Re: [A-List] Re: [TNF] 30-year Treasuries

["Anyutka" <annewilliamson@xxxxxxx>]

Amazing Times -- Credit Bubble Bulletin, by Edmund McCarthy
PrudentBear.com ^ | July 18, 2003 | Edmund McCarthy


Edmund M. McCarthy is President and CEO of Financial Risk Management
Advisors Company. This piece was originally published in his June 19
newsletter.


This effort is so entitled to recognize Doug Noland, who gave me this phrase
that, I believe, best describes the current global environment. I have
always been loath to accept any utterance that “It is different this time”
but in enlarging on the manifestations that follow, I can only conclude
that, if it is not different, it certainly includes an awesome number of
new/changed conditions not previously seen by the author or readily found in
economic history. I therefore concur with my friend Doug in deciding that,
for once, the legions using past trends, ratios, and happenstance to analyze
and predict are subject to a high probability of failure. Once, when
stationed in Canada many years ago, I had an associate who deplored the
usual reasoning for investors that they should invest for the long term with
the phrase: “In the Age of Aquarius, the long term investor may arrive at a
destination that is no longer there!” The Current consensus projections made
by the pundits leaves me with some sympathy for such a thought.

MANIFESTATIONS FOR WANT OF A BETTER WORD


-- 1. A near unanimous race by the Central Banks of the world to an interest
rate of 0%.

-- 2. With the exception of China, Russia and a few mini’s like Ecuador,
current and simultaneous economic downturn or stagnation on a global basis
which the above is supposed to overcome.

-- 3. Dual (Fed and GSE’s) Credit Creation mechanisms in the U.S. operating
enormous liquidity and liability creation surges concomitant with 1. above.

-- 4. “Institutionalization” (my word) of Investment Management of financial
resources which is virtually exclusively performance compensated.

-- 5. Unregulated “Hedge Fund” assets and numbers of enormous magnitude
($700 Billion +/- according to what can be gleaned.) Tack on the GSE balance
sheets that are subject to being considered hedge funds because they
resemble them in most respects, and there is more than $3 trillion of this
type of arcane unregulated machinery out there. Yes, admittedly, in the 1920
’s, there were the pools but they pale in comparison.

-- 6. Opacity on the part of Institutionalized Investment Management
(technical phrase I just coined) as to strategies, holdings and causes of
performance. Hedge funds tell you they wont tell you. Mutual funds tell you
they will only tell you quarterly after the fact, etc.

-- 7. Quoting Steve Roach at Morgan Stanley, “A Global Imbalance.” Author’s
opinion: an imbalance greater than any previous “manifestation” of
imbalance! (A.) Global net debt of the U.S. in excess of $3 trillion. The
U.S. currency is the global reserve currency. (B.) Approaching $1 trillion
of U.S. government debt (including the “too big to fail” Agencies) held
abroad. As much as 40% of new issuance bought abroad. (C.) Current Account
deficit approaching 5-6% of GDP in the Global Reserve Currency nation!
(Empires are supposed to produce surpluses.).

-- 8. Booming Debt and Equity markets at valuation and discount levels
previously considered to be absurd for such tremendous levitation.

-- 9. Creation of $8 trillion+ and growing of “Structured Finance”. While
lauded as risk dispersion by Sir Printsalot (Mr. Magoo/Greenspan) the bulk
of this NEW form of credit has been generated during a prolonged boom and is
virtually un-tested except by “models” a la LTCM!

-- 10. $140 TRILLION! Of notional amount of derivatives sloshing around the
global financial markets. The conventional wisdom is that these “artificial
moneys” also disperse risk. WE HOPE SO! But are not convinced.

-- 11. A Mortgage Refinance Boom coupled with a Housing Price Appreciation
Boom of magnificent proportions. Any cause/effect connection to the
aforementioned submarine-ing of interest rates and ballooning of liquidity
which might otherwise be characterized as a “BUBBLE” is dismissed by savants
as unlikely in housing.

-- 12. With some trepidation as such caviling is now frequently criticized
as unpatriotic, we observe a growing tendency of unilateral (with a few
“willing”) foreign military and diplomatic adventurism entailing not only
significant upfront expense but also a largely unrecognized long tail after
action expense.


This list could continue further but will be curtailed at this point as it
seems sufficient to illustrate the point that these are truly Amazing Times.
The multi-trillion dollar question is whether or not these unparalleled
measures and strategies, supported by the above-described unique if not new
machinery for credit creation can renew and prolong the multi-decade
expansion without serious downturn the U.S. economy has been privileged to
experience.


THE ANSWER IS YES, BUT! IN NO WAY DO WE WANT TO UNDERESTIMATE THE
ORCHESTRATORS OF THIS EXERCISE. IT HAS BEEN ASTONISHING AND AMAZING THAT THE
DRAMA HAS PLAYED OUT AS LONG AS IT HAS BUT NOT OUTSIDE THE REALM OF
POSSIBILITY FOR IT TO GO FURTHER HOW MUCH FURTHER? THE ANSWER IS, WE
BELIEVE, TO BE FOUND IN THE WILLINGNESS OF TWO CURRENT VICTIMS OF THE SILENT
DEVALUATION OF THE DOLLAR TO CONTINUE AS WILLING RECIPIENTS OF THE PAIN.
(1.) THE FOREIGN BUYERS OF U.S DOLLAR DENOMINATED SECURITIES, PARTICULARLY
DEBT SECURITIES AND (2.) THE AMERICAN PUBLIC.


Given the unanimity of ignorance of the American public on the issue, we
have presumed they would be the last to revolt. It would have seemed that
the combination of lower yield and currency loss would have curtailed the
foreign appetite by now. Many disparate factors, however, have lengthened
the masochistic willingness of the foreign side of the equation. The Chinese
(enormous buyers and holders) have long anticipated the recent demand by
Treasury Secretary Snow that they take a look at their ridiculously (some
estimate by as much as 50%) undervalued currency and can point to their
faithful accumulation of offsetting $ instruments. For a less sanguine view,
see the recent commentary on the prudentbear.com website by Marshall
Auerbach. He and I share the view that Chinese eleemosynary is an oxymoron.
The inscrutable Japanese are still an enigma. Admittedly, they actually have
a carry trade against their own yields and constantly falling rates and
rising prices have further lessened the currency pain. Following, still,
their failed policies, they are constrained to buy more and more to prevent
THEIR currency from appreciating to the detriment of the politically
powerful export cabal. While there is quite a bit of evidence that the Rest
of the World has largely moved to the sell side, it is at a glacially slow
pace. Some of this is, perhaps, again due to the rising prices/falling
yields in debt securities and mini-mania in equity propelled by the
continuing Niagara of Liquidity.


