FedUpUSA

Archive for the ‘Treasury debt’ Category

Tickerguy, Karl Denninger of the Market-Ticker and Co-Founder of FedUpUSA appeared on Neil Cavuto’s show on FoxBusiness last night with some news that most people here in the US are not even considering with regards to the disaster in Japan.

An 80% Sham Market, Zombie
Armies & Cheating Investors

by Daniel R. Amerman, CFA

Overview

About 80% of net issuance of total US Treasury and Agency debt has become an artificial market, lacking real investors, and relying on the fiction of Federal Reserve purchases with imaginary money in order to prop up prices and hold down yields.  At the same time, Treasury secretary Geithner claims to be so pleased with this non-existent market that he wants to increase the average term of Treasury borrowings.  The juxtaposition is deeply bizarre, yet passes nearly without comment in the mainstream media.  In this article we will delve beneath the façade being maintained by the government, Wall Street and the media, and will uncover the cheating of small investors in a market where most of the buyers don’t actually exist.  Finally, we will introduce the hidden opportunities within sham markets.

A “Twilight Zone” Treasury Market

When reading the financial pages, do you ever get the feeling that you’re reading the script for an episode from the old television series, “The Twilight Zone”?  Perhaps one where the normal family is inside eating dinner, getting ready to let the kids go outside and play, but what they don’t realize is that all the normal looking people they see walking past their windows are in fact zombies, and the entire town has been taken over?

I usually don’t spend too much time thinking about zombies, but this is the exact kind of feeling that I got when reading about United States Treasury Secretary Geithner’s plan to increase the duration of US treasury borrowings.  That is, he wants to take advantage of the “current low level of interest rates” to substantially increase the average term at which the Treasury borrows, so instead of an average due date of 49 months, he intends to move it out to an average of 72 months.

I first read about this in a Bloomberg article, and what brought “The Twilight Zone” to mind was that the entire article was written with a straight face, so to speak.  Reading the article, one would think we actually had a free market for US treasury debt, where demand for the debt and the interest rates on that debt were in fact being determined by investors of their own free will.  

This is where the zombie army comes in, that purported vast army of investors whose investment choices are determining current interest rates for US long-term and agency debt.  They don’t really exist.  Instead, the largest buyer of net issuances of US treasury bonds, of long-term agency debt, of mortgage-backed securities, is in fact the Federal Reserve.  (Net issuances being the excess of newly issued debt over retired debt, i.e. the net amount by which government debt is growing.)  And the Federal Reserve is effectively creating money out of thin air to buy these long-term treasuries. 

Plainly put –when one branch of the government is creating money out of nothingness to buy the debt of another branch of the government – they aren’t real buyers nor investors, but a sham.  A very dangerous sham for investors, who, based upon reading the mainstream financial media, believe the financial world is anywhere close to normalcy, and that they are getting fair returns for their investments.

The Real Source Of Funding (aka The Zombie Army)

Hedge fund analyst Jon Harooni and macro analyst Ravi Tanuku, in their article “Who Is Really Lending The U.S. All This Money?” (published in the hedge fund industry periodical Absolute Return + Alpha), track down what is actually happening, the real source of these funds.

Out of nearly $2.1 Trillion of net issuance across the Treasury, Agencies and MBS markets from June 2008-9, the Federal Reserve has accounted for nearly 40% of the total demand, buying more than every foreign government combined. It is also not a stretch to say the Fed has become the entire mortgage market; it has purchased nearly $500B of MBS securities during a period where there was only $350B issued. Looking at the first seven calendar months of 2009 yields similarly startling results: of the total $1.1 Trillion of net issuance across these markets, the Fed has purchased $861B or almost 80%.  (bold emphasis mine)

http://www.absolutereturn-alpha.com/Article/2319666/Who-is-really-lending-the-US-all-this-money.html

The reason that the Federal Reserve has been taking these unprecedented steps on a massive scale is that given the huge amount of current United States government deficits, combined with the weak economy, the vast amount of spending for bailout, stimulus and so forth, there simply aren’t enough buyers for all this debt.  Moreover, in a true free market, investors would demand a far higher interest-rate level than what they’re getting right now, if they were to continue to fund a government that is spending with neither restraint nor a credible source of funding for repayment.  In a free market, we would expect those interest rates to keep rising until they are so attractive that actual investors buy up all the debt.

