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Has the Fed Defused the Neutron Bomb?
Bruce Friesen of Global Investment Solutions forwarded Randall Forsyth's article which appeared in Barron's earlier this week, Deflation: the Neutron Bomb of Balance Sheets:
Low interests rates have made these the best of times for borrowers but the worst for savers and investors.
Blue-chip corporations never had it so good with the likes of Dow Jones Industrial Average members International Business Machines (IBM) able to issue new three-year notes at 1% and Johnson & Johnson (JNJ) paying less than 3% for new 10-year debt.
But
these historically low bond yields have a darker side: According to a
new report from Fitch Ratings, ultra-low interest rates will exacerbate
the underfunding of many U.S. corporations' pension plans.
Just as with American workers who have failed to save enough for retirement and have seen their assets lose value, companies also will have no choice but set aside more of their earnings. And just as that means belt-tightening for consumers, it means corporations have less to distribute to their shareholders.
The
burden of funding traditional pension plans—known as defined-benefit
plans—is why they have waned in Corporate America. More common are
defined-contribution plans—such as the ubiquitous 401(k)s—that have
supplanted DB plans in the private sector. As has been reported widely,
DB plans remain the standard in the public sector, which are decimating budgets of many states and municipalities.
But,
according to Fitch, the low-yield, deflationary environment is adding
to the problems of underfunded corporate pension plans. Again, the
problem is two-fold: The decline in the values of investments, such as
traditional stocks and commercial real estate, has hurt the asset side.
The rush into so-called alternative investments such as hedge funds
right at their peaks didn't help. The flip side is that low interest
rates increase the present value of future liabilities.
(Time
out for those who aren't finance geeks. If you put $1 in a savings
account at 7%, in 10 years you would have $2. Trust me on that. That
means the future value of $1 in 10 years, compounded at 7%, is $2.
Conversely, the present value of that $2 invested for 10 years is $1.
But
what if interest rates are just half as high, or 3.5%, a far more
realistic yield for a 10-year, high-grade corporate bond? The present
value of that $2 in 10 years is $1.42. Trust me again on that, or get a
financial calculator or find one on the Web. In other words, where it
took only $1 for you to wind up with $2 in 10 years if you invest at 7%,
it takes an investment of $1.42 to end up with that same $2 in 10
years at 3.5%. That means you have to set aside 42% more today to meet
your savings goal a decade hence.)
Thus,
a decline in bond yields can be as devastating to a savings plan as a
drop in the stock market. According to Kenneth S. Hackel, president of
CT Capital, a financial advisory firm, 1% cut in a retirement plan's
assumed rate of return is roughly equal to a 15% decline in stock
prices.
Fitch's analysts find the mean assumed return for
corporate pension plans in 2008 and 2009 was 8%. That's with an
allocation to fixed-income assets of 34% of the total. Treasuries and
investment-grade corporate bonds yield far less than 8%, which is
closer to the very long-term return from equities, which means they
haven't locked in much of yesterday's higher yields. And, in case you
need to be reminded, over the past decade or so, the return from stocks
has been practically nil.
In line
with Hackel's rough calculation, Fitch reckons a 1% cut in the assumed
discount rate for companies' DB plan can result in a 10%-20% increase
in the present value of future liabilities. How to bridge that gap?
"The
fact is that there are no shortcuts—prudent management will likely
require contributions well in excess of the minimum required given low
yields and low equity returns," Fitch analysts write. Simply hoping for
higher equity returns or bond yields simply isn't prudent, they add.
So,
what's the answer? You know those hefty cash holdings on corporate
balance sheets on which the bulls keep harping? Fitch thinks pension
funding requirements will have dibs on corporate cash flows, and then
the stock of cash on companies' balance sheets.
That's the thing about deflation; it's like a neutron bomb for corporate, public-sector and consumer balance sheets.
Asset values and returns get decimated while liabilities remain
standing. Except that falling interest rates make those future
liabilities more onerous, requiring more belt-tightening, which only
exacerbates the deflation.
As I've repeatedly
stated, deflation is the arch nemesis of the financial sector and the
Fed will do whatever it takes to avert it. Moreover, in order to address
pension deficits, you need a rise in bond yields (lowers present
value of future liabilities) and a rise in asset prices. In other words,
you need a lot more days like Friday where stocks took off and bond
yields backed up.
