Friday, February 13, 2009

Posturing, Not Problem-Solving

Evidence that Congress is part of the problem, rather than part of the solution, was on full display during Wednesday's hearing of the House Financial Services Committee. Invited to testify were the CEOs of eight of the nine mega-banks receiving a total of $125 billion in TARP money last October under the Treasury Department's Capital Purchase Program (CPP). Under intense scrutiny, the guest panelists submitted written testimony, then were subjected to a relentless grilling by irritated committee members.

I'll be frank, Barney. The proceedings were a disgrace. The lawmakers were not so much asking questions as blowing steam. Gathering and processing useful information is, um, way hard, requiring closed mouths and open minds. It is much more fun scoring clever sound-bites, first one to CNN or CNBC wins. Never mind the national interest; we gotta entertain the voters back home, make sure they have a target (other than us!) to whom they can vent their venom.

Congressmen who did actually read the written testimony (what? homework?) were reminded that most of these firms did not volunteer for the CPP. They were conscripted. In the words of Robert Kelly, CEO of The Bank of New York Mellon, "a key goal at the time was to have a range of institutions, including relatively healthy companies like [ours], participate in the Capital Purchase Program, removing any stigma that might be associated with accepting Treasury capital." The fear at the time was that a CPP beneficiary might be presumed by investors to be nearly bankrupt, thus inviting the kind of bank run that had brought down Lehman Brothers the month before. Treasury officials decided to hide the weak banks by mixing them into a larger flock of strong ones.

The strong ones signed on not because they needed the CPP, but out of patriotic duty. "We were not anticipating any injection of capital from the Treasury," Lloyd Blankfein, CEO of Goldman Sachs, testified. Indeed, Goldman had just raised over $10 billion in private capital--and could have raised more, as their common-stock offering was over-subscribed. A company like Goldman, acting in its own best interest, would have declined the CraPP and hunkered down for the inevitable industry shake-out. They would have emerged even more dominant than before. The word on the Street today is that Goldman, after Wednesday's circus on Capitol Hill, is more resolved than ever to give the government its money back, perhaps through a 40-million-share secondary offering.

The government needed Goldman more than Goldman needed the government. To show its appreciation, the Committee hauled in Blankfein and his Nifty Nine counterparts and scolded them over their compensation, practically guaranteeing that they will steer clear the next time they are needed.

Monday, February 9, 2009

Get Out the Alka-Seltzer

Uncle Sam is serving big portions, and investors may not have stomach enough. With $5.5 trillion of Treasury debt already out there, appetites may be sated. Still, the borrowing binge must continue, as new funds are needed for TARP, TALF, tofu, and whatever other menu options TurboTax Tim can cook up. “There is a lot of concern about who will be there at the end of the day to buy all this debt,” observes one bond trader, quoted at

When supply begins to overwhelm demand, higher interest rates are needed to bring dealers back to the table. Since the end of December, the yield on ten-year notes has climbed from 2.08 to 2.95%--and the 30-year bond from 2.68 to 3.70%--in anticipation of the U.S. Treasury's quarterly auction of $67 billion in long-term securities this week. In normal times, a rise in rates from such a low level accompanies an acceleration in economic activity. Not so now, as the economy continues to hemorrhage jobs (almost 600,000 lost in January alone).

Beyond a certain point, rising rates are unwelcome, choking further growth. The tentative progress made recently in refinancing home mortgages would probably stall, paving the way for further erosion in housing prices. The Federal Reserve has signalled that it may step in as a buyer of last resort of U.S. bonds, but only if "such transactions would be particularly effective in improving conditions in private credit markets," according to a statement released last week. For now the Fed would prefer to direct its firepower at consumer loans and home mortgages.

As already pointed out, private banks, faced with the prospect of rolling over $2 trillion in debt over the next two years, will be competing with the U.S. Treasury for the support of bond investors. All of these refundings must be absorbed in order for the system to avoid collapse.

[update, 11:00 a.m.--]
The yield on the 10-year note has just gone through 3%.

Wednesday, February 4, 2009

Twenty Million Man March

China's Great Wall is visible from space. So, too, may be the stream of China's newly unemployed, all 20 million of them, returning to their homes in outlying provinces. With shrinking worldwide demand for Chinese manufactured goods, factories along the industrialized seaboard are cutting back. China's white-hot economic growth is cooling.

Government officials plan to do something about it. They know darn well that social stability depends on keeping young workers busy. Borrowing from the Western playbook, they are devising massive stimulus programs to keep and create jobs. Unlike their counterparts in the U.S. and Eurozone, they can actually afford those programs, having amassed a sizable trade surplus over the past two decades.

National stimulus spending in China will mean a redeployment of capital normally used to purchase U.S. Treasury bonds. This is bad news for the U.S., which needs to borrow to finance its own stimulus initiative. As bidders for American debt walk away, yields will inevitably rise. And rising interest rates will abort any economic recovery that might be forthcoming.

Also threatening to drive up interest rates are the borrowing needs of American and European banks. As the chart below illustrates, over $2 trillion in bank debt will mature by the end of 2010. That debt will have to be refinanced with new issuance, and in today's market that appears impossible. The risk of government takeovers of troubled banks is just too great. Private investors who last fall bought bank-issued hybrid bonds and preferred stock have gotten crushed. They will not make the same mistake twice.

Widespread defaults, both by corporations and by sovereign nations, are in our future. The collapsing debt will create a vortex too powerful for meaningful government intervention.

Maturing Bank Securities in 2009/10 (USD)

Source: UBS

Sunday, February 1, 2009

The New Marathon Man

Rafael Nadal
2009 Australian Open Champion