Wall Street Bailouts Push 2009 Budget Deficit Estimates to a Record 12.5% of GDP

The new welfare queens, the Wall Street bankers, put all other non-military government programs to shame.

All holders of US dollars are going to be paying for this.

Taxation without representation is ... crony capitalism and dollar hegemony.

Cost of U.S. Crisis Action Grows, Along With Debt
By Matthew Benjamin

Oct. 10 (Bloomberg) -- The global financial crisis is turning into a bigger drain on the U.S. federal budget than experts estimated two weeks ago, ballooning the deficit toward $2 trillion.

Bailouts of American International Group, Fannie Mae and Freddie Mac likely will be more expensive than expected. States are turning to Washington for fiscal help. The Federal Reserve said this week it will begin buying commercial paper, the short- term loans companies used to conduct day-to-day business, further increasing costs. And analysts now say the $700 billion bank- rescue plan passed by Congress last week may have to be significantly larger. (You are not really surprised at this are you? - Jesse)

``I always assumed they would be asking for more money along the way if it was necessary, and it looks like it's going to be necessary,'' said Stan Collender, a former analyst for the House and Senate budget committees, now at Qorvis Communications in Washington. ``At the moment, there's nothing happening here that's positive for the budget. Nothing.''

The 2009 budget deficit could be close to $2 trillion, or 12.5 percent of gross domestic product, more than twice the record of 6 percent set in 1983, according to David Greenlaw, Morgan Stanley's chief economist. Two weeks ago, budget analysts said the measures might push deficit to as much as $1.5 trillion.

Yields to Rise

That means a lot more borrowing by Treasury, which will push up interest rates, said Greenlaw. ``The Treasury's going to be ramping up supply dramatically over the course of coming months to meet this enormous federal budget obligation,'' Greenlaw told Bloomberg this week. ``The supply will trigger some elevation in yields.''

Treasuries have fallen the past four days even as stocks sank, a sign investors are preparing for bigger U.S. government borrowing. Benchmark 10-year note yields rose to 3.82 percent at 7:49 a.m. in New York, from a close of 3.45 percent Oct. 6.

Payments the government allocated to keep vital companies solvent are beginning to look insufficient.

AIG, the giant insurance company that was taken over by the government in mid-September, said this week it may access $37.8 billion from the Federal Reserve Bank of New York, in addition to the $85 billion the government already loaned it to stave off bankruptcy.

``You're in for a dime, you're in for a dollar on this one,'' said David Havens, a credit analyst at UBS AG. (And boy don't these jokers know it - Jesse)

The financial health and earnings prospects of Fannie Mae and Freddie Mac -- seized by the government on Sept. 7 to prevent them from failing -- worsened in the second and third quarters, the companies' government regulator said this week.

Price Declines

The companies and regulators are recalculating the value of all of their assets to factor in price erosion. That may mean the government will have to spend more to keep the firms solvent.

Earlier this week the Fed announced it will create a special fund to buy commercial paper, the credit that businesses use to finance payrolls and other ongoing expenses. The Treasury will deposit money into the Fed's New York district bank to help set up the new unit. A Fed official said Treasury funding for the program could be ``substantial.''

California, Alabama and Massachusetts are urging the Fed and Treasury to include their securities in rescue plans designed for banks and businesses. The $2.66 trillion U.S. market for state and city bonds has been all but frozen since Lehman Brothers Holdings Inc., weighed down by losses in mortgage-backed bonds, declared history's largest bankruptcy on Sept. 15.

California has said it needs to sell as much as $7 billion in notes to maintain its schools, health system and other public services. The Bush administration said it is reviewing the states' financial positions.

Plan for Banks

Meanwhile, Treasury Secretary Henry Paulson indicated two days ago that he is considering buying stakes in a wide range of banks in coming weeks to help recapitalize them.

