"Although conventional interest rate policy is constrained by the fact that nominal interest rates cannot fall below zero, the second arrow in the Federal Reserve's quiver--the provision of liquidity--remains effective. Indeed, there are several means by which the Fed could influence financial conditions through the use of its balance sheet, beyond expanding our lending to financial institutions. First, the Fed could purchase longer-term Treasury or agency securities on the open market in substantial quantities. This approach might influence the yields on these securities, thus helping to spur aggregate demand."
Ben Bernanke auditions for MTV
Right, buy Treasuries because........NO ONE ELSE CAN BORROW BUT THE TREASURY BEN!!!!! They don't need your help to issue more debt. Treasuries have been trading at essentially 0% in the repo market, you can get PAID to borrow money for some Treasury issues and fail to delivers have sky rocketed. And Treasuries need another buyer........
Monday, December 1, 2008
Should U.S. Treasury Debt Be Downgraded?
As I have mentioned before, debt plays an important role in a capitalist society. The lag between production and sale is managed effectively by debt issuance. In addition, exogenous lags (weather delaying shipments, holidays/seasonal adjustments, etc.) in distribution are mitigated.
Debt does need to be paid back at some point. Interest is charged as well, the amount of which depends on the length of the loan, collateral and the perceived ability of the borrower to pay back the principal in the first place.
In looking at the debt of the U.S. Government, there seems to be no intention of ever paying back the "money" it owes.
The debt of the General Fund is closing in on $11 trillion dollars. This figure includes debt held by other government entities (Social Security trust funds hold about $2.3 trillion). The debt has doubled in the last 10 years and has grown at an annualized rate of 9.3% since 1974. In that time span, the debt outstanding increased every year.
In 1974, the debt could be measured at 33.2% of nominal GDP. This year, it hit 69.5% of GDP. GDP is a proxy of the potential tax pool for the government. Since 1974, government revenue has averaged 18.3% of GDP. This figure has been quite stable, ranging from 16.3% to 20.9%. So, debt outstanding has been growing relative to GDP, while revenue based on GDP has flatlined.
In 1974, for each additional dollar of debt outstanding, $4.52 of GDP was created. In 2008, a dollar of debt got us 46 cents of additional GDP.
This year, the Treasury agreed to strengthen the guarantee that Fannie Mae and Freddie Mac operated under. Although not an explicit guarantee, the Treasury acknowledged the importance of the orderly operation of the mortgage market and concluded that it was in the best interest of the economy to facilitate trading in these securities. The potential exposure to the government is $6.7 trillion.
The FDIC resembles a drunk trying to stand on one foot while buying a hot dog at the Papaya King window in the rain. I reviewed their position in 2 posts last week.
The TARP will require increased debt issuance as well. In addition, Congress is discussing another stimulus bill on the order of $500 - $700 billion.
On November 3, the Treasury announced that debt issuance would total $550 billion in the 4th quarter of 2008. DC has outdone itself, doubling the previous record (1st quarter of 2008). The only ray of sunshine is that nominal borrowing rates are quite low, good news for debt service. By the way, the interest on the debt accounts for 17% of the annual budget. Another way to look at it: 39% of individual income taxes go to paying the interest expense of the debt.
The U.S. has become reliant on foreign governments to purchase debt. Their patriotic duty is to protect their own county, not ours. While I agree with the position that liquidating their holdings would cause dramatic losses, they could seek higher yields or stronger trading positions to continue buying. Either way, the tax payer is compromised.
Debt does need to be paid back at some point. Interest is charged as well, the amount of which depends on the length of the loan, collateral and the perceived ability of the borrower to pay back the principal in the first place.
In looking at the debt of the U.S. Government, there seems to be no intention of ever paying back the "money" it owes.
The debt of the General Fund is closing in on $11 trillion dollars. This figure includes debt held by other government entities (Social Security trust funds hold about $2.3 trillion). The debt has doubled in the last 10 years and has grown at an annualized rate of 9.3% since 1974. In that time span, the debt outstanding increased every year.