If this free market scenario were to happen, the US government budget deficit would skyrocket to a far higher level, because the US government would be paying higher interest rates on its borrowing (the missing free market link that is supposed to restrain governments).  There would also be high pressure on housing markets, as mortgages became unaffordable.  So the situation is that in order to fulfill its plans, the US government needs to borrow fantastic sums of money – but the lenders simply aren’t there.  As the only alternative, the Federal Reserve effectively creates the money out of thin air to fund the rest of the government.

That is an extraordinary result, which shows just what a bizarre place the financial world has become, even as the government, media and investment firms struggle to put up a façade of normalcy.

Eighty percent of the US debt market no longer exists, in terms of net new debt issuance.  There isn’t enough demand, and increasing rates to find demand would inflict punishing damage.  So artificial “Zombie” investors are created, who buy the debt with artificial money, and the façade is maintained – at least for now.

The Systemic Cheating Of Small Investors

What is the price for individuals of buying into this façade?  Of leaving the safety of their home, and joining the Zombie army of phantasmic investors, buying at current market levels?  Whether directly, or through their mutual funds or retirement accounts?

This is not an innocent process, nor is it for the greater public good. Instead, let me suggest that it is a process that deliberately takes wealth from naïve investors, particularly individual investors who believe what they read in the mainstream media, and it transfers that wealth to both Wall Street and to the federal government. This is something that I have been writing and speaking about for a long time now (my article “Fed Manipulations Subsidize Wall Street And Cheat Investors”, addressed this subject two years ago).  So it’s been happening for quite a while, but it keeps getting worse and worse, and the idea that we’re indeed in the financial “Twilight Zone” becomes increasingly difficult to deny.

The problem with systemic government interventions is that as they grow in scale, the degree of mispricing grows greater and greater.   As any bond investor knows, for a given bond with a fixed coupon, the higher that interest rates move, the lower the price of that bond goes.  Why would anyone pay 100 cents on the dollar for a bond that pays a 3% interest rate, when there are plenty of new bonds around at 6% that can be bought at “par” (100 cents on the dollar)?  Therefore, anyone who pays full value for a new bond with a rate that is below market, is getting cheated at the moment they make their purchase.

This principle is illustrated in the graph above.  The all blue bar on the left side of the graph represents the value of 10 year US Treasury bonds with a 3.50% coupon.   If 3.50% were the real market rate (in which case Fed purchases would be unnecessary), then this bond would be worth 100 cents on the dollar.  With each bar to the right, the real interest rate shown on the bottom goes up – and the market price for 3.50% ten year bonds goes down. 

For instance, if real market rates would be 6.50% without zombie investors – the free market price would be less than 80 cents on the dollar.  Meaning current purchasers who buy into a manipulated market where the other investors don’t really exist, are getting cheated out of 20 cents on the dollar, every time their fixed income fund buys a 10 year treasury bond. 

However, keeping in mind that the US government was already effectively bankrupt before the financial crisis ever hit due to Boomer retirement obligations that can’t be paid, and the government is currently spending trillions without restraint – 6.50% would be a very low free market rate for the current situation.  If the proper market were 9.50% for the world’s largest unrepentant spendthrift – every investor is getting cheated out of about 40% of the value of their investment.

At 12.50% the true market price should be less than 50 cents on the dollar, and at 15.50%, it would be about 40 cents on the dollar.  Meaning investors are getting cheated out of 60 cents with each new bond they buy.  What the true market yield would be for the government to actually borrow “real” dollars, we can’t tell without a legitimate free market of actual investors.  But whatever the level, any individual who buys today at rates set by a market primarily made up of unreal investors, is getting cheated on a very real basis.

