Fragility: What Has the Watchers Worried In the US Debt Markets

As you know I am on the lookout for a 'trigger event' that might spark another financial crisis, given the composition of the economy and the financial markets. 

In the last financial crisis 2008, it was the failure of the two Bear Stearns hedge funds that exposed the grossly mispriced risks in mortgage backed financial assets, and the generally flawed nature of the market's collateralized debt obligations.  This led to a cascade of failures in fraudulently priced assets, and resulted in increasingly large institutional failures, including the collapse of Lehman Brothers.

One can draw some parallels with the financial crisis before that, which was the gross mispricing of risk and inflated values of internet-related tech companies that had grown to obviously epic proportions by 2000. A failure of several key tech bellwethers to make their numbers, and some negative results in the economy, showed the flaws in the underlying assumptions in what was clearly an asset bubble. And once the selling started, it was Katy-bar-the-door.

 

The failure of two relatively minor hedge funds was not a great event. The failure of a tech bellwether to make its quarterly numbers is not either. But their interconnectedness to the other portions of the world markets through the financial institutions on Wall Street, and more importantly, the fragile nature of the entire pyramid scheme of fraudulently constructed and mispriced risk of financial assets, caused an inherently shaky system to fall apart.  What was most shocking was how quickly it happened once the dominos started falling.

The debt market in the US, with its deep ties to private equities, is probably not a trigger event, the fuse itself.  But it well might serve as the powder keg that will transmit the effects of some more individual event throughout the world's markets and economies.

The gross mispricing of risks in financial paper, again, and the lack of reform in the financial system along with excessive leverage and mispricing of risk, the fragility of long distorted markets if you will, has certainly risen to impressive levels again.

 

It is a familiar template of recklessness, fraud, and  then reckoning.  Afterward there is the usual attempt to blame the government officials which have been corrupted, and the people who have been duped and swindled.  Quite often some scapegoat will be found to be demonized.

 

I am thinking that this time the problem will arise overseas, with the failure of some major financial institutions there.  Perhaps Greece will provide the spark.  Or the Ukraine, or Mideast, or something yet unforeseen.  The failure of some major European bank certainly has historical precedent.

 

And if we do experience another crisis, do not be surprised if the moguls of finance come to the Congress through their proxies again, with a sheet of paper in hand demanding hundreds of billions of dollars, or else.

Last time it was a bail-out, which was the printing of money by the Fed to monetize the banking losses and shift them to the public.  This time they are thinking of something more direct, talking about a bail-in.   What if they eliminated cash, and started utilizing and redploying financial assets like savings and pensions.   The uber-wealthy already have their wealth parked in hard income-producing assets and offshore tax havens.  Who would stop them?

Like war, there will be an end to this kleptocratic economy of bubble economics and financial crises when the costs are borne by those responsible for it, and who so far are benefitting from it, enormously.

 

Tell us why you think it might be different this time.   What has really changed?  From what I can tell, it has not only stayed the same for the most part under the cosmetics of change, and significant portions of the financial landscape have gotten decidedly more dangerous, larger, and more leveraged.

 

Wall Street On Parade

Here Is What’s Fraying Nerves Among the Financial Stability Folks at Treasury

By Pam Martens and Russ Martens

June 10, 2015

On Monday, Richard Berner worried aloud at the Brookings Institution about what’s troubling the smartest guys in the room about today’s markets.

Berner is the Director of the Office of Financial Research (OFR) at the Treasury Department. That’s the agency created under the Dodd-Frank financial reform legislation to, according to their web site, “shine a light in the dark corners of the financial system to see where risks are going, assess how much of a threat they might pose,” and, ideally, provide the analysis to the folks sitting on the Financial Stability Oversight Council in time to prevent another 2008-style financial collapse on Wall Street.

Two notable concerns stood out in Berner’s talk. First was a concern about liquidity in bond markets evaporating rapidly for reasons they don’t yet “sufficiently understand.”

...Another major concern are the bond mutual funds and ETFs that have mushroomed since the 2008 crisis and are stuffed full of illiquid assets or assets which might become illiquid in a financial panic.

Read the entire article here.

US Treasuries - Negative Returns Almost As Far As the Eye Can See

These charts compare the Nominal and Real Treasury Yield Curves provided by the Treasury Department.

