Bond Market Defies Fed

[Ahlevah]

wait.... are you saying that savings come before consumption???

Depends. If a company borrows money to buy machinery so it can hire people, then that might be a productive use of capital. If households take out HELOCS and max out their credit cards buying Chinese-made TVs and home theater systems to they can watch The Simpsons in Dolby TrueHD, then that might not be.

 

[oldreliable67]

To make matters worse, many of the "insurance policies" the crooks collected on were guaranteed by housewives and truck drivers from Moline, otherwise known as the U.S. taxpayer.

Well, no. The "insurance policies" were not guaranteed by taxpayers. Some of the underlying mortgage backed securities were guaranteed by Fannie or Freddie, which is now in effect guaranteed by the U.S. taxpayer, even though they weren't explicitly guaranteed by the U.S. at the time the deals were put together. Up until then, the guarantee afforded by the U.S. gov't had been implicit, relying on Fannie and Freddie's status as being created by congress, even though they weren't agencies of the federal gov't.

The closest you come to having a valid point with this is in the case of AIG. The bailout of AIG permitted AIG to repay Goldman and other counterparties quite a lot money, paying most of them 100 cents on the dollar for exposures that probably should have been negotiated down to 50, 60 or 70 cents on the dollar. The funds to make those payments came, ultimately, from the U.S. taxpayer. In the judgement of Treasury, at the time it was felt that a default on the huge, intertwined AIG obligations would have put the entire financial system at serious risk. Remember, at that time, interbank lending had frozen up like an iceberg; there was no interbank lending.

Would you rather have saved AIG, or had the entire financial system broken beyond repair?

 

[cpwill]

Depends. If a company borrows money to buy machinery so it can hire people, then that might be a productive use of capital. If households take out HELOCS and max out their credit cards buying Chinese-made TVs and home theater systems to they can watch The Simpsons in Dolby TrueHD, then that might not be.

if the company can purchase machinery, all it means is that it is purchasing the savings of others.

but i do see a good point in the difference between debt for capital v debt for consumption.

 

[oldreliable67]

Depends. If a company borrows money to buy machinery so it can hire people, then that might be a productive use of capital. If households take out HELOCS and max out their credit cards buying Chinese-made TVs and home theater systems to they can watch The Simpsons in Dolby TrueHD, then that might not be.

Chinese-made TV's don't have a labor component? Home theater systems assemble themselves? Both your illustrations require not only a labor component, most likely in some offshore market, but they both may have components that were manufactured in the US and sent offshore for assembly, then returned to the US for sale in stores employing workers. Moreover, credit card and HELOC-issuing companies employ people to manage those companies and administer those balances.

The point you're trying to make is a good one, but it just ain't that simple.

 

[Lord Tammerlain]

.... you are in favor of monetizing the debt...

... i will admit, i don't know how really to respond to this.

I never said I was in favor of it

I said that if the goal is to monetize the debt the amount done is too small to be able to offset the other issues with the economy.

I understand why they would take this route, I expected they would take this route (be it the Obama admin or McCain if he had won) and I expect this will not be the last time QE will be done in the US.

 

[washunut]

I never said I was in favor of it

I said that if the goal is to monetize the debt the amount done is too small to be able to offset the other issues with the economy.

I understand why they would take this route, I expected they would take this route (be it the Obama admin or McCain if he had won) and I expect this will not be the last time QE will be done in the US.

Does this to anyone like a Geithner/Bernanke Ponzi scheme? The amount of QE2 is very similar to the amount of debt the Fed will issue to cover the deficit the administration is running.

Madoff lasted many years until they caught up with him. I wonder if Geithner and Obama will still be in office when this Ponzi scheme is closed down.

 

[Lord Tammerlain]

Does this to anyone like a Geithner/Bernanke Ponzi scheme? The amount of QE2 is very similar to the amount of debt the Fed will issue to cover the deficit the administration is running.

Madoff lasted many years until they caught up with him. I wonder if Geithner and Obama will still be in office when this Ponzi scheme is closed down.

