US Markets and Foreign Ownership, Portfolio Risk and Net Investment Position

Keep in mind that when they talk about the "US position" or the "China position" this can include all ownership, both official and private, unless otherwise specified.

I was a little surprised to see the relative size of the US equity market versus the debt markets, ex-Federal Reserve ownership.

Also a bit of a surprise was the size of European Direct Investment in the US compared to other regions. No wonder Benny felt compelled to bail out their banks.

Things to look for in these graphs:

 Since 2002, the increase in foreign ownership of Treasury bonds has been driven almost entirely by government buyers. Until the 2007–2009 crisis, the same was true for bonds issued by governmentsponsored enterprises (agencies). In the postcrisis recovery, foreign private holdings of agencies are rising,
while foreign government holdings continue to fall.

 From 2005 to early 2007, foreign governments’ Treasury purchases were driven by China’s purchases. However, China became less significant during the crisis as other investors crowded in. Today, China’s purchases have remained elevated while the rest of the world is purchasing less than during the crisis peak.

 The Net International Investment Position (NIIP), meaning foreigners’ holdings of U.S. assets minus U.S. holdings of foreign assets, has remained remarkably resilient, even though the large U.S. current account deficit reflects a steady flow of net foreign purchases of U.S. assets. This trend is likely to persist if the dollar depreciates, since dollar depreciation results in gains in the dollar value of U.S. holdings of foreign assets.

 The U.S. portfolio of foreign assets is relatively risky, with a significant share of holdings in equities that generate gains during a boom but suffer losses when crisis strikes. By contrast, foreign holdings of U.S. assets are less volatile because of the concentration in treasuries. Following a sharp decline in 2008, the U.S. net international investment position recovered in 2009 due to strong equity market performance.

The entire report can be found here: Foreign Ownershp of US Assets - CFR Chartbook

click on a chart to view a larger version

Taleb: US Treasuries a 'No-Brainer' Short

"Investors should bet on a rise in long-term U.S. Treasury yields, which move inversely to prices, as long as Bernanke and White House economic adviser Lawrence Summers are in office..."

Directionally correct we would say, but it is certainly a contrarian view today, with Treasuries and the dollar acting again as the safe havens of choice as fears of US jobs losses and Eurozone sovereign defaults frighten the markets.

Keep in mind that his time frame is '2 to 3 years.' Most punters do not realize that funds and specs hold record long positions in the dollar according to the latest Commitments of Traders Reports. Treasuries were a strong performer last year, and may be overbought relative to underlying fundamentals. But one repeatedly hears the meme "Everyone is short the dollar." And dollar debt is not a short, if one has the option of default.

But it will take the appearance of the effects of the ongoing monetization of debt by the Fed and the government agencies and Treasury programs that Taleb cites to trigger the declines in the bond and the dollar. And the euro and the pound may go first, to cushion the blow. Everything is relative, and the US banks will throw their relatives, their European cousins, under the bus if it is required to save their bonuses. The saying "he would sell his mother for an eighth" is a Wall Street proverb.

With a fiat currency regime, one always has to say, "it depends..."

And China is looking a bit bubbly as well, although the Chinese bank is acting to try and stem the speculation. It may not be enough.

Bloomberg
Taleb Says ‘Every Human’ Should Short U.S. Treasuries
February 04, 2010, 11:01 AM EST
By Michael Patterson and Cordell Eddings

Feb. 4 (Bloomberg) -- Nassim Nicholas Taleb, author of “The Black Swan,” said “every single human being” should bet U.S. Treasury bonds will decline, citing the policies of Federal Reserve Chairman Ben S. Bernanke and the Obama administration.

It’s “a no brainer” to sell short Treasuries, Taleb, a principal at Universa Investments LP in Santa Monica, California, said at a conference in Moscow today. “Every single human being should have that trade.”

Taleb said investors should bet on a rise in long-term U.S. Treasury yields, which move inversely to prices, as long as Bernanke and White House economic adviser Lawrence Summers are in office, without being more specific. Nouriel Roubini, the New York University professor who predicted the credit crisis, also said at the conference that the U.S. dollar will weaken against Asian and “commodity” currencies such as the Brazilian real over the next two or three years.

The Fed and U.S. agencies have lent, spent or guaranteed $9.66 trillion to lift the economy from the worst recession since the Great Depression, according to data compiled by Bloomberg. Bernanke, who in December 2008 slashed the central bank’s target rate for overnight loans between banks to virtually zero, flooded the economy with more than $1 trillion in the largest monetary expansion in U.S. history.

In a short sale, an investor borrows a security and sells it, expecting to profit from a decline by repurchasing it later at a lower price.

