Today's Federal Action Will Alter the Face of Finance
Prices of Treasury coupon securities are, for the most part plummeting in response to the deus ex machina action by the Congress, the Administration and the Federal Reserve to confront the credit crisis with direct, forceful and radical action. As stitched together from various media reports, which I will link to later, the plan has three legs. The first leg is the SEC's (whacko) proposal to ban short sales. The second leg is a purgative act which would establish a mechanism by which the government would purchase illiquid assets from banks. Finally, the Federal Reserve would back stop money funds establishing some sort of FDIC insurance for money funds. There are no specific details on any of this at 630AM New York time but details are expected some time today.
The interesting detail will be the cost. It will be enormous.
The proposal will certainly come with a host of regulations and restrictions which will radically alter the face of the financial business. The freewheeling trading style which has been in vogue over the last generation will slip off into history.
I love history, and in the grand panorama of history I think that this proposal will mark a significant punctuation point. The high water mark of American liberalism and the New Deal era was the landslide election victory of Lyndon Johnson in 1964. At the time many thought that the two party system was dead and questioned the ability of the Republican Party to survive.
It turns out that the Republican Party and conservatism rose from the ashes of that ignominious defeat and both the party and the conservative idea have thrived and prospered for most of the last 44 years.
American history moves in cycles, and I think that this imminent government action in the financial markets represents the end of that cycle and will usher in the beginning of a new cycle of active and interventionist government. In a sense, this is an act of political exorcism and the ghost of Barry Goldwater has been expelled from the living room.
Back to the bond market. There has been a rather dramatic shift in the yield curve in response to this move by the government. The yield on the benchmark 2 year note has jumped 26 basis points to 1.96 percent. Recall that at one point yesterday it traded at 1.35 percent. The yield on the 5 year note has climbed to 2.80 percent. It traded in the 2.30s yesterday. The yield on the 10 year note has climbed 9 basis points to 3.64 percent.
The price action in the Long Bond is inexplicable. It has edged higher by just 2 basis points to 4.21 percent.
This government action will require massive outlays of funds. It will not be a short term enterprise. Some of those funds will be raised out the curve, for sure.
The proposal will also bring questions about the dollar and the potential inflationary impact of this type of massive spending proposal. Against that background, it is difficult for me to understand why anyone would accept a 4.20 percent yield on a 30 year piece of paper.
The 2 year /10 year spread has narrowed to 168 basis points. Recall that following the Bank of New York Mellon announcement that one of its money funds had broken the buck that the spread gapped to 195 basis points.
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This article has 25 comments:
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phdinsuntanning
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433 Comments
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Sep 19 08:43 AM-
John Pseudonym
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232 Comments
Sep 19 09:18 AMAnyone see a problem here?
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SW Richmond
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394 Comments
Sep 19 09:44 AM-
Jackson Cash
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293 Comments
Sep 19 10:13 AMWelcome to the Divided Socialist States of America (DSSR).
Kiss your treasuries goodbye!!!
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sardinero
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2 Comments
Sep 19 10:25 AM-
buyitcheap
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435 Comments
Sep 19 10:41 AM-
CRED Buyer
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6 Comments
My Website
Sep 19 10:43 AMUnlike the RTC which held bad debts from FAILED institutions, how can the FEDs force banks to sell "illiquid" assets at some price south of PAR and not force the banks into the same need to shore up Capital??? And if they do force them to sell at a "real" discount" will the FED then inject Capital and wipe out or dilute shareholders??
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Dan Walker
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75 Comments
Sep 19 10:45 AM-
Jackson Cash
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293 Comments
Sep 19 10:45 AM-
icandoitdon
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409 Comments
Sep 19 10:55 AMthis is supposed to be "confidence-inspi... how laughable.
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Karen Consumer
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6 Comments
Sep 19 11:10 AM-
sickofthehype
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236 Comments
Sep 19 11:17 AM-
cristian
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29 Comments
Sep 19 11:23 AMSssssssssh... idle moaning about the moratorium on shorting. Most of you people are not Bubba Beerbely, come election time cough up some money, and make the pigs pay.
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Kath H.
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28 Comments
Sep 19 11:27 AMWe might as well vote for the real communist. At least then the profits are socialized too.
wyosteven: "find out who is opposing the Congressional "oversight" and donate to their campaigns!!"
The problem with this is that a candidate's position changes after election, i.e. politicians lie.
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dips
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2 Comments
Sep 19 11:32 AMOf course that has been packaged and leveraged by irresponsable institutions...but ...
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PastTense
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120 Comments
Sep 19 11:38 AMGarbage. Conservatives of 44 years ago believed in a balanced budget and a limited government. The so-called "conservatives&qu... of 2008 believe in borrow and spend (mortgaging the next generation). We have a Bush government bigger than the Clinton government.