(It is a quite different story for institutional investors who borrow from the Fed at artificially low rates, to purchase bonds from the Treasury at somewhat higher artificially low rates, as covered in my previously mentioned article “Fed Manipulations Subsidize Wall Street And Cheat Investors”.)

Now the price of this manipulation after manipulation on top of manipulation is mispricing, mispricing, mispricing from the perspective of the average individual investor.  Believing what they’ve been hearing from the economics and financial community, and believing in what they’re reading in the mainstream financial media, these investors think that when they buy US treasury bonds they’re getting a fair rate of return on that treasury bond. They believe if they step up and buy a mortgage-backed security, they’re getting a fair rate on that mortgage backed security. And they believe if they purchase a stock with their 401(k) or IRA, they’re getting a fair price on that stock.

They’re not.  Instead, the Federal Reserve and US treasury are cheating small investors out of returns that should be theirs.  If someone buys a US treasury bond or a mortgage-backed security, the yield ought to be far higher in compensation for the risks that are involved right now with the US economy and the massive extraordinary government deficits.

The Next Step

Almost two years ago, in a series of public articles, I predicted not just financial disaster, but the process with which financial disaster would unfold. 

1. Using my professional background as a derivatives author and former investment banker, I explained why the subprime mortgage crisis would get much worse.
2. I explained the understandable, human reasons why the investment banking industry was creating enormous systemic risk with credit derivatives, and that the crisis would jump from mortgage derivatives to credit derivatives (i.e. AIG).
3. Long before September of 2008, I explained how Wall Street could melt down in a week or an afternoon, not from accounting losses, but from losing the short term funding that the heavily leveraged financial giants relied upon, as the extent of losses become clear to creditors during a derivatives market collapse.
4. I predicted that the government would not allow this meltdown to occur, but would instead engage in the largest bailout in financial history.
5. I projected that the bailout would necessarily reach a size that it could no longer be financed conventionally, and the Federal Reserve would resort to directly creating money without limits, to fund the massive bailout.
6. I explained why this would ultimately lead to the destruction of the dollar and of retirement savings through a massive bout of monetary inflation.

(All of these explanations were publicly published through contrarian websites and widely circulated on the Internet at that time.)

To my knowledge this accurate, step by step explanation of what would be happening and why, was absolutely unique – though for the sakes of all of us and of our families, it would have been much better if I had been entirely mistaken.

Unfortunately, it is very difficult to see any path out of this other than Step #6 – massive inflation that will destroy the value of the dollar, and conventional investment strategies along with it.  Indeed, it has already happened, and all that prevents a sudden spike in interest rates is the Fed’s 80% funding of the market for US and agency debt, in combination with China and Japan’s urgent economic need to prop up the dollar, manipulating its value through the purchases of US government debt.  Each source of funding creates ever growing instability, and that foreign investors are fleeing longer term agency debt is a sign that they are keenly aware that the end may be nigh.   

Your Choice:  Victim or Beneficiary

So what is an individual to do?

Let me suggest there are powerful reasons not to be taking your assets – particularly your retirement savings – and purchasing investments where we know that the value is being deliberately manipulated by the US government and Wall Street for their own purposes. To purchase under those conditions is to set yourself up for victim status.  I would argue that this applies as much to stocks as it does to Treasury Bonds.

There is another approach, which is to say that these fundamental unfairnesses, these fundamental manipulations, these fundamental mispricings by their very nature necessarily create arbitrage opportunities for individuals and institutions that know how to look for them.  Indeed, that is their very purpose – to effectively give “Free Money” to Wall Street in the form of huge profits with reduced risk, in order to rebuild firm capital – with much of those profits then passing directly into the bonus pools of the exceptionally politically well connected individuals involved. 

