The Trouble With Bonds
March 18, 2010 by admin · Leave a Comment
By Charles Hugh Smith, OFTWOMINDS
by Charles Hugh Smith
The trouble with bonds (the U.S. Treasury variety, among others) is simple: there’s too stinking many of them being issued. Given that every government on the planet except Lower Slobovia is issuing unprecedented quantities of debt (bonds) to fund their skyrocketing deficits (and Lower Slobovia would too, if its credit rating wasn’t -ZZZZZ), then we have to wonder who will be showing up to buy the $1.6 trillion in freshly printed T-bills the U.S. Treasury will issue this year to cover the expected Federal deficit.
This is of course “the new normal” given last year’s $1.4 trillion deficit.
So what does that number–$1.6 trillion in newly issued Treasury bonds to fund this year’s deficit–mean in the real world? We might start by asking who is going to buy that stupendous issuance of new debt.
Just to put that $1.6 trillion into some sort of context, let’s add up all the Treasury debt currently owned by the two largest foreign holders: China and Japan. According to the most recent statistics issued by the Treasury, China holds $889 billion and Japan holds $765 billion.
Together the two nations own $1.65 trillion in U.S. T-bills of varying maturity. Interestingly, both nations have been trimming their holdings of U.S. debt recently.
So to fund the current $1.6 trillion deficit, both China and Japan would have to double their holdings in just one year. (Perhaps they could use the $ .05 Trillion difference–$1.65T minus $1.6T–to visit Disneyland and Disneyworld.)
Since the two largest holders of debt are selling, not buying, hoping they will double their stakes this year is asking a bit much.
And then there is the 2011 deficit to sell, too, and we can’t expect China and Japan to pony up another $1.5 trillion for next fiscal year’s staggering deficit.
How about domestic demand for bonds? Aren’t we hearing pundits declare that Americans can easily support their own government’s deficits? Talk is cheap, especially for the punditry. According to BusinessWeek/Bloomberg, U.S. investors dumped $369 billion into bond mutual funds since March of 2009, while they extracted $26 billion from equity/stock funds.
That $369 billion went into a variety of public and private bonds, including local government municipal bonds and corporate bonds, so by no means did all of it go into T-bills.
But even if every cent had been used to purchase new Treasury debt, that $369 billion would have bought a mere 23% of the $1.6 trillion of new T-bills being issued this fiscal year to fund the deficit.
How about all those savings Americans are now socking away? Couldn’t we fund that $1.6 trillion a year out of savings?
Well, no. According to the BEA (Bureau of Economic Analaysis), the savings rate is 3.3%. A spike in the savings rate to 6.9% was reported in mid-2009 by the Commerce Department, but it seems that was inflated by stimulus checks distributed by the Federal government.
Feel free to argue the point with the BEA. Elsewhere they put it at 4.3%. Since total personal income is $12 trillion, then that means the total savings generated each year is on the order of $400 to $470 billion.
So taking the higher estimate ($470 billion), if every cent of savings stashed away by all 130 million American households was put into Treasury bonds, that would only come to 29% of the deficit.
It seems American investors aren’t buying many T-bills. According to Niall Ferguson in An Empire at Risk:
Unfortunately for this argument, the evidence to support it is lacking. American households were, in fact, net sellers of Treasuries in the second quarter of 2009, and on a massive scale. Purchases by mutual funds were modest ($142 billion), while purchases by pension funds and insurance companies were trivial ($12 billion and $10 billion, respectively). The key, therefore, becomes the banks. Currently, according to the Bridgewater hedge fund, U.S. banks’ asset allocation to government bonds is about 13 percent, which is relatively low by historical standards. If they raised that proportion back to where it was in the early 1990s, it’s conceivable they could absorb “about $250 billion a year of government bond purchases.” But that’s a big “if.” Data for October showed commercial banks selling Treasuries.
That just leaves two potential buyers: the Federal Reserve, which bought the bulk of Treasuries issued in the second quarter; and foreigners, who bought $380 billion. Morgan Stanley’s analysts have crunched the numbers and concluded that, in the year ending June 2010, there could be a shortfall in demand on the order of $598 billion—about a third of projected new issuance.