The 'real' return is the return on the debt less expected inflation. A note on how the Treasury calculates this is below. Since they use TIPS the real yield are only done for notes of 5 years or more duration.

The comparison is between February 22 data from this year and last year.

As one can see, the Fed's "Operation Twist" has had a profound effect on the real returns achieved by holders of US sovereign debt.

The real yields turn positive about the 15 year mark. The real return these days on a 30 Year Bond is about .76%. And that is probably using rather optimistic assumptions about inflation risk.

What this implies is that savers are by and large paying the US government to borrow from them.

Is this an effective economic stimulus for the real economy, or a sophisticated form of seignorage being performed by the Fed on behalf of its member Banks?

Interesting experiment. I hope Benny's model has the right risk parameters plugged in. If not, as Fed policy errors go, this one could be memorable.

No wonder certain alternative stores of wealth are rallying as a haven from this soft confiscation.

"Treasury Real Yield Curve Rates. These rates are commonly referred to as "Real Constant Maturity Treasury" rates, or R-CMTs. Real yields on Treasury Inflation Protected Securities (TIPS) at "constant maturity" are interpolated by the U.S. Treasury from Treasury's daily real yield curve. These real market yields are calculated from composites of secondary market quotations obtained by the Federal Reserve Bank of New York. The real yield values are read from the real yield curve at fixed maturities, currently 5, 7, 10, 20, and 30 years. This method provides a real yield for a 10 year maturity, for example, even if no outstanding security has exactly 10 years remaining to maturity."

SP Daily Chart Into End of Second Quarter: Not With a Bang But a Whimper

US equities went out of the second quarter on new lows.

There was a surprising amount of tape painting in individual stocks, that was almost funny at times. It is hard to hide behind the tape in these thin markets. I suppose that if I were fund manager carrying a large short position, I might want to artificially drive the price down to make things look better as I closed my books on the quarter.

The junior miners in particular are a real hoot to watch with their wide spreads, large short interests, openly aggressive naked short selling, and thin volumes. It takes a special kind of masochism to trade anything on the pink sheets, much less Canadian listed stocks.

Unemployment report out tomorrow, after which time the adults will be heading out to the Hamptons for the long holiday weekend, leaving the underclass of traders in charge with strict instructions and most likely a short leash.

The Non-Farm Payrolls report will be out on Friday, July 2. The consensus is for a loss of 100,000 jobs. The ADP report came in this week with a gain of 13,000 jobs, which was well below expectations of 61,000. A recovery in the US economy is an illusion.

It is typical Wall Street arrogance when they say that 'no one will be there to even hear the number, much less trade it.' As I recall, Asia and Europe will be open for business on Friday and Monday. But some might imagine them to be junior traders, taking their orders and queues from New York and London as well.



I am still running the long gold / short stocks hedge, with the add of a slight short in the long Bond which is probably anticapatory of a decline in July unless we get another leg down in equities that has legs.

Treasuries Fall After Weaker Than Expected Results in the Ten Year Auction

Interest rates rose and stocks and commodities faltered a bit on the result of this ten year treasury auction which was weaker than this Bloomberg piece suggests.

Metals declined as a reflexive reaction to 'higher interest rates.' The hit on the metals preceded the release of the results, in yet another bear raid by the Wall Street banks holding undeliverable short positions.

Foreign central banks were noticeably light buyers, much preferring the shorter durations like the three year.

Primary Dealers took a big chunk of the offering. Current trends suggest that Ben will take it off their hands through monetization.

The Fed will be under signficant pressure to buy the bonds as the bias to the short end of the curve creates imbalances that precipitate a funding crisis, and a possible currency crisis, at the Treasury in 2010 if this trend continues. It is unlikely that they will raise rates when monetization is a viable, if not preferred, option.

Geithner looks likely to be replaced in 2010 by a Treasury Secretary who is more 'seasoned' and who will guide the US multinational banking industry through what could be later known as the currency wars, analagous to the trade wars that occurred in the Great Depression. One might even say that they are already underway.


Bloomberg
Treasuries Fall After $21 Billion Auction of 10-Year Notes
By Cordell Eddings and Susanne Walker

Dec. 9 (Bloomberg) -- Treasuries fell after the U.S sold $21 billion of debt maturing in 10 years, the second of three note and bond auctions this week totaling $74 billion.