Such a move is allowed under the $700 billion bailout package Congress passed last week. Edmund Phelps, winner of the 2006 Nobel Prize for economics and a professor at Columbia University, said such action is necessary -- and will likely turn out to increase the measure's cost. Spending beyond the amount set in last week's bill would require further Congressional approval.

``We have to recapitalize the banks,'' Phelps told Bloomberg Television this week. ``I don't imagine that there's enough money in the first Paulson plan to be able to do all that needs to be done in that direction.''

The additional borrowing could push the national debt well past 70 percent of GDP, the highest since the immediate aftermath of World War II, when the U.S. was still paying off war debt....

SP Long Term Charts and the Reckless Adventurism of the Greenspan Federal Reserve

This chart shows the extreme effects of the Greenspan Federal Reserve on the stock market as a representation of its profound impact on the US economy, if not that of the world. Reckless adventurism may be too kind a description.

Two asset bubbles, back to back, were caused by the irresponsible expansion of credit and the lack of regulatory oversight of the banking system. This fostered malinvestment and a terrific destruction and reallocation of wealth.

This is what happens when the Fed takes its eye off the growth of money supply and credit, and instead focuses on exotic metrics and statistical rubbish, to the cacaphony and flourishes of pseudo-scientific oratory that confounds common sense.

There will be significant human dislocation and misery to come as the economy readjusts to more sustainable growth patterns and capital allocation.

Near term support levels are more obvious when looking at this chart below.

What we have are two neatly nested Head and Shoulders tops, at least.

Lehman Auction Sets up Largest CDS Settlement of $270 Billion

Bloomberg
Lehman Credit-Swap Auction Sets Payout of 91.38 Cents
By Shannon D. Harrington and Neil Unmack

Oct. 10 -- Sellers of credit-default protection on bankrupt Lehman Brothers Holdings Inc. will have to pay holders 91.375 cents on the dollar, setting up the biggest-ever payout in the $55 trillion market.

An auction to determine the size of the settlement on Lehman credit-default swaps set a value of 8.625 cents on the dollar for the debt, according to Creditfixings.com, a Web site run by auction administrators Creditex Group Inc. and Markit Group Ltd. The auction may lead to payments of more than $270 billion, BNP Paribas SA strategist Andrea Cicione in London said.

While the potential payout is higher than 87 cents on the dollar suggested by trading in Lehman's bonds yesterday, sellers of protection have probably written down their positions and put up most of the collateral required, said Robert Pickel, head of the International Swaps and Derivatives Association. More than 350 banks and investors signed up to settle credit-default swaps tied to Lehman. No one knows exactly who has what at stake because there's no central exchange or system for reporting trades.

``I don't think it buries anybody,'' said Brian Yelvington, a strategist at CreditSights Inc., a bond research firm in New York.

Sellers are required to post collateral, or pledge assets, to the buyer of protection, known as the counterparty, on the other side of the trade if the value of their positions declines. Because Lehman's bonds had already fallen, that collateral has probably been posted, Yelvington said.

Pimco, Citadel

The list of participants in the auction includes Newport Beach, California-based Pacific Investment Management Co., manager of the world's largest bond fund, Chicago-based hedge fund manager Citadel Investment Group LLC and American International Group Inc., the New York-based insurer taken over by the government, according to the International Swaps and Derivatives Association in New York.

Hedge funds, insurance companies and banks typically buy and sell credit protection, which is used either to insure a bond against default or as a bet against the company's ability to pay its debt.

The payments ``are insignificant when put into the context of the trillions of dollars of payments that are made through settlement systems each and every day,'' Pickel said on a conference call with reporters today.

Fears `Overblown'

Some funds may be forced to dump assets to meet the payment demands if they haven't hedged, BNP Paribas's Cicione said.

``Banks can go to the Federal Reserve, or use the commercial paper market where it is still functioning'' to meet protection payments, said Cicione, who said a 9.75 cent recovery rate would lead to payments of about $270 billion. ``But fund managers or hedge funds, once they've used their cash, have only one option: to sell assets.....''

