I had made a prediction last year, found HERE, that US Treasuries would be put on negative watch by Fitch and downgraded to junk by China. Well, I was wrong as it was S&P who made the call and actually did downgrade the US to AA+ which is still a joke as the government will never be able to actually repay much of the $14T it has outstanding without just printing money, which IS a form of default. China is now saber rattling about the US dollar again, but this time they are serious, I think at least, asking for a new reserve currency and I think they will get what they want as other countries have raised the same concerns.
The US deserved to be downgraded and we should be downgraded much further than AA+ as we will not get serious about debt reduction. To prove my point all we have to do is look at how the debate is structured. The politicians are all talking about annual deficits and NOT the outstanding debt load. They do all sorts of double talk to make sure the average person only believes we have a trillion or o in outstanding debt, but that trillion is just the annual deficit and no one talks about the big number of $14T in outstanding current liabilities. S&P gets it and that is why they are the first one to downgrade the US.
When the downgrade happened the Treasury Department acted quickly calling the move unjustified, political, terrible lapse of judgment, S&P made a mistake, and these are the same people who rated junk bonds AAA to begin with. While it is easy to criticize S&P for their prior actions, but relative to its sovereign debt ratings those arguments hold no water and anyone with a stitch of unbiased rationale realizes that the US is indeed in big trouble and we do not deserve a AAA rating. The worst part about this downgrade is the fact that the government is now baring down on S&P about this downgrade.
It was just announced that the Senate Banking Committee will be looking into the downgrade. While we do not know if hearings will happen or not the person close to the matter did say all options are on the table. I was under the impression that Congress wanted independent ratings agencies along with an independent Federal Reserve. Silly me I guess as the minute a ratings agency does the right thing they try to crush it with Senate investigations, but the Federal Reserve can monetize trillions in US debt without Congress blinking an eye, unreal.
What Congress is saying is be independent as long as you do what we say and want and if you decide to think for yourself, well, we will hunt you down and skin you alive. The government is acting very much like the old Soviet Union and is sending a message, not matter what we do keep us rated AAA. How can a ratings agency offer an independent review of a security if the government demands that it gets what it wants regardless of what the facts are? It is insane to think that the ratings agencies will remain independent if Congress has investigations if the US is downgraded. Frankly, this is extortion, blackmail or a combination of the two since the government is the one who issues S&P with its ratings license. Will S&P lose its license over this? I do not know, but it is possible and shameful if that is what happens.
As an American you should be angry over the downgrade, but not at S&P. You should be angry at the people who rubberstamps every bill that comes along wasting billions of dollars. You should be angry at their inability to work with each other and address the seriously obvious structural issues that will consume immense amounts of capital in the coming years. You should be angry that the Senate wants to investigate S&P while saying other quasi government agencies are left alone even though they are part of the problem. You should be angry that Alan Greenspan, Mishkin, Bernanke and every other clown out there says the US will never default because we can print our own money to pay the debt, devaluation IS a default.
You should NOT be mad at S&P and you should demand that Congress work on real problems because their lack of dealing with those problems is exactly why S&P downgraded them to begin with. We are not showing the world that we are capable of fixing any real problems. What we are showing the world is that if we do not get our way we will simply create problems were none exists and threaten the “trouble maker” with depriving them of their livelihood or by throwing them in jail. Way to go America.
I admit I have been delinquent on checking out the Euribor rates lately since the Federal Reserve has me scared to death about QE2, more on that later, but I do not think it will be what you believe it will be in November. However, the Euribor went ballistic thanks to the ‘perfectly safe’ Irish banks began to show that the ‘stress test’ were pure bull. How can a bank pass a stress test a couple of months ago and then do insolvent, basically? That doesn’t happen in a normal world and it proves that the ECB totally flubbed the stress test.
The fraud that the stress tests were showing up in the inter banking lending rates which went from benign to cancerous in a heartbeat. While the Euribor first continued to climb after the stress tests it did level out later in the summer, but now it went vertical and it probably is not looking back. Considering that European banks are still holding only God knows how much US MBS’s, which our current foreclosure fraud situation may render those MBS’s worthless over time, along with how much Greek, Portugal, Italian and Spanish debt and you got serious problems. The media is not going to touch this, but the bank lending markets talks about it only if you look at them.