The notes drew a yield of 3.448 percent, compared with the average forecast of 3.421 percent in a Bloomberg News survey of seven of the Federal Reserve’s 18 primary dealers. The bid-to- cover ratio, which gauges demand by comparing total bids with the amount of securities offered, was 2.62, compared with an average of 2.63 at the past 10 auctions.

“Investors are not sure they want to be holding this many Treasuries going into a year where duration is going to be extending and rates may go higher,” Suvrat Prakash, an interest-rate strategist in New York at BNP Paribas Securities Corp., said before the auction. BNP is one of the primary dealers, which are required to bid at Treasury auctions.

The yield on the current 10-year note rose five basis point to 3.44 percent at 1:02 p.m. in New York, according to BGCantor Market Data.

Indirect bidders, an investor class that includes foreign central banks, bought 34.9 percent of the notes at today’s auction. They purchased 47.3 percent at the November sale. The average for the past 10 auctions is 39.1 percent...

The spread between yields on 2-year and 30-year Treasuries touched 366 basis points as the U.S. prepares to sell $13 billion of bonds tomorrow. The last time the spread was so large was 1992, when the Federal Reserve cut interest rates to bolster growth after a recession...

Do Ben and Tim = Thelma and Louise?

One cannot help but note that Team Obama is trying to derail serious proposals regarding financial reform for Wall Street at the G20 meeting, as we suggested they would.

The concerns raised by US revelations at the G20 today about new intelligence regarding Iran's secret underground nuclear facility have overshadowed financial reform and economic problems, and Gordon Brown's prescription yesterday that the G20 would become the new governing council for the world. It also stepped rather heavily on the House Hearings on HR 1207 "Audit the Fed" bill sponsored by Ron Paul and a good part of the Congress.

Why waste a crisis indeed. Especially when you can cop a two-fer.

Yesterday we put forward a somewhat lengthy piece on the Fed and reverse repos being considered titled Fed Eyes US Money Market Funds.

There is a key quote in there that we would like to highlight today.

The central bank is now considering dealing with money market funds because it does not think the primary dealers have the balance sheet capacity to provide more than about $100 billion... Money market mutual funds have about $2.5 trillion under management..."

Only 100 billion in available capital for a relatively risk free short term investment in the global banking system including the Primary Dealers, does seem a bit tight for a set of such 'well capitalized' banks, especially since they aren't making many commerical loans, preferring to speculate in the commodity and equity markets for daytrading profits.

BNP Paribas Securities Corp., Banc of America Securities LLC, Barclays Capital Inc., Cantor Fitzgerald & Co., Citigroup Global Markets Inc., Credit Suisse Securities (USA) LLC, Daiwa Securities America Inc., Deutsche Bank Securities Inc., Goldman, Sachs & Co., HSBC Securities (USA) Inc. , Jefferies & Company, Inc., J. P. Morgan Securities Inc., Mizuho Securities USA, Morgan Stanley & Co. Incorporated, Nomura Securities International, Inc., RBC Capital Markets Corporation, RBS Securities Inc., UBS SecuritiesLLC.

Couple that with the revelation reported some time ago at ZeroHedge and covered here, that the Fed is taking on more than 50 percent of the longer dated Treasuries, and there is only about Ten Billion left on their balance sheet for expansion, and you get the picture of a financial system not cruising into recovery but heading straight at a confrontation with harsh reality.

We have considered the possibility that the Fed is doing this to place exclusively AAA and Treasuries on the balance sheets of the Funds, aka the Shadow Banking System, who are holding some seriously awful garbage. But this does not quite make sense unless those reverse repos are of a very long duration or rolled over automatically for a long period of time. A proper program such as was extended to the banks where the Fed buys the assets outright would be that solution. It made more sense to us that the banking system is still very tight on good capital assets and liquidity.

Here is an update from ZH that is somewhat compelling if one understand the implications. Visualizing the Upcoming Treasury Funding Crisis.

"Summary: foreign purchasers are congregating exclusively around the front end of the Treasury curve, meaning that the primary net purchaser of dated bonds has been the Federal Reserve. As everyone knows by now, the Fed only has $10 billion left out of the $300 billion total allotted for Treasury QE. That should expire next week. ... The time of unravelling may be upon us sooner than most think."

Do Tim and Ben = Thelma and Louise?