Of course, our friends in Beijing could ride to the rescue by increasing their already vast holdings of U.S. government debt. For the past five years or so, they have been amassing dollar–denominated international reserves in a wholly unprecedented way, mainly as a result of their interventions to prevent the Chinese currency from appreciating against the dollar.
At the peak of this process of reserve accumulation, back in 2007, it was absorbing as much as 75 percent of monthly Treasury issuance.
Our confrere Jesse at Jesse’s Cafe Americain addresses the same question with different sources and insights, but arrives at the same conclusion: Who is Buying All these US Treasuries (and can they keep it up in 2010)?
Another source of buying is–once again–China, based on the idea that since China runs a huge trade deficit with the U.S., it has to park all those dollars somewhere. True, but the trade deficit with China has shrunk to around $190 billion a year, so even if Beijing parked its entire surplus in T-bills, that would only soak up 12% of the $1.6 trillion.
There is simply no evidence that any pool of buyers exists outside of the Federal Reserve to soak up $1.6 trillion in newly issued Treasury debt this year. Yes, the Fed can “create” money and use it to buy Treasury debt via various third parties, but is that machinery up to buying endless trillions of dollars in new bonds to fund unprecedented deficits as far as the eye can see? Will there never be any consequence of that policy, or any limits imposed by the bond market?
The only proven way to attract buyers is to raise the yield on bonds. But we all know what will happen to interest-rate-sensitive assets like existing long-term bonds, stocks and real estate when rates rise: they will drop.
There is no free lunch, and the idea that the U.S. can sell endles trillions of new debt without consequence is an illusion.
I addressed some of these same issues in Why Interest Rates Will Rise in 2010 (December 24, 2009)
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Greece Gives Germany And European Union One Week Ultimatum (No, You Are Not Dyslexic)
March 18, 2010 by admin · Leave a Comment
First 130 Congressmen, now Greece: the examples of people who have no idea what the definition of negotiating leverage means just don’t stop. G-Pap has decided to go all in on 2-7 off suit. The problem is everyone knows what his cards are, and his bluff is about to be promptly called by everyone; too bad the Cyclades are still not in the pot. Give them a few weeks… Bloomberg reports that: “Greek Prime Minister George Papandreou set a one-week deadline for the European Union to craft a financial aid mechanism for Greece, challenging Germany to give up its doubts about a rescue package.” And here we were thinking only Bernanke was clinically insane. G-Pap, it turns out, is shocked that someone can just say no to his generous offer of allowing someone else to bail him out. Act now, or in one month when you can buy Greece (and its islands) in a 363 sale, it will be too late (to overpay).
From Bloomberg:
“It’s an opportunity to make a decision next week at the
summit,” Papandreou told reporters in Brussels today. “This is
an opportunity we should not miss. When you have that instrument
in place, that could be enough to tell the markets hands off, no
speculation, let this country do what it’s doing.”Greece pinned its hopes on the Brussels summit as German
officials voiced qualms about an EU-led rescue, potentially
backtracking on a commitment hammered out by finance ministers
just three days ago. Greek bonds and the euro fell.Greece, which was brought to a standstill on March 11 by
the second general strike this year, needs to raise about 10
billion euros ($14 billion) to refinance bonds that come due on
April 20 and May 19. Papandreou said Greece cannot afford to
keep paying current market rates.
The question of the day: are the acconts who bought into Greece’s most recent 10 year bond offering already underwater:
The yield on Greece’s 10-year government bond rose 14 basis
points to 6.23 percent at 2:25 p.m. in Brussels. The euro fell
for a second day against the dollar, slipping as much as 0.7
percent to $1.3648. Credit-default swaps on Greek sovereign debt
rose 7 basis points to 295, the highest in a week, according to
CMA DataVision prices.
And just to show that there is absolutely no confusion which way Germany is leaning when it comes to G-Pap’s ultimatum, Germany kindly suggested that Greece should leave the European Monetary Union. Asap. From Market News.