“Dynamite in the Hands of Children”

President Barack Obama has increased the U.S. marketable debt to a record $7.27 trillion as he tries to sustain the recovery from last year’s recession. The Obama administration projects the U.S. budget deficit will rise to a record $1.6 trillion in the 2011 fiscal year.

“Deficits are like putting dynamite in the hands of children,” Taleb said in an interview with Bloomberg Television. “They can get out of control very quickly.”

Taleb argued in “The Black Swan: The Impact of the Highly Improbable” that history is littered with rare events that can’t be predicted by trends. The best-selling book came out in 2007 before the global credit crisis sparked an economic slump and $1.7 trillion of losses at banks and financial institutions.

“The problem we have in the United States, the level of debt is still very high and being converted to government debt,” Taleb said in an interview with Bloomberg Television. “We are worse-off today than we were last year. In the United States and in Europe, you have fewer people employed and a larger amount of debt.”

Credit Outlook

Moody’s Investors Service Inc. said on Feb. 2 that the U.S. government’s Aaa bond rating will come under pressure in the future unless additional measures are taken to reduce budget deficits projected for the next decade.

Treasuries soared during the financial crisis, gaining 14 percent in 2008, as investors sought the relative safety of U.S. government debt. They fell 3.7 percent last year, according to Bank of America Corp.’s Merrill Lynch Unit, as risk aversion eased and the Standard & Poor’s 500 Index rallied 23 percent. So far this year U.S. government debt has gained 1.17 percent.

Yields fell today on concern European countries including Greece, Portugal and Spain face difficulty financing budget deficits. The yield on the benchmark 10-year note fell 6 basis points, or 0.06 percentage point, to 3.64 percent at 10:54 a.m. in New York, according to BGCantor Market Data.

“Democracies can’t handle austerity measures very well,” Taleb added. “We’re going to have a severe problem.”

Is China Losing Its Taste for US Debt?

International Herald Tribune
U.S. debt is losing its appeal in China
By Keith Bradsher
Thursday, January 8, 2009

HONG KONG: China has bought more than $1 trillion in American debt, but as the global downturn has intensified, Beijing is starting to keep more of its money at home - a shift that could pose some challenges to the U.S. government in the near future but eventually may even produce salutary effects on the world economy.

At first glance, the declining Chinese appetite for U.S. debt - apparent in a series of hints from Chinese policy makers over the past two weeks, with official statistics due for release in the next few days - comes at an inopportune time. On Tuesday, the U.S. president-elect, Barack Obama, said Americans should get used to the prospect of "trillion-dollar deficits for years to come" as he seeks to finance an $800 billion economic stimulus package.

Normally, China would be the most avid taker of the debt required to pay for those deficits, mainly short-term Treasury securities. In the past five years, China has spent as much as one-seventh of its entire economic output on the purchase of foreign debt - largely U.S. Treasury bonds and American mortgage-backed securities.

But now, Beijing is seeking to pay for its own $600 billion economic stimulus - just as tax revenue falls sharply as the Chinese economy slows. Regulators have ordered banks to lend more money to small and midsize enterprises, many of which are struggling with slower exports, and Chinese bankers say they are being instructed to lend more to local governments to allow them to build new roads and other projects as part of the stimulus program.

"All the key drivers of China's Treasury purchases are disappearing," said Ben Simpfendorfer, an economist in the Hong Kong office of the Royal Bank of Scotland. "There's a waning appetite for dollars and a waning appetite for Treasuries. And that complicates the outlook for interest rates." (The reason that China has been buying Treasuries is to sterilize the impact of their dollar trade surplus and to support their industrial exports policy. These are not 'investment.' - Jesse)

Fitch Ratings, the credit rating agency, forecasts that China's foreign reserves will increase by $177 billion this year - a large number, but down sharply from an estimated $415 billion last year.

In the United States, China's voracious demand for American bonds has helped keep interest rates low for borrowers ranging from the government to home buyers. Reduced Chinese enthusiasm for buying those bonds takes away some of this dampening effect. (And China will be under increasing pressue to maintain the peg of the yuan to the dollar at an artificially low rate despite their currency controls - Jesse)

But with U.S. interest rates still at very low levels after recent cuts to stimulate the economy, it is quite cheap for the U.S. Treasury to raise capital now. And there seem to be no shortage of buyers for Treasury bonds and other debt instruments: Prices for U.S. debt have soared as yields have declined. (Buying of the debt is heavily concentrated in safe haven buying domestically and a small number of foreign central banks. It is vulnerable at these prices - Jesse)

The long-term effects of this shift in capital flows - with China keeping more of its money home and the U.S. economy becoming less dependent on one lender - are unclear, but the phenomenon is something economists have said is long overdue. (The result will be few Chinese exports to the US and a stronger renminbi - Jesse)