As the Eagles sang:

"Take it, to the limit, one more time..."

The Bubble In US Treasuries and Its Implications

The Treasury bubble is likely to be much less destructive than the Internet and Housing Bubbles.

The bubble in the US dollar, however, if one wishes to consider it as an adjunct or outcome of the bubble in Treasuries, has the potential to be disruptive and devastating


Reuters
Buffett says U.S. Treasury bubble one for the ages
By Jonathan Stempel
Sat Feb 28, 2009 9:31pm GMT

NEW YORK (Reuters) - Warren Buffett, whose Berkshire Hathaway Inc. sits on $25.54 billion (17.8 billion pounds) of cash, said worried investors are making a costly mistake by buying up U.S. Treasuries that yield almost nothing.

In his widely read annual letter to Berkshire shareholders, the man many consider the world's most revered investor said investors are engulfed by a "paralyzing fear" stemming from the credit crisis and falling housing and stock prices. Treasury prices have benefited as investors flocked to the perceived safety of the "triple-A" rated debt.

But Buffett said that with the U.S. Federal Reserve and Treasury Department going "all in" to jump-start an economy shrinking at the fastest pace since 1982, "once-unthinkable dosages" of stimulus will likely spur an "onslaught" of inflation, an enemy of fixed-income investors.

"The investment world has gone from underpricing risk to overpricing it," Buffett wrote. "Cash is earning close to nothing and will surely find its purchasing power eroded over time."

"When the financial history of this decade is written, it will surely speak of the Internet bubble of the late 1990s and the housing bubble of the early 2000s," he went on. "But the U.S. Treasury bond bubble of late 2008 may be regarded as almost equally extraordinary."

DISMAY OVER MORTGAGE PRACTICES

Investors' flight to quality followed years of excessive borrowing, especially in housing, and Buffett used his letter to make plain his dismay with a variety of mortgage lenders.

He said many ignored Lending 101 by not checking customers' ability to pay off home loans, or foisting "teaser" rates that reset to higher unaffordable levels.

In contrast, Buffett said, Berkshire's manufactured housing unit Clayton Homes had a 3.6 percent foreclosure rate at year end on loans it made, up from 2.9 percent in 2006, though more than one in three borrowers had "subprime" credit scores. The unit was profitable in 2008, earning $206 million before taxes, though earnings fell 61 percent, Berkshire said.

"The present housing debacle should teach home buyers, lenders, brokers and government some simple lessons that will ensure stability," Buffett wrote. "Home purchases should involve an honest-to-God down payment of at least 10 percent and monthly payments that can be comfortably handled by the borrower's income. That income should be carefully verified."

The Treasury Bubble and the Central Banks: Imbalance à Go Go

The astute observer may notice a trend change in the way that foreign central banks choose to deploy their dollar reserves while supporting their industrial policies.

There should be little doubt why there is a bubble in Treasuries, and why the Federal Reserve is in the market buying mortgage debt.

Paulson Hitting a High Note in Treasury Debt Issuance

One might surmise that Treasury is hitting a hard high note on the Three Year Treasury issuance because this is the preferred duration of the central banks of China, Saudi Arabia and Japan among others, on behalf of their people.

At some point the Ten Year Note may become the favorite product of Mr. Bernanke, our own central banker, as a chaser to the the junk bond cocktails he is chugging down now.

As an aside, check out the action on the long end of the curve today in Big Daddy, the 30 Year Bond.

Across the Curve
Treasury Supply
By John Jansen
January 5th, 2009

Henry Paulson is not following the sage counsel of TS Eliot and is instead going out with a bang rather than Eliot’s whimper.

The Treasury announced today that they will auction $30 billion 3 year notes on Wednesday. The increase in issuance here is stunning. The 3 year was reintroduced in November at $25 billion. In its previous reincarnation it was a quarterly issue.

The US government has a desperate need for cash and in their infinite wisdom the debt managers chose to place this bond on a monthly cycle. In the span of two months they have bumped the total from $25 billion to $30 billion. If we start with the November issue and make the poor assumption that they will not tweak this again, the Treasury will raise an incredible $353 billion the 3 year sector in the year that ends October 31 2009.

The Treasury also announced the reopening of the 10 year note for a second time. Treasury issued $20 billion in November and $16 billion when they reopened it in December.