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cristian
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29 Comments
Sep 19 11:43 AMAnd why couldn't they afford it ? Where did most of the well paying jobs go ? If someone thinks that there can be an economy based on flipping hamburgers, I pity them. Well it can, but most of us will not like the adjustments that have to be made.
Anyway this government intervention is a lame attempt to prolong the agony and save some political necks.
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JasonC
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367 Comments
Sep 19 11:46 AMUm, you do realize what that whole string of horrible multi billion dollar losses all the banks have announced over the last year was, I hope. It was them all marking down the carrying value of their mortgage assets. They've already written off $500 billion as of today, since July 2007.
Banks don't carry their investments at cost these days. They have to mark to market if there is a market, and to the nearest proxy or modeled equivalent if there isn't. Those slow about it get into trouble rapidly - see AIG. Goldman has outperformed in part because they are so religious about it - most mark to market every quarter, they do it literally every day, and well enough that 99% of anything they sell is worth what they were carrying it at or more.
The agency will pay far below face for the weaker paper. Around what it is marked to, most of the time. Some banks may need to mark stuff slightly lower to park in there, and a few might release some existing loss reserves. Once the stuff is off their sheets, though, and with the other measures supporting the money markets, they will have little difficulting raising more money themselves.
Personally I think the Fed should also conduct open market operations in corporates, arbing the current insanely wide spreads between those and treasuries. It would be profitable enough it would pay for the rest of this and then some, while also supporting the banks indirectly by lowering their overall borrowing costs. But that is a detail and the congress can consider it through next week.
As for all the doom mongering end of the world trade shorts, did you seriously think the United States and modern capitalism were just going to roll over and die because you have an ideological script and bet on it?
It has buried far larger challenges that you-lot, and it will again.
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Hal.P.
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26 Comments
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Sep 19 11:46 AM-
JasonC
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367 Comments
Sep 19 11:56 AMBut the damage was caused more by people trying to get out of the way of the damage from that than by the direct loan losses. Like, 20 times as much. Right now the issue is just to contract spreads by restoring confidence and liquidity through transaction volume.
As for those who are worried about how expensive it might be, it will work fine and will be vastly less expensive than the alternative of inaction. Which would have resulted in no banking system whatever by the end of the month. You need the financial system like you need air to breath. It occasionally needs something, too.
American finance has paid vastly more to support your middle class entitlements than the government has ever paid in support of American finance. The three largest money center banks paid more in corporate income taxes alone in just the last 3 years, than the AIG bailout, which won't be lost anyway. To say nothing of the personal income taxes of their employees, or the economic benefits of their lending, etc. This whole one-entry accounting notion that finance is some net drain on the rest of us is hopelessly wrong. It is in fact the largest engine of net real wealth creation the world has ever seen.
Fixing it will allow it to go on being such and will pay vastly more than it costs, to all of us and to the treasury in particular. The populist objections on the grounds of expense are as silly as objecting to the cost of fire extinguisher that is saving your house.
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icandoitdon
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409 Comments
Sep 19 09:06 PMit wasn't just consumers that screwed the pooch. it was greedy mortgage and investment bankers, incompetent rating agencies, asleep-at-the-switch regulators, a clueless federal reserve and legislative and executive branches of our government that cultivated the "hands-off" culture that american capitalism took advantage of.
as for the "financial system" paying for this plan, business taxes are just another operating cost...in the end, businesses don't pay taxes...their customers do. cost of capital is ALWAYS determined on an after tax basis and that's the nut that corporations strive to meet on their incremental investments.
you're one of those who got screwed jason. you just don't know it.
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carey_jim
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559 Comments
Sep 20 10:43 AMIf Obama is elected, the Democrats will be blamed when it makes things worse for everyone.
If we didn't have the electoral college, I would urge everyone to vote for McCain/Palin this fall so Republicans can finish what they've started and then take the blame for it.
But people who live in New York and California, to mention only two of the most populated states, might as well not vote for president in the coming election because each state is already decided in favor of the Democrats and therefore all their electoral college votes will go for Obama.
Why don't we consider taking back our democracy with the first demand to abolish the electoral college?
We are the only country in the world that doesn't elect a president by popular vote. Even the Soviet Union does, as far as I know.
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adan
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304 Comments
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Sep 20 01:43 PMdepending on how much of this spending actually is done, it could go much much higher (i would think)
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adan
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304 Comments
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Sep 20 01:43 PMdepending on how much of this spending actually is done, it could go much much higher (i would think)
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chrispycrunch
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23 Comments
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Sep 22 11:26 AM