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HomeIs The Government Bond Bubble Getting Ready To Burst?
Posted by Larry Doyle on April 30th, 2009 5:45 AM |
The equity markets have rebounded significantly over the last seven weeks. The Dow and S&P are now down approximately 4-6% on the year. The tech heavy Nasdaq has distinguished itself and is up approximately 10% on the year.
At this juncture, if the equity markets are implying that the economy will not slip into Depression, then the bill for the stability in equities is being transferred to participants in the bond market. Government bonds are facing an almost weekly avalanche of tremendous supply. This week the market is absorbing over $100 billion in 2yr, 5yr, and 7yr Treasury securites. Take a deep breath and next week the market is faced with over $75 billion in 3yr, 10yr, and 30yr government securities. The Treasury is likely going to sell 30yr government debt on a monthly basis!!
The Federal Reserve has been the biggest buyer of Treasury and mortgage-backed securities. The Fed’s balance sheet may be large but it is not endless. What have 10 yr. Treasury securities done on the year? Even in the face of massive buying of these securities by the Fed, the 10yr has backed up almost 1% to a current level of 3.1%. That rise in rates is very significant.
I have maintained and continue to maintain that interest rates will move higher given the overwhelming demand for funds by global governments to pay for deficit spending. Central banks around the world may try to hold the respective bond markets up and interest rates down but investors will continue to demand a higher rate of interest in the process.
As government rates move higher, mortgage rates, and other corporate rates will likely move higher as well. If we get a whiff of early signs of inflation which I believe is coming these rates could ratchet higher and the bubble in the government market would not merely burst but would actually explode.
LD
Citi Wants Its Cake and to Eat It, Too
Posted by Larry Doyle on April 29th, 2009 7:15 PM |
Hasn’t the public had enough of excessive compensation and abusive bonus practices for employees of organizations saved by Uncle Sam? Why and how is it that Citi Seeks Approval to Pay Out Bonuses.
Vikram Pandit, the CEO of Citigroup, and every other executive at Citi needs to know that as wards of the state, you earn a government wage. While Vikram and team may decry the dissolution of their franchise, they need to wake up and smell the coffee. There would be no franchise at Citi without the taxpayer having injected tens of billions of dollars.
Citi employees took the risk in choosing to work at the firm just as any employee takes company risk in any firm. If any Citi employee wants to leave, my advice is “don’t let the door hit you on the way out.” Citi management may believe it is critical to the franchise to retain these employees in order to generate earnings and repay the government. My response is that with a Fed Funds rate at 0% and lending rates of between 5-20%, Citi will generate earnings without the risks embedded in proprietary trading.
If Citi can sell a division intact to generate income, why aren’t they already pursuing it? The WSJ offers further color:
Citigroup is trying to get U.S. approval for special bonuses for many of its employees. In a meeting earlier this month with Treasury Secretary Timothy Geithner, Citigroup CEO Vikram Pandit made the case for the stock-based bonuses. Executives are describing the bonuses as “retention” awards to perk up demoralized employees who the company worries are vulnerable to poaching by rival firms, people familiar with the matter said.
A person familiar with Mr. Geithner’s thinking said the Treasury hadn’t made a decision on whether to allow the bonuses. It is unclear how much Citigroup would pay out in bonuses if the government approved the move. A Citigroup spokesman declined to comment on details of the proposed compensation plans.
Citigroup’s request comes after Congress, the public and the president blasted pay practices on Wall Street. Bonuses at American International Group Inc. and Merrill Lynch & Co. ignited political infernos in Washington.
Citigroup has already gotten its own share of criticism for excessive spending, thanks in part to its aborted plans earlier this year to buy a new corporate jet. The company has received $50 billion in taxpayer aid, and the U.S. government is protecting Citigroup against most losses on $301 billion of its assets. The Treasury is poised next month to become Citigroup’s largest shareholder, owning as much as 36% of its common stock.
Why is this issue even being aired? Why hasn’t Turbo-Tim told Vikram and team, the answer is “NO.” Two letters, “N” and “O”. Which one of those don’t they understand?
LD
Review of Economy, Fed Reserve Statement, and Market
Posted by Larry Doyle on April 29th, 2009 2:57 PM |
The Federal Reserve released its regular statement on the economy at 2:15pm. The statement includes:
1. no change in the Fed’s interest rate policy with the Fed Funds rate remaining between 0-.25%.
2. no change in the Fed’s asset purchase program of government and mortgage-backed securities.
3. overall economic activity remains weak but the pace of decline is slowing.
4. inflation remains below the Fed’s long term target.
5. the Fed will employ all available tools at its disposal to help the economy recover.
The equity markets are having a strong upward move today based not on the Fed’s statement but reaction to the DRAMATIC decline in inventories reflected in this morning’s VERY weak GDP report. If an equity market rallying after a VERY weak GDP report seems counterintuitive it is due to the fact that if and when consumer demand picks up it will drive production.
In my opinion, banking on a pickup in consumer demand is a big if. With credit tight and likely to remain tight, I believe our economy needs to and will adjust to lessened demand.
