Wednesday, December 17, 2008

Denninger is at it again!

First, let's look at the TNX, which is the 10 year Treasury yield; we'll do two charts, the first being the 20 year Weekly:

Note that we've not been here before (within 20 years anyway); here's the daily for the last year:

Yesterday we closed at a historic low, and early indications today are even worse, at 21.20 The IRX, or yield on the 13 week T-Bill, is essentially zero.

One cannot argue one simple fact - Bernanke hasn't yet started buying the long end of the curve to any material degree. But he's been threatening, and today the FOMC statement made explicit what had been whispered before.

The mouth-breathers were all over CNBC and elsewhere yesterday and today claiming that this would "stabilize" the credit markets and make credit (and the economy) better, with the most outrageous displays of stupidity being put forth by Cramer and McCulley of PIM(p)CO.

Yeah, right.

Now let's take a more cynical, but realistic, view.

Remember last year. Oil went from $60 to $150 in the space of a few months. Why? Because it was no longer profitable to buy CDOs and RMBS, as they were imploding. The money has to go somewhere, and so traders bet in front of what they believed Bernanke would do - crank down interest rates at an insanely-accelerated rate, which would spike prices in commodities, as the economic slowdown had not yet occurred - and wouldn't for several months.

They were right. Bernanke did it, oil shot the moon and Goldman (and a few others) made a whole bunch of money.

Who paid?

You did, by paying $4/gallon for gasoline.

Now let's back up a bit. 2003, to be exact. What happened? Greenspan (and Bernanke) played the same sort of game and house prices went ballistic. A handful of people made fortunes securitizing various mortgage and other "assets" into complex (and opaque!) securities, foisting them off on the world.

Who paid?

You did, by overpaying by 20%, 50%, 100% or more for a house.

Ok, so the housing bubble collapsed, then the commodity bubble collapsed.

Now we've got people who for the last month who are once again front-running Bernanke's playbook, which he was convenient enough to publish in advance as his doctoral thesis. They are buying the long end of the Treasury curve not because they think that a 2.35% yield for ten years is a reasonable rate of return over inflation, but rather because they expect The Fed and Government to drive prices higher than when they bought the securities.

That is, they're after capital gains, not yield or "coupon", and are specifically gaming the government and Fed.

Who's going to get the bill this time?

You are!

How? Simple. Treasury seems to think they can issue essentially limitless debt to bail out banks and others, having committed nearly $7 trillion thus far. Most of that has been issued through various short-term paper which has a near-zero (or actually zero!) interest rate - that is, up until now that debt issue has been essentially free!

What happens when this bubble bursts?

You think it won't? Like hell it won't. And when it does - that is, when Mr. Market calls the bet and forces Bernanke to actually make good by starting to unload all these "accumulated" Treasuries into his gaping maw, we will see "shock and awe" of another sort.

See, if the selling starts rates go up. To stop that Ben has to take up the supply. This causes him to print more money (expand his balance sheet) which means that the full faith and credit he relies on is further damaged. That in turn causes more people to get the idea that they better sell now which in turn causes him to buy more which.....

Remember the waterfall in September and October in stocks?

The same thing can happen in the Treasury market, and if it does it will force a political decision to be taken - risk the destruction of the dollar and our government or remove - by immediate statutory change (and force if that is resisted) The Fed's authority.

The argument keeps being made that "we had to do this" to save the system. But what's not being talked about is what the real problem was, and who we're trying to save.

The political class keeps trying to tell us that "we have to do this for mainstreet" and "we have to help homeowners."

Oh really?

Let's look at a few facts, shall we?

First, total mortgage debt outstanding. Its about $14 trillion dollars.

With the $7 trillion dollars we have committed we could have literally given every homeowner with a mortgage a fifty percent reduction in the principal outstanding.

This would have instantaneously stopped all of the foreclosures by putting all (essentially) homes into positive equity - overnight!

So why wasn't this done?

Because the goal was never saving homeowners or Main Street.

In point of fact the problem that the government is "trying to solve" is instead the unregulated bets that were made in the OTC CDS space which were backed by exactly nothing; there was no capital behind any of these bets!

There is no fix for this problem; your leverage is effectively infinite if you have no capital behind your positions. You are limited only by your testosterone level and there's been far too much of that on Wall Street over the last decade.

This was not an accident; in fact Henry Paulson himself lobbied for the removal of the previous leverage limits as I have noted when he was Chairman of Goldman Sachs. Between that and the complete refusal to regulate anything or anyone by the SEC, OTS, OCC, The Fed or anyone else we have built what amounts to a pyramid scheme based on nothing other than debt.

What Bernanke and Paulson are in fact trying to do - and what they have been trying to do since this crisis began - is paper over the bad bets that companies like Citibank, Lehman, Bear Stearns and AIG made with zero (or nearly so) capital behind them.

That is why we have committed $7 trillion dollars, it is why Paulson keeps changing how the "TARP" is going to work and what it is going to do, it is why AIG has gotten bolus of money after bolus as its bets have deteriorated further and in fact it is why The Fed took the arguably-illegal step of buying the assets against which AIG wrote the bets (so it could null them out; you own both sides of a bet there is no bet at all - but the loss on the underlying is now yours!)

The problem with this strategy is that it hasn't changed a damn thing, because with the exception of Lehman (which was allowed to blow up) these contracts were never extinguished; a loss is a loss and when you own both sides you're guaranteed to be the sucker who eats the grenade. All we have done is change where the leverage lies; we have taken the 30 or 50:1 leverage from the investment and commercial banks and moved it onto the balance sheet of The Federal Reserve!