I think being in office will entirely depend on how the economy is doing in a couple of years. If the ponzi scheme can continue for that length of time, and temporarily make the economy seem strong, then yes Obama could be reelected. If the scheme fails to last untill then then both will be out. I generally doubt Obama will be in office in 3 years. Of course I have stated who ever got elected in 2008 was going to be a one term president due to the economy

 

[Ahlevah]

Would you rather have saved AIG, or had the entire financial system broken beyond repair?

I was referring to the CDS contracts issued by AIG. What you're really asking is would I rather have housewives in Moline pay Goldman Sachs et al 100 cents on the dollar or let AIG fail like it would have in a free market and have them collect squat or fight it out in court. I think I would have let it fail. It's time to resurrect an all-but-forgotten concept called moral hazard. Life went on after Lehman, life would have gone on after AIG. All of these bailouts will not save Wall Street from its greed and stupidity. They're just inspiring the next bubble and setting us up for an even greater problem in the future. The only thing that will save us is paying down the $52 trillion in credit market debt we've accumulated over the last several decades. If Wall Street investment banks, European banks, and hedge funds want to play casino, let them do it with their own money and not the taxpayers'.

 

[oldreliable67]

What you're really asking is would I rather have housewives in Moline pay Goldman Sachs et al 100 cents on the dollar or let AIG fail like it would have in a free market and have them collect squat or fight it out in court.

If all else had been equal, there is no doubt that the best course would have been to let AIG fail. But rarely is all else equal. It certainly wasn't in the case of AIG, as evidenced by the quite severe fall-out from the orders-of-magnitude smaller (relatively) Lehman bankruptcy.

After Lehman,the global financial system almost quit working; absent massive liquidity injections by the Fed, it might well have stopped in its tracks. Multiply that by some number, some order of magnitude, and you approach the potential for systemic failure from an an AIG bankruptcy.

It's time to resurrect an all-but-forgotten concept called moral hazard.

The application of moral hazard was exactly why Lehman was not merged into another firm and placed into liquidation instead. Remember the hue and cry about moral hazard after Bear Stearns? The arranged marriage for Bear Stearns was widely proclaimed a 'bail out' even though Bear Stearns stockholders got virtually nothing and saw their investments in the firm wiped out.

After Bear, Stearns there was simply no way that another near-death brokerage firm was not going to liquidated in bankruptcy - unless there was a high degree of certainty that to do so would be more disruptive to the economy than to not do so.

Recognition of moral hazard is alive and well at Treasury and the Fed. But sometimes there are larger considerations. The policy deliberations and decisions were not 'how do we save this firm or that firm?' but rather, 'how do we contain this recession so that it doesn't devolve into the Great Depression 2?

 

[Ahlevah]

After Lehman,the global financial system almost quit working; absent massive liquidity injections by the Fed, it might well have stopped in its tracks. Multiply that by some number, some order of magnitude, and you approach the potential for systemic failure from an an AIG bankruptcy.

I can see the Fed providing liquidity to an American commercial bank if it's experiencing a run and has assets it can't sell immediately. However, why should bailing out European banks, American investment banks, or hedge funds that bought CDS contracts on Lehman debt be the province of the U.S. taxpayer? I mean, one moment I see supposed free marketers and other assorted capitalist tools on CNBC saying that if Wall Street isn't bailed out we'll have financial Armageddon, then the next moment there is Lloyd Blankfein's mug on TV defending the billions of dollars worth of bonuses Goldman Sachs is set to pay out for the record year the bank had in 2009. Pity poor Goldman, which "only" paid out bonuses that still approached the GDP of Bolivia. Imagine if it had had a really good year.

 

[washunut]

I can see the Fed providing liquidity to an American commercial bank if it's experiencing a run and has assets it can't sell immediately. However, why should bailing out European banks, American investment banks, or hedge funds that bought CDS contracts on Lehman debt be the province of the U.S. taxpayer? I mean, one moment I see supposed free marketers and other assorted capitalist tools on CNBC saying that if Wall Street isn't bailed out we'll have financial Armageddon, then the next moment there is Lloyd Blankfein's mug on TV defending the billions of dollars worth of bonuses Goldman Sachs is set to pay out for the record year the bank had in 2009. Pity poor Goldman, which "only" paid out bonuses that still approached the GDP of Bolivia. Imagine if it had had a really good year.