In a column on June 24, Steve Roach of Morgan Stanley comes up with another
version of “Is it different this time”. He chronicles the failures of
Central Bank and fiscal policies over time. He further elucidates on the
obverse of our No. 1 above (The global race to 0% in interest rates), i.e.
the managed explosion in money supply accompanying this policy and the
proliferation of substantial deficits on the fiscal side and asks, “Can it
be different this time?” He makes his point that efforts of this nature have
failed in the past. We grant that point but revert to numbers 2-12 above. No
Nation has ever, to our knowledge, created such a proliferation of CREDIT
CREATING CAPABILITY. This combination of massive entities, coupled with an
Administration and Federal Reserve determined to use any and all measures to
restart an economy of serial failed bubbles with whatever bubble can be
found reinforces our conclusion of Yes, but!


DOES INFINITE LIQUIDITY EQUAL ZERO WRITE-OFFS? THIS SLIGHTLY FACETIOUS
QUESTION COMES AS WE PONDER 2002 CREDIT EXPANSION IN THE BANKING SECTOR OF
$800 BILLION+ AND STRUCTURED FINANCE CREATION OF $800 BILLION+ ALSO FOR A
TOTAL FOR THESE TWO OF $1.6TRILLION+ OR 16% OF GDP IN A YEAR WHERE GDP WAS
EXPANDING AT A SMALL FRACTION OF THIS NUMBER.


Certified curmudgeons find continuing credit expansion at multiples of GDP
without concomitant credit disaster to be counter-intuitive. However, in
this “New Age of Finance” there may be a new expansion of INVISIBLE CREDIT
DISASTER. We will go out on a limb (not such a long one where accounting
scandals have been exploding with monotonous repetition and the incentives
to create them in the form of options continue to expand) and say that we
are highly dubious of the continuing sanguine results in terms of credit
quality of the financial sector. ZERO WRITE-OFF may be approached if the
 “Re” prefix is used with sufficient vigor. What are we grumping about? The
development of the expanding cluster of terms/euphemisms(?) such as
Re-Aging, Re-Performing, and the older Re-Structure, Re-Schedule, Re-Finance
etc. Although not an “Re” word, inclusion of the term Forbearance is
something we believe justifiable. We listened to one of the purveyors of
this kind of finance explain that in this New Age of Finance, it was/is to
“everyone’s” benefit to adopt a “KINDER, GENTLER APPROACH” to troubled
credit. Foreclosure/sale/liquidation were tactics of the barbarous past.


With 33% more of the nation’s credit in structured finance than in the
banking system, our major concern is that there really is NO/VERY LITTLE
regulation of this $8 trillion and growing pile. Within the banking system
there is the wonderful world of “HELD FOR SALE”.


FULL DISCLOSURE! A CERTIFIED CURMUDGEON OF GREATEST CYNICISM IS HEREINAFTER
MAKING COMPLETELY UNJUSTIFIED AND PURELY SPECULATIVE REMARKS BASED SOLEY ON
40+ YEARS EXPERIENCE……..READERS UNDER THE AGE OF 50 MAY WISH TO DELETE OR
BURN BEFORE READING!


Long held to be a primary reason for the longevity of the Japanese collapse
was the unwillingness of the system to put defunct, superfluous or clearly
anachronistic companies out of their misery. Some of what is currently going
on in corporate credit in the United States may have more of a resemblance
when examined through the eyes of a curmudgeon than is comfortable. Without
maligning any specific financial institution, we decry the growing world of
Chapter 22. The number of bankruptcies ending in liquidation is accounted
for without using too many digits (fingers of the hand). The number in which
the sinner emerges shriven, reconstituted and re-financed must exceed the
number actually viable in such a state given the enormous over-capacity
almost always prevalent in the industry in which the respective company is
situated.


Why are these supposedly rational financial enterprises re-floating (our new
Re word!) these entities, many of which seem destined rapidly or eventually,
for another Chapter 11, thus reaching the Chapter 22 level! (If they go down
again after the 2nd 11 does the subsequent 7 bring the total to 29?) Two
reasons. The write-off in liquidation usually approaches total and there are
no fees for the erstwhile lenders. Go for a re-launch and such fees are
lusty, the collateral improves to what should have been gotten in the first
place making the subsequent re-entry into bankruptcy far less injurious to
the players. In the meantime, lots of DIP money to be made!


Without maligning any specific entity, we point to the whole miasma of
energy and the swamps called telecom and retail and, lastly, the ridiculous
world of airlines and airline finance as horrible examples. We know, after
the coming second half recovery, all of this form of forbearance will be
justified by the fantastic prospects of the resuscitated. That’s what the
Japanese have been saying for the last decade.


The WSJ article today on GM incorporated some comments on the giant bond
sale to make a bet that stocks can outrun interest paid to fix their pension
plan. There is a lot of research available to prove that the over-capacity
(still growing) in the global auto industry could best be solved by having a
couple of giant players disappear. Instead, there seems to be a march to
zombification (WSJ technical term). Occasionally an article appears on the
federal guaranty Agency for pensions which would be in Chapter whatever if
not federal. The zombies in auto’s steel, airlines etc. dwarf the future
resources of the entity. Ah well, Congress may legislate all the problems
away with a pension specific solution “re-aging” all the beneficiaries.
Anyhow, all of the company stock being dumped into the plans may go up a la
1997-2000 and bail everything out.


In the consumer arena, we are less able to point to specifics but the
growing anecdotal input we have is far from re-assuring.