Prior to November the 10 year auction occurred eight times each year. This is the first announcement of the expanded monthly cycle for that issue and they will sell $16 billion this time. That means that the taxpayers have issued $52 billion to the public of this mega issue.

Previously the Treasury had announced that it would sell $8 billion TIPS tomorrow.

I rarely wade into the bill pit but to make the point I would be remiss if I did not note the supply in that market.

Each Monday since time immemorial Treasury has issued three month bills and six month bills. Today is no different and they will raise in total $53 billion in those auctions.

I do not have the auction dates but the Treasury will also sell $24 billion four week bills and $35 billion special 70 day bulls this week.

Sister Consolata taught me very well in grammar school ( they taught grammar in the 1950s. We would diagram sentences) and the sum of those numbers is $166 billion.

Against that background, I suggest that Hank Paulson is leaving a blazing trail of glory in his wake.

Japanese Economist Urges Selective Default on US Treasury Debt

Here is an intriguing proposal for a 'selective default' of US Treasury debt to head off a massive devaluation of the dollar, and to promote the US recovery from the ravages of its self-inflicted financial damage.

No matter how one wishes to describe it, the US will have to default on its sovereign debt, most likely on a selective basis, writing down the rest through an inflated dollar. The Japanese recognize this and are volunteering a tentative plan to accomplish it to support their industrial policy.

Although there is a potential for a voluntary debt forgiveness from Japan as a loyal client state, we wonder if the rest of the world will be inclined to accept an unreformed dollar hegemony.

Can the economic world so woefully lack the will, knowledge, and the imagination to develop a more equitable mechanism for international trade?

Financial reforms, although not even on the table yet, are certain to come with any sustained recovery. There has been nothing even seriously proposed yet as Bernanke and Paulson rush to supply fresh capital to prop up the status quo and aid their cronies on Wall Street.

We can surely do better than this.


Bloomberg
Japan Should Scrap U.S. Debt; Dollar May Plummet, Mikuni Says
By Stanley White and Shigeki Nozawa

Dec. 24 (Bloomberg) -- Japan should write-off its holdings of Treasuries because the U.S. government will struggle to finance increasing debt levels needed to dig the economy out of recession, said Akio Mikuni, president of credit ratings agency Mikuni & Co.

The dollar may lose as much as 40 percent of its value to 50 yen or 60 yen from the current spot rate of 90.40 today in Tokyo unless Japan takes “drastic measures” to help bail out the U.S. economy, Mikuni said. Treasury yields, which are near record lows, may fall further without debt relief, making it difficult for the U.S. to borrow elsewhere, Mikuni said. (We struggle a bit with the notion of Treasury yields falling without a substantial debt relief. One would think they would be increasing to uncomfortable levels as the risk of an involuntary default increases, unless the Fed plans to aggressively monetize them to peg the yield curve, trashing the Dollar in the process. - Jesse)

“It’s difficult for the U.S. to borrow its way out of this problem,” Mikuni, 69, said in an interview with Bloomberg Television broadcast today. “Japan can help by extending debt cancellations.” (We seem to have surpassed the Ponzi viability boundary. - Jesse)

The U.S. budget deficit may swell to at least $1 trillion this fiscal year as policy makers flood the country with $8.5 trillion through 23 different programs to combat the worst recession since the Great Depression. Japan is the world’s second-biggest foreign holder of Treasuries after China.

The U.S. government needs to spend on infrastructure to maintain job creation as it will take a long time for banks to recover from $1 trillion in credit-market losses worldwide, Mikuni said. The U.S. also needs to launch public works projects as the Federal Reserve’s interest rate cut to a range of zero to 0.25 percent on Dec. 16. won’t stimulate consumer spending because households are paying down debt, he said. (One would look for policies to increase the median hourly wage to facilitate this. So far we are seeing nothing, if not the opposite, to support this. - Jesse)

U.S. President-elect Barack Obama wants to create 3 million jobs over the next two years, more than the 2.5 million jobs originally planned, an aide said on Dec. 20. Obama takes office on Jan. 20.

Marshall Plan

Japan should also invest in U.S. roads and bridges to support personal spending and secure demand for its goods as a global recession crimps trade, Mikuni said.

Japan’s exports fell 26.7 percent in November from a year earlier, the Finance Ministry said on Dec. 22. That was the biggest decline on record as shipments of cars and electronics collapsed.