What is clear is that the effect of the global downturn on China's finances has been drastic. As recently as 2007, tax revenue soared 32 percent, as factories across China ran flat out. But by November, government revenue had actually dropped 3 percent from a year earlier. That prompted Finance Minister Xie Xuren to warn Monday that 2009 would be "a difficult fiscal year." (China must stimulate their domestic economy and raise the median wage to encourage consumption of their own production - Jesse)

A senior central bank official mentioned last month that China's $1.9 trillion in foreign exchange reserves had actually begun to shrink. The reserves - mainly bonds issued by the U.S. Treasury and by Fannie Mae and Freddie Mac, the mortgage finance companies - had been rising quickly ever since the Asian financial crisis in 1998. (There was a massive dumping of Agency debt by the foreign central banks, but a parabolic increase in Treasury purchases as we have previously documents - Jesse)

The strength of the dollar against the euro in the fourth quarter of last year contributed to slower growth in China's foreign reserves, said Fan Gang, an academic adviser to China's central bank, at a conference in Beijing on Tuesday. The central bank keeps track of the total value of its reserves in dollars and a weaker euro means that euro-denominated assets in those reserves are worth less in dollars, decreasing the total value of the reserves.

But the pace of China's accumulation of reserves began slowing in the third quarter along with the slowing of the Chinese economy, and appears to reflect much broader shifts.

China manages its reserves with considerable secrecy, but economists believe about 70 percent is in dollar-denominated assets and most of the rest in euros. The country has bankrolled its huge reserves by effectively requiring its entire banking sector, which is state-controlled, to hand nearly one-fifth of its deposits over to the central bank. The central bank, in turn, has used the money to buy foreign bonds.

Now the central bank is rapidly reducing this requirement and pushing banks to lend more money instead. (Good this is what they must do to encourage real capital investment that does not flee at the first whiff of a crisis - Jesse)

At the same time, three new trends mean that fewer dollars are pouring into China - and as fewer dollars flow into China, the government has fewer dollars to buy American bonds and help finance the U.S. trade and budget deficits.

The first, little-noticed trend is that the monthly pace of foreign direct investment in China has fallen by more than a third since the summer. Multinational companies are hoarding their cash and cutting back on the construction of factories. (FDI cuts and runs quickly in a crisis - Jesse)

The second trend is that the combination of a housing bust and a two-thirds fall in the mainland Chinese stock markets over the past year has resulted in moves by many overseas investors - and even some Chinese - to get money quietly out of the country. They are doing so despite China's fairly stringent currency controls, prompting the director of the State Administration of Foreign Exchange, Hu Xiaolian, to warn in a statement Tuesday of "abnormal" capital flows across China's borders; she provided no statistics.

China's most porous border in terms of money flows is with Hong Kong, a semi-autonomous Chinese territory that has its own internationally convertible currency. So much Chinese money has poured into Hong Kong and been converted into Hong Kong dollars that the territory has had to issue billions of dollars' worth of extra currency in the past two months to meet the demand, shattering its previous records for such issuance.

A third trend that may further slow the flow of dollars into China is the reduction of its huge trade surpluses.

China's trade surplus set another record in November, at $40.1 billion. But because prices of Chinese imports like oil are starting to recover while demand remains weak for Chinese exports like consumer electronics, most economists expect China to run trade surpluses closer to $30 billion a month.

That would give China a sizable sum to invest abroad. But it would be considerably less than $50 billion a month that it poured into international financial markets - mainly U.S. bond markets - during the first half of 2008.

"The pace of foreign currency flows into China has to slow," and therefore the pace of China's reinvestment of that currency in foreign bonds will also slow, said Dariusz Kowalczyk, the chief investment officer at SJS Markets, a Hong Kong securities firm.

For a combination of financial and political reasons, the decline in China's purchases of dollar-denominated assets may be less steep than the overall decline in its purchases of foreign assets. (Their industrial policy of export to the US is the reason - Jesse)

Many mainland Chinese companies are keeping more of their dollar revenues overseas instead of bringing them home and converting them into yuan for deposit in Chinese banks. In essence, they would not show up on the central bank's books. So, overall Chinese demand for dollars would not be falling as much as the government's demand for dollars, said Sherman Chan, an economist in the Sydney office of Moody's Economy.com.

Treasury data from Washington suggest the Chinese government might be allocating a higher proportion of its foreign currency to the dollar in recent weeks and less to the euro. The data also suggest China is buying more Treasuries and fewer bonds from Fannie Mae or Freddie Mac.