The Fed's policy has been geared towards the
big banks and their big hedge fund clients. Reflate and inflate is the
official policy. By borrowing at zero and investing in higher yielding
Treasuries, banks lock in the spread, making instant profits which they
then use to trade risk assets all around the world.
Is this
policy succeeding? Yes and no. It's helping banks shore up their balance
sheets and some elite hedge funds who thrive on volatility, but doing
little to help the real economy which remains weak at this stage of the
cycle.
However, that all may be changing. Over the weekend, I
will go over some encouraging signs that receive little or no attention
in mainstream media. Below, listen to an interview with Nigel Gault,
chief U.S. economist at IHS Global Insight as he discusses his views on
the US economy and his take on Ben Bernanke's speech at the Fed's annual Jackson Hole confab.
»
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the fed is the f' n'bomb! it will not defuse itself.
the usa economy is not an island unto itself.
the fed is pretending that the threat of deflation
is bad, it is reality(not bad) and actually good
and necessary. just ask a recent college grad.
who would like to move out from mom's house
what they think concerning the price of lodging. housing?
it is too expensive. ask the homeless, or a war veteran or
a gardener or a cook or a sanitation worker or a librarian
or a carpenter or anyone other that a realtor or banker.
pricing of things is out of control, already. death by the f.i.re sector!
so they, the fed play that deflation is so bad, (yes speculators
will be fucked, too bad), because this lets them steal the function
of money creation and rob the currency directly from the treasury.
(as a matter of systemic necessity)..............
the ultimate high for a banker. it is better than laundering drug money
or even taking the drugs.
the fed is facilitating the bleeding to death of the feral government and "the people".
i suppose some would call this a good thing but those would be the one's who
have lost all belief in government and "the people" in any form, more or less. i'm not one
of them. they have an international agenda that does not prioritize the american
experience at all, just feeds on it. the fed is expansionist and beyond the law.
they will defuse nothing.
http://www.nakedcapitalism.com/2010/07/steve-keens-scary-minsky-model.html
.
Steve Keen’s Scary Minsky Model
....
His comments thus far:
Ponzinomics 101
If everyone tries to do what you are doing[ be it cutting wages, jobs to improve margins]
......It won't work!!!!!!!!
Can not believe Leo argues hedge funds can solve the pension underfunding problem. It increases arms length risk and fund managers have no choice but to role the dice, even if in small increments initially. By definition its the next bubble or accounting fraud in the making. Prolonged low interest rates cause wierd outcomes . Havent we learned anything!
Thank you Blindman. I think you can see very well.
Bernanke: " the Fed will do all it can to prevent deflation."
What he really meant:" we are out of bullets."
Can anyone tell I'm pissed?
not really. more harsh language please.
americans do not even hear a sentence if
it doesn't contain at least one "harsh" utterance.
The real problem is the illegal Federal Reserve.
Why does a private corporation (6 largest banks) own our credit and money? Suethefed.com is a start to take our country back. Join Congressman Ron Paul in his bill to audit the Fed. The Fed is bankrupting the USA for the profit of a few wealth internationalist.
Until we kill the Fed we will have wars and planned depressions as we have since 1913 when the Fed was illegally created Go to youtube and see the Money Masters and watch Alex Jones's film The Obama Deception. Research this and learn the truth. Death to the NWO and the Fed.
The Constitution gives Congress charge of America's purse. Congress created the Fed to manage the purse on behalf of Congress. Undesireable perhaps. But not illegal.
Leo, the debt clock is still running forward. We cannot get it to stop and we certainly cannot pay it down and reverse it. Debt=slavery. We are slaves! Do you not see that we are passing it on and on and on? There IS no solution. Our children will be born into a failed economy and perhaps a failed state. If you are optomistic in the face of all of this, I can see why some are aggrivated with you.
Beyond hope, there lies only madness.
...and ulcers and high blood pressure.
We are all of us dreamers of dreams,
On visions our childhood is fed;
And the heart of the child is undaunted, it seems,
By the ghosts of dreams that are dead...
‘Tis a cup of wormwood and gall
when the doom of great dream is said,
And the best of a man is under the pall
When the best of his dreams is dead...
Let him show a brave face if he can,
Let him woo fame or fortune instead,
Yet there’s not much to do but to bury a man
When the last of his dreams is dead.
(William Herbert Carruth, 1859-1924)
@ above...