I do not think any hedge funds got TARP. Also not sure Goldman needed the money they received. Remember they had gotten a loan from Buffet for $5 billion. Paulson made everyone take the money so as to not expose the weakest of the banks.

 

[Ahlevah]

I do not think any hedge funds got TARP.

They didn't have to. They got paid 100 cents on the dollar by AIG, which received almost $200 billion from taxpayers.

Also not sure Goldman needed the money they received. Remember they had gotten a loan from Buffet for $5 billion. Paulson made everyone take the money so as to not expose the weakest of the banks.

That's my point. There's a disconnect between the picture painted by the Chicken Littles who said the sky would have fallen without the U.S. Treasury and the Goldmans who said they didn't need Treasury support. I mean, if we had large investment/commercial banks saying they didn't need/want the money, then isn't it fair to ask whether the financial system would have collapsed without it?

 

[washunut]

They didn't have to. They got paid 100 cents on the dollar by AIG, which received almost $200 billion from taxpayers.



That's my point. There's a disconnect between the picture painted by the Chicken Littles who said the sky would have fallen without the U.S. Treasury and the Goldmans who said they didn't need Treasury support. I mean, if we had large investment/commercial banks saying they didn't need/want the money, then isn't it fair to ask whether the financial system would have collapsed without it?

Of course it is fair to ask the question. No one can know for sure. There is a good chance that Bank of America and Citicorp would have gone down. Perhaps Morgan Stanley as well. The second tier banks still have a problem with commericial real estate loans.

 

[Lord Tammerlain]

If I am not mistaken had thew US government bailouted out taken over AIG and only made whole US companies it would have left it self open for large lawsuits and filings under the WTO

 

[washunut]

If I am not mistaken had thew US government bailouted out taken over AIG and only made whole US companies it would have left it self open for large lawsuits and filings under the WTO

If the government had taken over AIG they would not have had to pay off on the derivative bets until they went bad. The government panicked, the banks played hardball and made a ton more money than they would have if they just took over the company.

 

[Lord Tammerlain]

If the government had taken over AIG they would not have had to pay off on the derivative bets until they went bad. The government panicked, the banks played hardball and made a ton more money than they would have if they just took over the company.

In my opinion that was the point. A backdoor bailout of the major financial industries that did not register as a bailout

 

[oldreliable67]

I can see the Fed providing liquidity to an American commercial bank if it's experiencing a run and has assets it can't sell immediately. However, why should bailing out European banks, American investment banks, or hedge funds that bought CDS contracts on Lehman debt be the province of the U.S. taxpayer?

It shouldn't-if the situation is confined to an American commercial bank experiencing a run. But that doesn't describe the situation that existed. The judgment of Treasury and Fed officials alike was that many, many related dominoes were in danger of toppling if some assistance was not forthcoming. A mere run on a single bank doesn't engender risk of a Great Depression 2.

We should not take lightly the combined judgment of those Treasury and Fed wonks who made those assessments and subsequent recommendations to their seniors who would ultimately make policy. They were many, and spent weeks of unending days ensconced at the major commercial banks and investment banks alike, poring over books and records. They did not come to those recommendations lightly. Only recently have the last of the regulatory supervisors left their assignments at the banks; until then, the banks executives could make no major (and in some cases, even minor) decisions without first consulting their in-place regulators.

 

[Ahlevah]

We should not take lightly the combined judgment of those Treasury and Fed wonks who made those assessments and subsequent recommendations to their seniors who would ultimately make policy. They were many, and spent weeks of unending days ensconced at the major commercial banks and investment banks alike, poring over books and records. They did not come to those recommendations lightly.

Keep in mind it was a conglomeration of many smart people who got us into this mess in the first place. Let me refer again to some prescient comments that were published several months before Lehman Bothers collapsed in September, 2008 when the word "deflation" was still a 1930s anachronism:

I have been both a central banker and a market regulator. I now find myself questioning whether my early career, largely devoted to liberalising and deregulating banking and financial markets, was misguided. In short, I wonder whether I contributed - along with a countless others in regulation, banking, academia and politics - to a great misallocation of capital, distortion of markets and the impairment of the real economy. We permitted the banks to betray capital into “hopelessly unproductive works”, promoting their efforts with monetary laxity, regulatory forbearance and government tax incentives that marginalised investment in “productive works”. We permitted markets to become so fragmented by off-exchange trading and derivatives that they no longer perform the economically critical functions of capital/resource allocation and price discovery efficiently or transparently. The results have been serial bubbles - debt-financed speculative frenzy in real estate, investments and commodities.