The head of Germany’s Ifo economic research
institute on Thursday said the best way to solve the Greek financial
crisis is for the country to leave the eurozone.“I would recommend that Greece leaves the European Monetary Union,”
Sinn said at a press conference in Berlin. The country should then
devalue its currency and a debt moratorium should be put in place, he
proposed.“This would be cheaper [for the other Eurozone countries] then to
permanently finance Greece,” Sinn said, arguing that Greece’s biggest
problem was its elevated foreign trade deficit and not mainly its high
public debt.
In the meantime, the market once again ignores all bad news, and just focuses on whatever good news there is, even if it means the reading of a Philly Fed, whose upward buoyancy is about to come to an end as the artificial economic stimulus begins to finally wane.
Portugal Prepares To Sell $1 Billion Of Dollar Denominated Bonds In Goldman-Led Deal
March 18, 2010 by admin · Leave a Comment
Yet more rape and pillaging of US taxpayers as Portugal now plans to join the long and exalted list of nearly bankrupt countries who wish to join the dollar devaluation bandwagon, and issue debt denominated in dollars. The P in PIIGS is in the same position as the US, needing to plug a massive budget deficit, so it has decided to do what the US does so well – issue bonds with a $ sign on them. Bloomberg reports: “Portugal is selling bonds in
dollars for the first time since November as part of a plan to
issue 25 percent more debt this year to fund its budget deficit. The nation is marketing $1 billion of five-year bonds that
may be priced to yield about 100 basis points more than the
benchmark mid-swap rate.” And this is merely the beginning: as most European countries are convinced the pain in Spain is nothing compared to what Washington is about to experience, we expect to see many more deficit whores attempting to jump on the dollar collapse bandwagon.
From Bloomberg:
“It’s not surprising that Portugal is coming to the market
now as many European sovereigns tend to borrow more in the first
half of the year,” said Ciaran O’Hagan, a fixed-income
strategist at Societe Generale SA in Paris. “Portugal will
likely achieve a better rate of funding in dollars so both the
government and taxpayers are getting a better deal.”The proposed spread on the new bond issue gives an overall
yield of 3.59 percent, according to data compiled by Bloomberg.
That compares with the 3.32 percent yield offered by Portugal’s
benchmark five-year issue in euros.By issuing in dollars, European governments can reduce the
cost of euro-denominated interest payments, as measured by the
five-year euro basis swap. The basis swap is at 20 basis points
less than the euro interbank offered rate, compared with 15
basis points less than Euribor in January, according to
Bloomberg data.Relative funding costs compared with a euro-denominated
bond sale were “favorable,” said Alberto Soares, chairman of
Portugal’s government debt agency in Lisbon.“It’s been our plan to issue foreign-currency bonds, and
it’s just a matter of identifying the window of opportunity,”
Soares said. “We may consider issuing bonds in other
currencies, but there’s no concrete plan on that for now.”
And so much for the lock out of Goldman Sachs from European bond issuance:
Deutsche Bank AG, Goldman Sachs Group Inc., HSBC Holdings
Plc and Morgan Stanley are managing the sale of bonds, the
banker familiar with the terms said.
Obama after One Year: Crisis, Response, Recovery
March 18, 2010 by admin · Leave a Comment
A couple days ago, I presented my views on the policy response to the financial crisis and the Great Recession in a UW Center for World Affairs and the Global Economy / UW CIBER / MITA and ICE sponsored event. The power point slides are here (big file, 1.3MB). I took the latitude as the invited speaker to expand the topic from the Obama Administration’s measures to encompass the response to the crisis and recession from both the fiscal and monetary policy authorities.
One slide I generated for the talk is of particular interest, when thinking about the combination of monetary and fiscal policies — it is the plot of consumption and household net wealth.
Figure 1: Log consumption, Ch.2005$ SAAR (blue, left scale) and log househld net wealth (red, right scale), Ch.2005$, deflated using PCE. NBER defined recession dates shaded gray; assumes last recession ended 09Q2. Source: BEA, GDP 09Q4 2nd release; Federal Reserve Board, Flow of Funds, March 11, 2010.
What is quite remarkable is the fact that real consumption expenditures have been essentially flat for a year and a half — even at a time when population has grown. (Since 08Q2, consumption has fallen 0.6 while population has risen 1.3%.) One question is whether the rebound in net wealth will support a resumption in consumption growth even as disposable income growth remains lackluster.