Example: Not once, but more than several times we have run across instances
of home-owners falling in arrears, which would have resulted in summary
foreclosure. In this “kinder, gentler” world, they are contacted by the
lender for a “re-finance”. The appraisal shows sufficient equity to bring
payments current, escrow several months into the future and handle taxes and
insurance as well as all the substantial requisite fees for the lender.
Future ability to service is not of interest to the lender as there is now
way this sucker is staying on the balance sheet. For those of you who have
not been there, I commend the Appraisersforum.com. Some of the chat on
pressure from lenders to over-appraise is startling. The mortgage inception
process also has devolved into a situation without a responsible adult in
the origination process. The anecdotal we are receiving may explain why
recent statistics released show delinquencies down while ultimate
foreclosures are up to a record. “Refi until it gets impossible and then
shut down.” Tangentially, bankruptcies continue to hit new records. As long
as the bubble in residential is provided some of that 16% growth
aforementioned the dance can go on. By the way, each appraisal obviously
affects all the “comparables”. Is there any wonder we have double-digit
growth in prices. Is it any wonder that the buyer (previously the ultimate
check on prices) cares less or is motivated to “BUY BEFORE THE PRICE GOES UP
AGAIN, NOW!?


I also again commend to you the entity mentioned previously in earlier
writings. I point to that strange “piscatorial” venture “C-Bass” jointly
owned by a couple of outstanding Mortgage Insurance entities, MGIC and
Radian. They do “re-performing mortgages”. Constituting a large and growing
part of earnings for their parents, this curiosity is obviously relying on
the self-reinforcing housing bubble for valuations permitting the
prestidigitation necessary to turn non-performing dross into “re-performing
gold”.


Then we get to the wonderful world of “re-aging”. If only it were physically
so easy! Credit card outstandings have some fairly simple rules for
write-off. Not if things get re-aged. Sometimes another “Re” not previously
mentioned, re-affirmation, is included, maybe sometimes not. Sometimes maybe
the original issuer re-ages, sometimes they buy somebody else’s write-offs
and get reaffirmation, sometimes there may be methodology yet not described.
Suffice it to say that, since virtually no card outstandings are on anybody’
s books but are virtually all in some form of structured credit, it may be a
little difficult to really know what is going on. Theoretically, the Master
Trust tells one on a periodic basis. Nevertheless, as long as the ratios are
as required, the Master Trust numbers pass muster. Who is actually looking
at individual loans. NO ONE!


It may not be the Age of Aquarius but it definitely is the age of accounting
fraud. Are we actually to believe that the $8+ trillion in structured
finance is immune? Has human nature been repealed?


Speaking of individual loans, we find the area of auto finance
incomprehensible. Again, digging down to the individual loan is virtually
impossible. Almost all vehicle finance is now structured. Vehicles continue
to sell at near record rates with record incentives. Particularly for the
domestic producers, it is profitless prosperity on the vehicle sale itself.
The profits substantially are in the finance entity. These worthies actually
carry a notch higher credit rating than the parent! The rest is in various
Master Trusts as in cards. I was reading a provocative article on “Where are
the repo’s?” recently and that added to the incomprehensibility. What is
happening to the flood of used cars? The likelihood that they are being
resold without significant losses is slight but any such losses are not
making any headlines. Suffice it to say that our credulity is strained. As
with the housing bubble, this sales phenomenon depends on the continuation
of even higher and higher discounts, lower rates for financier and buyer and
somehow dealing with all the used cars. Again, not a problem as long as tame
rating agencies and loads and loads of continuing lower cost credit is
available. We suspect, being the cynics we are, that a lot of used car
finance may be using “re-value” in what the car is financed for, and
absorbing any losses in the financing process. DON’T STOP THE CARNIVAL! to
use the title of a book describing another economic incongruity.

Many years ago in a universe in which we still live but with totally
different credit creation and evaluation standards, the writer was so stupid
as to approach a senior lender with the proposition that we take as primary
collateral a second mortgage which appeared on the appraisal to provide
value. After a short stint in the emergency room, we have never forgotten
the response. Obviously negative, the primary tautology was the necessity to
buy out the first to realize. We wonder how many of the ubiquitous players
in this world of “HOME EQUITY” have actually undergone the process.


WE ALSO WONDER HOW HIGHER INTEREST RATE HOME EQUITY LOANS CAN EXPAND IN THE
NEW WONDERFUL WORLD OF INSTANT RE-FINANCE BUT THEY ARE DOING SO!


One possible answer is the ubiquitous offers to do your home equity flooding
mailboxes in an industry desperate for further growth where finance
availability saturates every facet of the market. These are only possible if
the aforementioned appraisal for whatever is required is available. We
obviously are jaundiced on the whole subject of appraisals! Since appraisals
beget “comparables” which beget appraisals which beget comparables which
beget loans for the fastest (resembling the oldest) profession in the world,
mortgage broking, you may understand our yellow color on the subject.


Again, the wonderful world of structured finance readily takes these loans
and transforms them into magnificent rated securities. As long as the ratios
meet their computer derived tests, the ratings are fine. How can we be
suspicious that anything could ever be done to keep these all important
ratios where they should be of a dubious nature?


In Summary, AMAZING TIMES encompasses CREDIT CREATION CAPABILITY never seen
before, ENORMOUS SELF INTEREST on the part of the credit creators, Official,
semi-official (the GSE’s) and private, to keep INFLATING the credit and even
more ENORMOUS SELF INTEREST to maintain ratios on all the Structured Finance
so created. In this Age of Accounting Prestidigitation are we actually to
put totally unbounded faith in the results. Not this curmudgeon!


FOR ANYONE WHO UNDERSTANDS THAT THE RESULTS OF ANY SUCH PRESTIDIGITATION
(FOR THOSE WHO DON’T KNOW THIS TERM IT DESCRIBED THE MAGICIAN’S “NOW YOU SEE
IT; NOW YOU DON’T”) CAN BE MANAGED AS LONG AS THE DENOMINATOR IN THE RATIO
EXPANDS FAST ENOUGH THE REASON FOR ALL THE PLAYERS WANTING TO CONTINUE OR
EXPAND THE CREDIT CREATION IS OBVIOUS.


NOBODY IS REALLY GOING TO CLOSELY EXAMINE INDIVIDUAL ELEMENTS IN THE
NUMERATOR AS LONG AS THE RATIOS HOLD UP AND THEY WILL AS LONG AS THE
DENOMINATOR EXPANDS FAST ENOUGH


WATCH OUT BELOW WHEN YOU SEE THE FIRST SIGNS OF SLOWING!



