A Lack Of Trust Between Lender And Debtor Is At The Root Of The Lending Gridlock
Monday, 6. October 2008, 04:07:13
Introduction
A Lack of trust between lender and debtor is at the root of the lending gridlock.
And there are a number of factors causing economic dysfunction.
The factors of economic dysfunction include:
1) Different interest rates between central banks. The US is at 2%, the ECB 4% and the Bank of Japan is at 0.5%; and the BoJ loans aggressively to the well connected. These of late have gone short the EUR/JPY, causing the yen carry trade, better termed the euro carry trade, to unwind, unleashing many deflationary hurricanes.
Interest rate differential investing took the Australian natural resource investing shares up, and then down as can be seen in the ongoing Yahoo Finance chart of Australia stocks, and the metal mining shares, and the Australian Dollar. The Elliott Wave 3 Down is always more sharp than the Elliot Wave 3 Up. Currency traders in London, Hong Kong, Brussels, and the Caribbean Cove Islands became super wealthy on the wave up and also on the wave down by borrowing at 0.5% interest from the Bank of Japan lending window. The ongoing Yahoo Finance Chart of EWA, XME, and FXA shows the recent dissolution of stock wealth caused by currency traders as they work interest rate differentials to their advantage ... EWA, XME and FXA
The chart of the yen carry trade, that is EURJPY, FXE:FXY, shows the power of interest rate differential working in reverse ... FXE:FXY
2) The interest rate on the 10 Year US Treasury Note, $TNX, and the 30 Year US Government Bond, $TYX, are too low; that is they do not reflect the risk of default on home ownership. And they do not reflect the true cost of capital.
Government interest rates being low discourage saving, and encourage speculative investing in gold.
But you know, now that the US Government has nationalized the housing industry by acquiring the two private lenders, Fannie Mae, and Freddie Mac, and will become title owner of foreclosed homes given the passage of EESA, the default risk of loss of capital investment has gone down considerably now that the risk has been passed on to the US taxpayers.
And the interest rate on the 10 Year note could go lower. I personally want to go 250% long the 10 Year interest rate, with the Direxion mutual bond fund DXKSX; but am restrained from doing so by the knowledge that EESA provides the authority for the Federal Reserve to go to zero percent interest rate. And I am very troubled by that prospect.
Unfortunately, we live in a topsy turvy world where down is up, and left is right. The Cat In The Hat has unleashed a party globally. Will it return to set things right? Or will a global monetary authority, GMA, arise to provide unified regulation of banking globally?
3) The 911 of capitalism, investing and lending occurred on September 11, 2008, when banks and other financial institutions found that they could not obtain capital by selling stock.
The banks started to turn off the spigots of lending, driving corporate finance officers and Treasurers to the press to moan bitterly.
The reason banks became unable to sell stock on September 11, 2008 include:
1) no one knows the true value of the CDOs, level two assets, and level three assets on the banks balance sheets.
2) no one knows how much asset, that is debt, is kept off balance sheet in QSPEs, and SIVs.
3) no one knows what exposure to counterparty risk the banks have to the settlement of Lehman Brothers credit default swaps.
4) tax rules of accounting started to disfavor investing in banks.
5) interbank lending became non existent because banks are unsure if their peer is going under.
6) few believe the S&P and Moody's ratings on suretors and guarantors such as Radian Group, RDN, Ambac, ABK, and MBIA, MBI.
7) few believe the S&P and Moody's rating on mortgage backed securities.
4) Most tax free municipal bond funds and bond funds want to own short term municipal debt and short term US government debt, and nothing else, the demand being reflected in the short term government bond ETF SHY moving higher, and the debt ETFs, and the tax free municipal bond mutual funds and municipal bond ETFS lower beginning 9-11-2008, when banks could not sell stock to obtain capital; these caused all lending markets to become "dis-eased".
Debt ETFs include LQD, HYG, CFT and EMB which will likely continue to loose value; and the principal value of the tax free municipal bond mutual funds like USSTX, will likely continue to fall, as interest rates rise. And the municipal bond ETFs such as MUB and TFI will likely continually go lower as well ... Chart of SHY, LQD, HYG, CFT, EMB, and MUB.
Jeremy R. Cooke of Bloomberg in September 30, 2008 article reports: "U.S. state and local government bonds are headed for their worst quarterly performance in as much as 14 years as a wave of Wall Street consolidation undermines support for the municipal market. Tax-exempt bonds have fallen 3.15 percent since the end of June, according to Merrill Lynch & Co.'s total-return Municipal Master Index. The quarter's decline may exceed the 3.18% drop in the second period of 2004, which was the steepest since the 5.75% decline in the first three months of 1994."
Jeremy R. Cooke of Bloomberg in October 3, 2008 article reports: "U.S. states and municipalities were all but shut out of the tax-exempt bond market for a third week, as borrowers managed to sell less than 15% of a typical week's new fixed-rate issues, data compiled by Bloomberg show ... 'This market has run into trouble again,' T.J. Marta, a fixed-income strategist at RBC Capital Markets ... said ... 'The most recent dislocation will exacerbate the negative developments already taking place for state and local government finances.'"
Michael McDonald in October 2, 2008 Bloomberg article repots: "Massachusetts Governor Deval Patrick said he is seeking budget cuts amid financial market turmoil that forced the state this week to cancel plans to borrow money to fund operations. The governor, citing a $223 million shortfall in tax collections, ordered a spending reduction of 7%. The state this week canceled the sale of commercial paper as investors boycotted the markets."
These reports tell me that the municipal bond market has utterly broken down. This is a silent neutron bomb that is going to cause massive layoffs in state and local governments; these governmental units will basically have to go into shut down mode; except for some low level of law enforcement there will be a swift shut off of services.
Cynthia Koons of Dow Jones in October 2, 2008 article reports: "The junk bond market suffered its largest monthly decline in more than 20 years last month ... The widely quoted Merrill Lynch Master II index was down 8.3% for September, spelling year-to-date returns of negative 10.6% ... 'Underlying it all is just a breakdown of ordinary banking, the nuts and bolts of the credit markets, counter-party approvals, and the commercial paper market,' [Marty] Fridson said."
