[MrBill]

More likely as institutional investors pull money out of junk bonds they will plow it back into investment grade securities, like government bonds, to match their assets to their liabilities. If previous runs on junk bonds is any indication this is actually positive for govies. However, it will hit bond traders, which is why majors such as Citibank & BofA have been struggling as of late with their fixed income trading. Major contributors to their bottom line. But, to put it in context, since cleaning up their balance sheets years ago, many US & international banks sold their large exposures in corporate bonds to hedge funds and other speculators. They will take the hit harder than the banks themselves.

This was an accident happening in slow motion. Yield hungry investors compressed yields to historic lows and in turn tempted more and more companies to tap the sub-investment grade market. Well, if you buy junk, you have to expect some defaults.


Credit is not evaporating. There is too much global liquidity at the moment. If US treasuries rise another 50 bps. it will not pressure homeowners who have jobs and fixed rate mortgages. However, if we see job losses then this will have a much larger affect on the housing market than US treasuries going up to 5%?

Poor borrowing decision linked to poorly thought out and exectued M&A activity is more responsible for these defaults than lack of liquidity. Did anyone expect discounts and rebates to save Detroit? I think digital is the demise of Kodak's film business not interest rates?

[falser]

$this->bbcode_second_pass_quote('MrBill', 'M')ore likely as institutional investors pull money out of junk bonds they will plow it back into investment grade securities, like government bonds

[MrBill]

$this->bbcode_second_pass_quote('falser', '')$this->bbcode_second_pass_quote('MrBill', 'M')ore likely as institutional investors pull money out of junk bonds they will plow it back into investment grade securities, like government bonds

[falser]

You could have just said you disagree with me and leave it at that. Personally, that US government bonds lock you into US dollars and something like $2 billion worth have to be bought every day to keep the US afloat is enough to keep me away. But alas I am not a professional trader, so I'll leave these investment tools for others.

[stu]

Would it be an overstatement to say that this amazing?

I mean this in two respects.

The first is the amount and size of companies in the financial situation that they are in and the second is the lack of serious media coverage this is getting.

If the US goes belly up 95% of people are going to say they had no idea it was coming.

[rogerhb]

$this->bbcode_second_pass_quote('MrBill', 'M')eanwhile I am losing real money in these markets and that tends to keep you focussed on the fundamentals.

[MrBill]

I don't know, I was thinking about this last night over a beer and this morning while I was getting ready to come to work. Yes, I gamble for a living. But, I do understand the fundamentals behind what I am doing. If I lose money, it is no one's fault, but my own. Someone else was more clever, quicker or just luckier. That is the game.

However, on the other hand, I have been successful at it for 20-years in commodities, foreign exchange, money markets, fixed income, equities and now energy markets.

I have lived through several currency crashes and survived - the drop in the dollar in the 80's, the ERM crisis in 1992, the Asian crisis, the Czech currency crisis in 1997 and the Russian crisis in 1998. I was trading the entire time. Market making. Providing liquidity to the market. Smoothing the volatility. I have watched other defaults like the Argentine default from the sidelines. I have seen a few near misses like Turkey & Brazil more recently where you wonder how they managed to pull another rabbit out of the hat? I guess to keep from walking over a cliff you do not have to turn around, you just have to stop going forward?

On the otherhand, I have seen the excesses in Japan & HK worked off much more slowly. A decade of deflation in asset prices, slow to no growth and several recessions. It is not as spectacular as a currency crisis, but it is good medicine for an economy whose fundamentals get outta whack.

Most people probably are only vaguely aware that the dollar was at 0.8200 against the euro in 2000 and at 1.3670 in 2004. That is a swing of 40% (i.e. the external value of the dollar lost 40% of it's purchasing power outside the USA). I saw the yen at 80.00 and at 145 in 1995 and 1998 that is a move of 45%. Yet, in neither case did the system implode in Europe, Japan or the USA. Real wealth was created and destroyed, but most people were quite unaware about it or very passively interested because it might have effected where they took their vacation. Sometimes these asset reallocations are necessary.

So, yes, the US borrow too much money. They do not raise enough taxes to pay for their spending. Housing markets need to correct downwards. Relative to incomes, housing prices are less affordable today than they were in 1991, and that is in a low interest rate environment, so as interest rates rise, this will be a shock to homeowners. Nevermind high heating bills this winter, which I am sure many households have not budgeted for as the savings rate in the US is negative.

It is going to get painful. There is no avoiding this. And, if the government tries to borrow their way out of this coming recession it will only make America's external situation worse (i.e. higher interest rates and/or a weaker dollar). I would not rule out a euro/dollar of 1.4000 in the next 2-years and Fed funds of 6% in any case.

But, back to sub-investment grade junk bonds. There is chance of default attached to every bond by S&P, Moody's, Fitch, Dun&Bradstreet, etc. All the way from AAA to D for default. The lower the rating the greater the chance of a default. This has very little to do with the availibility of credit or liquidity, but is a mathmetical formula that measures a firm's ability to repay debt just like your own personal credit score measures how big a mortgage you can repay. Now you may have a crap credit score and your local bank may still give you a loan. That is silly, but it happens. A firm may issue debt with a really bad credit rating and if investors are foolish enough to buy their debt then they deserve to lose money.

