Archive - Jan 2010 - Story

"For interest rate exposure, or duration, we are currently cutting back in the U.S. and U.K. because, as mentioned before, supply and demand dynamics are likely to be negatively affected as borrowing rises and central bank buying declines...With corporate bonds, we are becoming a bit more cautious than we have been. In the third and fourth quarters of 2009, we believed the massive narrowing of spreads we saw in the second quarter wouldn’t go much further. We weren’t necessarily selling credit on any scale, but we’d reduced buying....In agency MBS, we are underweight, having reduced our exposure as the Fed’s buying programs have dramatically tightened spreads...we are underweight TIPS versus the benchmark, reflecting our view that risks are currently weighted toward a disinflationary environment." Paul McCulley

Though certainly a kind of libertarian streak exists here at Zero Hedge we try not to make a habit of covering purely civil liberties issues on what is, after all, at its core a financial publication. Sometimes, however, events relevant to online publications with a contrarian (or, if you prefer, anti-authoritarian) bent expose such profound incompetence and overreaching on the part of the powers that be that we simply would be remiss not to review them here.

When it comes to the asset side of the Federal Reserve's balance sheet, there are no secrets: with the winddown of the bulk of the Fed's emergency liquidity programs by February 1, the majority of the Fed's current $2.2 trillion in assets will continue being outright-held securities. And even as the emergency programs sunset, the quasi-permanent, QE remnants will be here to stay. What we know for certain is that the current $1.8 trillion in Treasuries and MBS will rise to at least $2.2 trillion, as the balance of QE round 1 is exhausted. Will this purchasing of outright securities end there? Hardly. As the Fed is the only market for MBS, and as the MBS market can not allow a dramatic rise in 30 year mortgage rates, which is precisely what will happen if the buyer of first resort disappears, we fully expect some form of QE to show up and grab the baton where QE 1.0 ends. In fact just today, Fed economist Wayne Passmore, under the aegis of Atlanta Fed president Dennis Lockhart, stated during the annual American Economic Association meeting that GSE ABS should have an outright explicit guarantee by the Federal Reserve. Forget about QE then - this would be an onboarding of over $6 trillion in various assets of dubious worth, which currently exist in the limbo of semi-Fed guaranteed securities, yet which have an implicit guarantee. Of course, should the broader Fed listen to young master Passmore, look for John Williams' expectation of hyperinflation as soon as 2010 to be very promptly met. The danger of the Fed's next unpredictable step is so great that it is even causing insomnia for none other than BlackRock big man Larry Fink, who asks rhetorically "Are they going to kill the housing market?" Well Larry, unless the Wall Street lobby hustles, and the Fed isn't forced to print another cool trillion under the guise of Mutual Assured Destruction, they very well might.

So now that we (don't) know about the assets, what about that much less discussed topic: the Fed's liabilities?

When Henry Paulson publishes his long-awaited memoirs, the one section that will be of most interest to readers, will be the former Goldmanite and Secretary of the Treasury's recollection of what, in his opinion, was the most unpredictable and dire consequence of letting Lehman fail (letting his former employer become the number one undisputed Fixed Income trading entity in the world was quite predictable... plus we doubt it will be a major topic of discussion in Hank's book). We would venture to guess that the Reserve money market fund breaking the buck will be at the very top of the list, as the ensuing "run on the electronic bank" was precisely the 21st century equivalent of what happened to banks in physical form, during the early days of the Geat Depression. Had the lack of confidence in the system persisted for a few more hours, the entire financial world would have likely collapsed, as was so vividly recalled by Rep. Paul Kanjorski, once a barrage of electronic cash withdrawal requests depleted this primary spoke of the entire shadow economy. Ironically, money market funds are supposed to be the stalwart of safety and security among the plethora of global investment alternatives: one need only to look at their returns to see what the presumed composition of their investments is. A case in point, Fidelity's $137 billion Cash Reserves fund has a return of 0.61% YTD, truly nothing to write home about, and a return that would have been easily beaten putting one's money in Treasury Bonds. This is not surprising, as the primary purpose of money markets is to provide virtually instantaneous access to a portfolio of practically risk-free investment alternatives: a typical investor in a money market seeks minute investment risk, no volatility, and instantaneous liquidity, or redeemability. These are the three pillars upon which the entire $3.3 trillion money market industry is based.

Yet new regulations proposed by the administration, and specifically by the ever-incompetent Securities and Exchange Commission, seek to pull one of these three core pillars from the foundation of the entire money market industry, by changing the primary assumptions of the key Money Market Rule 2a-7. A key proposal in the overhaul of money market regulation suggests that money market fund managers will have the option to "suspend redemptions to allow for the orderly liquidation of fund assets." You read that right: this does not refer to the charter of procyclical, leveraged, risk-ridden, transsexual (allegedly) portfolio manager-infested hedge funds like SAC, Citadel, Glenview or even Bridgewater (which in light of ADIA's latest batch of problems, may well be wishing this was in fact the case), but the heart of heretofore assumed safest and most liquid of investment options: Money Market funds, which account for nearly 40% of all investment company assets. The next time there is a market crash, and you try to withdraw what you thought was "absolutely" safe money, a back office person will get back to you saying, "Sorry - your money is now frozen. Bank runs have become illegal." This is precisely the regulation now proposed by the administration. In essence, the entire US capital market is now a hedge fund, where even presumably the safest investment tranche can be locked out from within your control when the ubiquitous "extraordinary circumstances" arise. The second the game of constant offer-lifting ends, and money markets are exposed for the ponzi investment proxies they are, courtesy of their massive holdings of Treasury Bills, Reverse Repos, Commercial Paper, Agency Paper, CD, finance company MTNs and, of course, other money markets, and you decide to take your money out, well - sorry, you are out of luck. It's the law.