Denis Maternovsky and William Mauldi in October 3, 2008 Bloomberg article report: "Developing nations' borrowing costs jumped to the highest in four years compared with U.S. rates while stocks headed for the worst week since 2002, as the global banking crisis drives investors from emerging markets ... The extra yield investors demand on developing-nation bonds over Treasuries increased 14 bps to 4.45 percentage points, the highest level since 2004, JPMorgan Chase & Co.'s EMBI+ Index shows."
5) We have arrived at the point where the government is the 'only lender' and 'last lender of resort'. As mentioned above banks have turned off their spigot of liquidity. The TAF, TSLF, and PDCF stock market rally ended May 19, 2008. Ever since, all liquidity that has been supplied by ongoing TAF and recent $600 billion emergency liquidity injection, has been trapped. Scott Lanman of Bloomberg details the injection: "Commercial banks and bond dealers borrowed $348.2 billion from the Federal Reserve as of yesterday, an increase of 60% from the prior week amid a worsening credit freeze. Loans to commercial banks through the traditional discount window rose about $10 billion to $49.5 billion ... The total surpassed the previous record after the 2001 terrorist attacks. Borrowing by securities firms totaled $146.6 billion, up from $105.7 billion. Under a new emergency program announced September 19, banks borrowed $152.1 billion as of yesterday to buy commercial paper from money-market mutual funds, more than double a week ago."
I believe that the $700 billion of EESA bailout liquidity will be evaporated, that is vaporized, as soon as it is injected.
6) Cash hoarding by banks and corporations as reported by October 2, 2008, The Economist Print Edition article World On Edge that reports: "Banks used to borrow from each other at about 0.08 percentage points above official rates; on September 30th they paid more than four percentage points more. In one auction to get dollar funds overnight from the European Central Bank, banks were prepared to pay interest of 11%, five times the pre-crisis rate. Astonishingly, rates scaled these extremes even as the Federal Reserve promised $620 billion of extra funding.
Bankers have always earned their crust by committing money for long periods and financing that with short-term deposits and borrowing. Today, that model has warped into self-parody: many of the banks’ assets are unsellable even as they have to return to the market each day to ask for lenders to vote on their survival. No wonder they are hoarding cash.
This is why those politicians who set the interests of Main Street against those of Wall Street are so wrong. Sooner or later the money markets affect every business. Companies face higher interest charges and the fear that they may one day lose access to bank loans altogether. So they, too, hoard cash, cancelling acquisitions and investments, in order to pay down debt".
Capitalism, investing and lending is a dead thing. It has been replaced by state corporatism, that is state corporate rule.
Corporatism has come by three means:
1) Announcement of framework agreements, declaration of initiatives, and provision of working groups and councils. Two cases in point being the Declaration of EU US 2008, at the White House, and the Security And Prosperity Partnership Of North America, the SPP at Baylor University. The former has generated a demand that Iran reveal its nuclear ambitions or face confrontation. The latter has produced the North American Competitiveness Council, the NACC, as well as various Working Groups.
2) Ruling, that is edict, of governmental agency. A case in point being that of the SEC to abandon 'fair value accounting rules' on October 2, 2008, which will only make the credit dis-ease greater. Another case in point being the ban on short selling; I lost a whopping 30%, when I was forced to close out of my investment in the 200% inverse of the financial sector SKF as a short covering rally took financial stocks massively higher.
3) Legislative granting to rulers unprecedented authority and power. A case in point being the granting to the chairman of the Federal Reserve, dramatically new authority and power in the passage and signing of Emergency Economic Stabilization Act, which provides the TAPR facility. The truth about EESA is that it is a weapon of mass financial destruction.
The fairy tale neoliberal laissez fair economic policies of Milton Friedman died September 11, 2008. The age of asking "free to choose" is gone. I once thought as a child, but now being an adult, I put the childish ways and thinking aside.
Who is trustworthy?
Trust is a two way street.
Lenders, being capital impaired, have become untrusting.
And debtors, seeing high interest rates, consider banks to be untrustworthy.
Reports of distrust include
1) ... Philip Blenkinsop and Michele Sinner in October 4, 2008, Reuters report: "Belgium and Luxembourg scrambled on Saturday to find a buyer for the remains of troubled financial group Fortis and mulled a further nationalization after the Netherlands took over its Dutch units.
The break-up of the cross-border banking and insurance group, less than a week after a first rescue attempt in which the three governments injected 11.2 billion euros ($15.4 billion), highlighted the ferocity with which the global crisis has swept into Europe.
Luxembourg's economy minister said French bank BNP Paribas was one possible bidder for parts of Fortis and a solution had to be found by the end of the weekend.
"BNP Paribas is one among many possibilities," Jeannot Krecke told Luxembourg's RTL radio station.
"Now we have to return to the solution we were looking at last Sunday, that is to find a strong partner because the Belgian government is the main shareholder of Fortis Luxembourg Dutch media were split on Saturday over the government's decision to put the Dutch units under state control.
Calling it a baffling move, leading financial daily Het Financieele Dagblad said in an editorial: "In one move, ABN AMRO and Fortis have become the most trustworthy banks in the market. This is an unfair competitive advantage during the current credit crisis."
But left-wing daily De Volkskrant said the move was unavoidable due to the uncertainties swirling around ABN AMRO and as depositors withdrew their money.
Fortis, a Belgian-Luxembourg group, is now made up of Fortis's banking and insurance activities in Belgium, Fortis Banque Luxembourg, international operations, notably banking in Poland and Turkey, and asset management arm Fortis Investments".