Another slide, pertaining to the rebalancing issue, is an update of my net exports/real exchange rate graph.
Figure 2: Log US dollar real broad exchange rate, lagged two years (blue, left scale), net exports to GDP (red, right scale), and net exports ex.-oil to GDP (green, right). NBER defined recession dates shaded gray; assumes last recession ended 09Q2. Source: BEA, GDP 09Q4 2nd release; Federal Reserve Board; and NBER.
If previous patterns hold, then — to the extent that the 08Q4-09Q2 dollar appreciation was understood to be transitory — the trade balance (at least the ex-oil component) should not deteriorate substantially going forward. This conclusion is consistent with the October IMF WEO discussed in this post.
As I’ve mentioned before, continued progress in keeping the trade deficit relatively small depends in part upon the trajectory of consumption. A resumption of consumption growth would be — all else held constant — desirable, but would tend to worsen the trade deficit. An exogenous upward shift in US exports would relax that constraint (as would further dollar depreciation). This is why the Obama administration has stressed export promotion [1] [2].
On a slightly different matter, the IMF provided an interesting heat map summarizing growth across the G-20, in this Staff Position Note.
Figure from IMF Note on Global Economic Prospects and Policy Challenges, February 27, 2010 – Seoul, Korea.
The map highlights the two-speed nature of the global recovery.
Update: 7:30am, Pacific
One of the graphs that didn’t make it into the presentation is an elaboration of how certain fiscal measures — EGTRRA, JGTRRA, and the total cost of operations in Iraq — limited the fiscal space available to policy makers. In the absence of these measures, we would not have to worry so much about rising debt-to-GDP levels. In other words, deep recessions are the times to run deficits, not in non-recessionary times.
Figure 4: Impact on budget balance, in billions of FY2010$, for EGTRRA; for JGTRRA; and budget authorization for operations in Iraq, FY01-FY10. Source: CBO, Budget and Economic Outlook: An Update (August. 2001), Table 1-4; CBO, Budget and Economic Outlook: An Update (August 2003), Table 1-8 (revenue implications only); A. Belasco, The Cost of Iraq, Afghanistan, and Other
Global War on Terror Operations Since 9/11,” Congressional Research Service report RL33110 (September 28, 2009), Table 3..
I first made this point about fiscal space (although I didn’t use the phrase) in 2006 [3].
Non-Story On Regulator Bonuses: A Mind Is a Terrible Thing to Waste
March 18, 2010 by admin · Leave a Comment
AP broke the big news — better be sitting down: “During the 2003-06 boom, the three agencies that supervise most U.S. banks – the Federal Deposit Insurance Corp., the Office of Thrift Supervision and the Office of the Comptroller of the Currency – gave out at least $19 million in bonuses”
Oh my god! oh my god! Just think, the money used to pay bonuses at these three agencies over this three year period would have been almost enough to pay the one-year bonus of a single top performer at Goldman or AIG. What an incredible waste of taxpayer dollars.
It is understandable that AP would look into this issue, but responsible people there should have quickly realized that there is nothing here. We have all sorts of incompetents running the regulatory agencies (starting with Federal Reserve Board Chairman Ben Bernanke), and we should certainly be asking about whether they deserve their paychecks, but the money at issue with these bonuses is far too trivial to waste anyone’s time with.
–Dean Baker
TARP Give Aways
March 18, 2010 by admin · Leave a Comment
The Post discussed the extent to which banks have repaid their TARP money, noting that small banks have been much slower to pay back the government loans than large banks. At one point the article discusses the sale of warrants on bank stock that the government received as part of the package. It comments that: “the goal of requiring the warrants was to ensure that taxpayers would see a return once the banks recovered.”
It is worth noting that the government lent TARP funds at interest rates that were far below the interest rates prevailing in the market at the time. In many cases these below market loans were needed to allow banks to survive. In all cases, the subsidy provided by these below market loans amounted to a substantial gift to the bank.