.."The Fed's policy has been geared towards the big banks and their big hedge fund clients. Reflate and inflate is the official policy. By borrowing at zero and investing in higher yielding Treasuries, banks lock in the spread, making instant profits which they then use to trade risk assets all around the world.
Is this policy succeeding? Yes and no. It's helping banks shore up their balance sheets and some elite hedge funds who thrive on volatility, but doing little to help the real economy which remains weak at this stage of the cycle."..
.
the policy = stealing money in broad daylight in the witness of blind morons.
( no offense to the truly disabled intended).
is it working? yes and yes.
Reflections on Bernanke’s Yo-Yo Speech
Hey Leo ,
I agree with you this time
Follow TPTB and their money!
Can you take an inspired Guess what the cash rich Tech giants have in their Radar after 3par
fun for the whole family
Tony Robbins Economic Warning 1-2
http://www.youtube.com/watch?v=Z_rShZA_IjE
The Fed HAS NO CHOICE but to continue to do QE.
Look, you have to step back and examine how money is created and what happens when it is.
Simple thought experiment. Bank lends $100 in FRNs at 5%. The $100 exists, the $5 owed at EOY 1 does not. Someone else has to borrow it, perpetually increasing the credit base.
When we hit credit peak a couple of years ago, people are not borrowing in increasing amounts. The Fed has no choice but to effectively PRINT the interest owed that does not exist and will not be borrowed otherwise the credit base will implode as a matter of basic mathematics. Look, you can run this on a simple excel spreadsheet and see what happens when borrowing goes into reverse. All of the interest payments due begin to compete for the money supply along with the principal due.
This is how we can have this big QE but no apparent inflation or deflation as expressed by aggregate prices. This is highly probative that the interest claims on the monetary base for the QE period were $1.75T. THAT is the required additional borrowing needed in order to service TODAY's interest claims on TODAY's monetary base.
This is exactly what Japan has done to prevent deflationary collapse, they print the interest owed. Printing interest owed really divorces interest from reality, because the money is coming from nowhere and then being extinguished as payment to a bank to prevent cascading default and monetary collapse. This is why real yields are near-zero, because there is nothing REAL behind the interest. The Fed may as well be scratching out the interest component on a piece of paper and calling it even.
If I lent one of you $100 at 5% interest and I forgave you the interest, what is my yield? There is your ZIRP.
Addendum: so I lent you $100 at 5%. At the EOY, you are like look dude, times are tough, I can't pay you the $5; I can't service the debt. So I offer you $105 at 3%. Perhaps you think well, I couldn't have come up with $10 at EOY2, but maybe I can swing $8. Maybe at EOY2, times are still tough, so I drop it to $108 at 1%. Maybe there's demand for a loan on those terms. I've just cut my effective yield from getting $15 at EOY3 to $9. At which point I begin saying hey, I'll just take the principal, no interest, I have gotten to ZIRP. This is how the FFR follows the aggregate market.
The market is telling the Fed that the economy cannot service the debt, thus there is no demand for higher-interest money. So the Fed tries to find a point at which there will be demand for it, and here we are at 0. ZIRP effectively forgives interest. It doesn't forgive PAST interest, just future interest, basically, pay me what you already owe me and no more from this point on.
If you review my loan example, it does grow credit outstanding and prevent default by the borrower. However, it has no effect on the efficacy of his harvest or whether the coal seam he originally borrowed to finance development of has been exhausted. And that's the fundamental problem here, money is NOT the economy, which has its own problems revolving around the decreasing EROI of energy supply creating effectively less net aggregate energy.
Didn't the Baltic Dry Index dip down again, which was already near the lows !!!
Yeah, that would work
by the way, if the Fed really wanted to avoid bad economy for all of us, why can't all working adults get same deal as banks, say we all can borrow 1 million dollars for nothing and go buy short term Treasuries with it...how much would that yield on a monthly basis? And the extra income in our pockets, wouldn't we pay our debts to the banks with some of it, buy food and shelter. Shoot, we could form all new banks with it...buy up the branches, accountants and techonologies from the bankrupt banks...why does the FED give our money to banks and leave us hanging?
I am new, and a little retarded, but let me see if I am getting a better understanding of how things really work...."why does the FED give our money to banks and leave us hanging?" Its not our money, its the Federal Reserve's money, the Fed creates it out of thin air and lends it to the banks, we are just the suckers that pay the interest on the money the Fed loans. Eh?