Zero Hedge recently wrote about the dramatic transformation in the supply/demand landscape in US fixed income issuance, where courtesy of the Federal Reserve, marginal buyers needed to fill a demand hole of just over $200 billion. This number skyrockets elevenfold in the coming 12 months, all else being equal. And already the US Government is lining up the very first offering for 2010: in the first half of January we will likely see the following being offered, likely in increments of tens of billions:

* 28-Day Bills - January 7

* 91-Day Bills - January 14

* 182-Day Bills - January 14

* 364-Day Bills - January 14

* 3-Year Notes - January 15

* 10-Year Notes - January 15

* 30-Year Notes - January 15

Yesterday's post on documented Treasury outlays for unemployment insurance benefits, spurred various questions which we wanted to shed some light on. To recap: the gist of the post was that the divergence of average monthly premia paid by the Federal government, superimposed with actual changes in the population of those collecting unemployment insurance (per the government's data) has diverged dramatically. The key premise in the analysis is that average monthly "allowance" paycheck has been relatively flat, and while there have been marginal changes ($25 dollar increases to a fraction of the population eligible for such increase), the core of the problem is captured by the chart below. As one can see, the average monthly payment since the beginning of Fiscal 2008 has been $1,207. If one excludes the divergent period since March of 2009, the average was just $1,109 per month. Yet the most recent data indicates that in December, according to the government's data, the actual outlay came down to $1,536, 21% higher to the total average, and 28% to the narrower average payment of $1,109. Is the government engaged in another, stealth stimulus by gradually padding unemployment insurance benefits? After all the money printer is on, and with banks not lending, what easier way to get the money straight to the (unemployed) population.

California was counting on $2 billion dollars or so in cost savings generated by Governor Arnold Schwarzenegger's mandatory 3 day a month furlough program for state workers. The Service Employees International Union was having none of that sort of thing on its watch, so they sued. In the process, the SEIU managed to have the program declared "illegal" by Alameda County Superior Court Judge Frank Roesch primarily because, near as we can tell, savings wasn't coming out of the general fund, but separate state funds designed for the relevant agencies. Off-budget savings, it seems, don't count. We are fairly sure this will dim ever-so-slightly the brightly glowing esteem in which Zero Hedge readers hold unions generally. Still, resort to the courts to lock in the porky bits in state budgets is not just a time honored tradition, it is a political tool with teeth, and it could mean fiscal doom for more municipalities than just California.

Some days ago we wondered aloud after the blank check extended to Fannie and Freddie along with the suspiciously convenient timing of those announcements on Christmas Day.  Back then we wondered if we had been told the entire story. Recent news not only tells us that we had not, but points astute observers to what might well be one of the largest financial frauds in the history of... well, ever.

As we move into the new year and 2010 forecast after forecast hits the Street, invariably the “mountain of money on the sidelines” argument is being put forth by more than a good number of Street seers and pundits as a rationale for bullishness on financial assets, and equities specifically. We’ve heard this same argument again and again for decades now. Invariably these seers and pundits are referring to money market fund balances in their so-called analysis. Don’t get us wrong, over the last few decades we have seen record money market fund balances be created. But the fact is that if you go back to the early 1980’s and move forward, there has virtually never been a down year for money fund balances straight through to 2002. Point-to-point from 2002 through 2006, money fund balances experienced no growth. But you also know that during this exact period, we experienced both a cyclical bull market in equities and a coincident multi-generational residential real estate bubble of incredible proportion. It’s no wonder money fund balances did not grow as it‘s simply not often that we get a double barreled asset class movement as was the case from ‘02 through ‘06. But off to the races with growth in 2007 and beyond has once again been seen in money funds until just recently, punctuated by the safety trade movement of last year and early this. Of course once Bernanke and friends moved the Fed Funds rate to academic zero, dragging money fund rates with it, mom and pop investors have dutifully moved into bond funds in record amounts. Just as the Fed wanted, but ultimately to investor’s detriment when generational low interest rates are no more. The point is that the theoretical “mountain” of money has been on a path of growth for three decades now. The mountain simply grows ever higher and analysts again and again point to it in each cycle as a rationale for yet ever higher financial asset prices (of course completely disregarding the issue of valuation in the investment decision making process using this logic). As we see it, if the mountain of money argument held significant water, we would never have experienced two instances in the same decade where the equity market was cut in half. The so-called mountain of money in money funds should have cushioned such an extreme historical outcome…but they did not.

There is an old saying, "when in doubt follow the money." These days investors have lots of doubt about pretty much everything (if not so much money). And with data from the government increasingly bearing the Quality Control stamp of approval of the Beijing Communist Party, there is much doubt in store courtesy of an administration which will stop at nothing in its competition with China as to who can blow the biggest asset bubble the fastest, data integrity be damned. Undoubtedly, of all government released data, the most important is, and continues to be, anything relating to unemployment. This is precisely where the government's propaganda armada is focused. Yet in matters of (un)employment, the ultimate authority is, luckily, the Treasury, and not the Fed. "Luckily," because when it comes to making money "difficult to follow" Tim Geithner's office still has much to learn. Which is why when we looked at the Daily Treasury Statement data we were very surprised: because it indicates that the government could be underrepresenting employment data by up to 32%!