Combining debt waivers with infrastructure spending would be similar to the Marshall Plan that helped Europe rebuild after the destruction of World War II, Mikuni said.

“U.S. households simply won’t have the same access to credit that they’ve enjoyed in the past,” he said. “Their demand for all products, including imports, will suffer unless something is done.”

The plan was named after George Marshall, the U.S. secretary of state at the time, and provided more than $13 billion in grants and loans to European countries to support their import of U.S. goods and the rebuilding of their industries

Currency Reserves

The Japanese government could use a new Marshall Plan as a chance to shrink its $976.9 billion in foreign-exchange reserves, the world’s second-largest after China’s, and help reduce global economic imbalances, Mikuni said.

The amount of foreign assets held by the Japanese government and the private sector total around $7 trillion, Mikuni said.

Japan will also have to accept that a stronger yen is good for the country in order to reduce excessive trade surpluses and deficits, he said. The yen has appreciated 23 percent versus the dollar this year, the most since 1987, as the credit crisis prompted investors to flee riskier assets and repay loans in the Japanese currency.

“Japan’s economic model has been dependent on external demand since the Meiji Period” that began in 1868, Mikuni said. “The model where the U.S. relies on overseas borrowing to fuel its property market is over. A strong yen will spur Japanese domestic spending and reduce import prices, thereby increasing purchasing power.”

Black Swan Dive: Life On the Tails

The worst case scenario is if the Dollar, Bond, and Equities start going down together as the world repudiates the US Dollar Reserve Currency and Credit Bubble.

This is not a probable scenario.

The last time it happened was in 1933 in the trough of the Great Depression.

But we may have the opportunity to see something as once-in-a-lifetime and memorable as John Law's Banque Générale and the Mississipi Bubble.

Let's hope the Federal Reserve can reach deeper in its pockets for a better class of tricks than just front running the dollar and the bonds until they fall over.

Certainly anything is possible, but it does appear as though the US Long Bond is hitting a 'high note' of improbable valuation unless the world accepts a single currency dollar regime.

The Long Bond Is Holding a High Note

US Treasuries and our Horribly Distorted International Currency Exchange Mechanism

At some point as the Fed seeks to create inflation it will cut the reserve deposit returns to banks until they are forced to lend.

Can the Fed create monetary inflation? That is the question and Bernanke believes he has the answer.

It will require the cooperation of foreign buyers of US credit seeking to underwrite their mercantilism and low domestic wage and consumption policies.

The key to recovery is the median real hourly wage, not the further expansion of credit and the perpetuation of an economic system based on an inefficient drag on economic growth by percentage-taking banks and rent-seeking elites who add little or no productive value.

We have a 'chicken and egg' standoff between aggregate workers wages and profits at the moment which only the government can move forward, but with care.

The seemingly radical but all too obvious answer is to begin to tax imports from nations who continue to refuse to float their currencies. This merely reverses the decisions that were made by Clinton and Bush to allow China to devalue and fix their currency and still obtain favored nation trading status without consequence.

It was always the answer. It will disadvantage the global financial sector through the dollar, but will begin to breathe life into economic reform around the world. The key is not taxes, but a market free of draconian industrial policies such as that which spawned the long deflation in Japan.

Countries which discourage domestic consumption and wages to build up the wealth of the State on the backs of the workers in the name of growth, and manipulate their currencies to promote trade policies must be discouraged from doing so, as they will.

This seems a radical solution because it is a change from the accepted economic dogma of the past thirty years, more ingrained as slogans than sound thinking. Smoot-Hawley, classic error. It will make things worse. Rubbish. The tariffs and trade barriers are already in place because of currency manipulation and artificial fixes. Why do some countries accumulate destabilizing and enormous deficits and credit balances? Because of the artificial thwarting of the markets. One only has to work the math.

But the alternative to a structural reform is almost certainly economic stagnation and increasing global conflict.

At some point even mighty China will find itself sitting on a pile of useless bonds with fire in the cities, unless it accepts change and stops hiding behind a Great Wall of Paper.

This is not to say that the fault lies with China or Japan. The primary cause of our distorted global economy is in the dollar reserve currency arrangement that is the mother of commodity wars and artificial imbalances.