If you have to ask...
The only thing they can reflate that matters is wages.
That won't happen with global wage arbitrage in place.
We've been at these reflationary policies for 3 years now with no discernible effect on the general economy, and we'll go on another 20 until they recognize this.
the neutron bomb already went off....it's too late to diffuse....the only actions remaining are plowing under the too big too fail asshole racketeers...
ps. i'm still waiting for those 1-2 million net new jobs 01q10 to show up.
Yeah, but I thought the neutron bomb was supposed to leave the Real Estate intact...
And now that I think about it for a second, even if a real neutron bomb left all the real estate standing, who the hell gets stuck with the maintenance bill for a city full of corpses and dodgy, depreciating buildings?
Don't worry. The RE is just waiting for the elites to come in and scoop it up at a fraction of its worth. And maintenance and future use? Why do you think the government has no interest in closing the southern border? They're just going to import a new crop of citizens who just won't demand as high of living standards as the current crop. Not to mention don't have any expectations of democracy or fairness from a government either.
I have this dvd which I bought to test my home cinema system which had over 200 nuclear explosions on it. VERY cool and addictive. I love nuclear and neutron bombs.
I think we should use the more often.
Take a look at a 'contrarian view'(no, not a proxy for T.Hoenig )
'Ultra-low rates encourage people to borrow to acquire assets, and are partly responsible for both the over-building in housing and the over-indebtedness of households, as well as the over-leveraging of the financial sector. More generally, a subsidy to capital will imply greater capital intensity (and waste) of capital, greater short-term leverage and excessive growth of sectors that rely on either fixed asset investment or credit. Is this the appropriate way to go (especially if we want more labor-intensive sectors to grow to provide the jobs that are needed), and is it sustainable?'
http://freakonomics.blogs.nytimes.com/2010/08/25/why-we-should-exit-ultr...
That's all loosely connected, sorry, I kind went off half-cocked
You were fully-cocked... just aiming at the wrong target.
Okay, reign in this loose term 'Deflation': if I'm reading this article right, the 'increase in availablity of money' which is propping up risk assets -is keeping present values from tanking a sizeable industry. Take away that crutch and levered instruments could go into loss. -- firstly, it's about the details; are we looking at a net debit rather than a writedown on credit?
I don't think we should be trying to preserve current price levels, I think the cost of living should go down, I think it wants to go down and instead of stopping that, the Federal reserve system should want to be helping that to happen. There are hundreds of reasons why this is good thing, or not; mine is that a high consumption burden makes for a segregated, avaricious society -that's my beef. The main criterion for a disaster due to deflation is working capital in the private sector, this is an input-price problem: Oil, Wages, Materials, Bills and things. ...if we can match the writedown of levered instruments, like insurances and pensions, to a cut in input prices, across the board, AND wages, so that in real terms we haven't moved, then the only outstanding issue is SVB issue and their interest. These issues are making the market anyhow- that's a situation that makes no sense. Yes, the banks are in a strange place, but they've increased their risks while increasing their balance sheets, but what can you do with a banker who's stupid?
Why is it that when my grandma had no troubles saving for her old age ? Our elders of yesteryear didn't have "investments". All they had to do is save a dollar in a savings account & earn interest on those accounts ! My grandma managed to "save" herself a little fortune AND leave an inheritance to her children ! OH! NOW I KNOW ! WE WERE ON A GOLD STANDARD BACK THEN WHEN A DOLLAR WAS A DOLLAR WAS A DOLLAR. People weren't being forced into speculating with their money in order to 'grow their money' . ZIRP is criminal, end the fed, enough damage has been done. This, too, will end & we will go back to stable money, the people will demand it.
I have two words for you: interest rates, if you offered me 15 [percent interest rate, I'd be more interest in saving then in stocks...
And this is the problem!
Gramma's savings was what Gramma ACTUALLY SAVED.
You don't work and produce for compound fucking interest! You're just a rentier usurer!
We're ALL looking to let TIME make us rich and get something for nothing! Let someone else do the work, I'll just use interest compounding.
All the fucking complaints about the elite yet none of you seem to understand how they STAY ELITE. Their money "works" so they don't have to.
nice writing. and..