The 3 month Euribor rate was below .90% until a week ago when it jumped to about 1%, .993% as I write this, which isn’t much until you consider we are in a zero interest rate policy (ZIRP). Actually, we are in a negative interest rate policy right now if you count all the QE going on. When you factor that in it kind of brings to light that something is wrong in Europe, still. US treasuries for 3 months are yielding about .14% so clearly European banks are pricing in a risk premium. The question is, what is the risk premium for? Clearly default is part of it and I think you will see more issues with banks very soon.
It is impossible to have bank holdings that consist of sovereign debt that is in trouble plus MBS holdings and not have any problems. There certainly will be more insolvency issues, but even if a bank is not insolvent their balance sheets will be impaired further. It is a mess and the real problem is that it is just not European banks, but US banks as well. While US banks do not hold a lot of sovereign debt, they do own tons of MBS holdings, unless the Fed buys them from the banks, which foreclosuregate, I hate these names we have now, will make many of these securities worthless or at the very least impair them well below par.
I do not know what is going to happen, but I am convinced that the serious problems that many thought were behind us never really went away. All we ended up having done was the government and the Fed paper over the problems. This went on all over the world with the ECB following suit as well. The Eurubor is telling us something, are many listening? Nope. Stocks are moving higher on some idiotic belief that inflating our way out of this mess will work, it might in nominal terms, but not in real terms. Phony stress tests clearly are not the answer as the fraud gets uncovered when banks that passed suddenly need a bailout. How central banks and governments have any credibility is simply beyond me. When a fraud is uncovered people usually talk about it, but the news on some financial channels is mute on the issue. When lending costs climb rapidly it usually makes news, did you hear about it? Nope. It is all just one big farce out there. I personally believe that the only safe haven seems to be commodities and I believe stocks are not as safe as people believe.
The smart money is always in the bond market, mostly because it is institutional money instead of retail investors. Anyone watching the last 2 treasury auctions see something wrong, a major problem in fact. The auctions were duds, dare I say failures? The primary dealers are taking in a large swath of the last 2 auctions, this has actually been a trend over the last few weeks, and the direct bidders are now gone. Yields are perking up to levels not seen in months, something isn’t right.
Whether it is sovereign debt or the markets frothy valuation, the bond market is signaling trouble ahead. Yields are not increasing for any good reason other than there is no demand for the hundreds of billions the U.S. needs to raise to keep the lights on. Perhaps the market has had enough or the Chinese are just not buying because Krugman and Schumer called them currency manipulators, you never make your largest lender mad at you when you need to raise billions of dollars.
Either way you look at this there is a problem and I do not know what it is other than a general buyers strike. However, what scares me is that this is following some historical events. In the late 1970’s there was a huge treasury bubble and rapid inflation, this is no secret, which led to the dollar’s decline in value. This was no big deal until the treasury bubble burst in 1980 and the treasury market imploded. What happened was treasuries sold off and the primary dealers, still in bubble mode and required to suck in supply, began to buy when prices went lower. Their thought was this was a steal, it wasn’t. This happened for a few days and prices continued to decline to the point where the primary dealers were on the verge of failure.
This was a serious situation as the companies that raise money for the government, the primary dealers, were almost all gone because of massive losses, they bought on leverage of course. This led to Volcker doing what he is famous for and Carter issuing credit controls. No one talks about this, and I overly simplified the story, but it was perhaps the days that almost ended America. I am not saying this is happening now, but if the primary dealers have to bring in supply and the prices on treasuries keep dropping, this could be a major problem. Of course, everyone is too big to fail, but still.
While I do not know if this is a short-term problem or the beginning of bond buyers telling the U.S. to get its act together, I believe it is the vigilantes, I do know this has serious potential problems. We need to wait to see what happens over the next few weeks, but more ‘failed’ auctions may be a problem bigger than a worldwide embarrassment, but our lenders cutting up our credit card. This will lead to more quantitative easing and dollar destruction which would mean we would actually begin to see higher prices without money velocity, don’t think that can happen? It can and just might happen.
Most disturbing is that we are talking 5’s and 7’s that could not get placed, that is easy paper. I sure hope Washington is worried enough to take the national debt situation seriously after this week. If they do not we all could be in for a rude awakening very quickly.
In a story from the New York Times Goldman Sachs is at the heart of yet another financial crisis, Greece and some of the other PIIGS. The firm, apparently, helped Greece raise a substantial amount of money secretly in order to avoid the EU from knowing the country was violating the debt to GDP ratio. While I am not a regulator and my opinion is worth whatever the reader thinks, in my opinion Goldman, the Vampire Squid, is guilty of several EU rules and should be banned from doing business in the Euro Zone. The firm should also disgorge all fees paid to them for helping Greece bamboozle the world.