----------------------------------------------------------------------------
----

----- Original Message -----
From: "Gary Santos" <evs@xxxxxxxxxxxx>
To: <TheNewForum@xxxxxxxxxxxxxxx>; <pkt@xxxxxxxxxxxxxxxx>;
<a-list@xxxxxxxxxxxxxxxxxxx>
Sent: Sunday, July 20, 2003 6:41 AM
Subject: [A-List] Re: [TNF] 30-year Treasuries


> "The agencies have also been hedging their interst rate exposures with
> derivatives. There is on-going investigation that will eventually reveal
> very unwelcome disclosures, the tip of the iceberg having been hinted in
> recent weeks."
> --------------------------------
> Henry,
>
> What sort of investigation? How rolled over derivatives are booked?
>
> Gary
>
>
> ----- Original Message -----
> From: "Henry C.K. Liu" <hliu@xxxxxxxxxxxxxx>
> To: <pkt@xxxxxxxxxxxxxxxx>; <a-list@xxxxxxxxxxxxxxxxxxx>;
> <TheNewForum@xxxxxxxxxxxxxxx>
> Sent: Sunday, July 20, 2003 5:54 AM
> Subject: [TNF] 30-year Treasuries
>
>
> > The following is a composite summary of recent market reports from a
> > variety of media sources interlaced with my comments to give my sense of
> > an overview picture.
> >
> > The 30-year bond (US30YT=RR) gained 8/32 to yield 4.68 percent on
> > Friday, July 11 shrugging off some of the pressure exerted since
> > Wednesday, July 9 2003, when Treasury Undersecretary Peter Fisher
> > announced his intention to resign.
> >
> > Fisher played a key role in the elimination of the 30-year bond back in
> > October 2001 and speculation had mounted over the chances of its
> > reintroduction once he leaves.
> >
> > The Washington Post reported in mid May that Treasury Undersecretary for
> > Domestic Finance Peter Fisher had withdrawn his name for consideration
> > as president of the New York Fed.
> >
> > The market believed that as long as Pete 'The fixer' Fisher
> > (LTCM) remained in his current position at the Treasury, the 30-year
will
> > not be reinstated. It was Fisher's decision to eliminate the 30-year
> > bond on Halloween day 2001 and his reputation and credibility are tied
> > to it.  Recently, while still at the Treasury, he said rumors of the
> > return of the 30-year 'aren't worth spit'.
> >
> > With barely any warning to the financial markets, Fisher announced in
> > October 2001 that Treasury would no longer issue 30-year bonds--the
> > so-called benchmark securities that had set prices for the whole
> > bond market. The rationale was that the government was paying too much
> > in interest for the long bond. Besides, big budget surpluses had reduced
> > the need for the 30-year.  It is cheaper for government to issue new
> > money (non-interest bearing state credit instrument) through the Fed
> > than to issue sovereign debts through the Treasury.  Of course Fisher
> > did not point out that an sustainable long term monetary policy requires
> > a constant but low rate of inflation - which is essential the money
> > holder's interest cost to the state money issuer.  Thus money in a
> > working growth economy is not really interest free.
> >
> > Greenspan said in the Q&A during his July 15 Humphrey Hawkins testimony
> > to the Senate that while the Fed has no opinion of the 30-year bond
> > policy, it is obvious that things have change:  meaning federal deficits
> > have replaced federal surpluses in the foreseeable future.
> >
> > Things have indeed changed dramatically, with the federal deficit in
> > 2003 hitting $450 billion or 4.5% of GDP, not even counting
> > war/occupation costs. And the government's bond rates have
> > fallen, causing a boom in bond prices until recently.
> >
> > Many market participants think the Treasury should reverse its
> > decision--and start issuing new 30-year bonds. Doing so would help
> > government finances, give investors a long-term, risk-free investment
> > option, and allow corporations to more easily price long-term debt.
> > There was a time this would be true. The long bond used to be the safest
> > hedge instrument before the emergence of structured finance. The entire
> > fixed income sector was based on the long bond.  Today, derivatives and
> > swaps have changed the meaning of hedging, turning it from a risk
> > management device to a risk taking play for high returns for
> > speculators. Structure finance, not withstanding the claim of Greenspan
> > that derivative provide market stability.  Structured finance
> > dis-integrates long term security into short term differentials, with
> > profit driven by volatility. A stable market is bad news for hedge
> > funds.  Structured finance has reduced the relevance of the long bond.
> >
> > The term fixed income has come to mean fixed only for the duration of
> > the derivative contract term, even for the long bond.  Widows and
> > orphans trust funds, pension funds as well as Freddie Mac mortgages have
> > all been exposed to inappropriate risk by derivative plays, at the mercy
> > of hedge funds.
> >
> > It wouldn't be the first time the government changed its policy on the
> > long bond. From the 1950s through the middle of the 1970s, 30-year bonds
> > were issued only sporadically. It was not until 1977 that Treasury
> > started using large quantities of 30-year bonds to fund growing and
> > permanent deficits.
> >
> > The theory for bring the long bond back is that Treasury would gain by
> > tapping into institutional and foreign investors attracted to the
> > 30-year. More buyers means lower rates for the government. And a 30-year
> > issue would lock in low rates for the next 30 years, holding down
> > interest payments and reducing future deficits. But with agencies play
> > derivates, it is not clear that government actually saves money by
> > issuing the long bond. Even though new 10-year notes cost the Treasury
> > 0.8 percentage points less in interest than 30-year rates today, in a
> > decade, they might have to be refinanced at higher rates. "The U.S.
> > Treasury should be at least as smart as homeowners," notes David A.
> > Wyss, chief economist at Standard & Poor's, a unit of The McGraw-Hill
> > Companies.  But it is, even with the 30-year bond because the market
> > value, therefore the effective yield of the long bond is not at all
> > fixed over its life time.  The the net value of government long debt is
> > not constant at any moment in time, nor its effect on the credit market.
> >   The only thing fixed is the interest payout by the government on the
> > outstanding long bonds. Since new long bonds are issued at market rates,
> > the average cost of long bonds to the government is not constant.
> > Besides, what Fisher missed is that the purpose of the long bond is not
> > to fund government cash needs, but to provide a benchmark for the credit
> > market.  The interest cost to the government has little macroeconomic
> > consequence, except to those who misunderstood macroeconomics as a
> > branch of accounting.
> >