2) ... Nouriel Roubini on Friday Oct 3, 2008 in article Financial And Corporate System Is In Cardiac Arrest: The Risk of the Mother of All Bank Runs relates: "Several hundreds of billion dollars in emergency liquidity support to the financial system by the Fed and other central banks in the last week alone have not been enough to stop the seizure of liquidity in interbank markets and the shut down of financing for the corporate sector as counterparty risk is now extreme (no one trusts any more in this crisis of confidence even the most reputable and trustworthy financial and corporate counterparties".
3) ... See Think Feel in article Seizure relates: "Short-term money markets remained in turmoil, heightening the likelihood the credit pullback may harm the broader economy.
Inside markets that are hidden to most Americans -- the overnight Treasury repo market, the short-term commercial-paper markets and the floating-rate municipal bond markets -- action was unfolding that will soon affect how companies meet payroll, pay vendors and make investments.
These markets allow companies with ample reserves to squeeze out a few extra dollars by investing the cash in securities with life spans of just days or weeks. All that cash helps keep the economy lubricated by distributing money to other firms that need short-term loans to buy inventory or meet payroll.
Some distressing signs emerged Thursday from one of the most important of these marketplaces, the commercial-paper market, where companies borrow money for periods of just a day to up to a year. The market contracted by $61 billion in the week ended Sept. 24, its largest decline since August 2007, when investors fled over some of the first warning signs of the subprime-mortgage crisis. In the latest week, banks and other financial companies accounted for most of the decline, as they took $50.3 billion of paper off the market.
The decline follows a $52.1 billion shrinkage in the week ended Sept. 17, which reduces the overall market to $1.702 trillion".
And continues citing (“Debt Market Distress Spreads; Commercial Paper Shows Signs of Tightening as Investors Flee.” Liz Rappaport and Anusha Shrivastava. Wall Street Journal: September 26, 2008. pg. C.1)
"NOTHING ELSE MATTERS if markets cease to function. That is the end of capital-ism as we know it.
We have long put our trust in the notion that value and worth were established by the invisible hand of buyers and sellers exchanging in an efficient nexus of supply and demand.
If we see markets ceasing to establish reliable indications of value and worth, if market prices appear capricious and disconnected from reality, we lose confidence in the validity of the market mechanism. We hold back from participating; there is no market, and we can't see anything.
Once this unreliability and invalidity catch hold in the minds and hearts of those who otherwise would be market participants, markets seize-up and a market-based economy falters and halts.
If this occurs in money markets, then other markets likely will freeze too.
Faith, hope, belief, trust -- the eyes, ears, mind, heart, spirit and soul of our world".
4) ... The Foreign Currency Exchange Outlook in September 22, 2008 article How $200 Billion Of Bad Mortgages Could Have Created Such A Falling Pyramid Effect relates: "We are having a hard time understanding how $200 billion of bad mortgages could have created such a falling-pyramid effect. It’s true that banks and brokers tried to make a silk purse out of a sow’s ear, with the aid of the ratings agencies, believing modern portfolio theory was the alchemist’s stone, but still, how did something so small become so big?
The answer is that it didn’t.
The $200 billion in liar’s loan mortgages were not magically, virally multiplied to infect every CDO and other alphabet-soup asset class to the extent of $700 billion or $1.5 trillion or any other number.
In fact, because of various accounting and mark-to-model rules, the ultimate owners of a lot of this paper are going to make a tidy profit of it. It’s not bad, just not trusted. (That doesn‘t mean the US taxpayer will get the profit. The agencies tasked with buying and then selling the paper will manage to siphon off the gains to the insiders and interested parties).
The key is “not trusted.” Trust is everything. It’s everything in romance, commerce and finance. In a nutshell, the banks don’t trust one another today, perhaps projecting their own bad actions on others, and the old banker’s principle of “know your customer” is out the window.
You can’t legislate trust.
Critics are moaning about how the fat cats will only get fatter from the bailout while the little guy gets hosed, but anyone with a 401k plan is not complaining too loudly and in any case, the immediate losses or escape from losses is not the main event.
The main event is the loss of trust in society at large, not just the financial sector. The social contract was broken, and it was broken in Washington. Raw naked capitalism may be good at setting optimal prices, but that’s about it. To say total lack of regulation is a necessary corollary of capitalism is to have read no economic history and to misread human nature.
And gosh, isn’t Washington where the rescue is coming from? If a poll were taken today asking the public whether it trusts Wall Street or Washington to “do the right thing,” the answer would be an overwhelming “no.” This is not a political statement (please don’t write) but rather an economic observation.
Trust is essential to economic activity. You need trust to get new companies funded and trade conducted (think of letters of credit, not to mention open account trade). You need trust to let the gas tank in your car go down to one-quarter and not be filling it up every day just to be sure you can get it. You need trust to have a successful economy.
Observers in less developed countries note that the key reason they do not get growth is that they have no banking sector or capital markets.
Well, why not?
In large part because Tribe A doesn’t trust Tribe B.
We can see nothing that Washington or Wall Street can do this week to reverse the situation. In fact, more bad news is surely on the plate. The only thing that can save the US Dollar Outlook now is a Shock from elsewhere, like Germany. (Japan seems safe for the moment.) Aside from the mysterious yen, the US dollar is toast.
5) ... Doug Noland in September 27, 2008, Safehaven.com article Changed Financial Landscape relates "Today's finance-related economic headwinds are Cat-4 (and gaining) Hurricane Systemic Credit Seizure, compared to last year's Tropical Storm Subprime. Federal Reserve-dictated interest rates are extremely low - and the Fed and global central bankers have injected unfathomable amounts of liquidity - yet Credit Conditions have turned the tightest they've been in decades.
The Lehman bankruptcy marked a major inflection point in the confidence of contemporary "money." It was a decisive blow against trust in various money market instruments - the very foundation of our monetary system. "Money" has now tightened significantly for virtually all players that had previously enjoyed cheap short-term financings." (Financings which were used to invest long, Richard)
The Lehman bankruptcy also marked a major inflection point in confidence for the various "daisy chain" players involved in intermediating risky loans into contemporary "money." The market was convinced Lehman was "too big to fail." Its failure inflicted thousands of market participants with losses - from Primary Reserve Money Fund investors caught with short-term Lehman paper to holders of Lehman's long-term bonds. Investors all over the world were impacted.