Goldman clearly suffers from a lack of a conscience and needs to attend business ethics training, although if you need to learn about ethics chances are you simply have none, as they clearly would sell their soul for a few million in fees. I agree that Goldman Sachs probably has the best f the best working for them, but that does not excuse the fact that, apparently, the firm helped a country violate rules and hide their reckless spending. At the core of the problem is also another familiar financial product, derivatives.
Apparently Greece, in order to keep spending, also sold their rights to airport landing fees, roads and lottery revenue in return for short-term money upfront which lowered their deficits in the near-term. Many of these deals were done in the early 2000’s which begs the question, what else is Greece and, apparently, Italy hiding? It also begs the question of what else has Goldman been up to? We know that Goldman went to Greece to help with a solution to their problems, which means kick the can down the road while sucking the remainder of Greece’s blood, but Greece said no to their plans.
Unfortunately, the story about Greece seems to be getting worse and worse as more details come out. As more of the story comes out I have a feeling we will learn more about Goldman’s and JP Morgan’s involvement in this deceitful tale. One also wonders if the US has also participated in such shenanigans as well. At this stage of the game, with the close ties Goldman has with Treasury, would it really surprise anyone if the US engaged in idiocy like the Greece government?
What is most disturbing about this whole story is the fact that Greece basically sold off their public entities to a firm like Goldman and JP Morgan. Essentially, those public utilities, which is the best description of what Greece gave as collateral, revenues would go to these banks. Along with that disturbing piece of financing news we also find out that if Greece takes a bailout the population will be forced to give up part of its sovereignty as well. How would you like to be a citizen of Greece knowing your Politian’s sold your sovereignty out in secret to private banks and now to the EU.
If there is a moral to this story it is why is Goldman allowed to exist at all? They clearly provide no real value to society or even governments as they made it so Greece could sell worthless bonds to foreign governments. This is also the second time the world is witnessing a credit crisis with a major US bank, Wall Street if you will, creating the mess or at least adding to it. Goldman and JP Morgan literally threw gasoline onto the fire in the case of Greece and, perhaps, Italy as well. How can we trust a firm who consistently knows how to make money for themselves, but screw everyone else? At the end of the day, why should Goldman exist at all?
Regular readers know that I am or have become a bigger proponent of income investing lately and if you don’t know what I am talking about you should be reading my material more. However, there seems to be preconceived disconnect with my philosophy and what you believe to be true about interest rates moving forward. Some people see my bullishness on bonds in the face of rising interest rates as purely insane, especially given what treasuries are doing, but I can assure you it is not.
Keep in mind I am talking about investment grade corporate bonds and high yield bonds, my favorites are ‘BB’ and ‘BBB’ rate paper in an ETF format, I do not like mutual funds because of the once a day pricing. As an aside I do like selective sovereign debt as well, but don’t go out and buy Eastern European government debt or anything, be selective as the risk return is there, but supply is going to be an issue moving forward so it will pay to be extremely selective in 2010. Anyhow, back to corporate debt and why I like it.
Treasuries are entering a bear market for the first time in my memory and I expect there to be a bear market until the next crisis hits, so for only a few months. The reason there is a bear market is simple, supply, end of story. You cannot issue an endless amount of paper and expect the market to eagerly accept it without paying more for it because people, foreign central banks in this case, know they will never fully be repaid for the US debt they buy now, it is mathematically impossible for the US to repay its debt so don’t shoot the messenger hate the calculator. Because of that mathematical probability interest rates on treasuries are going higher and, according to those wonderfully bullish, and misguided, government data figures investors are pricing in interest rate hikes which kill treasuries and other high grade corporate debt, high grade being the operative word, so remember that please.
High grade corporate debt is technically, and in my opinion, anything rated higher than ‘A’ and issues interest rates slightly above treasury yields. We are talking about your really safe corporate paper issued by IBM and similar firms. Essentially, those are a riskless investment which is why your yield is so close to treasuries and why those bonds will get crushed when/if interest rates go higher. For those who do not understand how bonds work think of bonds and interest rates like a teeter-totter with interest rates on one side and bond prices on the other side, when one goes up the other side goes down. Therefore rising interest rates are bad for bonds because new bond issues will have higher yields so your existing bond will have less appeal in the marketplace and if rates go down new issue bonds will have lower rates which means your existing bond will be more attractive because it has a higher interest rate. Make sense, good.