Figures from the U.S. Federal Reserve and the Treasury point to a sharp increase in Chinese holdings of Treasury bonds in October. China passed Japan in September as the largest overseas holder of Treasuries, and took a commanding lead in October, with $652.9 billion compared to $585.5 billion for Japan.

But specialists in international money flows caution against relying too heavily on these statistics. They mostly count bonds that the Chinese government has bought directly, and exclude purchases made through banks in London and Hong Kong; with the financial crisis weakening many banks, the Chinese government has a strong incentive to buy more of its bonds directly.

The overall pace of foreign reserve accumulation in China seems to have slowed so much that even if all the remaining purchases were U.S. Treasuries, the Chinese government's overall purchases of dollar-denominated assets will have fallen, economists said.

But China's leadership is likely to avoid any complete halt to purchases of Treasuries for fear of looking like it is torpedoing the chances for a U.S. economic recovery at a vulnerable time, said Paul Tang, the chief economist at the Bank of East Asia here.

"This is a political decision," he said. "This is not purely an investment decision."

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.

Is the Fed Taking the First Steps to Selective Default and Devaluation?

We have been looking for an out-of-the-box move from the Fed, but this was not what we had expected.

The obvious game changing move would have been for the Treasury and the Fed to make an arrangement in which the Fed is able to purchase Treasury debt directly without subjecting it to an auction in the public market first. This is known as 'a money machine' and is prohibited by statute.

But as usual the Fed surprises us all with their lack of transparency. They are asking Congress about permission to issue their own debt directly, not tied to Treasuries.

This is known in central banking circles as 'cutting out the middleman.' Not only does the Treasury no longer issue the currency, but they also no longer have any control over how much debt backed currency the Fed can now issue directly.

If the Fed were able to issue its own debt, which is currently limited to Federal Reserve Notes backed by Treasuries under the Federal Reserve Act, it would provide Bernanke the ability to present a different class of debt to the investing public and foreign central banks.

The question is whether it would be backed with the same force as Treasuries, or is subordinated, or superior.

There will not be any lack of new Treasury debt issuance upon which to base new Fed balance sheet expansion. The notion that there might be a debt generation lag out of Washington in comparison with what the Fed issues as currency is almost frightening in its hyperinflationary implications.

This makes little sense unless the Fed wishes to be able to set different rates for their debt, and make it a different class, and whore out our currency, the Federal Reserve notes, without impacting the sovereign Treasury debt itself, leaving the door open for the issuance of a New Dollar.

What an image. The NY Fed as a GSE, the new and improved Fannie and Freddie. Zimbabwe Ben can simply print a new class of Federal Reserve Notes with no backing from Treasuries. BenBucks. Federal Reserve Thingies.

Perhaps we're missing something, but this looks like a step in anticipation of an eventual partial default or devaluation of US debt and the dollar.


Wall Street Journal
Fed Weighs Debt Sales of Its Own
By JON HILSENRATH and DAMIAN PALETTA
DECEMBER 10, 2008

Move Presents Challenges: 'Very Close Cousins to Existing Treasury Bills'

The Federal Reserve is considering issuing its own debt for the first time, a move that would give the central bank additional flexibility as it tries to stabilize rocky financial markets.

Government debt issuance is largely the province of the Treasury Department, and the Fed already can print as much money as it wants. But as the credit crisis drags on and the economy suffers from recession, Fed officials are looking broadly for new financial tools.

The Federal Reserve drained $25 billion in temporary reserves from the banking system when it arranged overnight reverse repurchase agreements.

Fed officials have approached Congress about the concept, which could include issuing bills or some other form of debt, according to people familiar with the matter.

It isn't known whether these preliminary discussions will result in a formal proposal or Fed action. One hurdle: The Federal Reserve Act doesn't explicitly permit the Fed to issue notes beyond currency.

Just exploring the idea underscores many challenges the ongoing problems are creating for the Fed, as well as the lengths to which the central bank is going to come up with new ideas.

At the core of the deliberations is the Fed's balance sheet, which has grown from less than $900 billion to more than $2 trillion since August as it backstops new markets like commercial paper, money-market funds, mortgage-backed securities and ailing companies such as American International Group Inc.

The ballooning balance sheet is presenting complications for the Fed. In the early stages of the crisis, officials funded their programs by drawing down on holdings of Treasury bonds, using the proceeds to finance new programs. Officials don't want that stockpile to get too low. It now is about $476 billion, with some of that amount already tied up in other programs.

The Fed also has turned to the Treasury Department for cash. Treasury has issued debt, leaving the proceeds on deposit with the Fed for the central bank to use as it chose. But the Treasury said in November it was scaling back that effort. The Treasury is undertaking its own massive borrowing program and faces legal limits on how much it can borrow.

