Courtesy of Douglas Borthwick at Faros Trading
US Yields Not Reflecting Risk (pdf)
Today's tax compromise in the US extended all expiring Bush tax cuts by two years. The story though does not end here. The most important thing missing from the tax extension was the expected extension of the Build America Bond program. The Build America Bond program has been the municipal market's saviour over the past 18 months. Since their introduction in April 2009 more than 174 Bio USD of taxable securities have been sold by municipalities backed by the program, one where the US pays 35% of the interest due on the debt.
This week we learned that the New York State Pension Plan is facing a 70 Bio USD deficit; in addition, New York State decided they would hold back 2 Bio USD from New York City. We also noted that the State of California issued a State of Fiscal Emergency at a time when their expenses will out-pace their revenues over the next 18 months by around 26 Bio USD. Governor Schwarzenegger stated that "There is no money, except when the economy comes back." We do not see the economy coming back soon.
Last week Sheila Bair, the Chair of the Federal Deposits Insurance Corp. wrote in an editorial in the Washington Post that "relentless federal borrowing will directly threaten our financial stability by undermining the confidence that investors have in US government obligations." Explaining that the US needs to cut its debt or the next financial crisis may start in the US. Today's tax-cut extension does not help.
On a day when the market focussed on the Budget vote in Ireland, a country that makes up about 1.8% of Europe's GDP, we are concerned that no one is looking at the growing problems in New York, California and Illinois, three states that comprise 25% of the US GDP. The expiration of the Build America Bond program could prove to be a terrible price for the US to pay and we expect squabbles in the US Congress regarding the bailing out of States in 2011 that could easily rival that which we have witnessed from the European Union over Ireland and Greece.
The ECB is the only body capable of helping Europe see through their issues and we understand the FED is growing increasingly frustrated that it is the only one capable of action in the US, given a locked Congress and an austerity-driven Tea Party. Fed Chairman Bernanke said as much in his op-ed in the Washington Post, where he stated "The Federal Reserve cannot solve all the economy's problems on its own. That will take time and the combined efforts of many parties, including the central bank, Congress, the administration, regulators and the private sector." We continue to expect that QE3 will include the purchase of Municipal debt, a true can of worms.
Incidentally, as our recent poll demonstrates, Zero Hedge readers agree with this assessment, and continue to be about a month ahead of the curve.