than by equity. Debt is not negative net worth. It is merely one form in which assets may be financed. What causes the asset values in the first place is the income stream of real services being thrown off by capital. It is quite irrelevant (for its size) how that stream is divided, between equity and debt financing. The most one can say, following Minsky, is that too high a portion of it being debt financing tends to increase credit-instability.

This is an ordinary feedback. Anything smooth and safe enough will be leveraged until it isn't smooth and safe anymore. Anything showing rocky returns and jumping all over the place, will be carried only by equity and capital will exit that use, which will calm its returns over time. There is no possibility of endlessly sustained calm; calm is itself the inducement or signal that leverage can be added. That traditional point about the inherent instability of credit was reiterated by Minsky, though hardly noticed by him first.

There is no need for continual trillion dollar deficits to avoid economic collapse. There is no need for the private sector to run its savings rates up to 20% or more, let alone increase them continually. Positive private savings rates are not a Keynesian "hording" bete noir consuming entire economies through errors of one-entry accounting.

People can save the portion of their income they like; they will receive income from doing so; they will create real capital that produces real incomes maintain those capital values (with the pie redivided amongst investors based on their individual success forecasting equilibrium rates of return and their associated asset prices, to be sure).

Economics is less dramatic and much less political than pundits of this sort suppose. There are lots of freely choosable alternative places the economy can sustain itself. There is no tendency to necessary inflationary or deflationary doom. There is merely a cycle, and no it isn't any different this time. The long financial cycle is longer than many commentators expect and some of its adjustments more gradual, playing out over multiple GDP cycles. Who cares?

Market Outlook: Bill Gross Has It Exactly Right

"Banks have what is called "core capital". I think Treasuires count as "core capital" whereas a car loan doesn't count as core capital"

Um no. The capital of a bank is a liability side item, while both treasuries it owns and car loans in makes are asset side items.

The core capital of a bank is its common stock equity, its preferred stock equity, and its loan loss reserves. All at book value.

(As an aside notice, when a bank marks down its assets to add to loan loss reserves, this figure does not change. Realized losses do reduce it, provisions for future ones do not).

What you are probably thinking of is the credit risk reserve requirement under Basel II. Banks must have capital equal to 8% of risk-adjusted assets. The risk adjustment for loans or corporate credits is 100%, for first mortgages secured by real property it is 50%, and for government bonds it is 0%. (Some agencies and foreign government bonds get 20%).

So when a bank shifts part of its portfolio from car loans to treasuries it does not change its core capital - nothing moved on the asset side of the sheet changes the liability side of the sheet. What it does do is reduce their Basel II regulatory requirements for the ratio of capital to total assets.

So yes, shifting to governments from general loans to the market does reduce a banks capital *requirements*, but it doesn't change its *capital*.

Also note that all banks must also keep capital against interest rate risk, as distinct from credit risk. They often run swap books to manage this. A move from a T-bill to a 10 year treasury requires either extra capital against the greater interest rate risk, or a swap position to hedge it that will give up much of the incremental yield.

A move from a home mortgage to a 10 year, on the other hand, gains the bank convexity with the immediate interest rate risk reduced somewhat, while also reducing its credit risk capital requirements (to 0% of 8% of loan amount moved from 50% of 8% of loan amount moved).

Those are mechanics.

Federal Reserve: Readying a Stealth Tightening of Monetary Policy?

$700 billion in short term credits the Fed supplied as of this April have already been repaid.

Prepare Yourself for the Inflation Invasion

Um, default is a ridiculous concern. TIPS are a better bet long term than nominal notes at 3.5% certainly, that just isn't saying much. I can get intermediate and long corporates at 7% and change - first tier names.

On TIPS and any difficulty paying them, again not a serious concern, there simply aren't enough of them outstanding to be material. The Fed would frankly like a larger and more liquid demand for them to assess inflation expectations more reliably, but they are complex enough that demand for them has been punk since inception.

When they are over 3% real yield they are good long term value though...

Prepare Yourself for the Inflation Invasion

Sethbru is the only one so far to get his facts straight.

The size of the Fed's sheet peaked on April 23rd. It has contracted 10% since then, $200 billion. This has coincided with stocked bottoming and the rally. Everyone pretending that the Fed is still inflating is simply not doing their homework by reading the actual balance sheet.

I see pundit after pundit predicting that as soon as the Fed stops expanding the market will tank, when it stopped over 4 months ago and the market took off like a rocket.

$700 billion in the short term loans, 90 days and under, that the Fed made at the peak of the crisis, have run off into cash, repaid to the Fed. If the Fed had just extinguished all of it immediately, it would have been the most rapid deflation in history. As it is, the run-down rate is as fast as the early 30s.