More recently, the Fed has funded programs by flooding the financial system with money it created itself -- known in central-banking circles as bank reserves -- and has used the money to make loans and purchase assets.

Some economists worry about the consequences of this approach. Fed officials could find it challenging to remove the cash from the system once markets stabilize and the economy improves. It's not a problem now, but if they're too slow to act later it can cause inflation.

Moreover, the flood of additional cash makes it harder for Fed officials to maintain interest rates at their desired level. The fed-funds rate, an overnight borrowing rate between banks, has fallen consistently below the Fed's 1% target. It is expected to reduce that target next week.

Louis Crandall, an economist with Wrightson ICAP LLC, a Wall Street money-market broker, says the Fed's interventions also have the potential to clog up the balance sheets of banks, its main intermediaries.

"Finding alternative funding vehicles that bypass the banking system would be a more effective way to support the U.S. credit system," he says.

Some private economists worry that Fed-issued bonds could create new problems. Marvin Goodfriend, an economist at Carnegie Mellon University's Tepper School of Business and a former senior staffer at the Federal Reserve Bank of Richmond, said that issuing debt could put the Fed at odds with the Treasury at a time when it is already issuing mountains of debt itself.

"It creates problems in coordinating the issuance of government debt," Mr. Goodfriend said. "These would be very close cousins to existing Treasury bills. They would be competing in the same market to federal debt."

With Treasury-bill rates now near zero, it seems unlikely that Fed debt would push Treasury rates much higher, but it could some day become an issue.

There are also questions about the Fed's authority.

"I had always worked under the assumption that the Federal Reserve couldn't issue debt," said Vincent Reinhart, a former senior Fed staffer who is now an economist at the American Enterprise Institute. He says it is an action better suited to the Treasury Department, which has clear congressional authority to borrow on behalf of the government.

T-Bills Hit Zero

AP
Point of no return: Interest on T-bills hits zero
By MADLEN READ and MARTIN CRUTSINGER
December 9, 2008

NEW YORK – Investors are so nervous they're willing to accept the same return from government debt that they'd get from burying money in a coffee can — zero.

The Treasury Department said Tuesday it had sold $30 billion in four-week bills at an interest rate of zero percent, the first time that's happened since the government began issuing the notes in 2001.

And when investors traded their T-bills with each other, the yield sometimes went negative. That's how extreme the market anxiety is: Some are willing to give up a little of their money just to park it in a relatively safe place.

"No one wants to run the risk of any accidents," said Lou Crandall, chief economist at Wrightson ICAP, a research company that specializes in government finance.

At last week's government auction of the four-week bills, the interest rate was a slightly higher but still paltry 0.04 percent. Three-month T-bills auctioned by the government on Monday paid poorly, too — 0.005 percent.

While everyday people can keep their cash in an interest-earning CD or savings account at the bank, institutional investors with hundreds of millions of dollars on their hands often use government debt as part of their investment strategy.

In the Treasury market, the U.S. government, considered the most creditworthy of borrowers, issues IOUs of varying durations to raise money.

The zero percent interest rate is no reason to panic. As recently as Monday, investors were plowing cash into stocks, and averages like the Dow industrials are off their lows.

And long-term government bonds, while near record lows, are still paying decent money considering the tumultuous climate. The yield on a 30-year bond on Tuesday was a little higher than 3 percent.

There's good news in all this for taxpayers: Low interest rates on government debt mean the United States is financing its $700 billion bailout of the financial system very cheaply. The Treasury has sold mountains of debt to pay for it.

But the trend also underlines stubborn anxiety in the financial market that could keep the economy sluggish for years to come, and it translates into stagnant returns for people who have their money in places like money market funds.

"There's a price for safety," said Peter Crane, president of money market mutual fund information company Crane Data LLC. "Down slightly is the new up."

As the stock market has taken its alarming plunge, people have been moving money from riskier assets to safer ones. According to Crane Data, funds invested purely in Treasurys have surged more than 150 percent over the past year, to $726 billion.

Earning zero percent on an investment for a short while may not seem that dire for the average person. But a zero percent rate has serious consequences for the complex credit markets.

Those markets have been dysfunctional since Lehman Brothers Holdings Inc. went bankrupt in September, scaring away investors who normally buy bonds from seemingly creditworthy borrowers. Lending, the lifeblood of the economy, has frozen up.

One corner of the credit markets is the repurchase markets, known as "repo," where banks and securities firms make and receive short-term loans backed by collateral, usually Treasury bills.

When those T-bills are yielding nothing, there's little incentive to deliver them on time. If the holder loses the interest, it's no big deal.