> > The conventional wisdom is that reissuing the 30-year bond would also
> > offer risk-shy investors more choices, helping both institutional
> > investors with a long-term investment horizon and individuals building a
> > retirement portfolio. Correctly done, investing in a 30-year Treasury
> > bond means that "people who are 35 or 40 years old who are saving for
> > their retirement would know exactly what they're going to have in 30
> > years," says Wharton School economist Jeremy Siegel. While other
> > long-term securities exist, none are truly risk-free.
> >
> > It is argued that bringing back the long bond would also help pension
> > funds, insurers, and corporate borrowers. Pension funds, hit hard by
> > market volatility, could better protect returns by upping their
> > long-term risk-free holdings. Insurers could better match long-term
> > investment to long-term liabilities. But few retirment accounts are
> > satisfied with long bond yields.  No pension fund manager can keep
> > his/her job for long if the assets under management is excessively heavy
> > in long bonds. And issuers had been chasing high returns by borrowing
> > short term to invest in long bonds, and will be caught short when a
> > reverse yield curve takes over, as it did during the final years of the
> > Clinton "boom".
> >
> > And it is also argued that a reissued 30-year would help companies price
> > their own long-term debt, attracting more investment. But short term
> > debts are now routinely used to finance long term liabilities, making
> > the long corporate bond a wall flower, a mere underlying benchmark to
> > calculate spread.  GE cannot afford to borrow long term debt. It is the
> > low rate GE commercial papers that give GE the spread to be a financial
> > powerhouse.  GE is extremely vulnerable to deflation and to reverse
> > yield curves.
> >
> > It would be tough for Treasury to reverse the decision to drop the  long
> > bond. To guarantee buyers sufficient liquidity, Treasury would have to
> > commit itself to issuing 30-year bonds for several years, which makes
> > sense only if deficits are going to persist--and that's something the
> > Bush Administration isn't willing to admit yet, despite irrefutable
> > evidence.
> >
> > Shock waves from Greenspan virtually disavowing unconventional policy
> > means (buying long bonds) have fully eclipsed the gains set in motion by
> > his original references to deflation. Longer-dated bonds proved
> > particularly vulnerable, especially after the release of
> > stronger-than-expected June retail sales. Their premium evaporated just
> > as a record $450 billion 2003 deficit was predicted by the White House
> > following elevated hopes for a reinstatement of bond issuance recently
> > with Fisher's resignation.
> >
> > The curve steepened sharply, not only pricing in economic recovery but
> > also the likelihood that Fed funds will be held low, so long as Fed
> > reflation efforts continue. While Greenspan digged hard for additional
> > grounds for optimism on the economy, he made it clear that while on the
> > verge of price stability rates would be kept low. The September bond
> > closed over 2 points lower at 112-16, while the 2-year note and 30-year
> > bond spread jumped 10 basis points from pre-testimony levels to +350
> > basis points -- fresh 11-year wides. Fed funds futures predicted 25-30%
> > odds of another quarter point cut.
> >
> > The bond market has been on a roller-coaster ride recently as investors
> > struggled to divine the intentions of the Fed. Gambling that
> > the Fed would buy bonds to help ward off deflation, investors piled into
> > the market in mid-June, sending the yield on the 10-year Treasury note
> > to a 45-year low of 3.1%. But when the Fed opted to merely trim interest
> > rates on June 25, investors turned tail and sold bonds.
> >
> > The coup de grâce came on July 15 as Chairman Alan Greenspan forecast
> > faster economic growth and seemingly all but ruled out bond purchases by
> > the Fed. The bond market quickly tanked. Greenspan tried to turn the
> > tide the next day by saying he hadn't taken bond buys off the table, but
> > the damage had been done, and the 10-year yield ended the day at close
> > to 4%.
> >
> > The wild market fluctuations have left a sour taste in the mouth of many
> > market participants. Some mutter about being manipulated and misled by
> > the Fed. "Greenspan has lost some credibility with the market," says
> > Melvyn B. Krauss, senior fellow at Stanford University's Hoover
> Institution.
> >
> > Of course, some of the rise in bond yields is due to growing hopes for
> > an economic rebound -- a phenomenon to be welcomed but highly unlikely
> > given the poor fundamentals, geo-political uncertainties, and policy
> > fixations.  Yet the rapid increase in long-term interest rates
> > also reflects wariness about the Fed floundering with wishful thinking.
> > If investors feel they can't count on a predictable and level-headed
> > Fed, they're apt to push bond yields and long-term rates up higher than
> > justified by the perceived or wishful strengthening economy alone.
> >
> > A premium for Fed risk could even lift rates to the point where they
> > hurt the very economic recovery the bulls are anticipating. "This is not
> > an economy that's going to take off like a rocket," says former Fed
> > Governor Lyle Gramley, now senior economic adviser for Schwab Capital
> > Markets. "I would be more comfortable if 10-year yields were at 3 1/2%,
> > instead of 4%."  It is an economy that will most likely explode during a
> > unprepared takeoff from leaky ideological O rings.  It will move from
> > unpleasant recession to fatal catastrophe.
> >
> > The federal budget deficit is ballooning. The White House on July 15
> > predicted a financing shortfall of $455 billion in fiscal 2003, and $475
> > billion for fiscal 2004, which may well come in at $600 billion. The
> > forecast fanned fears in the bond market of stepped-up sales of Treasury
> > securities, helping to send prices even lower and yields higher.
> >
> > Dealers, banks, and hedge funds are sitting on large bond positions they
> > built up via so-called carry trades -- borrowing money at low short-term
> > rates and then investing it in longer-dated securities. This is what is
> > behind bank profit in the latest quarter, which most have hailed as good
> > news rather than the bad news that it actually represents. But with the
> > value of those bond investments falling, there's a risk of a major
> > sell-off as those trades are unwound, says economist Henry Kaufman.
> > Kaufman has seldemn if ever been wrong on the economy in his long career
> > on Wall Street.
> >
> > Fed policymakers egged on investors in June with warnings about the
> > dangers of falling prices, capped off by Greenspan's colorful comments
> > on the need to build a "firebreak", Greenspan’s word in a June 3 speech,
