Opening Comments September 22 2008

Prices of Treasury coupon securities have erased some of the outsized losses which resulted from the announcement of the Treasury plan to bailout the financial system with the purchase of illiquid assets from the portfolios of financial institutions. The plan reduced safe have demand for Treasury debt and also raised the specter of huge sales of debt by the Treasury to finance the proposed endeavor.In overnight trading the yield on the 2 year note has tumbled 7 basis points to 2.10 percent. The yield on the 5 year note has slipped 6 basis points lower to 2.98 percent. The yield on the 10 year note has edged lower by 3 basis points to 3.78 percent. The yield on the Long Bond has actually edged higher by 2 basis points to 4.40 percent.

The motivating force in the market throughout this week will be the formulation of a legislative package to implement the proposal submitted by the US Treasury. The Treasury and the Administration will aim to keep the legislation austere and unadorned while some lawmakers with misgivings may feel compelled to add provisions of their own.

There are several topics which will provoke serious debates. The Democrats and some Republicans seem intent on proposing some sort of salary cap for executives of companies which participate in the program. The Administration opposes these efforts as it believes that passage of such a provision would cause some firms to opt out of the program which would make it less effective.

There is another debate raging about accountability. Early drafts of the plan would establish the Secretary of the Treasury as Economic Czar and master of the universe in all matters pertaining to the purchase of mortgage assets. One version of the bill would make his decisions and actions “non reviewable” by any court or Administrative agency.

To give any man that wide a swath and discretion over a $700 billion program seems unconscionable. Some Democrats have proposed carving out a role for Congressional watchdog agency, the General Accounting Agency which would seem to be a very worthwhile addition to the bill.

Other lawmakers want to aid homeowners who face foreclosure. One article raised the interesting point that such an action would put the Treasury in a dichotomous position as actions to reduce homeowner liability would reduce the value of the mortgage portfolio as individual loan balances are reduced.

Finally, some lawmakers want to attach some economic stimulus to this package with provisions to create jobs and other provisions to extend unemployment benefits.

This will be a contentious discussion in the middle of a hotly contested Presidential race. I think a bill will emerge quickly and the major change will be increased oversight by the Congress. I think that other goals can be achieved later with passage of a different bill.

I do not have a strong feel for Treasury bond prices in the short run. We have backed up so much that some buyers will certainly emerge. However, there is a heavy spate of Treasury issuance this week which should serve to cap any strong advance.

In the longer run it is very difficult to posit sharp gains for Treasuries. The Treasury market is about to become a growth industry again. When the bailout bill passes, issuance from the Treasury will increase across the board. The burden of supply will lead to higher rates as investor appetite for Treasury debt will rapidly wane.

I am also fearful that the combination of increased issuance and a loss of confidence in the US will lead foreign investors to restrain their purchases of Treasury paper. I think that we are in for a rocky road ahead.

Originally published at Across the Curve and reproduced here with the author’s permission.

One Response to "Opening Comments September 22 2008"

  1. Jerry   September 22, 2008 at 2:24 pm

    An easy way to notify your Congressman if you do not agree with the Congressional bailout is to send the following petition found at the following petition reads:Stop The Bailouts!We the Undersigned Americans, having seen two 500-point selloffs in the Dow over the last week, witnessing the bankruptcy of Lehman Brothers and the bailouts of AIG, Fannie and Freddie, and seeing over eight hundred billion dollars of new debt being taken on by America that we do not have, demand immediate action of our Congress and Executive.All the “bailouts” and other similar actions have accomplished is to speed up the economic and market crash; they are now coming not on six month intervals but on one month intervals, and are more severe in each instance.This ongoing crash in our markets was caused by a refusal to force banks and other institutions to stop lying about their debt – both in the “credit default swap” market and with so-called “Level 3” assets. As a direct consequence of not being able to determine what a company is actually worth it becomes impossible for their stock to find price support.In addition, it was the “excess liquidity” of the years from 2001 – 2007, intentionally created by Alan Greenspan and Ben Bernanke, that led to this mess – inappropriate and even fraudulent lending – in the first place. Providing “more liquidity”, which has been Bernanke’s primary strategy since last August, is like giving a drunk a bottle of whiskey as a “treatment”, and is equally indefensible.If this is not stopped the selling will rotate from financial stock to financial stock until all are zeros. Each will in turn need to be “bailed out”; down this road lies disaster as not only will the stock market crash beyond anything since 1929, but in addition we will take on so much new Federal Debt that it is very likely that foreign governments will refuse to fund our deficits – a threat that China issued, obliquely, through their official State newspaper on the 17th of September.This is likely to produce a bond market “dislocation” and crash in the economy similar to the 1930s if it is not stopped now. You have been petitioned in the past on these measures but have failed to act; you must now choose between decisive and immediate action and being responsible, in full, for the consequences.We insist that Congress and Treasury:Direct Ben Bernanke to “drain the swamp” and shut down the TSLF, PDCF and TAF, returning the “slosh”, or free liquidity, to normal levels. We must take the bottle of whiskey away from the drunk.Direct The SEC, OTS and OCC to have all financial firms mark to market all assets on their books, bring all off-balance-sheet vehicles back on the balance sheet, and stop hiding assets in “Level 3” where values are literally made up.Insist that all “over the counter” derivatives either be moved to an exchange with a central clearing party, thereby enforcing margin limits and providing published open interest figures, or, in the alternative, declared void.Direct that all firms with a federal guarantee or “backstop” of any sort, including but not limited to investment and commercial banks, be strictly limited to a leverage ratio of 12:1, which is the natural limit for a system with an 8% reserve.Remove all “game-playing” with reserves in our nation’s banks, including “zero reserve” sweeps and other similar evasions of reserve requirements, as this game-playing is part and parcel of the excessive leverage that created this mess in the first place.Remove Treasury’s authorization to issue more debt for bailouts or any other purpose without an explicit Congressional authorization for each such action. Hank Paulson said he would not use his “Bazooka”; he lied. In addition he has now announced plans to issue $100 billion of funds for “more slosh” to be provided to The Federal Reserve, yet nowhere has this been authorized by a specific bill in Congress. Per the Constitution, all spending bills must originate in The House.Remove all regulators involved in willful blindness from office, including the Mr. Lockhart (formerly OFHEO), the OTS, OCC, FDIC and SEC chairs, Treasury Secretary Paulson and Fed Chair Ben Bernanke.. All must be replaced immediately as all have willfully looked the other way for nearly a decade – or more – while this fraudulent credit bubble was being fostered.These remedies cannot wait for the next Congress; Henry Paulson, Ben Bernanke and the other regulators are increasingly “making it up as they go along”, with the latest instances adding (according to the CBO) $5.3 trillion dollars to the Federal Debt, or a doubling in just one act, plus the additional $800 billion spent on other bailouts and “market stability actions” – all money we do not have.We VOTE and elections are held November 4th, 2008.——————————————————————————–If you’d like to “sign” this petition, enter your information below and click “SIGN”. This petition will be faxed to President Bush, your members of Congress, and Henry Paulson, Secretary of the Treasury. You may only sign the petition once, and your email address must be valid (the system will email you a confirmation code and instructions.)I have read the above petition and agree with its contents. The above information is my registered voter address, or, if I am not registered, my legal address, I am qualified to vote, and will so register prior to the next election