The hedge fund community suffered mightily. The status of hundreds of billions of derivatives and counterparty obligations was suddenly up in the air or in the hands of the bankruptcy court. And, importantly, huge losses were suffered in the Credit Default Swap marketplace - the marrow of one of history's most spectacular speculative manias. (This created a Liquidity Meltdown, Richard)
Trying to add a bit of simplicity to the Complexity of a Credit Market Breakdown, I'll say the Lehman collapse marked a critical inflection point in at least five major respects: First, the Crisis of Confidence jumped the "firebreak" from risk assets to contemporary "money," shattering trust in various facets of contemporary finance that was forged over decades. Second, it required the marketplace to reexamine exposures to various direct and indirect counterparty risks, a terminal blow for derivatives markets. Third, it pushed the Credit default swap marketplace into full-fledged dislocation and instigated a long-overdue regulator onslaught. Fourth, it decisively burst the "leveraged speculating community"/hedge fund Bubble. This has ushered in another round of problematic de-leveraging and accelerated the reversal of "Ponzi Finance" dynamics. Fifth, it instilled global fear with respect to the risks of participating in the inter-bank lending market with American institutions.
Basically, the Lehman collapse marked the end of "Wall Street" risk intermediation as a significant component of system financial intermediation. Going forward, Credit growth will be chiefly generated by the banking system, supported by various forms of government backing (Fed, FDIC, Washington bailouts/recapitalizations, etc.), the government-operated GSEs, and various forms of federal government debt issuance.
Importantly, this new financial structure will ensure minimal risky lending as well as significantly reduced risk-taking. And from a global perspective, I believe newfound fears of lending to the American financial sector marks the beginning of the end of our economy's capacity for trading new financial claims for imports of energy and goods.
Over time the Changed Financial Landscape will have a profound impact on the underlying economic structure. Our economy will have no alternative than to get by on less Credit, less risk intermediation, and fewer imports.
In the near-term, the effects will be a rapid and pronounced slowdown of our economy's "output."
And while we'll only know over time, I'd bet this new financial structure will allocate much less finance to entrepreneurial activities, productive endeavors and the asset markets - while at the same time providing ample (government-directed) purchasing power to ensure stubborn consumer price inflation."
6 ... Asha Bangalore of Northern Trust in October 2 2008, Daily Global Commentary, October 2, 2008 relates the ripple effects of frozen money markets: "Latest evidence indicates that a thaw of frozen money markets is not around the corner. The spread between the 3-month Libor and the 3-month Treasury bill rate is scaling new heights everyday. This reflects the intensity of suspicion about what is contained on the balance sheets of institutions. "The reach of this frozen money market is far and wide because it affects everyday activities of the economy. The cost of inter bank borrowing for the short-term has risen by over 200bps versus the target federal funds rate instead of a few basis points above the target rate. Firms are charged a spread above the Libor rate for their credit lines depending on the risk involved in their business. Anecdotal evidence of a sharp increase in borrowing costs and reduced credit lines for firms with sound credit history has already appeared in main stream media. If firms continue to face tight credit conditions, payrolls may not be met, payments to suppliers may suffer, and job losses will follow. The Senior Loan Officer's Survey of the Fed has ample evidence of tightening of credit conditions which runs counter to the fact that the Fed has eased monetary policy." Current Quote Of The Ted Spread by Bloomberg ... Chart of The TED Spread
7) Bespoke Group reports in October 2, 2008 article Yield Spreads At Record Highs: Up, Up, And Away! Yesterday, we highlighted that high-yield credit spreads were approaching record highs. Less than a day later, high-yield spreads are now at record highs. As of yesterday's close, based on data from Merrill Lynch, the interest rate spread between high yield bonds and comparable Treasuries rose to 1,124 basis points. This breaks the previous record of 1,120 basis points that we saw in October 2002, and given today's market action, these spreads are only likely to rise.
Printing more money won't make the credit dis-ease go away
The TARP facility provided under the authority of EESA, is definitely the printing of more money, right out of thin air.
Elaine Meinel Supkis relates the cost of credit default swaps has gone up, and this makes credit more expensive even to the best of companies; she says "The cost of credit defaults has shot up because no one is paying up after selling their services! The default credit default payee are the unfortunate taxpayers of the G7 nations, in particular, the USA. So many investors [the Chinese and OPEC] have been badly burned and require a lot of persuasion before handing out the legendary 'savings glut' money to various people in the G7 seeking loans. This is natural in all contractions. And the central banks thought, all they had to do was print more money and voila! More credit would be available".
One is guided by either a philosophical belief or spiritual doctrine.
Philosophical beliefs or spiritual doctrines form the basis of one's knowledge, and they influence one's action which has moral consequence. And the government's and business leader's beliefs form policies which guide a nation's economy and influence.
I trust gold will better preserve my wealth than Bernanke's banks.
Yes great trust that gold will preserve and protect my wealth; and no trust that Bernanke and his banks will do so.
I recommend diversification of investment in gold in four locations immediately because of financial system instability and lack of liquidity: the gold ETF, GLD, directly through streetTRACKS Gold Trust, and not in a brokerage account; two BullionVault, three GoldMoney; and four a limited number of gold coins.
I am guided by the Christian doctrine of the Election of Grace
I find God and His Word alone to be trustworthy.
I believe in the doctrine of the Election of Grace. And thus I believe that God from eternity past foreordained those to be saved; that He choose me to believe in Him, and to stimulate me to call upon the Name of the Lord, and be saved; and that he will preserve me from the corruption of sin until my Judgment Day.
I trust in God, I believe Him to be Sovereign, and what ever He provides is fine by me.
Keywords
nationalized banks, nationalization of banking, liquidity crisis, liquidity evaporation, liquidity vacuum, evaporation of liquidity, financial system meltdown, financial system breakdown, liquiditymeltdown, liquidity meltdown, liquidity evacuation, financial armageddon, crisis of confidence and trust,
A Lack of trust between lender and debtor is at the root of the lending gridlock.