For example, Goldman Sachs (one of the more creditworthy banks) had to pay 10 percent interest on the money it borrowed from Warren Buffet at almost the exact same time as it got TARP loans from the government. The interest rate on TARP loans was 5 percent. It also had to provide Buffet far more warrants per dollar of loans. In the case of Goldman, the subsidy from its below market TARP loans almost certainly amounted to more than $1 billion, even if the government still reports a profit on these loans.
It is deceptive to say that the government made a profit on its TARP loans since it could have made a much larger profit if it had lent this money at market rates. Making capital available to favored borrowers at low cost, in the middle of a financial crisis, allowed these favored banks to make enormous profits with the government’s money.
–Dean Baker
Barclays calls Vale’s dollar denominated bonds cheap after euro issue
March 18, 2010 by admin · Leave a Comment
The dollar-denominated bonds fell heavily Wednesday after a euro-denominated bond was issued for the first time
Are Technology Stocks Gearing Up for Another Bubble?
March 17, 2010 by admin · Leave a Comment
The next time we get a serious dip in the stock market, there is one sector that I am going to jump into with both of my size 14 boots: technology stocks.
After the dotcom bust of 2000, these bad boys spent nearly a decade in the penalty box, shunned by the investing world as the poster boys for wild excess. Think Robert Downey, Jr. on steroids. During this time, cash balances doubled, free cash flows soared, outstanding shares shrank, and multiples fell to a tenth of their bubblicious peaks.
I started recommending this group at the absolute bottom of the market last March (click here for the call at http://www.madhedgefundtrader.com/March_2__2009.html ), and it was no surprise to me when they outperformed almost every sector on the upside. With 60%-80% of their earnings coming from abroad, primarily Asia, I saw them really as foreign stocks wearing cowboy hats, pearl snap buttoned shirts, and Ray Ban aviator sunglasses.
They were great weak dollar plays. They did not need banks, as they are almost entirely self financed. They avoided many of the management errors that torpedoed so many other US firms, like derivatives books and leveraged real estate exposure. While their American customers were getting poorer, hundreds of millions more overseas were getting richer.
The industry represents the last, best hope that America has for competing globally, as it is our only means of staying on top of the international value added chain. It seems that in addition to bulk commodities like corn, wheat, soybeans, coal and timber, aircraft, weapons, and movies, tech companies are among the few that make things foreigners want to buy.
The lessons of the bubble made them ultra conservative in their capital spending which will lead to product shortages and much higher prices in any recovery. Memory, for example, has seen no capex at all for three years. They are surfing the wave of innovation, and will cash in big time from the mobile computing revolution, cloud computing, and the virtualization of data centers.
During the last tech bubble, the industry did not have the global market that it does today. Now, demand from the rising emerging market middle class is kicking in, as it is for commodities. The nine month tech rally we saw in 2009 could just be the down payment of a decade long bull market in these stocks, which will end with another bubble.
When John Chambers, a first class manager, discussed Cisco’s (CSCO) outlook after announcing blowout Q4 earnings, he was so effusive he sounded like he was on ecstasy. Take a look at Juniper Networks (JNPR), JDS Uniphase, (JDSU), Sandisk (SNDK), Micron Technology (MU), and lithography toolmaker (ASML). Long dated call spreads in all of these make sense on a decent dip.
For more iconoclastic and out of consensus analysis, you can always visit me at www.madhedgefundtrader.com , where the conventional wisdom is mercilessly flailed and tortured daily, or listen to me on Hedge Fund Radio at http://www.madhedgefundtrader.biz/ .
Summarizing Today’s Fed Chairman Q&A: Prepare To Vastly Exceed Your Recommended Daily Allowance Of Bernanke’s Prevarications
March 17, 2010 by admin · Leave a Comment
Going through today’s pertinent Q&A with Bernanke, initially we focus on Fed nemesis #1, Ron Paul. First question of relevance: “Do you Mr. Bernanke think that rates were hold too low for too long?” The degree of Fed delusion is easily seen by the response: “the bottom line is nobody really knows for sure, but the evidence is quite mixed.” Obviously the bald one has never attempted to sell a home in the Inland Empire. The evidence sure would be a little less mixed in that case. But at least Bubble Ben has given a speech on it (which incidentally caused John Taylor to almost have a conniption against the stupidity of the Fed’s chairman). Yet just in case you thought the man may have at least one screw unloose in his voluminous cranial hollow, Bernanke opens his mouth and says “Even if rates were too low for too long, the magnitude of the error was not big enough to account for the huge crisis we had. I think what caused the crisis was a failure in regulation.”…..And this is the man who determines monetary policy….Only now do we find out he has never actually ever opened an Econ 101 textbook, instead opting to go straight to writing them. Luckily Ron Paul proceeds to give the Princeton “expert” a much needed lesson in monetarism, and what happens when rates are zero for far too long.