"This is a particular problem in a time like this, because people are buying Treasury securities for their security, for their safety. It's important that they're delivered," Crandall said. (You can bet the shorts are piling on - Jesse)

And high demand for government debt rather than corporate debt could stifle economic growth.

Corporate bond rates have been surging to record levels compared with Treasurys, which makes it more expensive for companies to raise money. And when companies can't raise money, they often have to cut costs, sometimes through layoffs.

Only a few corporate bond deals have been going through lately, and most have been through the government, which has agreed to guarantee financial institutions' bond sales. American Express Co., for one, said Tuesday it has issued $5.5 billion through the government program.

Many worry that the government will become the most attractive lender and borrower in the market — crowding out others in the private sector....

Breaking the ZIRP barrier

From Across the Curve:

T Bills
December 4th, 2008 11:42 am

I just spoke to a bill trader who noted that a large chunk of the bill list is trading at zero percent. He mentioned a point that I had forgotten but is worth noting. Bills always trade well in December because at year end there is demand for them as investors of every ilk dress up their balance sheets. He has seen that demand to a far greater extent than normal.

He says that given all that has transpired this year there will be enormous demand for bill through the entire month of December. He has seen demand from an eclectic group of investors from around the globe. He expects the treasury to announce shortly a series of cash management bills which would total about $100 billion.

In his opinion if they do not issue bills will scream through zero.

So get used to these low rates they are here for a while.

Let's revisit the current situation.



The comparisons are not quite focused with today in terms of bills and bonds, since the funding preferences of Treasury are different now than they were back then, but you get the general idea of 'Treasuries' and their role in a flight to safety in a portfolio allocation.

US Treasury Default Swaps Soar to Records

Reuters
U.S. Treasury CDS Hit Record Wide Levels
By Richard Leong and George Matlock in London
Mon Nov 24, 2008 11:21am EST

NEW YORK, Nov 24 - The spread or risk premium on 10-year U.S. Treasury credit default swaps hit record wide levels on Monday, prompted by worries about how the cost of rescuing banks and carmakers would affect U.S. creditworthiness, CMA DataVision said.

As the global financial crisis worsened in recent weeks, traders increased their bets on the bigger toll of the U.S. government's array of programs to help these ailing industries.

Ten-year U.S. Treasury CDS edged out to 49.8 basis points from 49.3 basis points at Friday's close, according to the credit data company.

Five-year Treasury CDS grew to 43.5 basis points versus 43.0 basis points late Friday, it said.

The risk premiums have nearly doubled from levels seen two months ago after the collapse of Lehman Brothers.

Prior to the financial crisis, default risk premiums on U.S. government debt had been running in the low-to-mid single digits.

A Record Number of Buyers Cannot Take Delivery of the US Treasuries that They 'Own'

He who sells what isn't his'n
Must buy it back or go to Prison.
Daniel Drew

Naked short selling and float and reserve plays are causing a record 'failures to deliver' in the US Treasuries markets. Some of this may be a 'kiting' scheme in which the sellers are playing an aribtrage against the slight fees and penalties versus returns on price distortions and extremes in volatility.

Or it might be a case of selling and using the same thing so many times as collateral that you don't really know what is your actual condition, solvent or insolvent. We can think of several (roughly nine) derivative and instrument laden banks that are utterly insolvent if forced to deliver their net obligations.

The Fed cannot even regulate its own products among its own dealer circles. What could possibly possess anyone to believe that they can do this with any other product in a larger, less exclusive market?

There are system breakdowns that have caused signficant spikes in failures, such as the widespread technical failures following the distruptions caused by 911.

But we are not aware of any massive computer system failures and shutdowns at this time. This may be a case of when the going gets tough, the frat boys bend the rules until they break, and then line up for a slap on the wrist from dad's business associates.

Is this because of the failures of Lehman and Bear Stearns and AIG? Hard to believe but we have an open mind. Transparency builds confidence more effectively than rhetoric and empty promises.

Who are the responsible parties? Let's have a list of the prime offenders of this market. We might *not* be surprised at who is failing to deliver what they sell. It might be an indication that they are in trouble. Oops, perhaps that is why we can't have it.

We suspect the Fed is turning a 'blind eye' to this activity. But more transparency would be helpful to alleviate that concern.

And do not be surprised when other things that you think that you are buying or think you own fail to show up.

There are some who see an approaching 'fail to deliver' spike at the COMEX and they may be right. There were some who believed that LTCM was short 400 tons of gold at the time of its failure, and that several central banks stepped in to depress price and increase supply to alleviate the potential shock on counterparties.

Replay in progress? It could get interesting if it is.



Stand and Deliver: Significant Fails in the US Treasury Market - 10 Oct 2008


Delivery failures plague Treasury market
Total hit a record $2.29 trillion as of Oct. 1
By Dan Jamieson
October 19, 2008

The credit crisis is causing a growing number of delivery failures with Treasury securities.