In 1974, the debt could be measured at 33.2% of nominal GDP. This year, it hit 69.5% of GDP. GDP is a proxy of the potential tax pool for the government. Since 1974, government revenue has averaged 18.3% of GDP. This figure has been quite stable, ranging from 16.3% to 20.9%. So, debt outstanding has been growing relative to GDP, while revenue based on GDP has flatlined.
In 1974, for each additional dollar of debt outstanding, $4.52 of GDP was created. In 2008, a dollar of debt got us 46 cents of additional GDP.
This year, the Treasury agreed to strengthen the guarantee that Fannie Mae and Freddie Mac operated under. Although not an explicit guarantee, the Treasury acknowledged the importance of the orderly operation of the mortgage market and concluded that it was in the best interest of the economy to facilitate trading in these securities. The potential exposure to the government is $6.7 trillion.
The FDIC resembles a drunk trying to stand on one foot while buying a hot dog at the Papaya King window in the rain. I reviewed their position in 2 posts last week.
The TARP will require increased debt issuance as well. In addition, Congress is discussing another stimulus bill on the order of $500 - $700 billion.
On November 3, the Treasury announced that debt issuance would total $550 billion in the 4th quarter of 2008. DC has outdone itself, doubling the previous record (1st quarter of 2008). The only ray of sunshine is that nominal borrowing rates are quite low, good news for debt service. By the way, the interest on the debt accounts for 17% of the annual budget. Another way to look at it: 39% of individual income taxes go to paying the interest expense of the debt.
The U.S. has become reliant on foreign governments to purchase debt. Their patriotic duty is to protect their own county, not ours. While I agree with the position that liquidating their holdings would cause dramatic losses, they could seek higher yields or stronger trading positions to continue buying. Either way, the tax payer is compromised.
Friday, November 28, 2008
The FDIC Keeps Getting Thinner and Thinner
http://www.fdic.gov/news/news/financial/2008/fil08103.html
The Temporary Liquidity Guarantee Program (TLGP) is the FDIC's foray into backing corporate debt. It was announced about a month ago, but it was utilized extensively this week:
JP Morgan Chase: $6.5 billion in debt issued, AAA rated based on FDIC backing
Morgan Stanley: $5.75 billion in debt issued, AAA rated based on FDIC backing
Goldman Sachs: $5.0 billion in debt issued, AAA rated based on FDIC backing
In an earlier post this week, I mentioned that the Deposit Insurance Fund's reserve ratio dropped to 0.76% at the end of the 3rd quarter. So, (all else being equal) if the FDIC had to pay off the above referenced bonds, the fund would be cut in HALF.
The Temporary Liquidity Guarantee Program (TLGP) is the FDIC's foray into backing corporate debt. It was announced about a month ago, but it was utilized extensively this week:
JP Morgan Chase: $6.5 billion in debt issued, AAA rated based on FDIC backing
Morgan Stanley: $5.75 billion in debt issued, AAA rated based on FDIC backing
Goldman Sachs: $5.0 billion in debt issued, AAA rated based on FDIC backing
In an earlier post this week, I mentioned that the Deposit Insurance Fund's reserve ratio dropped to 0.76% at the end of the 3rd quarter. So, (all else being equal) if the FDIC had to pay off the above referenced bonds, the fund would be cut in HALF.
Wednesday, November 26, 2008
Economic Reports: We're Not Out Yet
Several numbers were released today, including weekly jobless claims (released early due to holiday on Thursday), none of which pointed to the bottom of economic activity. I would like to focus on Durable Goods and New Home Sales:
Examples of durable goods are automobiles, household appliances and home furnishings; goods with an expected life of 3 years or so. This is a glimpse into the follow on effects of the housing crunch. Not only will there be lower demand for durable goods because of fewer housing transactions, but the elimination of the home equity "ATM" will have a dampening effect on the normal renewal cycle. This is the first time since 2005 that this number has come in below $200 billion and the lowest since April of that year.