To be expected, Bernanke certainly did not appreciate being schooled in Econ 101. After Paul rips Bernanke’s face off with the Chairman’s constant excuse that regulation is the answer to everything, arguing instead that artificially low rates merely send constantly flawed price signals, Bernanke retorts “Well you need some system to set the money supply. I guess you are a gold standard supporter.” At this point Paul gives the most priceless response ever: “I am for the constitution.” (4:50 into the clip)… A flabbergasted Bernanke again proceeds to cast the blame… This time everywhere but the Fed: “Every major country in the world uses a Central bank to make some decision about the money supply.” We ask the philosophy experts among our readers to tell us just what type of fallacy this is. Ron Paul once again has a brilliant response: “Then there is no good information for the investor unfortunately.” What are you talking about Ron – there is Cramer. At least until such time as his particular regulators wake up… Which they seem to have done so today finally.
Next up, California’s Brad Sherman asks the current-former Fed Chief duo the following runner up to the most critical question of the day: “Bureaucracies hate bad headlines, they’ll often do desperate things behind the scenes to avoid that big headline from breaking. Prudential regulators are going to get bad headlines if a big institution fails, particularly under some circumstances, and if they can prevent that failure, if they can just put it off for six months, their reputations and careers can be saved. Monetary policy, just cutting the interest rate by quarter point can save a troubled institution. So how can we be sure that monetary policy is not influenced by the natural human desire of bank supervisors, to save one or two institutions, for at least long enough for them to move over to another department. How do we make sure that monetary policy does not meet the career needs of bank supervisors?” And the token bullshit response from the follicularly confused one: “I don’t think that’s a very realistic scenario.” Oh really? We think it is, and in fact we think that the probability of influence on monetary policy arising from this line of thinking is much, much greater than all that other BS we have been hearing about how an audit will make the Fed become an engine of hyperinflation, the argument that Barney Frank, Chris Dodd, Mel Watt and all the other bought and paid for Wall Street cronies are using to prevent Ron Paul’s audit the Fed initiative from ever passing. Bernanke elaborates on what one day will be an amusing case study: “I suspect the Central Bank Chairman will be around and concerned about his or her reputation when the economy has excessive inflation or whatever problem might arise from bad interest rate policy. I don’t think there is much evidence for that particular issue.” How about the issue that every reputation can be bought and paid for by someone with a big suitcase full of brand new $100 trillion bills, with a portrait of Supreme Chancellor Blankfein on the front? This is post the hyperinflation – certainly the Central Bank chairman will not be dumb enough to want to be paid in Pre-Petition money.
Yet of all questioners, Rep. Scott Garrett asks the truly most relevant questions of the day. First among them: “Are the GSE obligations sovereign debt?” Bernanke’s response: “We stand behind it, but whether it is legally sovereign debt or not, I am not equipped to tell you.” Same thing from Volcker, who adds that it is a “bad arrangement where you have this quasi private organization and the government stands behind it.” So not even the wannabe uber regulator knows how to account for an amount equal to half of the total US Federal Debt. Swell.