All of that is important because we are at zero interest, technically we are in the negative interest rate area because of quantitative easing and deflation which is bond friendly. However, this red hot economy we are in, sarcasm is my trademark, many people are expecting an interest rate hike to happen at some time this year and they are right. The Fed will raise interest rates in 2010 from 0-.25% to .25-.50%, wow. There is an outside chance that rates may go to 1% by the end of the year, but that is pure speculation right now because the economic data or ‘recovery’ is spotty at best. Even if rates go up it is relatively meaningless to lower grade corporate bonds because it does not hurt the spread as badly as it does for higher grade corporate bonds.
What I mean is newer higher grade corporate debt and treasury debt will have higher yields than current issues so existing paper will get slammed. However, existing lower quality corporate paper will do OK as we would need rates to go up substantially in order to really hurt the spread. I am not saying that there is no risk in lower quality corporate debt, defaults will be a huge issue moving forward, but I am also betting that the Fed’s liquidity programs end up not going away either. In fact, I would speculate that the Fed’s balance sheet will continue to expand over the next 12 months, perhaps double again if the FASB gets its way and the SIV’s have to be added to banks balance sheets right away, but again that is speculation right now.
If the Fed does actually raise interest rates this would be a bullish signal to the markets because it means we have real growth in the economy as well. This means lower grade paper would perform better, even if that growth is only at lower levels. However, higher interest rates will not be good for stocks, in my opinion, which is why I shifted focus to lower quality corporate bonds and to companies like Alteria. I would not expect, even if the economy is cruising, to see rates go much higher than 1-1.5% though because the Fed is stuck and it cannot move rates higher or to a meaningful level ever again. Regardless, corporate bonds of ‘BBB’ or ‘BB’ and selective ‘junk’ should do OK moving forward in the face of higher interest rates because of what I said previously. We will not see huge returns like that of 2009, but I think they will do better than stocks moving forward, plus you are first in line when the company folds, something to think about.
Why the Fed is stuck
What do I mean by that, a meaningful level? You see, the US is in a debt trap that we cannot escape from, it is simple mathematics. The Fed will not be raising rates to protect the dollar, they want a weak dollar that is for another post, they do not really care about inflation as they really want massive inflation but we cannot create it. The Fed will raise interest rates to keep politicians off of its back and that is about it, but raising rates higher than 1.5% presents problems that the US cannot handle.
Congress just had to raise the debt ceiling by a few hundred billion to fund the government for the next 6-8 weeks, unbelievable, and a more ‘permanent’ fix of raising the debt ceiling to about $14T will be coming soon.
I know this is no big deal to liberal democrats because, after all, under Bush we had to raise the debt ceiling 7 times and to them 8 or 9 wrongs make a right, but this is a major, major problem. Considering that raising the debt ceiling to $14T moves the total US debt to just about 100% of GDP marks a new low for the US and is the greatest amount of debt any country has ever attempted. What I am saying is that our current debt servicing costs with the Fed holding rates at 0% and using QE is about $500B+ a year and our average maturity of our debt is less than 10 years, again this is a first in all of the world’s history.
If the Fed moves rates up past 1.5% then that debt servicing cost will go up, dramatically, and there will be major consequences that the American people are not ready to face. Forget the debt ceiling, we will repeal that silly little rule, especially since we have to raise it almost every year anyhow. Within 7 years out debt servicing costs will begin to take its toll on the national budget squeezing out typically paid for items, like earmarks. Defense spending will have to decline immensely which is why the US remains a superpower even though we have a relatively small manned military compared to say a China, India or North Korea. The dollar will decline much further, it will anyhow as the latest rally, which I anticipated, is a head fake and was driven by Dubai, Greece, Fear, short covering and the selling will comeback harder and faster than you could ever imagine.
All of the senseless spending is coming home to roost, now. China is telling us where to stick it as there is not enough dollars to buy our debt, which is kind of funny in a sick way, and they said no to strengthening their Yuan which makes sense for them and smells of protectionism to me. When we demand a foreign country make their products more expensive in the US just so we can shrink out trade deficit thereby boosting our GDP and sell more products to them that is protectionism, straight up. I do not like to be so grime, but many of the things I foresaw and have been keeping to myself are coming out in the open. Things are not good, but hey as long as the market keeps going up, who cares right? Well, you will when it comes crashing down around you. Fixed income never looked so attractive right now.
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