The Fed lent $500 billion to US banks in term auction credit and through the discount window. 45% of that has been repaid already. The Fed lent $250 billion directly to US corporations in its commercial paper and asset backed facilities. 65% of that has been repaid. The Fed lent $250 billion to foreign central banks via swap lines, indirectly supporting the dollar business of European banks especially. 70% of that has been repaid.

The Fed has extinguished a third of the money as it flowed back to them, invested a third in mortgage backed securities, and the remaining third in treasuries (plus actually about 40%, with 10% in agency debt).

In doing so, the Fed has rebuilt the treasury position it had back in 2007, but no more than that. It sold off the bulk of that position between Bear Stearns and Lehman, while it was running up its loans to the banking system. Those loans did not grow the sheet before Lehman, because they were offset dollar for dollar by feeding treasuries into the market. After Lehman they doubled the sheet size. Now they are running off all the extraordinary short term stuff and rebuilding the treasury position they had at the outset.

The only large new item on the sheet is the big position in mortgage backed securities. In case nobody noticed, Fannie and Freddie went broke in the meantime. The home loan banks have run off $250 billion in their sheet while the Fed has expanded. Overall, the Fed has taken over the busted role of the agencies in supplying marginal new mortgage financing, while the agencies concentrate on workout stuff and controlling their credit losses.

It is completely unsurprising that the result has been a decline not an increase in average prices, 2% at the consumer level and 5% at the producer level. The biggest being energy - the swing in the terms of trade there alone comes to several percent of GDP.

Also in case everyone just forgot, the inflationary brainstorm that any real asset would go to infinity in money terms, *was* the bubble and it comprehensively busted. Those so predicting were wrong to the tune of $15 trillion in asset price losses.

But the same crowd are still chirping away their sacred hymnal that inflation must be right around the corner. If they think so, hey, buy up all the mansions and all the half empty new suburbs and all the half occupied strip malls. Oh wait, they tried that already.

Sometimes a debt denominated in nominal dollars is simply worth more than a real asset you can hit with a stick. Value isn't a material thing. And no, central banks that put their economies through the wringer we just went through when necessary to maintain the purchasing power of their currency, do not see that currency repudiated by the people, which is what hyperinflation is. All of the hyperinflation predictions are utter nonsense.

Next to those who think the public debt is so ruinous it must bankrupt everything. They continually confuse debt with negative net worth. Take TARP, which is always presented as "costing" $700 billion. Um, where do they think that money went, to the great money-pit in the sky? Every dollar of it was someone's receipt, so yeah I think it will be available to the private sector. And oh yeah, the government got $700 billion in bank preferred stock for it, at depression prices and terms. All of it entirely profitable already, let alone longer term.

Anybody here think you can go broke borrowing at 2 to lend at 5 with a nice double on the capital after converting? Anyone think if the amount so deployed is really big, it means you are that much moer broke? It was merely a good trade, better than half the people here can boast of recently.

In the last 2 years and a quarter, the treasury has placed over $3 trillion in net new debt at rates under 4%, with a blended cost more like 2%. How have you done, in comparison? Oh and the Fed took a net zero of that, while US private investors took 65%. The vaunted Chinese buyer mentioned in every single breathless news report took 11%. The rise in the US savings rate since last summer replaces everything the Chinese invest here 3 times over and to spare.

Why does no one do their homework on this stuff, even here?

On Aug 24 12:53 AM lance sjogren wrote:

> Inthemoney: I agree the stock market rise the last several months
> is probably largely due to monetary expansion.
>
> In my view, stocks have become severely overvalued due to too much
> money sloshing around looking for a home.
>
> What I wonder is when will that stop. Stocks represent companies
> that operate in the REAL economy (aside from fiancials, of course).
> The REAL economy sucks.
>
> Stocks are way overvalued considering the horrendous state of the
> real economy.
>
> But still, the money printing goes on, and all that new money has
> to go somewhere.
>
> The smart investor is one that can figure out where people are going
> to shift all that money once they realize that stocks are overvalued
> and due for a major correction.
>
> I wish I knew.
>
> I think at some point it will be commodities, especially precious
> metals, but that may still be 2-3 years down the road.

Why Did AIG Rally Yesterday?

AIG is a giant bond fund, as well as several sound operating insurance companies. Bonds have been in an epic rally since November, accelerating since March. They just reported earning $1.8 billion for the quarter. The shares are a warrant. Yes they have a huge hole to climb out of...