On Lehman Garrett asks “The Fed was there on scene, your folks were there at Lehman’s. Was the Fed aware of the Repo 105 and the accounting irregularities going on?” Bernanke answers “No – they were hidden. We are currently, for example, the principal regulator of Goldman Sachs, and we have about a dozen people on site, and another dozen who are looking at the company. We had in this case two people assigned to Lehman. And their main obligation was to make sure we get paid back our loans…. Our objective on the discount window loan was to make sure it was safe and they were safe.“
Now parse the last few sentences carefully. Not only does the Fed admit that it is and was in the Fed’s interest to delegate manpower to make sure that Goldman is fine (in an agent ratio of 6-to-1 “scouring” over Goldman’s books), but Bernanke blatantly contradicts himself when claiming the reason for the presence of the Fed’s entourage. If the Fed was indeed so focused on recouping its discount window borrowings, then how on earth did Geithner green light that Lehman would be allowed to deposit a nearly $3 billion CDO, which contained loans by CFC, which after a cursory look Citigroup determined was “Bottom of the barrel” and “junk”? What is the basis of this dual standard – why does the Fed pretend to be concerned with safeguarding taxpayer money (with which Bernanke justifies its minimalist presence at Lehman) when it comes from the Discount Window yet is happy to collateralize “junk” paper in the Primary Dealer Credit Facility? Is whoever was in charge of the Lehman account at the FRBNY some schizophrenic (and please let it not be discovered that the person in charge was, just like in AIG’s case, again Steven Manzari)? And why does the Fed believe it has any credibility as an uber-regulator when it constantly fails a less than uber-one?
In earlier questioning by Spencer Bacchus, Bernanke answered that the only reason why the Fed had a “couple” of people in the company, was to make sure that Lehman “repaid the money lent by the Fed’s Primary Dealer Credit Facility.” Yet the Fed had lent out money, as noted above, collateralized by, well, excrement. Once again that is a truly “brilliant” overture by a wannabe regulator of all that has a dollar sign in front of it.
Bernanke digs himself even deeper. When explaining why the FRBNY got paid back, BB says “we took collateral and we took extra large haircuts to make sure it was safe.” Oh… so now you care about getting paid back. Was it, perhaps, under the guidance of one Goldman Sachs, who may have at this point decided it was time to rid the world of the pesky Lehman Brothers that made you start enforcing legitimate collateral controls?
Then Garrett asks the key question: “In light of these reports is this something that we should be concerned about? Is activity at these other [banks such as Goldman] is that something that (a) we should be concerned about and (b) something the Fed should be concerned about and are you looking into it.” Bernanke’s retort “[the banks] are now under our consolidated supervision, so we are now paying attention to these issues.” That’s the non-answer. As to the answer of whether the Fed is looking at whether shady accounting is going on or was going on in the past, Bernanke’s version of the Fifth is as follows: “I don’t know. This report just came out this week.” In other words if Peck had not agreed to declassify Valukas’ report, if there was no pressure to put the Examiner’s report in the public domain the Fed would never have expressed any interest into just what kind of shady accounting goes on to mask the Tier 1 and Risk Based Capital of the banks under its supervision, and that leverage ratios by most of the banks it supervises are likely complete shams?
A relentless Garrett keep probing: to the NJ representative’s question whether the Fed demanded that Lehman’s regulator (whoever it may be since it was not the Fed, even though the Fed had implemented three separate liquidity stress tests, of which Lehman failed every single one) require that Lehman raise its liquidity, Bernanke once again gets an acute case of amnesia: “I don’t have the exact information that you are asking.” So once again the Fed proves that the only thing it can regulate is the bribery sinking fund at Goldman et al with direct recipient Federal Reserve governors. Everything else will just fall into place once yet more of Goldman’s competitors are done away with, and Goldman (and JPM, of course, can’t forget Fed, Jr), are left standing as the only two financial firms in the known universe. And this is the Fed that lame duck and financially supremely challenged Chris Dodd wants to put in charge of regulating everything in this country? If that really ends up happening, we are so #&$*ed… but not before Goldman funnels all of Americas’ money into its Middle-Class Irredeemable Negative Interest Rate All-market Fund SIV.
Pigs at the Trough
March 17, 2010 by admin · Leave a Comment
Reading the mainstream papers or watching the business news, one could be forgiven for thinking Australia has completely sidestepped the continued global depression, with our miracle economy continuing to perform divine acts. But while residential property continues its irrational bubble, for many Australians, the global financial crisis was very real – ask anyone who has owned shares in Babcock & Brown, Allco, MFS and a host of other collapsed enterprises.
