Wednesday, September 24, 2008

How Much is TOOOOOOO Much ?

Although the details are still to be determined, it appears that the U.S. Treasury will spend $700 billion to buy unattractive, illiquid and unhedgeable mortgages and mortgage backed securities. What makes the Government think that they can trade a product that no other desk could, a product for which there is no data, no history, no reliable me. The securities are "bad" for a number of reasons: bad collateral, bad pricing (initial rates of return were too low), bad structures (leveraged, embedded options, contractual catches, etc.).

I sense that am going to rail on and become incoherent because I am truly upset by the amount of execution risk that talking heads are arrogant enough to assume. So, I'll stick to the facts:

U.S. Government General Fund Debt: $ 9.7 trillion

Office of Management & Budget 2009 Deficit Estimate: $ 482 billion

That brings the debt to roughly $ 10.2 trillion next year. Assuming GDP growth is 4% (yeah, I know. But I'll run with the Budget Office's estimate.), the debt to GDP ratio would be 68%. The last time we hit that high water mark, President Eisenhower was working hard to pay off the WW II debt.

Since the plan summary presented to Congress included a request to increase the debt limit by $ 700 billion, it is safe to assume that Treasury securities will be issued to fund the acquisition plan. Hmmm, borrowing money to buy crap bonds.....sounds like a winner.

That now brings the debt to $ 10.9 trillion or 72.7% of GDP. The S & L Crisis took roughly six years to clean up, a pretty impressive feat. This resolution is bigger and messier, so I'm going to guess eight years. More guessing: half will be funded by T-Bills, 30% in 2 year notes, 15% in 5 year notes and the remainder in ten year notes.

Remember, the Treasury is kind of, sort of on the hook for Fannie & Freddie stuff. Based on GSE debt rolling off in 2009, we need to add $400 billion. I'll ignore credit losses for now, I don't have the models.

$ 11.3 trillion

75% of GDP

Wow. There is no margin for error. If you think the Chinese government played games with our debt markets before, what on Earth is next? Where will the capital come from after the Treasury itself sucks up the liquidity? I'm going to sleep.

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