GMAC & Ford credit have been on my radar screen for at least 3-years as their ratings continued to slide. Serious investors have been shedding their debt at each negative turn. The only ones holding their debt now are the speculators, hedge funds and a core of investors who believe naively that GM & Ford are too big to fail therefore there will always be a rescue somewhere along the line. I don't buy that line of thinking. I have seen enough defaults to know better.

However, it is very hard to protect investors from their own greed. When an Italian retail (i.e. amateur) customer buys Argentine bonds because they carry a high coupon or interest rate it is his own naive belief that the IMF or someone will never let Argentine default, except Argentine has spent roughly half of the past 200-years in technical default on their debts, then who am I to stop them? They are not a good investment. Emerging market bond traders know this. Ordinary investors should just avoid them. If Argentina defaults it has nothing to do with the health of the global economy and everything to do with their own mismanagement and prolifagy.

Did anyone seriously believe that people would keep buying SUVs forever? That Ford & GM could keep giving zero interest loans and rebates forever? That Toyota and it's competitors were just going to let Ford & GM dominate forever despite making inferior autos? That Ford & GM could borrow at will from their employees pension fund accounts and then magically make those funds reappear when their employees retired and started drawing pensions? It is criminal what these firms did. Fobbing off their pension liabilities on Delphi or on the federal government. However, it did not stop stupid investors continuing to back their idiocy by buying GM & Ford stock or investing in GMAC & Ford Credit bonds. Buyer beware. I certainly regret buying Ford stock in 2003 'for the bounce'!

So, if you think the US will default on their debt you can invest in other asset classes. But, before you do, you may want to compare the debts & deficits of the US to each country of the eurozone like Italy, Portugal, Greece, Spain & France, and you might find out that the US' deficit is no worse. You may want to consider that gasoline in the US is $2.50-3.00 versus $5.00-6.00 in Europe; that income taxes are 29% vs. 41%; that sales taxes are 3-4% vs. 17% VAT in Europe; that the US economy grows at roughly twice the pace of Europe (3.5-4.0% vs. 1.5-2.0%); you may look at the US economy with 5% unemployment vs. Europe with over 10%; and then you might consider the costs of integrating the newer members into the EU15, and the efficiency of transfering wealth from successful economies to less successful ones as a matter of policy?

There are good reasons to invest in some parts of Europe, but after you add up the sums, you might consider the size of the US' deficits against potential revenue it can raise from taxes vs. how highly Europeans already are taxed and their deficits are no better. It is your decision, but just do the math before you write the US dollar off and tell me how great the euro is. I like Europe. I have spent the past 13-years living in Austria, Germany, the UK, the Czech Republic, the Ukraine, Russia and now Cyprus. I really enjoy the quality of life & diversity of languages & cultures. However, I don't pretend that I like paying up to 50% of my income in taxes, healthcare and unemployment insurance like I had to in Germany. Mind you I have those same high costs if I move back to Canada, too. So, it is just a personal choice.

Take care of your own personal finances and urge your government anyway you can to curb their spending. I am just watching from the sidelines. It won't hurt me per se, but a lot will get hurt if the US does not mend its ways.

In the meantime, I will continue to second guess central bankers, undermine prolific governments and try to keep them honest. If I lose money, no big deal, it is someone else's gain. But, yesterday was a bad day. No one is smarter than the markets. It is very humbling.

[SHiFTY]

Interesting commentary. Thanks for that.

I guess my biggest fear is the sheer size of the US deficit and debts. Sure, in percentage terms it is on par with those of many Euro-zone countries, but in sheer dollars, wow.

I would imagine the US cannot borrow 85% of the world's savings, $2b a day, forever. There must be consequences.

[MrBill]

I agree. I think the US absorbs 70% of the world's current account savings, but let's not tribble over details. It is still a huge amount. Here is a new article in this week's Economist. Very timely.

$this->bbcode_second_pass_quote('', 'B')rad Setser and Nouriel Roubini, of Roubini Global Economics, a consultancy, reckon that central-bank buying at its peak could have dampened Treasury yields by up to two percentage points. And a new paper by Francis Warnock and Veronica Cacdac Warnock, of the University of Virginia, published by the Fed, finds that if foreign central banks had bought no Treasuries over the past year, ten-year yields would be 60 basis points higher. If all foreigners had boycotted American bonds, the increase would be 1.5 percentage points.

[MrBean]

$this->bbcode_second_pass_quote('MrBill', '
')It is a big problem. But, what scares me is the current admin's almost total disconnect from reality over this and other issues. Ideology is dangerous. It is much better to be pragmatic and fiscally conservative.

[MrBill]

$this->bbcode_second_pass_quote('', 'W')ell if it's true what many observers say, that the bureaucratic and politically mangled CPI number (not even mentioning the utterly ridiculous "core" CPI) is downgraded by several points compared to "real" inflation... then it's not just the current admin but the whole economic community that is disconnected from reality.