And there are a number of factors causing economic dysfunction.
The factors of economic dysfunction include:
1) Different interest rates between central banks. The US is at 2%, the ECB 4% and the Bank of Japan is at 0.5%; and the BoJ loans aggressively to the well connected. These of late have gone short the EUR/JPY, causing the yen carry trade, better termed the euro carry trade, to unwind, unleashing many deflationary hurricanes.
Interest rate differential investing took the Australian natural resource investing shares up, and then down as can be seen in the ongoing Yahoo Finance chart of Australia stocks, and the metal mining shares, and the Australian Dollar. The Elliott Wave 3 Down is always more sharp than the Elliot Wave 3 Up. Currency traders in London, Hong Kong, Brussels, and the Caribbean Cove Islands became super wealthy on the wave up and also on the wave down by borrowing at 0.5% interest from the Bank of Japan lending window. The ongoing Yahoo Finance Chart of EWA, XME, and FXA shows the recent dissolution of stock wealth caused by currency traders as they work interest rate differentials to their advantage ... EWA, XME and FXA
The chart of the yen carry trade, that is EURJPY, FXE:FXY, shows the power of interest rate differential working in reverse ... FXE:FXY
2) The interest rate on the 10 Year US Treasury Note, $TNX, and the 30 Year US Government Bond, $TYX, are too low; that is they do not reflect the risk of default on home ownership. And they do not reflect the true cost of capital.
Government interest rates being low discourage saving, and encourage speculative investing in gold.
But you know, now that the US Government has nationalized the housing industry by acquiring the two private lenders, Fannie Mae, and Freddie Mac, and will become title owner of foreclosed homes given the passage of EESA, the default risk of loss of capital investment has gone down considerably now that the risk has been passed on to the US taxpayers.
And the interest rate on the 10 Year note could go lower. I personally want to go 250% long the 10 Year interest rate, with the Direxion mutual bond fund DXKSX; but am restrained from doing so by the knowledge that EESA provides the authority for the Federal Reserve to go to zero percent interest rate. And I am very troubled by that prospect.
Unfortunately, we live in a topsy turvy world where down is up, and left is right. The Cat In The Hat has unleashed a party globally. Will it return to set things right? Or will a global monetary authority, GMA, arise to provide unified regulation of banking globally?
3) The 911 of capitalism, investing and lending occurred on September 11, 2008, when banks and other financial institutions found that they could not obtain capital by selling stock.
The banks started to turn off the spigots of lending, driving corporate finance officers and Treasurers to the press to moan bitterly.
The reason banks became unable to sell stock on September 11, 2008 include:
1) no one knows the true value of the CDOs, level two assets, and level three assets on the banks balance sheets.
2) no one knows how much asset, that is debt, is kept off balance sheet in QSPEs, and SIVs.
3) no one knows what exposure to counterparty risk the banks have to the settlement of Lehman Brothers credit default swaps.
4) tax rules of accounting started to disfavor investing in banks.
5) interbank lending became non existent because banks are unsure if their peer is going under.
6) few believe the S&P and Moody's ratings on suretors and guarantors such as Radian Group, RDN, Ambac, ABK, and MBIA, MBI.
7) few believe the S&P and Moody's rating on mortgage backed securities.
4) Most tax free municipal bond funds and bond funds want to own short term municipal debt and short term US government debt, and nothing else, the demand being reflected in the short term government bond ETF SHY moving higher, and the debt ETFs, and the tax free municipal bond mutual funds and municipal bond ETFS lower beginning 9-11-2008, when banks could not sell stock to obtain capital; these caused all lending markets to become "dis-eased".
Debt ETFs include LQD, HYG, CFT and EMB which will likely continue to loose value; and the principal value of the tax free municipal bond mutual funds like USSTX, will likely continue to fall, as interest rates rise. And the municipal bond ETFs such as MUB and TFI will likely continually go lower as well ... Chart of SHY, LQD, HYG, CFT, EMB, and MUB.
Jeremy R. Cooke of Bloomberg in September 30, 2008 article reports: "U.S. state and local government bonds are headed for their worst quarterly performance in as much as 14 years as a wave of Wall Street consolidation undermines support for the municipal market. Tax-exempt bonds have fallen 3.15 percent since the end of June, according to Merrill Lynch & Co.'s total-return Municipal Master Index. The quarter's decline may exceed the 3.18% drop in the second period of 2004, which was the steepest since the 5.75% decline in the first three months of 1994."
Jeremy R. Cooke of Bloomberg in October 3, 2008 article reports: "U.S. states and municipalities were all but shut out of the tax-exempt bond market for a third week, as borrowers managed to sell less than 15% of a typical week's new fixed-rate issues, data compiled by Bloomberg show ... 'This market has run into trouble again,' T.J. Marta, a fixed-income strategist at RBC Capital Markets ... said ... 'The most recent dislocation will exacerbate the negative developments already taking place for state and local government finances.'"
Michael McDonald in October 2, 2008 Bloomberg article repots: "Massachusetts Governor Deval Patrick said he is seeking budget cuts amid financial market turmoil that forced the state this week to cancel plans to borrow money to fund operations. The governor, citing a $223 million shortfall in tax collections, ordered a spending reduction of 7%. The state this week canceled the sale of commercial paper as investors boycotted the markets."
These reports tell me that the municipal bond market has utterly broken down. This is a silent neutron bomb that is going to cause massive layoffs in state and local governments; these governmental units will basically have to go into shut down mode; except for some low level of law enforcement there will be a swift shut off of services.
Cynthia Koons of Dow Jones in October 2, 2008 article reports: "The junk bond market suffered its largest monthly decline in more than 20 years last month ... The widely quoted Merrill Lynch Master II index was down 8.3% for September, spelling year-to-date returns of negative 10.6% ... 'Underlying it all is just a breakdown of ordinary banking, the nuts and bolts of the credit markets, counter-party approvals, and the commercial paper market,' [Marty] Fridson said."