The solution may be the adoption of a trade balanced basket of currencies, including some commodities not so easily manipulated by the central banks such as gold and silver and oil, as the basis for continuing world trade based on market economics.

Financial Times
Insight: Return-free risk
By James Grant
December 4 2008

US Treasuries are the investment asset of the year. The less they yield, the more their fans adore them. Then, again, these fearful days, yield seems to have nothing to do with investment calculation. Purported safety is all.

“Super-safe Treasuries”, the papers call these emissions of a government that, this year, will take in $2,500bn but spend $3,500bn. “Toxic assets” is how the same papers characterise orphaned mortgage-backed securities—or, for that matter, secured bank loans, convertible bonds, junk bonds or almost any other kind of debt obligation not bearing the US imprimatur.

“There are no bad bonds, only bad prices,” the traders used to say. They should say it again, only louder. In the spring of 1984, long-dated Treasuries went begging at yields of nearly 14 per cent in the context of an inflation rate of just 4 per cent. Those, too, were fearful times, the recollected horror being the great inflation of the 1970s. Inflation was ineradicable, the bondphobes said. Now a new generation of creditors espouses the opposite proposition. Deflation is baked in the cake, they say.

The truth is that no investment asset is inherently safe. Risk or safety is an attribute of price. At the right price, a lowly convertible bond is a safer proposition than an exalted Treasury. Watching the government securities market zoom, many mistake price action for price.

Yes, Treasuries might conceivably redeem the hopes of their besotted admirers. Maybe a deflationary chasm is about to swallow us all. Never before has the US been so leveraged. And—just possibly—never before were lending standards so reckless as the ones that brought joy to so many astonished mortgage applicants in 2005 and 2006.

In their magnum opus Security Analysis Benjamin Graham and David L. Dodd advise that “bonds should be bought on their ability to withstand depression”. They wrote that in 1934. So far is that rule from being honoured by today’s financiers that not a few bonds—and boxcars full of mortgages – could hardly withstand prosperity. Two urgent questions present themselves. One: does something far worse than recession loom? Two: does that certain something definitely spell much lower interest rates?

We can’t know, but we can at least observe. What I observe is a monumental push to reflate. The Federal Reserve is creating more credit in less time than it has ever done before – in the past three months the sum of its earning assets, known in the trade as Reserve Bank credit, has grown at the astounding annual rate of 2,922 per cent. Are the bond bulls quite sure that these exertions will raise no inflationary sweat?

Evidently, they are—at least, forward swap rates betray no such concern. The market’s best guess as to what the 10-year Treasury will yield in 10 years’ time is 2.78 per cent, never mind the famous (and now, as it seems, prophetic) remark of Fed Chairman Ben Bernanke that the Fed could drop dollars out of a helicopter in a deflationary pinch.

The non-Treasury departments of the credit markets have crashed. No surprise then that prices and values are deranged. Market makers have closed up shop for the year, while hedge funds cower in fear of redemptions. You’d suppose that professional investors – doughty seekers of value – would be combing through the debris for bargains. Alas, no. Most seem content to lend money to Henry Paulson (subsequently to Timothy Geithner) at 2 per cent or 3 per cent.

In corporate debt and mortgages, anomalies and non sequiturs abound. They are especially prevalent in convertible bonds. More so than even the average stressed-out fund manager, convertible arbitrageurs have been through the mill. It was they—and almost they alone—who owned convertibles. Now many of these folk must sell them.

Few buyers are presenting themselves, however, though extraordinary bargains keep popping up. Thus, at the end of October, a Medtronic convertible bond with a 1.5 per cent coupon with the debt maturing in April 2011 briefly traded at 80.75. This was a price to yield 10.6 per cent, an adjusted spread of 1,600 basis points over the Treasury curve (adjusted, that is, for the value of the options embedded in the convert, notably the option to exchange it for common stock at the stipulated rate). Contrary to what such a yield might imply, A1/AA minus rated Medtronic, the world’s top manufacturer of medical devices for the treatment of heart disease, spinal injuries and diabetes, is no early candidate for insolvency. Almost every day brings comparable examples of risks not borne by people who, in this time of crisis, have come to define risk as “anything not guaranteed by Uncle Sam”.

“Risk-free return” is the standard tag attached to the government’s solemn obligations. An investor I know, repulsed by prevailing government yields, has a timelier description – “return-free risk”.