Not only did investors and banks lose billions as Australia’s financial engineers crashed, but hundreds of other companies, including the once venerable Rio Tinto and Australia’s oldest property trust, GPT, desperately raised fresh capital from institutions at prices which would have been unthinkable a year earlier. The pain for retail (or ‘mum and dad’ shareholders) was compounded – not only did they suffer capital losses on their holdings and their dividends drastically reduced, but they were generally unable to participate in highly discounted capital raisings (the fruits of that were shares by a select few institutions).
Last year I spent several months working on what became Pigs at the Trough: Lessons from Australia’s Decade of Corporate Greed. The book covered various examples of corporate governance failings and executive greed, providing ‘lessons’ to help shareholders avoid being caught in the next, inevitable, downturn (which, as Bill Bonner continues to suggest, could happen sooner rather than later).
The biggest story to come out of the spate of Australian collapses is that there was no real story. The bankruptcies of MFS, Allco and Babcock in particular all bore a striking resemblance. All three companies considered themselves ‘asset originators’ – that is, their business was essentially buying stuff and selling it to what was usually a captive satellite fund. Aside from the obvious issue that buying and selling assets like toll roads, coal terminals, hotel chains or Irish telecommunication companies adds no net value to society as a whole, but also, their entire business models largely consisted of charging excessive fees to captive vehicles.
The entire arrangement was made all the more sordid by the fact that the agreements between the mothership and the various satellite companies were intentionally withheld from shareholders. This was all allowed by the ASX. Perhaps coincidentally, various ASX directors also sat on boards like Babcock & Brown (Michael Sharpe) and Brisconnections (Trevor Rowe).
In terms of sheer audacity, the collapse of Babcock & Brown is difficult to top. Led by former tax lawyer Phil Green, Babcock grew from a small leasing business based in San Francisco to a diversified investment bank which at its zenith, had more than $70 billion worth of assets under management. Babcock’s share price grew like a rocket in the late 1990s – rising from $5.00 when floated in 2004 to almost $35 in mid-2007 before the credit crunch took hold.
During that time Babcock’s leading executives, like their investment banking brethren across the globe, gorged from the trough of fees. In four years as a listed entity, Babcock paid its top dozen executives almost $300 million in cash alone, along with a couple of hundred million of (ultimately worthless) shares. The cash remuneration paid was of course – not refundable. Sadly for shareholders, neither were the billions of dollars of losses racked up by the bank through foolish real estate deals and the grossly over-priced purchase of the already highly-engineered Western Australian power company, Alinta.
But it wasn’t only the financial engineers which came crashing down as the market reassessed its tolerance of risk. The high-profile fall of Eddy Groves’ ABC Learning Centers was even more remarkable given the business earned around half of its revenue directly from taxpayers. While Eddy Groves never received a large salary, his company paid more than $100 million to his brother-in-law, Frank Zullo, for untendered maintenance works at ABC’s centres. ABC also paid Austock (the broking house which was partly owned by Groves) around $50 million in investment bank fees.
ABC surprised shareholders, banks and the Singapore Government when it announced that its fabulous business model wasn’t really that fabulous. In fact, the company’s $437 million loss in 2008 dwarfed all the alleged profits that the business ever made.
Then there were the somewhat more predictable collapses – the downfalls of the agribusiness twins – Timbercorp and Great Southern Plantations. Both companies were caught holding illiquid assets as they weren’t able to refinance debt to support their Ponzi schemes.
The biggest problem from Timbercorp and Great Southern was that while their schemes timber and horticulture schemes provided a tidy tax deduction for city folk, many of the schemes didn’t actually make any money. (In 2005 Great Southern admitted in the finest of fine print deep in its Annual Report that the company was funding its schemes after the company realised the woodchips it had harvested were worth less than the costs of planting and maintaining the trees). Great Southern told shareholders the bad news a couple of months after founder and managing director, John Young, sold $30 million worth of shares.
The common link across many of collapses?
Excessive use of debt coupled with almost universally poor governance practices and a remuneration structure geared toward short-term cash bonuses. Have we learned from the mistakes? If the real estate bubble and worldwide government indebtedness is any guide, it doesn’t look like it.
Adam Schwab
for The Daily Reckoning Australia
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