New home sales dropped to an annualized rate of 433,000. At that rate, it would take a little over 5 YEARS to eliminate the number of vacant housing units. That is assuming that there is no addition to the housing supply over that time span. This is the result of the rampant real estate speculation that occurred over the last 7 years. Individuals purchased homes as investment vehicles, hoping to turn the house for a profit. However, in order for a house to ultimately be useful, household creation must take place. Remember, a house depreciates and is replaceable. It is a manufactured good and it costs money to keep a house in operating order. This carry cost can seriously impact return on investment. The supply of housing has barely corrected and more price declines are imminent.
Tuesday, November 25, 2008
Term Asset-Backed Securities Loan Facility (TALF)
More Federal Reserve lending:
$200 billion available for non-recourse loans, target collateral is asset based securities
$600 billion available for non recourse loans, target collateral is GSE debt/MBS
Below is some interesting text from the press release:
Eligible Borrowers
All U.S. persons that own eligible collateral may participate in the TALF. A U.S.
person is a natural person that is a U.S. citizen, a business entity that is organized
under the laws of the United States or a political subdivision or territory thereof
(including such an entity that has a non-U.S. parent company), or a U.S. branch or
agency of a foreign bank.
$200 billion available for non-recourse loans, target collateral is asset based securities
$600 billion available for non recourse loans, target collateral is GSE debt/MBS
Below is some interesting text from the press release:
Eligible Borrowers
All U.S. persons that own eligible collateral may participate in the TALF. A U.S.
person is a natural person that is a U.S. citizen, a business entity that is organized
under the laws of the United States or a political subdivision or territory thereof
(including such an entity that has a non-U.S. parent company), or a U.S. branch or
agency of a foreign bank.
FDIC Quarterly Banking Profile
Key takeaways:
-- Earnings for the industry dropped to $1.7 billion, 3rd quarter of 2007 the number was $27 billion
-- Industry coverage ratio drops to 0.85 (85 cents in loan loss reserves for each dollar of non-current loans)
-- THE DEPOSIT INSURANCE FUND RESERVE RATIO IS 0.76%. $34.6 billion held to insure $4,544 billion in deposits. The backstop is the Treasury and since the Treasury has no money (they borrow, $10 trillion in debt) any significant failures will increase our tax burden.
-- The FDIC is tracking 171 banks with $116 billion in assets that have significant operating issues.
-- Net charge offs total $69 billion through 9/30/08: banks have wiped these loans off the books. Remember, the money supply HAS to decrease by roughly $690 billion as a result.
New Bad Bank List
Updated with 9/30/08 data. I think this modified "Texas Ratio" is the best indicator of a potential bank failure. More on the FDIC data release later.
Monday, November 24, 2008
Citi Is Not The Only One Who Never Sleeps....
So, here is the plan:
-- The Treasury Department will purchase $20 billion of preferred stock, funds will come from the TARP. The quarterly, 8% dividend is cumulative. In addition, the Treasury will receive 10 year warrants for the purchase of $2 billion of common shares. The strike price on the warrants is $10.61.
-- Citigroup, Inc. will issue an additional $4 billion of the preferred to the Treasury and $3 billion to the FDIC as payment for a limit on asset losses. This pool of assets is comprised of residential (10 year window) and commercial (5 year window) mortgage related loans and securities, a total of $306 billion worth. Citi will absorb the first $29 billion of losses (pre-tax), after which the the government will absorb 90% of further losses. Since Citi is only on the hook for 10% of the further losses, the risk weighting will be lowered to 20%. This has the effect of adding $16 billion of capital to Citi's reserves. Citi will also be able to count $3.5 billion of the "put premium" as capital.
-- The Federal Reserve has agreed to extend Citi a non-recourse loan to backstop the positions. Should the loan become exercised, the rate would be OIS + 300 basis points.
-- Citi also agrees to a government approved executive compensation plan and common stock dividend policy. The dividend is limited to $0.04 per year for the next three years, unless approved by the government.
Equity futures are pointing to a 1% rally, Citi shares have traded over $5 in Germany.
-- The Treasury Department will purchase $20 billion of preferred stock, funds will come from the TARP. The quarterly, 8% dividend is cumulative. In addition, the Treasury will receive 10 year warrants for the purchase of $2 billion of common shares. The strike price on the warrants is $10.61.