" Their money "works" so they don't have to."...
and then they get bailed out because they wisely
invested in buying the political class of the entire country/s.
etc,,, ...
hehehehh damn right it does. Not so much now as when rates were much higher, but still easy to make money no matter what happens if you are on top of things.
i don't really care if the market goes up or down, even sideways still offers some short term trading opportunities.
i spend my days playing poker, travelling and hanging out with friends.
I haven't worked hard in a year, and have no plans to work hard again.
envy is a bitch isn't ?
So funny this blind faith. As is the Fed could really avoid deflation anyway. News flash - they cannot stop it. You will eventually have to accept that fact. There will be bubbles you can point to and say see, see its working here or there, but the real economy will not be affected. Its because there simple laws at work - easy money destroys credit. Government debt destroys its authority and legitimacy.
As per the video, it is stated that massive action may gain a few 10s of basis points, but then we try and guess the FED's actions as somehow economy changing. Is this all we have left. The FED will create the economic future of America. Tell me again who runs the country?
The problem is why would the FED further debase the currency for no meaningful economic outcome.
Ben, at some point, please demonstrate why you deserve our respect.
Mark Beck
"Is this policy succeeding? Yes and no. It's helping banks shore up their balance sheets"
Leo, how have you arrived at the conclusion that 'banks are shoring up their balance sheets'?
I realize that this is the standard logic and a long held belief but can you prove it?
Thanks
are you saying that allowing the banks to borrow hundreds of billions at 0 and earn 3% is not helping shore up the banks?
I think it's pretty obvious, isn't it?
Doesn't mean it's enough, but the fed is just buying time, hoping for a miracle.
Also doesn't mean it's moral, to rob from the savers to give to the banks, but it is reality.
IMHO kicking the can down the road can go on for a couple of years, maybe longer, really no idea how to tell.
End result will be far worse than if they just had just let the market work the first time, no question.
But in the meantime zirp makes me less aggressive shorting and at some point buying blue chips with good dividends will look mighty tempting. (We're not there yet, since my borrowing costs are 3%, not 0%, but we aren't too far away)
System-wide, bank balance sheets are crap. Loan loss provisions are delusionally inadequate. Extend and Pretend can't last forever, and won't last long enough for Timmy's pals to "earn" their way out of their own excrement.
Yep, recapitalizing the banks without seeking / needing / getting the taxpayer / citizen / congressional approval...
But, I'm sure that's going to trickle down to the average Joe and Jill.
See, It's working (whatever that is supposed to mean)!
I'm not so certain that recapitalization is ongoing...or, I should say that recapitalization is not going to dent the off balance sheet bad paper that the banks are sitting on.
Meanwhile, the bankers are continuing to pay themselves huge bonuses for creating this financial crisis.
While the banks are sitting on reserves provided by the Fed and earning a free spread...little or nothing is trickling down to Main St.
Has anyone estimated the amount of time it would take to really recapitalize the big banks at the current rate? Infinity? Longer?
Snidley,
It's not just the banks, although one might argue they've been the worst perpetrators.
It's been people (for whatever reasons, and I know it's not as simplistic as it sounds) borrowing beyond their means, chasing property ownership as house prices have been rising, Government (as much here in the UK as in the US) being spendthrift during the 'good times' (Gordon Brown's comment of 'the end of boom and bust' rankles with me now as much as it did when he said it) and central banks chasing down interest rates to keep the good times rolling.
The piper must be paid at some point.
DavidC
I think we have a systemic problem when it comes to savings (and the economy as well). We are trying to attach a savings system to a fiat which is designed to be an exchange of labor, goods, etc, not a long term storage device, it was never designed to be that.
Can there be a true correlation to bonds and stable money or are they the true relic from a time when currency was backed by real money?
I want to believe.
I think I can, I think I can...
There's an enormous difference between Ben's equivocating promise that the Fed will do "all that it can" and your blind, irrational faith that the Fed will do "whatever it takes". Mind the gap.
Leo, I'm confused. The article you quote clearly says that zirp is killing us. It just makes the assets smaller and the liabilities larger. So zirp = death for the pension funds. As that happens it will flow through to the beneficiaries and there will be a disaster. Death spiral.
But you summarize that what we really, really need is more zirp. It will not work. It will just aggravate the problems and cause deflation.
A good read for you Leo, the Barron:
http://online.barrons.com/article/SB500014240529702048857045754477215683...