This explains why The Fed is "resisting" Bloomberg's FOIA and has forced Bloomberg to file a lawsuit; laying bare the "assets" being held would allow independent evaluation of their value. This is extraordinarily dangerous to The Fed because if "we the people" (or worse, foreigners who have loaned us those trillions of dollars) were to get a look inside these "assets" and found that they were in fact so-called "AAA" mortgage bundles that have forty percent default rates embedded in them (as was found in one particular WaMu securitization I and Mish Shedlock were writing about earlier in the year) fair-minded people might conclude that The Federal Reserve is in fact broke and lying about their own solvency!

What other possible explanation is there folks?

Why keep something secret unless disclosing it would be embarrassing - or worse?

The Fed is not an independent, private entity. They are literally charged with maintaining the currency that represents the future output of every American. That is, their "stock in trade" is actually your willingness to get up, go to work, earn money and thus pay the taxes that underpin our currency and monetary system.

No taxes, no Treasury, no Government and no dollar.

Now tell me again why you're willing to get up and go to work when the organization that is effectively taxing you through these policies won't tell you how much you're going to be paying and the truth about why?

Here's yet another problem on the "unintended consequences" side, beyond the fact that the market can (and will) call Bernanke's bluff to buy "everything and anything" - its that there is no longer any reason whatsoever for you, or anyone else, to keep money in a bank account or Treasuries when the rate of return is in fact negative.

That's right - as of today there are money market accounts that have negative yields, and yet those funds are critical to the commercial paper markets.

What's Ben going to do about that little problem?

He can't force people to keep their money in an "investment" that has a negative return! And yet that is precisely what Bernanke did today - he guaranteed that virtually every single money market account across America will be decimated with withdrawal requests in the coming days and weeks.

And why not? Why would you be so stupid as to keep your money in an account that is guaranteed to lose not just value but actual principal?

We all "tolerate" inflation's cost on our funds - mostly because the vast majority of Americans don't understand it.

But everyone understands seeing their brokerage statement with a so-called "money market" that is actually going down in value every month!

That's going to last all of about one day beyond when the first statements go out that contain these losses, and will cause an instantaneous run on money market accounts across the United States. Those firms that decide to "eat" management fees to avoid this still will find themselves with a zero return which leads one to start wondering why they're giving someone use of their money for nothing and how long those firms can operate cash-flow negative before they blow up.

And that leads us to the next question - how many more Madoff's are out there? The "bezzle", as it is called, is the underlying embezzlement that is always present in an economy.

Bluntly, someone is always stealing - its part of human nature.

In good times this theft is just thought of as "shrinkage" and people tend to ignore it, because while it does count the total amount of money lost is small compared to the total profits. It can be hidden and often is - nobody is the wiser (other than the thief, of course, who is doing quite well.)

But in bad times these losses compound upon economic losses, and suddenly "the bezzle" becomes evident to everyone. The thieves try to maintain the patina of normalcy but to do so they must steal a greater and greater percentage of the principal that remains until finally the books are laid bare and there is literally nothing left.

That's what happened with Madoff and yet the SEC and other regulators were told as far back as 1999 that it was going on.

They ignored it because, well, times were good and exposing this scam would have been "embarassing."

Is your broker a Madoff?

How do you know? Is your 401k safe? Your IRA Trustee? Your online brokerage account? Is there any reason to believe it is, and any way to know it is, when a $50 billion apparent swindle goes unchecked and unstopped for ten years despite multiple written warnings sent to regulators?

Confidence? What's that? How can I reasonably know that any investment house - no matter who they are - is clean?

I can't, and that's a problem that can't be accounted for with classical "bankers theories" or "a doctoral thesis." Confidence, once destroyed, is rarely ever fully recovered.

Ben thinks he has this economy and market problem all figured out.

Unfortunately his thesis failed to account for all the unintended consequences thus far, and will continue to do so, because Ben suffers from the same sort of bloated-head syndrome that is endemic among academics - they believe they can say something and make it so as a consequence of their "degree."

The real world laughs at such hubris and severely punishes the fools who persist in their beliefs despite being proved wrong - especially when it happens more than once.

We are now in the end game; Treasuries are the last bubble, and when it bursts, we will find ourselves in a Depression that will make the 1930s look like a Cakewalk.

Bernanke has gone "all in", and he holds 2-7 offsuit.

He needs 7-7-2 on the board or he's dead.

You run the odds, then figure out what you need to do.

I am no longer looking at a 1930s scenario as my base case; that has shifted to the panic of 1873, which was far worse than the 1930s and included widespread civil unrest. Go do some reading - and make sure you're sitting down. The parallels in the foundation of how that panic occurred - industrial shifts (US >> China) and insanely-loose mortgage credit (European in particular) are stunning - and troubling.

If Bernanke won't cut this crap out Congress needs to do so, and do it now. A replay of the 1873 Depression in today's society will be catastrophic, with unemployment reaching 30% or more and leaving essentially everyone - corporate or otherwise - carrying any form of debt wiped out. Deficit spending will become instantly impossible; go figure out what that does to the Federal Budget.

We are running out of time to stop that outcome and if effective action is not taken before the Treasury Bubble pops it will, quite simply, be too late. That Genie is not the friendly sort, and once he pops out there is no stuffing him back into the bottle.

There will be more on this in the Year In Review And Look Ahead Ticker, due out in a couple of weeks.

Here's hoping the bluff doesn't get called before then .

1 comment:

Home Energy Miser said...

Outstanding piece! Good chance of being correct, yet few people seem to see the danger or are willing to acknowledge it.

I do have a few questions. First, you say towards the end of your article that anyone with debt will be wiped out. Why?

Although I understand that debtors who can't make their payments may be wiped out, we would also likely be in a hyper-inflationary time, which would cause debt to shrink in value.

Also, assuming you are correct, what's your guess as to the time line for the last bubble burst, and where should people be putting their money? Gold?