-- Citigroup, Inc. will issue an additional $4 billion of the preferred to the Treasury and $3 billion to the FDIC as payment for a limit on asset losses. This pool of assets is comprised of residential (10 year window) and commercial (5 year window) mortgage related loans and securities, a total of $306 billion worth. Citi will absorb the first $29 billion of losses (pre-tax), after which the the government will absorb 90% of further losses. Since Citi is only on the hook for 10% of the further losses, the risk weighting will be lowered to 20%. This has the effect of adding $16 billion of capital to Citi's reserves. Citi will also be able to count $3.5 billion of the "put premium" as capital.
-- The Federal Reserve has agreed to extend Citi a non-recourse loan to backstop the positions. Should the loan become exercised, the rate would be OIS + 300 basis points.
-- Citi also agrees to a government approved executive compensation plan and common stock dividend policy. The dividend is limited to $0.04 per year for the next three years, unless approved by the government.
Equity futures are pointing to a 1% rally, Citi shares have traded over $5 in Germany.
Saturday, November 22, 2008
Another Look at Citigroup, Inc.
Not a good week for Citi as the shares fell to the $4.00 range. Mike Mayo, bank analyst at Deutsche Bank, reiterated his (heavily caveatted) price target of $9.00 and that got me thinking: what would the numbers have to be for Citi to be worth $4.00?
- earnings per share of $0.70 for 2009, increasing at about 5.2% per year through 2014
- dividend per share drops to $0.14 for 2009, 20% payout rate
- book value per share of $10.81 to begin 2009, currently reported at around $17.85
That would do it. The consensus analyst EPS forecast (revised downward dramatically this week) for 2009 is $0.76 and a dividend cut seems to be in the offing. That leaves asset valuation as the key component.
- earnings per share of $0.70 for 2009, increasing at about 5.2% per year through 2014
- dividend per share drops to $0.14 for 2009, 20% payout rate
- book value per share of $10.81 to begin 2009, currently reported at around $17.85
That would do it. The consensus analyst EPS forecast (revised downward dramatically this week) for 2009 is $0.76 and a dividend cut seems to be in the offing. That leaves asset valuation as the key component.
Friday, November 21, 2008
...And The Hits Just Keep on Coming
Three more banks were closed today (23 for the year) by the FDIC. All three were on the watch list I posted a few days back. Follow the link below for more details:
http://www.fdic.gov/bank/individual/failed/banklist.html
http://www.fdic.gov/bank/individual/failed/banklist.html
Tuesday, November 18, 2008
ABX & CMBX: Indicies at All Time Lows
Securitization is the process by which bonds are created from individual loans. Thousands of loans are bundled together and the cash flows from those loans are used to pay the principal and interest due on the bonds. Therefore, the bonds perform well when the loans perform well. Conversely, when the loans default, the bonds crater.
Asset backed security (ABS) is the market term for these bonds, although the term is usually used when describing bonds backed by credit card loans or auto loans. Mortgage backed securities (MBS) and commercial mortgage backed securities (CMBS) describe bonds backed by residential and commercial mortgages respectively. Please drop me a line if anyone is interested in a more expansive post, the subject deserves it. Much like a gun, securitization can be an extremely helpful tool. However, we all know the devastation a gun can wreak in the wrong hands.
ABX is an asset backed security index and CMBX is a commercial mortgage backed index. There are several tranches for each, divided by loan vintage and credit ratings. A trader or speculator can take a long or short position in the index.
ABX pricing is similar to the way a typical bond is priced. The ABX index rises when the underlying credit improves, i.e. the likelihood of default decreases.
CMBX trades on a credit spread basis. When the index rises, the underlying credit deteriorates (the likelihood of default increases).
I bring this up because EVERY SINGLE ABX AND CMBX TRANCHE IS TRADING AT THEIR ALL TIME WORST LEVELS. Market participants clearly do not want to hold credit risk in their portfolios.