James Grant, editor of Grant’s Interest Rate Observer, is an editor of the newly published sixth edition of “Security Analysis,” by Benjamin Graham and David L. Dodd.

Central Banks Shun the US Long Bond Auction - "Too Many Unknowns"

"Indirect bidders, a class of investors that includes foreign central banks, bought 18 percent of the securities offered, down from 43 percent at the last sale"

U.S. Treasuries Fall After Investors Shun 30-Year Bond Auction
By Cordell Eddings and Sandra Hernandez

Nov. 13 (Bloomberg) -- Treasuries fell, led by 30-year bonds, after investors shunned the government's $10 billion sale of the securities amid concern that U.S. debt sales will grow...

``The 30-year is not a central bank product, and there's no real interest from pension funds'' at a yield below 4.5 percent, said Andrew Brenner, co-head of structured products in New York at MF Global Ltd., the world's largest broker of exchange-traded futures and options contracts. ``There's just no interest in it...''

``In the current market environment there are still too many unknowns,'' said William Larkin, a portfolio manager at Cabot Money Management in Salem, Massachusetts, which manages about $500 million in assets. ``People are looking for the safety of the shorter-term securities....''

Indirect bidders, a class of investors that includes foreign central banks, bought 18 percent of the securities offered, down from 43 percent at the last sale....

Futures on the Chicago Board of Trade show an 80 percent chance the Fed will lower its 1 percent target rate for overnight bank lending by a half-percentage point at its Dec. 16 meeting. The odds were 58 percent a week ago.

The difference between what banks and the Treasury pay to borrow money for three months, the so-called TED spread, was 1.96 percentage points, compared with 4.57 percentage points a month ago.

The federal budget deficit in October, the first month of fiscal 2009, climbed to a record $237.2 billion, spurred by U.S. purchases of stakes in some of the country's largest banks. It exceeded the budget shortfall for President George W. Bush's first full year in office...

The Next Bubble: Treasury Borrowing for Quarter to be $408 Billion More Than Expected

A tsunami of reserve currency debt issuance, coming soon to an economy near you.


MarketWatch
Treasury expects to borrow record $550 billion
By Rex Nutting
3:00 p.m. EST Nov. 3, 2008

WASHINGTON -- The U.S. government is expected to borrow a record $550 billion in the current quarter, including $260 billion in special funding for the Federal Reserve's extraordinary liquidity programs, the Treasury Department said Monday.

The borrowing estimate is $408 billion more than estimated three months ago. For the first three months of 2009, the government is expected to borrow $368 billion, the government said.

In the three months ending September, the government borrowed $530 billion. The Treasury will announce on Wednesday the sizes and terms of its quarterly refunding auction.

AP
$900 billion in gov't borrowing seen through March
Goverment, raising cash for rescue, projects borrowing of more than $900 billion through March
November 03, 2008: 6:23 PM EST

NEW YORK (Associated Press) - The government, raising cash to pay for the array of financial rescue packages, said Monday it plans to borrow $550 billion in the last three months of this year --- and that's just a down payment.

Treasury Department officials also projected the government would need to borrow $368 billion more in the first three months of 2009, meaning the next president will confront an ocean of red ink.

The nonpartisan Committee for a Responsible Budget estimates all the government economic and rescue initiatives, starting with the $168 billion in stimulus checks issued earlier this year, total even more -- an eye-popping $2.6 trillion.

One day before voters set out to elect the 44th president, new economic reports brought more bad news...

In addition to the borrowing numbers, Treasury released estimates by major Wall Street bond firms projecting that total borrowing for this budget year, which began Oct. 1, will total $1.4 trillion, nearly double the previous record.

Major Wall Street firms were equally pessimistic about the size of the federal deficit this year. They projected it will hit $988 billion for the current budget year, more than twice the record. In July, the administration projected a deficit for this year of $482 billion, but that was before the financial crisis erupted in September.

Supporters of the government rescue packages argue that the ultimate cost to taxpayers should end up being a lot smaller, partly because the Federal Reserve is extending loans to banks that should be paid back.

And in the case of the $700 billion rescue package, the government is buying assets - either bank stock or distressed mortgage-backed assets _ that it hopes will rebound in value once the crisis has passed.

But the government still needs to borrow massive amounts to buy the assets, an effort that has driven up borrowing costs to levels never before contemplated....