Denis Maternovsky and William Mauldi in October 3, 2008 Bloomberg article report: "Developing nations' borrowing costs jumped to the highest in four years compared with U.S. rates while stocks headed for the worst week since 2002, as the global banking crisis drives investors from emerging markets ... The extra yield investors demand on developing-nation bonds over Treasuries increased 14 bps to 4.45 percentage points, the highest level since 2004, JPMorgan Chase & Co.'s EMBI+ Index shows."
5) We have arrived at the point where the government is the 'only lender' and 'last lender of resort'. As mentioned above banks have turned off their spigot of liquidity. The TAF, TSLF, and PDCF stock market rally ended May 19, 2008. Ever since, all liquidity that has been supplied by ongoing TAF and recent $600 billion emergency liquidity injection, has been trapped. Scott Lanman of Bloomberg details the injection: "Commercial banks and bond dealers borrowed $348.2 billion from the Federal Reserve as of yesterday, an increase of 60% from the prior week amid a worsening credit freeze. Loans to commercial banks through the traditional discount window rose about $10 billion to $49.5 billion ... The total surpassed the previous record after the 2001 terrorist attacks. Borrowing by securities firms totaled $146.6 billion, up from $105.7 billion. Under a new emergency program announced September 19, banks borrowed $152.1 billion as of yesterday to buy commercial paper from money-market mutual funds, more than double a week ago."
I believe that the $700 billion of EESA bailout liquidity will be evaporated, that is vaporized, as soon as it is injected.
6) Cash hoarding by banks and corporations as reported by October 2, 2008, The Economist Print Edition article World On Edge that reports: "Banks used to borrow from each other at about 0.08 percentage points above official rates; on September 30th they paid more than four percentage points more. In one auction to get dollar funds overnight from the European Central Bank, banks were prepared to pay interest of 11%, five times the pre-crisis rate. Astonishingly, rates scaled these extremes even as the Federal Reserve promised $620 billion of extra funding.
Bankers have always earned their crust by committing money for long periods and financing that with short-term deposits and borrowing. Today, that model has warped into self-parody: many of the banks’ assets are unsellable even as they have to return to the market each day to ask for lenders to vote on their survival. No wonder they are hoarding cash.
This is why those politicians who set the interests of Main Street against those of Wall Street are so wrong. Sooner or later the money markets affect every business. Companies face higher interest charges and the fear that they may one day lose access to bank loans altogether. So they, too, hoard cash, cancelling acquisitions and investments, in order to pay down debt".
Capitalism, investing and lending is a dead thing. It has been replaced by state corporatism, that is state corporate rule.
Corporatism has come by three means:
1) Announcement of framework agreements, declaration of initiatives, and provision of working groups and councils. Two cases in point being the Declaration of EU US 2008, at the White House, and the Security And Prosperity Partnership Of North America, the SPP at Baylor University. The former has generated a demand that Iran reveal its nuclear ambitions or face confrontation. The latter has produced the North American Competitiveness Council, the NACC, as well as various Working Groups.
2) Ruling, that is edict, of governmental agency. A case in point being that of the SEC to abandon 'fair value accounting rules' on October 2, 2008, which will only make the credit dis-ease greater. Another case in point being the ban on short selling; I lost a whopping 30%, when I was forced to close out of my investment in the 200% inverse of the financial sector SKF as a short covering rally took financial stocks massively higher.
3) Legislative granting to rulers unprecedented authority and power. A case in point being the granting to the chairman of the Federal Reserve, dramatically new authority and power in the passage and signing of Emergency Economic Stabilization Act, which provides the TAPR facility. The truth about EESA is that it is a weapon of mass financial destruction.
The fairy tale neoliberal laissez fair economic policies of Milton Friedman died September 11, 2008. The age of asking "free to choose" is gone. I once thought as a child, but now being an adult, I put the childish ways and thinking aside.
Who is trustworthy?
Trust is a two way street.
Lenders, being capital impaired, have become untrusting.
And debtors, seeing high interest rates, consider banks to be untrustworthy.
Reports of distrust include
1) ... Philip Blenkinsop and Michele Sinner in October 4, 2008, Reuters report: "Belgium and Luxembourg scrambled on Saturday to find a buyer for the remains of troubled financial group Fortis and mulled a further nationalization after the Netherlands took over its Dutch units.
The break-up of the cross-border banking and insurance group, less than a week after a first rescue attempt in which the three governments injected 11.2 billion euros ($15.4 billion), highlighted the ferocity with which the global crisis has swept into Europe.
Luxembourg's economy minister said French bank BNP Paribas was one possible bidder for parts of Fortis and a solution had to be found by the end of the weekend.
"BNP Paribas is one among many possibilities," Jeannot Krecke told Luxembourg's RTL radio station.
"Now we have to return to the solution we were looking at last Sunday, that is to find a strong partner because the Belgian government is the main shareholder of Fortis Luxembourg Dutch media were split on Saturday over the government's decision to put the Dutch units under state control.
Calling it a baffling move, leading financial daily Het Financieele Dagblad said in an editorial: "In one move, ABN AMRO and Fortis have become the most trustworthy banks in the market. This is an unfair competitive advantage during the current credit crisis."
But left-wing daily De Volkskrant said the move was unavoidable due to the uncertainties swirling around ABN AMRO and as depositors withdrew their money.
Fortis, a Belgian-Luxembourg group, is now made up of Fortis's banking and insurance activities in Belgium, Fortis Banque Luxembourg, international operations, notably banking in Poland and Turkey, and asset management arm Fortis Investments".
2) ... Nouriel Roubini on Friday Oct 3, 2008 in article Financial And Corporate System Is In Cardiac Arrest: The Risk of the Mother of All Bank Runs relates: "Several hundreds of billion dollars in emergency liquidity support to the financial system by the Fed and other central banks in the last week alone have not been enough to stop the seizure of liquidity in interbank markets and the shut down of financing for the corporate sector as counterparty risk is now extreme (no one trusts any more in this crisis of confidence even the most reputable and trustworthy financial and corporate counterparties".