Since August of 2007 we have been seeing a steady constriction of credit markets, starting with subprime mortgage back securities, spreading to commercial paper and then to interbank credit and then to bond markets and then to securities generally. While the problem is usually expressed as one of confidence, a more honest conclusion is that credit extended in the past has been employed unproductively and so will not be repaid according to the original terms. In other words, capital has been betrayed into unproductive works....

I’m seriously worried that reflationary practice by Washington and the Fed in response to every market hiccup in recent decades was storing up a bigger debt deflation problem for the future. This very scary chart (click through to view) gives a measure of the threat in comparing Depression era total debt to GDP to today’s much higher debt to GDP.

Certainly Washington and the Fed have been very enthusiastic and innovative in “reflating” the debt-sensitive financial, real estate, automotive and consumer sectors for the past many years. I’m tempted to coin a new noun for reflation enthusiasm: refllatio?

Had Fisher observed the Greenspan/Bernanke Fed in action, he might have updated his theory with a revision. At some point, capital betrayed into unproductive works has to either be repaid or written off. If either is inhibited by reflation or regulatory forbearance, then a cost is imposed on productive works, whether through inflation, higher interest, diversion of consumption, or taxation to socialise losses. Over time that cost ultimately hollows out the real productive economy leaving only bubble assets standing. Without a productive foundation, as reflation and forbearance reach their limits, those bubble assets must deflate.

London Banker: Fisher's Debt-Deflation Theory of Great Depressions and a possible revision

So if "London Banker" is correct and capital has been "betrayed into unproductive works," did the Fed and Treasury really do us any favors in the longer run by propping up banks that issued these loans? Wouldn't death by fire have been preferable to death by a thousand paper cuts? How many "zombie banks" do we have that are sitting on mountains of bad loans they refuse to write down because if they did they would be insolvent? Why are many financial stocks retreating significantly from their 52-week highs while the economy is supposedly recovering? You don't have to be an economist to see that real estate is still deflating and what that will do to bank balance sheets and lending prospects going forward.

 

[oldreliable67]

So if "London Banker" is correct and capital has been "betrayed into unproductive works," did the Fed and Treasury really do us any favors in the longer run by propping up banks that issued these loans? Wouldn't death by fire have been preferable to death by a thousand paper cuts?

You gloss over and seriously underestimate the societal ramifications a Great Recession 2. I do agree with the assertion that the capital markets have become the big casino. That is unfortunate and must be corrected. But not at the risk of plunging society into an economic maelstrom.

Why are many financial stocks retreating significantly from their 52-week highs while the economy is supposedly recovering? You don't have to be an economist to see that real estate is still deflating and what that will do to bank balance sheets and lending prospects going forward.

Indeed not. The financial services sector had grown to the point where it comprised almost 40% of the profits of the entire S&P 500. That clearly is not going to be the case going forward, at least not for a while, if ever. Add in the unresolved questions about foreclosures and the risk to bank balance sheets that situation poses, and the retreat of bank stocks is understandable.

The rest of the economy does continue to recover, albeit slowly. Ironically, the Fed just lowered their forecasts for 2011 and 2012, just in time for a few indicators to suggest a modest acceleration in growth might be in the offing.

And while you're lamenting the state of bank balance sheets and lending prospects, think what they might have been if the choice had been 'death by fire.'

 

[Ahlevah]

You gloss over and seriously underestimate the societal ramifications a Great Recession 2.

Well, if I did, it wasn't intentional. I was under no illusion that unwinding the leverage financial institutions built up over almost forty years would be painless. The only question to me was when we should feel it. There will be a lot of pain, but not as much as we'll get if we reflate once again. As "London Banker" maintained, eventually we reach a point at which efforts to reflate are for naught. I think we've reached that point, because bank assets are concentrated in commercial and residential real estate and once a bubble of this magnitude pops all of the greater fools head for the exits. So instead of new growth, what we'll get is stagnation as the weeds (bad loans) choke the garden.