> > against deflation. In private meetings and public speeches, Fed
> > officials suggested they were deliberately trying to guide long-term
> > rates lower and left open the possibility of buying bonds to help their
> > chances.
> >
> > There's no doubt that investors read more into some comments than the
> > Fed intended. They ignored repeated warnings by Greenspan and other Fed
> > policymakers that the risk of deflation was, after all, remote. Instead,
> > they snapped up bonds in the mistaken belief that a desperate Fed would
> > bail them out by buying up their securities. "The market has got to take
> > some responsibility for its own actions," says former Fed Governor
> > Laurence H. Meyer.  This is rational expectation at work to the point of
> > irationality.  The detonator is the Fed's claim that the risk of
> > deflation is remote.  Not even taxi drivers believe it.  Even the BIS is
> > calling for anti-deflationary measures for all of the world's central
> > banks.  Greenspan's war plan is always to anticipate phantom inflation
> > and deny real deflation.  When Greenspan again recite his mantra that
> > America enjoys the highest stabdadr of living, presumably due to his
> > monetary genius, he was interrupted by the senator from Vermont, the
> > Greenspan should visit Vermont to find out how hard life really is in
> > America.  The high standards of living is limited to the few who
> > Greenspan's policies had been designed to favor, namely financiers and
> > top executives.
> >
> > The markets' eroding confidence in the Fed has consequences. The danger
> > grows if investors feel so threatened by what they see as an unsteady
> > Fed policy that they demand ever higher risk premiums on Treasury bonds.
> > Greenspan has been repeating his promise to buy long term treasuries if
> > the economy needs it. His out is that the economy never needs it.
> > Greenspan is milking the economy dry to maiantain the financial markets.
> >   And, American voters, hurt by the economy, will turn against the
> > financial markets and its managers.
> >
> > The unconventional means suggested by Bernanke is that the Fed can buy
> > 10 or 30 year treasuries from open market operations and create new
> > reserves in the banking system. This drains treasuries from the market
> > and makes each treasury worth more as a result. This allows the sellers
> > to offer lower yields to the new buyers and still be able to sell them.
> > Simple supply and demand at work.
> >
> > As the yield on the 10 or 30 year treasury falls all other rates that
> > are tied to it fall, corporate debt, fixed and floating home mortgages
> > of all durations. When Greenspan says he is ready and willing to buy
> > long treasuries to stimulate the economy what he means is that he will
> > manipulate mortgage rates down to attract new buyers into housing and
> > cause another refinance boom, which has come to a screeching halt in
> > recent months.
> >
> > The 30 year fixed rate mortgage accounts for about 65% of all mortgage
> > loans in the US. The rate on that loan is determined largely by the cost
> > of borrowing money at Fannie Mae and Freddie Mac. Their borrowing cost
> > is determined by the yield on the 10 year treasury because most 30 year
> > mortgages are refinanced with 10 years. That rate will be the 10 year
> > treasury yield plus a risk premium for lending money to Fannie and
> > Freddie versus lending money to the US government. As the yields on
> > the 10 year US treasury fall lenders to Fannie and Freddie are willing
> > to accept a corresponding reduction in rate they will accept from Fannie
> > and Freddie for lending money to them as well. Fannie and Freddie then
> > pass this reduction on to the banking and mortgage industry in the form
> > of lower PAR rates or cost of money for mortgages. The banking and
> > mortgage industry then pass this reduction on to each home owner by way
> > of lower mortgage rates.
> >
> > This process has been going in a passive manner for the past year, as
> > the Fed has indirectly been the cause of lower mortgage rate over the
> > course of this year. This is Greenspan housing bubble after his eqity
> > bubble burst.
> >
> > For the past year the Fed has been increasing money supply by buying
> > treasuries form the banks and replacing them with bank reserve, high
> > power money. The banks in turn have been turning around and re-buying
> > treasuries on the open market. The result has been lower long term rates
> > and a refinance boom in the US housing market.
> >
> > The agencies have also been hedging their interst rate exposures with
> > derivatives. There is on-going investigation that will eventually reveal
> > very unwelcome disclosures, the tip of the iceberg having been hinted in
> > recent weeks.
> >
> > The Fed's primary supply side game plan was to encourage banks to lend
> > to corporations which has not occurred becuase of overcapacity that
> > erodes pricing power and proifts. The reduction in mortgage rates
> > during this period was a peripheral bonus that sustained consumers
> > spending by the Fed repricing long term debt to support the economy
> > while the Fed attempted to get corporations to borrow. The housing
> > refinance boom provided cash-outs from appreciated equity resulting from
> > the housing bubble as well as lower loan payments to finance consumer
> > spending. When the housing bubble bursts, negative equity will create
> > chaos in the financial markets through the collapse of collateralized
> > martgage obligations (CMO).
> >
> > Greenspan appears to have shifted Fed policy to preempt deflation and
> > aggressively move rates down ahead of the economic contraction and is
> > now preemptively telling the market he may move out on the yield
> > curve to long bonds and buy long treasuries with the explicit goal of
> > driving mortgage rates down.
> >
> > The reason he is being so vocal about his possible intentions to buy
> > long term treasuries is to ensure hedge funds and most importantly the
> > soeverign debt markets are hedged against falling rates before it
> > occurs. It is a warning or "heads up" so to speak to them.
> >
> > Last summer the duration gap problem at Fannie Mae was the direct result
> > of Fannie Mae not anticipating that the 10 year treasury yield would go
> > below 4%. When it did their duration gap widened and they lost enormous
> > amounts of money. The reason they were not properly hedged is that they
> > anticipated that the reduction in Fed Funds and corresponding increase
> > in money supply would depreciate the dollar and increase the potential
> > for future inflation in the US economy which would have been reflected
> > in rising 10 year treasury yields rather than falling.
> >
> > But, because the corporations refused to borrow and banks refused to