3) ... See Think Feel in article Seizure relates: "Short-term money markets remained in turmoil, heightening the likelihood the credit pullback may harm the broader economy.
Inside markets that are hidden to most Americans -- the overnight Treasury repo market, the short-term commercial-paper markets and the floating-rate municipal bond markets -- action was unfolding that will soon affect how companies meet payroll, pay vendors and make investments.
These markets allow companies with ample reserves to squeeze out a few extra dollars by investing the cash in securities with life spans of just days or weeks. All that cash helps keep the economy lubricated by distributing money to other firms that need short-term loans to buy inventory or meet payroll.
Some distressing signs emerged Thursday from one of the most important of these marketplaces, the commercial-paper market, where companies borrow money for periods of just a day to up to a year. The market contracted by $61 billion in the week ended Sept. 24, its largest decline since August 2007, when investors fled over some of the first warning signs of the subprime-mortgage crisis. In the latest week, banks and other financial companies accounted for most of the decline, as they took $50.3 billion of paper off the market.
The decline follows a $52.1 billion shrinkage in the week ended Sept. 17, which reduces the overall market to $1.702 trillion".
And continues citing (“Debt Market Distress Spreads; Commercial Paper Shows Signs of Tightening as Investors Flee.” Liz Rappaport and Anusha Shrivastava. Wall Street Journal: September 26, 2008. pg. C.1)
"NOTHING ELSE MATTERS if markets cease to function. That is the end of capital-ism as we know it.
We have long put our trust in the notion that value and worth were established by the invisible hand of buyers and sellers exchanging in an efficient nexus of supply and demand.
If we see markets ceasing to establish reliable indications of value and worth, if market prices appear capricious and disconnected from reality, we lose confidence in the validity of the market mechanism. We hold back from participating; there is no market, and we can't see anything.
Once this unreliability and invalidity catch hold in the minds and hearts of those who otherwise would be market participants, markets seize-up and a market-based economy falters and halts.
If this occurs in money markets, then other markets likely will freeze too.
Faith, hope, belief, trust -- the eyes, ears, mind, heart, spirit and soul of our world".
4) ... The Foreign Currency Exchange Outlook in September 22, 2008 article How $200 Billion Of Bad Mortgages Could Have Created Such A Falling Pyramid Effect relates: "We are having a hard time understanding how $200 billion of bad mortgages could have created such a falling-pyramid effect. It’s true that banks and brokers tried to make a silk purse out of a sow’s ear, with the aid of the ratings agencies, believing modern portfolio theory was the alchemist’s stone, but still, how did something so small become so big?
The answer is that it didn’t.
The $200 billion in liar’s loan mortgages were not magically, virally multiplied to infect every CDO and other alphabet-soup asset class to the extent of $700 billion or $1.5 trillion or any other number.
In fact, because of various accounting and mark-to-model rules, the ultimate owners of a lot of this paper are going to make a tidy profit of it. It’s not bad, just not trusted. (That doesn‘t mean the US taxpayer will get the profit. The agencies tasked with buying and then selling the paper will manage to siphon off the gains to the insiders and interested parties).
The key is “not trusted.” Trust is everything. It’s everything in romance, commerce and finance. In a nutshell, the banks don’t trust one another today, perhaps projecting their own bad actions on others, and the old banker’s principle of “know your customer” is out the window.
You can’t legislate trust.
Critics are moaning about how the fat cats will only get fatter from the bailout while the little guy gets hosed, but anyone with a 401k plan is not complaining too loudly and in any case, the immediate losses or escape from losses is not the main event.
The main event is the loss of trust in society at large, not just the financial sector. The social contract was broken, and it was broken in Washington. Raw naked capitalism may be good at setting optimal prices, but that’s about it. To say total lack of regulation is a necessary corollary of capitalism is to have read no economic history and to misread human nature.
And gosh, isn’t Washington where the rescue is coming from? If a poll were taken today asking the public whether it trusts Wall Street or Washington to “do the right thing,” the answer would be an overwhelming “no.” This is not a political statement (please don’t write) but rather an economic observation.
Trust is essential to economic activity. You need trust to get new companies funded and trade conducted (think of letters of credit, not to mention open account trade). You need trust to let the gas tank in your car go down to one-quarter and not be filling it up every day just to be sure you can get it. You need trust to have a successful economy.
Observers in less developed countries note that the key reason they do not get growth is that they have no banking sector or capital markets.
Well, why not?
In large part because Tribe A doesn’t trust Tribe B.
We can see nothing that Washington or Wall Street can do this week to reverse the situation. In fact, more bad news is surely on the plate. The only thing that can save the US Dollar Outlook now is a Shock from elsewhere, like Germany. (Japan seems safe for the moment.) Aside from the mysterious yen, the US dollar is toast.
5) ... Doug Noland in September 27, 2008, Safehaven.com article Changed Financial Landscape relates "Today's finance-related economic headwinds are Cat-4 (and gaining) Hurricane Systemic Credit Seizure, compared to last year's Tropical Storm Subprime. Federal Reserve-dictated interest rates are extremely low - and the Fed and global central bankers have injected unfathomable amounts of liquidity - yet Credit Conditions have turned the tightest they've been in decades.
The Lehman bankruptcy marked a major inflection point in the confidence of contemporary "money." It was a decisive blow against trust in various money market instruments - the very foundation of our monetary system. "Money" has now tightened significantly for virtually all players that had previously enjoyed cheap short-term financings." (Financings which were used to invest long, Richard)
The Lehman bankruptcy also marked a major inflection point in confidence for the various "daisy chain" players involved in intermediating risky loans into contemporary "money." The market was convinced Lehman was "too big to fail." Its failure inflicted thousands of market participants with losses - from Primary Reserve Money Fund investors caught with short-term Lehman paper to holders of Lehman's long-term bonds. Investors all over the world were impacted.