Asset backed security (ABS) is the market term for these bonds, although the term is usually used when describing bonds backed by credit card loans or auto loans. Mortgage backed securities (MBS) and commercial mortgage backed securities (CMBS) describe bonds backed by residential and commercial mortgages respectively. Please drop me a line if anyone is interested in a more expansive post, the subject deserves it. Much like a gun, securitization can be an extremely helpful tool. However, we all know the devastation a gun can wreak in the wrong hands.
ABX is an asset backed security index and CMBX is a commercial mortgage backed index. There are several tranches for each, divided by loan vintage and credit ratings. A trader or speculator can take a long or short position in the index.
ABX pricing is similar to the way a typical bond is priced. The ABX index rises when the underlying credit improves, i.e. the likelihood of default decreases.
CMBX trades on a credit spread basis. When the index rises, the underlying credit deteriorates (the likelihood of default increases).
I bring this up because EVERY SINGLE ABX AND CMBX TRANCHE IS TRADING AT THEIR ALL TIME WORST LEVELS. Market participants clearly do not want to hold credit risk in their portfolios.
Note, there is no ABX tranche for 2008 issuance. THAT IS BECAUSE THERE HAS BEEN SO LITTLE ISSUANCE TO HEDGE.
The problem is simply stated below. It represents the holdings of Federal Reserve primary dealers. Primary dealers are authorized to trade directly with the Federal Reserve. For a list, click the below link. The run-up in risky assets speaks volumes about the issues the financial markets are facing today.
http://www.ny.frb.org/newsevents/news/markets/2008/an081001.html
Monday, November 17, 2008
CDS Settlement for the Nationalized Icelandic Banks
I'm a bit late on this, about a week ago, auctions were held to determine the payout amounts for credit default swaps (CDS) for the banks that Icelandic regulators seized in October. The CDS holders will receive the difference between par value and the auction result.
Bank | Senior Debt | Subordinated Debt |
Value | Value | |
Landsbanki | 1.250% | 0.125% |
Glitnir Bank | 3.000% | 0.125% |
Kaupthing Bank | 6.625% | 2.375% |
Yep, that's right. Landsbanki's subordinated debt is only worth 0.125 cents on the dollar. The banks succumbed to levered speculative positions and sprawling European operations. The result was a decimated currency and a crisis that still might wipeout an entire country. The banks are embroiled in lawsuits and asset seizures (U.K. in particular) that afford us a glimpse at the depth of the mismanagement on the global landscape.
More on Iceland:
Saturday, November 15, 2008
TARP Infusion Recap: $250 billion Allocation
List is comprised of distributions of $200 million or greater. Although the $40 billion going to AIG is from the TARP, it is not being taken from this allocation. Remember, the $700 billion EESA of 2008 was broken into tranches. The President needs to sign off on the next $100 billion installment: this is where AIG will get the funds.
The Bernanke Hotel & Casino
From the Federal Reserve statistical release H.4.1 (11/13/08):
-- The Federal Reserve System holds $52.84 in assets for each dollar of capital
-- Their holdings of U.S. Treasury securities have decreased by $303 billion in 1 year
-- Other loans (this includes broker/dealer loans, the asset backed commercial paper liquidity program and the initial AIG loan) total $316 billion
-- The U.S. Treasury has now supplied the Fed with $559 billion via the Supplementary Financing Program (unchanged versus last week). Please check the 10/8/08 post "Some Bullet Points" for Program details.
-- The Federal Reserve System holds $52.84 in assets for each dollar of capital
-- Their holdings of U.S. Treasury securities have decreased by $303 billion in 1 year
-- Other loans (this includes broker/dealer loans, the asset backed commercial paper liquidity program and the initial AIG loan) total $316 billion
-- Commercial Paper Funding Facility has provided $257 billion in liquidity
-- Other assets stand at $611 billion, a $570 billion increase from 1 year ago
-- The U.S. Treasury has now supplied the Fed with $559 billion via the Supplementary Financing Program (unchanged versus last week). Please check the 10/8/08 post "Some Bullet Points" for Program details.
I can't wait to see what this mess balloons to once the new AIG package hits the balance sheet.
Subscribe to:
Posts (Atom)