[linlithgowoil]

i always wondered why they dont include housing costs in inflation? isnt this the most important thing to the average person? if house cost inflation is rising at 20% but everything else is at 2% (including wages), this is a bad thing. It means houses are becoming less affordable, and given that 'shelter' is one of the basic things you need in life, surely it is wrongto omit this from inflation numbers.

who cares if the cost of a plastic dvd player from china has deflated 50% in 2 years if you are homeless?

[MrBean]

$this->bbcode_second_pass_quote('MrBill', '
')So, your complaint may be that because housing isn't captured in CPI that it is invalid, but a housing component in the form of rents is included in CPI, and data on housing itself is captured somewhere else, so it is not like they have forgotten about it. And, as most OECD countries collect data in a similar manner and is compared with the OECD, World Banks, IMF's own forecasts you can compare countries quite easily. Also, as the data is collected in the same manner month after month, you can look for emerging trends, and discount any outliers which may be corrected at a later date.

[MrBill]

Ah Mr. Bean I should have left you on ignore. My curiosity always gets the best of me. A shadow ministry of statistics? What in someone's basement or do they actually carry out all their own surveys?


Estimates, forecasts, actual numbers & revisions are all released daily from various government and non-government agencies. They are usually all based on sample estimates drawn from a population. They are all open to samply bias and error. Collecting all the 'correct data' would be impractical. And as it changes so rapidly quickly out of date in any case.

A temperature will not tell a doctor whether a patient has a flu or is dying of cancer, it just tells him what the patients temperature is at that moment. Without a baseline reading the doctor does not even know if the temperature is rising or falling? And the doctor does not only rely on the thermometer, but also looks for other symptoms before making a diagnosis. Even then the doctor can get the diagnosis wrong, but at least he has collected the data and made the observations, so that if there is a mistake he knows where to start looking.

For me any given number is not very important, but many observations taken together. Usually when a headline number is released the market reacts to the number based on its own prediction of the number. If the number comes out as expected there is little or no reaction. If the number is higher or lower than expected, then the market reacts, often violently, to the new information. Also, the market quickly discounts today's number and looks forward to the next set of numbers. It is like wishing your life away.

Is the system perfect? Obviously not, but without economic statistics you are a blind as a ship in the fog without navigational maps or a compass. So, whether I am naive or not is not really the issue. You work with the numbers you have and make the best of them.

If Italy, Spain, Greece and Portugal get caught lying about their debts & deficits in order to qualify for entry into the euro it has political as well as economic ramifications on the value of the euro and European interest rates. Deliberate falsification of data released to the market is inexcusable.

However, unless you trust a number until proven otherwise it is the number you use. Otherwise you would be paralyzed. Just sitting there wondering if the world had 25-50-75-100-125 mpbd of oil or not? Does VZL produce 3 mbpd or just 2.3 mbpd? You rely on various sources and if it is 3 mio as Chevez says then you have to ask where are the $4 billion in central bank reserves that should be there from the revenue?

I guess I am naive.

[MrBill]

$this->bbcode_second_pass_quote('', 'O')ctober 14, 2005; Page C3
The price of Refco Inc. bonds yesterday plunged to levels that suggested the derivatives-trading company might renege on its debts, adding to concerns in a junk-bond market already jittery over troubles in the automotive industry.
Investors headed for the exits as Refco shut down trading subsidiary Refco Capital Markets Ltd., citing a shortage of cash. Also, people familiar with the situation said yesterday that Refco may be meeting with its bankers to discuss the company's financial situation.
The market value of Refco bonds maturing in 2012 fell as low as 30 cents on the dollar, from 76 cents on Wednesday and 108 last week. The price of the company's traded loans fell as low as 60 cents on the dollar, from more than 90 cents Wednesday. Ratings firm Standard and Poor's downgraded Refco's "junk," or speculative-grade, subordinated debt two notches, to triple-C from single-B-minus.

[BabyPeanut]

$this->bbcode_second_pass_quote('MrBill', 'S')ometimes you rol with the punches, sometimes you get knocked-out.

[rkerver]

OH NOOOO! Not just MrBill, we're all silly putty! Squish.

[MrBill]

$this->bbcode_second_pass_quote('', 'D')erivatives, derivatives...where have I heard that term before? Oh! I remember it was the phrase "ticking timebomb derivatives market". That was it!

[BabyPeanut]

Thanks. I always feel like I learn so much here.

[Leanan]

Jerome a Paris posted a fascinating article at DailyKos.com yesterday. One way or another, he thinks we're headed for trouble. The "fundamentals" are simply too far out of whack.

One interesting tidbit he posted was that 31% of American consumption has been funded by re-financing homes. With interest rates rising, that source of cash has been cut off. And with high energy prices, the bankruptcy bill, and the change in credit card minimum payments, at the very least, people are going to have to severely cut back on their spending.

He thinks we might be facing a '70s type situation, or worse, hyperinflation a la Weimar.

Meanwhile, CNN this morning reported on the rush to declare bankruptcy. The deadline was today, I believe. They showed photos of lines of people, all waiting to declare bankruptcy. Some bankruptcy lawyers have been forced to turn people away. In New York, people waited all day in the pouring rain. In Atlanta, the line stretched for blocks.