The hedge fund community suffered mightily. The status of hundreds of billions of derivatives and counterparty obligations was suddenly up in the air or in the hands of the bankruptcy court. And, importantly, huge losses were suffered in the Credit Default Swap marketplace - the marrow of one of history's most spectacular speculative manias. (This created a Liquidity Meltdown, Richard)
Trying to add a bit of simplicity to the Complexity of a Credit Market Breakdown, I'll say the Lehman collapse marked a critical inflection point in at least five major respects: First, the Crisis of Confidence jumped the "firebreak" from risk assets to contemporary "money," shattering trust in various facets of contemporary finance that was forged over decades. Second, it required the marketplace to reexamine exposures to various direct and indirect counterparty risks, a terminal blow for derivatives markets. Third, it pushed the Credit default swap marketplace into full-fledged dislocation and instigated a long-overdue regulator onslaught. Fourth, it decisively burst the "leveraged speculating community"/hedge fund Bubble. This has ushered in another round of problematic de-leveraging and accelerated the reversal of "Ponzi Finance" dynamics. Fifth, it instilled global fear with respect to the risks of participating in the inter-bank lending market with American institutions.
Basically, the Lehman collapse marked the end of "Wall Street" risk intermediation as a significant component of system financial intermediation. Going forward, Credit growth will be chiefly generated by the banking system, supported by various forms of government backing (Fed, FDIC, Washington bailouts/recapitalizations, etc.), the government-operated GSEs, and various forms of federal government debt issuance.
Importantly, this new financial structure will ensure minimal risky lending as well as significantly reduced risk-taking. And from a global perspective, I believe newfound fears of lending to the American financial sector marks the beginning of the end of our economy's capacity for trading new financial claims for imports of energy and goods.
Over time the Changed Financial Landscape will have a profound impact on the underlying economic structure. Our economy will have no alternative than to get by on less Credit, less risk intermediation, and fewer imports.
In the near-term, the effects will be a rapid and pronounced slowdown of our economy's "output."
And while we'll only know over time, I'd bet this new financial structure will allocate much less finance to entrepreneurial activities, productive endeavors and the asset markets - while at the same time providing ample (government-directed) purchasing power to ensure stubborn consumer price inflation."
6 ... Asha Bangalore of Northern Trust in October 2 2008, Daily Global Commentary, October 2, 2008 relates the ripple effects of frozen money markets: "Latest evidence indicates that a thaw of frozen money markets is not around the corner. The spread between the 3-month Libor and the 3-month Treasury bill rate is scaling new heights everyday. This reflects the intensity of suspicion about what is contained on the balance sheets of institutions. "The reach of this frozen money market is far and wide because it affects everyday activities of the economy. The cost of inter bank borrowing for the short-term has risen by over 200bps versus the target federal funds rate instead of a few basis points above the target rate. Firms are charged a spread above the Libor rate for their credit lines depending on the risk involved in their business. Anecdotal evidence of a sharp increase in borrowing costs and reduced credit lines for firms with sound credit history has already appeared in main stream media. If firms continue to face tight credit conditions, payrolls may not be met, payments to suppliers may suffer, and job losses will follow. The Senior Loan Officer's Survey of the Fed has ample evidence of tightening of credit conditions which runs counter to the fact that the Fed has eased monetary policy." Current Quote Of The Ted Spread by Bloomberg ... Chart of The TED Spread
7) Bespoke Group reports in October 2, 2008 article Yield Spreads At Record Highs: Up, Up, And Away! Yesterday, we highlighted that high-yield credit spreads were approaching record highs. Less than a day later, high-yield spreads are now at record highs. As of yesterday's close, based on data from Merrill Lynch, the interest rate spread between high yield bonds and comparable Treasuries rose to 1,124 basis points. This breaks the previous record of 1,120 basis points that we saw in October 2002, and given today's market action, these spreads are only likely to rise.
Printing more money won't make the credit dis-ease go away
The TARP facility provided under the authority of EESA, is definitely the printing of more money, right out of thin air.
Elaine Meinel Supkis relates the cost of credit default swaps has gone up, and this makes credit more expensive even to the best of companies; she says "The cost of credit defaults has shot up because no one is paying up after selling their services! The default credit default payee are the unfortunate taxpayers of the G7 nations, in particular, the USA. So many investors [the Chinese and OPEC] have been badly burned and require a lot of persuasion before handing out the legendary 'savings glut' money to various people in the G7 seeking loans. This is natural in all contractions. And the central banks thought, all they had to do was print more money and voila! More credit would be available".
One is guided by either a philosophical belief or spiritual doctrine.
Philosophical beliefs or spiritual doctrines form the basis of one's knowledge, and they influence one's action which has moral consequence. And the government's and business leader's beliefs form policies which guide a nation's economy and influence.
I trust gold will better preserve my wealth than Bernanke's banks.
Yes great trust that gold will preserve and protect my wealth; and no trust that Bernanke and his banks will do so.
I recommend diversification of investment in gold in four locations immediately because of financial system instability and lack of liquidity: the gold ETF, GLD, directly through streetTRACKS Gold Trust, and not in a brokerage account; two BullionVault, three GoldMoney; and four a limited number of gold coins.
I am guided by the Christian doctrine of the Election of Grace
I find God and His Word alone to be trustworthy.
I believe in the doctrine of the Election of Grace. And thus I believe that God from eternity past foreordained those to be saved; that He choose me to believe in Him, and to stimulate me to call upon the Name of the Lord, and be saved; and that he will preserve me from the corruption of sin until my Judgment Day.
I trust in God, I believe Him to be Sovereign, and what ever He provides is fine by me.
Keywords
nationalized banks, nationalization of banking, liquidity crisis, liquidity evaporation, liquidity vacuum, evaporation of liquidity, financial system meltdown, financial system breakdown, liquiditymeltdown, liquidity meltdown, liquidity evacuation, financial armageddon, crisis of confidence and trust,
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