> > lend, in a classic Keynesain liquidity trap, and the rest of the world
> > continued to buy US treasuries with their trade surpluses from US
> > consumers, the dollar did not depreciate against the Yen and Euro until
> > recently and by not much. Even now the euro is only back at the exchange
> > value it adopted at the time of its intrduction. This was the first
> > major international empirical signal that this was not the same type of
> > economic contraction that we have experienced since the end of WW2.
> >
> > Every other post war recession has been the result of the Fed
> > maintaining too tight a monetary policy as they preemptively tried to
> > predict and stop inflation. In other words the Fed caused every other
> > post WW2 recession up to and with the exception of this one.
> >
> > Every time the Fed lowers rates, equity traders buy stock. This
> > exaggerates volatility in the stock market. Young traders, and trading
> > is a field dominated by youth, today have never experienced a market in
> > a true long wave economic down cycle rather than a Fed induced
> > contraction.  Economic down cycles have never been stopped by
> > monetary policy before. Greenspan's reputation had been built on
> > postponing the business cycle by flooding the system with money to feed
> > a debt bubble.  There are two problems with that approach: 1) a day of
> > rekoning can only be postponed but not avoided, and 2) debt is
> > unsustainable without inflation and fatal with deflation.
> >
> > Driving down mortgage rates worked through 2002, but it has come to an
> > end. It brought Greenspan time but nothing else.  The interest rate
> > induced recovery will run out of steam by the thrid quater of 2003, not
> > withstanding the Fed optimistic pronouncement that the economy will
> > recover by then.  What the Fed is really saying id that the economy had
> > better recover by then or we will all be in the soup.
> >
> > NEW YORK, Jul 15, 2003 (AP Online via COMTEX) -- Investors dumped
> > Treasury bonds Tuesday, sending yields higher, after Federal Reserve
> > Chairman Alan Greenspan indicated that the Fed would not buy back bonds
> > as a way to keep long-term interest rates low.
> >
> > Greenspan's remarks, which came in one of his twice-yearly economic
> > reports to Congress, further disappointed bond investors following the
> > Fed's smaller-than-expected interest rate cut in late June.
> >
> > Greenspan said he would likely use the Fed's main tool, cutting
> > short-term interest rates, to stimulate the economy. That disappointed
> > investors who hoped the Fed might buy back long-maturity bonds, which
> > would increase their value.
> >
> > The price of the benchmark 10-year Treasury note fell 1 27/32 point, or
> > $18.44 per $1,000 in face value. Its yield, which moves in the opposite
> > direction, rose to 3.96 percent compared with 3.73 percent late Monday.
> >
> > The 30-year Treasury bond fell 2 7/8 point to yield 4.95 percent, up
> > from 4.77 percent a day earlier, according to Moneyline Telerate.
> >
> > The benchmark 2-year note fell 3/16 point to yield 1.45 percent, up from
> > 1.35 percent Monday. Intermediate maturities fell between 7/16 point and
> > 1 19/32 point.
> >
> > Yields on one-month Treasury bills were 0.89 percent as the discount
> > rose 0.01 percentage point to 0.87 percent. Yields on three-month
> > Treasury bills were 0.91 percent as the discount rose 0.03 percentage
> > point to 0.89 percent. Six-month yields were 0.97 percent, as the
> > discount rose 0.02 percentage point to 0.95 percent.
> >
> > Yields are the interest bonds pay by maturity, while the discount is the
> > interest at which they are sold.
> >
> > The federal funds rate, the interest on overnight loans between banks,
> > rose to 1.19 percent from 1.06 percent late Monday.
> >
> > In the tax-exempt market, the Bond Buyer index of 40 actively traded
> > municipal bonds fell 13/16 111 17/32. The average yield to maturity rose
> > to 4.97 percent from 4.90 percent.
> >
> > A single speech by Alan Greenspan may have squashed what remained of a
> > tidal wave of mortgage refinancings that began three years ago.
> >
> > The Federal Reserve chief spooked the bond market Tuesday when, during
> > his semiannual address to Congress, he said the central bank did not
> > plan to buy bonds on the open market. The comments caused mortgage
> > rates, which are tied to bond yields, to shoot up to their highest
> > levels in three months.
> >
> > Within minutes after Greenspan completed his address Tuesday, lenders
> > said they were besieged with telephone calls from anxious homeowners
> > rushing to refinance before rates edged even higher.
> >
> > "My fear is that we may be seeing the last, dying gasp of the 'refi'
> > boom," said Mark Ralston, senior loan officer at AccessOne Mortgage, a
> > mortgage banking and brokerage firm based in Raleigh. "Most people have
> > already refinanced. And those who were on the fence are doing it now."
> >
> > And that could be bad news for the economy. Mortgage refinancings, in
> > which borrowers trade one mortgage for another at a lower interest rate,
> > have funneled billions of dollars into consumers' pockets over the past
> > three years. Borrowers have used the extra cash to renovate their homes,
> > buy cars and pay for their children's college education.
> >
> > In mid-June, when the 30-year mortgage rate dipped to a 45-year low of
> > 5.28 percent, lenders and mortgage brokers were overwhelmed with
> > mortgage refinancing requests. Some lenders turned away potential
> > business because they lacked the manpower to process the applications.
> >
> > "I've been in this business 20 years, and I have never seen anything
> > like the amount of refinancings we saw in May and June," said David
> > Novak, a loan officer at Home Mortgage Company of North Carolina in
> > Cary. "It was almost out of control."
> >
> > Now mortgage lenders say this refinancing wave may have crested, in the
> > same way that stocks peaked in March 2000. And most blame Greenspan.
> >
> > About halfway through his address Tuesday, Greenspan said he saw no
> > imminent need for the Federal Reserve to buy bonds on the open market.
> > Earlier this year, the Fed had floated the idea of buying bonds, which
> > would have driven interest rates even lower.
> >
> > When Greenspan pronounced that possibility "most unlikely," investors
> > and Wall Street traders began dumping large numbers of bonds. That
> > sell-off drove down bond prices and pushed up their yields, which move
> > inversely to each other.
> >
> > Most lenders base mortgage loans on the 10-year bond's yield, which
> > jumped 0.26 percentage points Tuesday to 3.983 percent -- the highest
> > level since April.
> >
> > Greenspan tempered his comments Wednesday, when he finished his
> > semiannual report to Congress, by saying that he has not ruled out