The WSJ comments on this economic activity, U.S. Economy Shrank At 6.1% In First Quarter:
Weaker investment in housing combined with the enormous inventory adjustment to pull the economy downward. But the aggressive drawdown of stockpiles of goods, while hurting the economy in the short run, is beneficial because it is an important step toward bringing inventories under control and ending a production freefall. U.S. industrial production retreated a fifth straight month in March, recent data show. Over the past 12 months, output was down nearly 13%. Capacity use by industries receded to 69.3%, a historical low since records began in 1967.
One area of concern for me is the uptick in prices. Although economists and analysts are panning the near term inflation risks, in my opinion, this risk should not be underestimated. The increase in prices in today’s GDP report has received little coverage, but
Price indicators within Wednesday’s report suggested inflationary pressures rose in first-quarter 2009, easing fears of deflation. For instance, the price index for personal consumption expenditures fell by 1.0%, a decline much smaller than the fall of 4.9% in the fourth-quarter 2008. The PCE price gauge excluding food and energy rose 1.5%, after increasing 0.9% in the fourth quarter.
Free money in the form of a 0-.25% Fed Funds rate will continue to help banks recover but government deficits as far as the eye can see must be addressed. If the economy stabilizes, look for interest rates to ratchet higher.
In fact, in today’s trading government bonds are down and rates are back to the highs seen last November.
LD
“FINRA Is Supposed To Police The Market”
Posted by Larry Doyle on April 29th, 2009 6:52 AM |
I have written extensively about FINRA’s ownership of Auction Rate Securities over the last few months. This morning Bloomberg reports, FINRA Oversees Auction-Rate Arbitrations After Exiting Market.
The Bloomberg article (I am humbled by Bloomberg quoting me in the story) answers a number of questions I have raised, while also opening the door to other issues needing to be addressed:
1. Was FINRA blinded – if not totally conflicted – in addressing the trading, selling, and marketing of Auction Rate Securities? Try 862 million times.
2. Was FINRA lucky, prescient, or well informed in the timing of the sale of their own Auction Rate Securities? We may never know but given that their first “guidance for investors” was not published until after the market had totally frozen, they certainly did not provide much investor protection as is their mandate.
3. I have also written, and Bloomberg highlights, that FINRA had money invested in hedge funds. In light of market developments, I think the public has a right to know which hedge funds. Will FINRA release that information?
4. I unearthed all the information of FINRA’s investment activities from its 2007 Annual Report published in April 2008. I am still waiting for FINRA to release its 2008 Annual Report and wonder why it seems to be delayed.
5. As we move forward with likely regulatory changes for Wall Street, I believe the very nature of a self-regulatory organization funded by the banks it is charged to oversee presents massive conflicts of interest. This specific situation of FINRA’s investment in ARS is indicative of those conflicts. Will Congress have the courage to address these conflicts and serve the public interest in the process?
“To me it smacks of incompetence and negligence,” said Larry Doyle, who worked 23 years on Wall Street and runs a Web site called Sense on Cents. “Finra is supposed to police the market.”
I view FINRA as akin to the palace guard. The question remains, Does The Palace Guard Have No Clothes?
LD
Markets Catch the Flu, Down 2% Overnight
Posted by Larry Doyle on April 28th, 2009 6:48 AM |
The global equity markets are down approximately 2% overnight for a variety of reasons, including:
1. Citi and BofA will likely be forced by regulators to raise more capital. Company shares are down 7-8% on this news. It also seems likely that regulators will force changes on the boards of these companies. Do not be surprised to see management changes as well. Has Ken Lewis become a government liability based upon his assertion of being pressured by Hank Paulson and Ben Bernanke to complete the BofA-Merrill Lynch merger?
Is this story of increased capital needs really news? I don’t think so.
On the regional bank front . . . Suntrust, Regions Financial, and KeyCorp are speculated to need increased capital.
When it is widely accepted that our domestic banking system still has $750 billion to $1 trillion in embedded losses, it can’t be the case that all the banks are fine. In my opinion, Geithner did investors a disservice last week in promoting the overall health of the banking industry.
Bloomberg provides more insight: Citigroup, Bank of America Decline on Capital Report.
2. Markets are also down based upon some weak earnings news, increased loan loss provisions at NAB (National Australia Bank), and price declines in commodities due to the impact of the swine flu outbreak.
In my opinion, the markets and investors have gotten somewhat complacent given the rally in equities since early March. I still view risks as very high. It is growing increasingly likely that we will have a meaningful government presence as equity holders in some critical industries for a protracted period. This development will not only occur in the United States but in many regions globally. The impact of this government presence will effect not only specific companies but, in turn, industries as a whole. (more…)
Is Uncle Sam Getting in the Automotive Business?
Posted by Larry Doyle on April 27th, 2009 4:17 PM |
The proposal made by General Motors to its bondholders today for a debt to equity swap, in my opinion, virtually guarantees a bankruptcy proceeding.