The latest data from the Federal Reserve Bank of New York showed that cumulative failures hit a record $2.29 trillion as of Oct. 1. The federal settlement period is T+1 (trade date plus one day).

The outstanding U.S. public debt is $10.3 trillion.

"Current [fail] levels are at historic levels," said Rob Toomey, managing director of the Securities Industry and Financial Markets Association's funding and government and agency securities divisions. "There's been significant flight to quality" with the market turmoil, he said.

With the strong demand for Treasury securities, "some of the entities that bought Treasuries are not making them available in the [repurchase] market, which is the traditional way to get them," Mr. Toomey said.

Unlike some past bouts with high failure rates that involved particular bond issues, the current high fails involve all types of maturities, he said. (Such as in the 2001-2003 market crash - Jesse)

This month, New York- and Washington-based SIFMA came out with a set of best practices to reduce failed deliveries.

This year, the New York Fed revised its own Treasury market trading guidelines. Its guidelines, originally released last year, warned that short-sellers "should make deliveries in good faith." (And all good boys and girls should remain pure until they are married - Jesse)

LACK OF LIQUIDITY

Chronic failures can increase illiquidity problems in the market and expose market participants to losses in the event of counterparty insolvency, according to the New York Fed.

"There is a question about there being some impact on liquidity if [delivery failures] last for a long period," Mr. Toomey said.

Many retail investors also own Treasury securities, either directly or indirectly. The Treasury market is also an important fixed-income benchmark, so any liquidity problems can affect all participants.

In extreme cases, chronic fails could cause participants to limit their trading in secondary markets, the New York Fed said.

"Who wants to buy what they're not going to get?" said Susanne Trimbath, a market researcher with STP Advisory Services LLC of Santa Monica, Calif. In a September research paper, she estimated that based on failure rates in 2007 and 2008, the cost to investors from failed deliveries is about $7 billion annually. (Pays for the facials - Jesse)

The cost arises because sellers don't have access to their money. In addition, the federal government loses $42 million a year in lost revenue, and the states miss out on an additional $270 million in revenue due to excessive claims of tax-exempt income on state-tax-free Treasury securities, Ms. Trimbath said.

She and researchers at the New York Fed said that some delivery failures are intentional. (We're shocked, shocked! - Jesse)

As with naked shorting of stocks, naked shorting of Treasuries "allows you to avoid the borrowing costs," Ms. Trimbath said.

"There can be circumstances in a low-rate environment where it's cheaper to fail" than deliver, Mr. Toomey said. Such an environment also reduces incentives to act as a lender of securities, he said.

A 2005 study by the New York Fed confirmed that episodes of persistent settlement fails are often related to market participants' lack of incentive to avoid failing. (Thanks for the kind of knowledge that most mothers, teachers, and adults over the age of 25 could have told us for free, propeller heads - Jesse)

"We've got to get the [Securities and Exchange Commission], the Fed and SIFMA in there to force" Treasury traders to deliver securities, Ms. Trimbath said. (That ought not to be hard. We hear the Fed has people on premise every day with most of the probable perpetrators - Jesse)

The Department of the Treasury has a buy-in rule for the cash markets, but the repurchase markets rely on contracts, Mr. Toomey said. Currently there are no penalties for failures, and regulators to date have not required disclosure whether the dealer or the client fails to deliver. (Self regulation at its finest. Sounds like the honor system my neighbor uses to sell tomatoes in the summer from a box in her front yard. Except for the most part the people here in our neighborhood are not greedy, self-centered, shameless, hedonistic shits - Jesse)

By industry convention, fails are generally allowed to roll over until they are eventually closed out, Ms. Trimbath said.

SCRUTINY

She said that scrutiny by the SEC and the Fed, and widespread investigations into short-selling practices, are driving the industry to rein in questionable practices with Treasuries. (Apparently with 'great success,' Borat, given the record number of fails - Jesse)

Mr. Toomey said that one of SIFMA's best-practices suggestions is to require that extra margin be provided by the party that is underwater due to a failed delivery. (Wrist slap by fines is a real deterrent - Jesse)

SIFMA also said that it is establishing a Treasury fails monitoring committee, with representatives from the Fed and Treasury.

The committee will alert the market "when marketwide mitigation, remediation and the attention of management is warranted" because of a high level of fails, SIFMA said in a statement.

Investment Performance for 2007

We were curious to see how various investments had done in 2007, after reading some of the information on internet chat boards this evening. Internet chat boards are places where facts and opinions get tossed around like beer bottles at Jerry's Country Playhouse on a Saturday night.