> > buying bonds to stimulate the economy. Yet that did not reassure bond
> > investors, as the yield on the 10-year bond remained high Wednesday at
> > 3.92 percent.
> >
> > Normally, mortgage lenders issue one set of mortgage rates in the
> > morning and leave them unchanged for the day. But within an hour after
> > Greenspan's speech, banks began increasing their mortgage rates in
> > response to the bond sell-off.
> >
> > By Wednesday afternoon, the average rate on a 30-year mortgage had
> > jumped 22 basis points to 5.83 percent (a basis point is one-hundredth
> > of a percentage point), according to Bankrate.com of North Palm Beach,
> Fla.
> >
> > The sharp increase caught some mortgage brokers off guard. Ralston of
> > AccessOne said he had to call back some borrowers Tuesday afternoon and
> > tell them that the rate he quoted them in the morning was no longer
> > accurate. In some cases, people who were considering plans to refinance
> > decided against it because of the rate increase.
> >
> > "There is a profound sense of lost opportunity among people who did not
> > refinance three or four weeks ago," said Greg McBride, senior analyst at
> > Bankrate.com.
> >
> > And the Fed's bullish comments on the economy suggest that mortgage
> > rates will continue edging up, McBride said. Also Tuesday, the Fed
> > released its semiannual report to Congress. In the report, the Fed
> > predicted that the U.S. economy will grow 3.75 percent to 4.75 percent
> > in 2004.
> >
> > When the economy is growing, investors tend to prefer stocks over bonds.
> > As demand for bonds falls, their yields rise -- pushing up mortgage
rates.
> >
> > On 16 July 2003, the chairman of the US Federal Reserve delivered an
> > optimistic growth forecast and bond traders reacted with heavy selling
> > activity which sent yields at the long end of the curve soaring. Such a
> > reaction is not likely to be what Greenspan wanted, as low long-term
> > bond rates help to determine mortgage and corporate lending rates, and
> > can stimulate borrowing and spending. Traders, however, are wary of
> > being trapped with portfolios heavy with relatively expensive long-dated
> > Treasury bonds when interest rates eventually rise.
> >
> > On 16 July 2003, Alan Greenspan, the chairman of the US Federal Reserve,
> > issued a surprisingly upbeat assessment of the US economy, and said that
> > the Reserve no longer felt it necessary to employ strategies such as
> > buying back bonds to protect against deflation. Bond market traders
> > responded with a global sell-off of long-dated bonds,
> >
> > Even though Federal Reserve Board Chairman Alan Greenspan told Congress
> > on Tuesday that he wants to keep interest rates low to help the economy,
> > bond investors had other ideas.
> >
> > The prices of long-term bonds plummeted -- and their yields soared --
> > shortly after Greenspan implied the Fed probably won't need to buy back
> > long-term bonds to contain deflation.
> >
> > Higher yields on long-term bonds push up mortgage rates, and on Tuesday,
> > mortgage rates spiked up sharply. In the Bay Area, some 30-year fixed
> > rate mortgages are now close to 6 percent, nearly a full percentage
> > point from their lows in mid-June.
> >
> > If rates continue to climb, they will crimp borrowing and spending and
> > weaken the fragile recovery -- the exact opposite of what Greenspan
wants.
> >
> > However, investors were struck not just by Greenspan's words but by his
> > tone. His words still reflected the Fed's readiness to cut rates if the
> > economy looks weak -- but his tone showed more confidence that won't be
> > necessary.
> >
> > Only a few weeks ago, the Fed's main worry was on deflation, a
> > destructive cycle of falling prices and wages that erode the economy's
> > productive capacity. Not so much now, it appears.
> >
> > "What was very, very important in May became lip service in June and is
> > somewhat secondary now," said Gary Schlossberg, senior economist at
> > Wells Capital Management in San Francisco.
> >
> > In addition, Greenspan gave a fairly optimistic forecast for growth,
> > especially next year. Although he predicts the economy will expand at a
> > slow 2.5 percent to 2.75 percent this year, he thinks it will rebound at
> > 3.75 percent to 4.75 percent in 2004. If so, unemployment could drop to
> > 5.5 percent by the end of the year, he said.
> >
> > Again, what's good news for the economy would depress bond prices from
> > the unusually high peaks now.
> >
> > The price of the benchmark 10-year Treasury note sank $18.44 per $1,000
> > in face value. Its yield, which moves in the opposite direction, rose to
> > 3.96 percent compared with 3.73 percent late Monday. The yield on the
> > 30-year Treasury bond shot up to 4.95 percent on Tuesday from 4.77 the
> > day before.
> >
> > That's a significant increase in yields from mid-June when the rate for
> > the 30-year Treasury bond was only 4.17 percent. But will rates continue
> > to rise or are they just bouncing up before they resume their downward
> > trend?
> >
> > Gibbons Burke, the editor of markethistory.com, thinks a major change in
> > the bond market depends on whether the 30-year Treasury bond yield rises
> > above 5 percent -- roughly its level late last year and early this year.
> > If it does, then that will signal the end of declining rates, he said.
> > If it doesn't, rates could continue to stay low or sink.
> >
> > "We're at the moment of truth," Burke said.
> >
> > Bonds fell after Greenspan indicated the Fed would be unlikely to pursue
> > unconventional tactics against deflation such as buying up long-term
> > Treasuries, the Wall Street Journal reported.
> >
> > Greenspan said the Fed will hold short-term interest rates low "as long
> > as it takes" and may even cut interest rates further if necessary.
> >
> >
> >
> >
> >
> >
> >
> > ------------------------ Yahoo! Groups Sponsor ---------------------~-->
> > Buy Ink Cartridges or Refill Kits for Your HP, Epson, Canon or Lexmark
> > Printer at Myinks.com. Free s/h on orders $50 or more to the US &
Canada.
> > http://www.c1tracking.com/l.asp?cid=5511
> > http://us.click.yahoo.com/sOykFB/k9VGAA/ySSFAA/qkHolB/TM
> > ---------------------------------------------------------------------~->
> >
> > TNF has two guidelines designed to maintain a positive tone.
> >
> > (1) If you take offense at another member's message, write to that
person
> privately; if you think the moderators should be informed, CC your private
> message to thenewforum-owner@xxxxxxxxxxxxxxxx
> >
> > (2) Avoid on-list meta-discussions or co-moderation; address such
matters
> to the individuals involved and/or to the moderators.
> >
> >
> >
> > Address to unsubscribe: TheNewForum-unsubscribe@xxxxxxxxxxxxxxx
> >
> >
> >
> >
> >
> > Your use of Yahoo! Groups is subject to
http://docs.yahoo.com/info/terms/
> >
> >
> >
> >
>
>