Stand and Deliver - Significant Fails in the US Treasury Market

This is the worst 'failure to deliver' Treasuries that we've seen since we started tracking this on a weekly basis in 2003.

An explanation of the Settlement Failures from the Federal Reserve is listed below.

There was no corresponding spike in Agencies, MBS, or Corporates in the data.

Fails data reflect cumulative "fails to receive" and "fails to deliver" over the course of a week for the primary dealer community only. The cumulative weekly totals are calculated by summing the fails outstanding on each business day of the reporting week.1 These totals include both fails that started during the reporting week as well as fails that started in prior weeks and have not yet been resolved. The aggregate fails data include fails associated with both outright transactions and financing transactions.

Fails data are reported for four distinct categories: Treasury Securities, Agency Securities, Mortgage-Backed Securities and Corporate Securities. Mortgage-backed securities include those issued and insured by government sponsored enterprises. Privately issued mortgage-backed securities are categorized as corporate securities. The FRBNY has collected aggregated fails data in this form since July 1990 for Treasury, Agency and Mortgage-Backed securities, and since July 2001 for Corporate securities.

Reported fails numbers sometimes can reach elevated levels due to so-called "daisy chains" and "round robins" in which an initial delivery failure causes a chain of subsequent fails as the party expecting to receive the security in the initial transaction fails to deliver to its counterpart in the second transaction, and so on. Daisy chains and round robins are ultimately not the cause of fails. Fails, at root, are caused by the core short positions of cash and repo market participants.

As described in the primer below, there are many factors that can create an initial delivery failure. Once a significant volume of fails occurs, lenders of collateral sometimes also withhold collateral because they are concerned that existing fails diminish the likelihood of that collateral being returned to them. Such withholding can be self-fulfilling because withholding scarce collateral can increase the incidence of fails in and of itself.

The importance of delivery chains and the potential for feedback effects from changes in the withholding behavior of collateral lenders also imply that relatively small amounts of collateral can settle a larger volume of failed transactions: an increase in collateral can be delivered from one party to the next to clear up a chain of failed trades and the resolution of failed trades may, in turn, make collateral lenders more willing to lend securities that had been in short supply.

Reasons for Settlement Fails

Fails occur for a variety of reasons. One source of fails is miscommunication. Despite their best efforts to agree on terms, a buyer and seller may sometimes not identify to their respective operations departments the same details for a given transaction. On the settlement date the seller may deliver what it believes is the correct quantity of the correct security and claim what it believes is the correct payment, but the buyer will reject the delivery if it has a different understanding of the transaction. If the rejection occurs late in the day there may not be enough time for the parties to resolve the misunderstanding.

In some cases a seller or a seller’s custodian may be unable to deliver securities because of operational problems. An extreme example is the September 11 catastrophe that destroyed broker offices and records, impaired telecommunications links between market participants, and damaged other critical infrastructure. Less extreme operational problems can also precipitate settlement fails, and are not uncommon.

Finally, a seller may be unable to deliver a security because of a failure to receive the same security in settlement of an unrelated purchase. This can lead to a “daisy chain” of fails; where A’s failure to deliver bonds to B causes B to fail on a sale of the same bonds to C, causing C to fail on a similar sale to D, and so on. A daisy chain becomes a “round robin” if the last participant in the chain is itself failing to the first participant.

Fails also occur “naturally” when special collateral repo rates approach or reach zero. In general, a market participant would be better off borrowing securities to avoid a fail even if the interest on the money lent in the specials market is below the general collateral repo rate, because (as explained below) the alternative is forgoing interest altogether.3 However, this incentive becomes less compelling as a specials rate approaches zero. A specials rate will approach zero if there is unusually strong demand to borrow a security, e.g. following heavy short selling by hedgers, or if holders are unusually reluctant to lend the security.

Source: Federal Reserve Bank