Based on the proposal put forth by GM (and you know they are working in lock step with the government task force headed by Steve Rattner), Uncle Sam and the UAW will have an 89% equity stake in the company while the bondholders would be paid 38 cents on the dollar for an 11% stake in the company. The bonds of GM have been trading in the vicinity of 15 cents on the dollar so the bondholders are receiving a premium, but for a heavily diluted equity stake.
In addition to the financial proposal, GM is putting forth plans for more layoffs, plant closings, and discontinuing the Pontiac brand.
While various constituencies within General Motors along with creditors and the UAW may debate the relative merits of the proposal, ultimately this company will be a government owned and managed enterprise. The FT provides clear analysis, U.S. To Take Majority GM Stake.
The automotive situation again highlights the predicament of measuring government intentions for those looking to invest in the markets. That predicament rests in the conundrum of standard return on capital versus promoting an administration’s social program.
While the FT may report,
“The Treasury has not demonstrated any interest in actually running the company. They want to make sure the company runs well for the shareholders and various constituencies”.
The fact remains, it is highly likely that Uncle Sam will in fact be the largest shareholder and will influence the manner in which GM operates.
LD
How Would You Like to Earn -5% On Cash Deposits?
Posted by Larry Doyle on April 27th, 2009 1:12 PM |
Can you imagine putting money into a bank and agreeing to accept a minus 5% rate of interest? Well, the Federal Reserve believes the appropriate rate of interest for this economy is in fact -5%. The FT reports, “Fed Study Puts Ideal U.S. Interest Rate at -5%.”
The world is awash in a sea of debt. The debt is piled highest in Europe on a relative basis while in actual terms the debt in the United States outpaces all other parts of the world. As the deleveraging process continues, the demand for new money to spur growth is anemic. The paradox of thrift (excessive savings inhibits growth) is keeping our economy in a state of stagnation. The Fed and U.S. Treasury are utilizing all tools in their box to restructure debt and promote lending without risking default. Ultimately, all the Fed and Treasury programs will devalue the debt via inflation. Inflation, in which future dollars are worth less than current dollars, is akin to paying a negative rate of interest on money. (more…)
Summers and Jarrett Provide Hints of What Is To Come
Posted by Larry Doyle on April 27th, 2009 8:57 AM |
Larry Summers threw some cold water on the economy yesterday morning in stating his belief the economy will continue to decline for some time to come. Specifically,
“I expect the economy will continue to decline,” with “sharp declines in employment for quite some time this year,” Summers said today on “Fox News Sunday.”
Is Summers positioning the administration for a forecast more in line with IMF projections than the Congressional Budget Office? Recall that the IMF believes the U.S. economy will have flat to only slightly positive growth in 2010 with a double digit unemployment rate. Those projections are decidedly weaker than projections previously employed by the administration.
Is Summers starting to manage expectations downward given what he sees on the horizon? I believe so.
Furthermore, Valerie Jarrett, senior economic advisor, offered hints of administration plans for our banking system this weekend, in stating:
“Whether management changes occur, whether banks are asked to raise more capital, all of that’s going to come forth in the coming week,” Jarrett said on CNN’s “State of the Union” program today.
My instincts tell me that an advisor in Jarrett’s position releases that statement in preparation for exactly those moves. Will this be Vikram Pandit’s last week at Citigroup? Will Ken Lewis be forced out at Bank of America? I think the odds for either of those moves – if not both – just increased.
Management of any organization, including the White House, needs to maintain credibility by providing a reasonably accurate flow of information. The Sunday morning talk shows provide a forum and I think Summers and Jarrett provided solid hints at what is to come from the White House in the days and months ahead. Bloomberg provides a full summary of these points and others, Summers Says U.S. Economy to Decline ‘For Some Time.’
LD
Tune in Sunday Evening to NoQuarter Radio’s Sense on Cents with Larry Doyle
Posted by Larry Doyle on April 26th, 2009 9:25 PM |
UPDATE: The show has concluded, but you can listen to it in its entirety by clicking on the Play button on the audio player below. Once the playback has started, you can fast forward or rewind to any portion of the show by clicking at any point along the play bar.
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Please join me Sunday evening from 8-9 p.m. ET for NoQuarter Radio’s Sense on Cents with Larry Doyle. The developments in the markets, economy, global finance, Wall Street, and Washington are occurring at breakneck speed. 
I will try to slow things down a bit and provide a sense of perspective. What did we learn in the markets over the last week and what does that mean for the weeks and months ahead? We will address a wide range of issues, including: Hank Paulson blindsiding Ken Lewis, 1st quarter earnings (their transparency and quality), market performance this week, month, and year to date, the outlook for our financial regulatory structure, and upcoming bank stress test results.
These are truly historic times in the global economy. Let’s “navigate the economic landscape” without the pandering or nonsense found elsewhere! What is on your mind? What would you like to address? Please share your questions and thoughts by calling in to (347) 677-0792, and also join our live chat room, which I’ll start up about 10 minutes before the show begins.
Many thanks to Larry Johnson and the rest of the team at NoQuarterUSA blog for providing such a vibrant vehicle as NoQuarter Radio. I look forward to having you join me Sunday evening as we collectively navigate the economic landscape!!
LD