We Trust In God, Everyone Else Shows the Data

We like to check the data. The reason should be obvious, but if not, its because often people deal with the complexities of life by using assumptions, which are a kind of shorthand way of breaking reality down into manageable chunks. Everyone does it. You have to. But every once in a while its useful to check those assumptions you make, and that other people are making, to see if they are still valid, especially if they involve things that are important. Does your wife still love you? Is there a bus coming down the road you are crossing? Do you really still look as hot as you did last year? Are you financially solvent? Those sorts of things.

2007 Returns of Some Major Stock Indices

Let's compare the 2007 year-to-date performance of some of the major stock indices. As always, if you click on the chart you will see a larger, much easier to read version.

Its a little suprising that the Russell 2000 is still not quite positive for the year, not including dividends or subtracting fees and commissions. There was quite a bit more divergence in the gains of the major stock indices. An index after all is just a grouping of things for measurement purposes. The Russell is the broadest, most inclusive of the indexes we normally watch.

It looks like tech was the champ of the broad stock sectors this year, if for no other reason that they are NOT financial and NOT housing. The Wall Street storyboard is that tech is invulnerable to the vagaries of housing and financial bubbles, and actually benefits from the weakened US dollar because the we are the champions, the kings of tech, and are selling it to the rest of the world, although very little of it is actually made here anymore, and what we do invent is copied and pirated shamelessly. Its a revenue concept thing perhaps, moreso than real hard cash, like page views and web searches and collateralized debt obligations.


Let's Get Physical

Let's take a look at a different type of investment. How about something that is supposed to be impervious to inflation, a barbarous relic, the bane of central banksters and financial voodoo? Since the generally transitory, subjective, and vaporous nature of financially engineered products is in the headlines it might not be a bad idea to throw in something with a long track record as a hardened test of monetary value into the mix.

Holy goldaroney, Batman! That is one surprisingly fine performance for gold this year. Even we did not think that it has been this good. The assumption has been, at least lately, that gold's day will come soon, especially when the Central Banks get finished monkeying with it. Well, its been a much better return this year than most would think offhand. We're in that group, and we watch it! See how easy it is to fall prey to your own assumptions, especially when you think you have been watching something for a long time.

The Usual Investment Suspects

Let's widen the data net a little more, and see how different things compare. We apologize for the lack of variation in colors on this chart, but we had to tinker with the charting tool a little to get so many items on a single snapshot.

Well, there you have it. Some real information about how various investments performed during 2007. We new the US dollar was doing badly. We did not know that gold had done so well, and had outperformed most of the other major alternative so handily (don't forget about those dividends guys. Gold does not pay any, just like a high performing tech stock).

Let's have one more look at a sector that we have admittedly been cool towards for the latter half of this year, because of the general reluctance we have had toward equities.

Data Mining

Well, as someone who has not owned miners for the latter part of the year, we're just a little disappointed that we overlooked such a hot performing sector. Its been a wild ride, and keep in mind that with high returns comes higher beta (variability of return aka risk, and lately that includes return of capital). Remember this is the HUI gold bugs index, and if you have been playing the junior miners heavily you might have ground your teeth to a fine white powder trying to ride those bucking beta broncos.

Our personal preference is to find a few well financed miners that have a shot at paying dividends for a long time if the dollar really tanks and stocks gets smacked down. Bennie and Hank and crew are working overtime to make sure this happens, make no mistake about it. They are just trying to push the date of reckoning into the future. We admit to a bias that says the dollar will inflate significantly further, and then at some point deflate. Its just that we think the deflation will be when they knock a couple zeros off buckaroo. It might not happen that way. We'll stay flexible.


When people put forward ideas that might be important to you, ask for the data. People are often afraid to ask, because they don't want to look foolish. Some people like to put forward their ideas with great ceremony and pomp, and browbeat and belittle anyone who disagrees with them. They often speak with great confidence bordering on arrogance. We'll let you in on a little secret. What we have learned over the years is that if someone can't explain their ideas to you, it just might be that they do not understand the idea themselves. Don't get us wrong. There are some very fundamental beginner questions that people must and should as. Its just that they aren't necessarily best directed to the advanced class. But that doesn't mean you shouldn't ask. Just try to ask the right person in the right places in the right way.

Questions can be annoying. But we find that often they provide the kind of impedance that causes us to revisit them and test our assumptions, to try to explain things over again to ourselves. If you put in an honest effort, it makes our assumptions and ideas stronger, more reliable. Some people might even publish their ideas so that they can be tested in an environment of peer review. Just putting ideas down on paper forces one to really thing them through. You might even decide to put them into charts and a blog, to force your own performance to a higher standard. Interesting concept.