However, participating in these handouts is not your intended role.  From a traditional mainstream finance perspective, your role is to systematically take your savings and every month invest them in mispriced securities, for which you will pay the financial institutions an all-in average of about 2% in fees every year, even while the benefits of the mispricing pass to others.  As an individual, you cannot directly participate in Wall Street’s insider’s game, not unless you are bringing many millions to the table, and then it is still somewhat problematic whether you will end up as predator or prey.  However, in the process of manipulating markets, the government also necessarily did something else – and that was to leave the back door open. 

A mispriced market is a market that is rife with profit opportunities.  The trick being how to access these opportunities, when traditional personal finance strategies involve buying overpriced securities.   To find the back door, we have to leave the traditional personal finance strategies behind, and learn exactly how the system is being manipulated for the benefit of institutional insiders, through liability based bailouts.  When we clearly see those manipulations, then we have something else that opens up for us –  a veritable playground of opportunities for investment, indeed, some of the best we may find in our lifetimes.

But first we need to be able see these opportunities and that means we need to start with education.

This morning we got this from Bloomberg:

Retiree Annuities May Be Promoted by Obama Aides (Update2)

By Theo Francis

To contact the reporter on this story: Theo Francis in Washington at tfrancis14@bloomberg.net.

Jan. 8 (Bloomberg) — The Obama administration is weighing how the government can encourage workers to turn their savings into guaranteed income streams following a collapse in retiree accounts when the stock market plunged.

The U.S. Treasury and Labor Departments will ask for public comment as soon as next week on ways to promote the conversion of 401(k) savings and Individual Retirement Accounts into annuities or other steady payment streams, according to Assistant Labor Secretary Phyllis C. Borzi and Deputy Assistant Treasury Secretary Mark Iwry, who are spearheading the effort.

Annuities generally guarantee income until the retiree’s death, and often that of a surviving spouse as well. They are designed to protect against the risk that retirees outlive their savings, a danger made clear by market losses suffered by older Americans over the last year, David Certner, legislative counsel for AARP, said in an interview.

“There’s a real desire on a lot of people’s parts to try to encourage something other than just rolling over a lump sum, to make sure this money will actually last a lifetime,” said Certner, legislative counsel for Washington-based AARP, the biggest U.S. advocacy group for retirees.

Promoting annuities may benefit companies that provide them through employers, including ING Groep NV and Prudential Financial Inc., or sell them directly to individuals, such as American International Group Inc., the insurer that has received $182.3 billion in government aid.

Balances Fall

The average 401(k) fund balance dropped 31 percent to $47,500 at the end of March 2009 from $69,200 at the end of 2007, according to a Fidelity Investments review of 11 million accounts it manages. The Standard & Poor’s 500 Index tumbled 46 percent in that period. The average balance of the Fidelity accounts recovered to $60,700 as of last Sept. 30 as the stock market rebounded.

There is “a tremendous amount of interest in the White House” in retirement-security initiatives, Borzi, who heads the Labor Department’s Employee Benefits Security Administration, said in an interview.

In addition to annuities, the inquiry will cover other approaches to guaranteeing income, including longevity insurance that would provide an income stream for retirees living beyond a certain age, she said.

“There’s been a fair amount of discussion in the literature taking the view that perhaps there ought to be more lifetime income,” Iwry, a senior adviser to Treasury Secretary Timothy Geithner, said in an interview.

Lump Sums

“The question is how to encourage it, and whether the government can and should be helpful in that regard,” Iwry said.

While traditional defined-benefit pensions were paid out as annuities, providing monthly payments for retirees and often their spouses, workers increasingly are taking advantage of options to receive lump-sum distributions.

Only 2 percent of 401(k) plan participants convert retirement savings into an annuity on retirement, according to a July 2009 report from the Retirement Security Project, a joint venture of Georgetown University’s Public Policy Institute and the Brookings Institution in Washington.

A survey of 149 companies released on Dec. 17 by employee- benefits consultant Watson Wyatt Worldwide, now part of Arlington, Va.-based Towers Watson & Co., suggested that about 22 percent of employers with retirement savings plans offered retirees the choice between an annuity and a lump-sum distribution.

Annuity Sellers

Government success in getting workers to move retirement assets into annuities may prove profitable for insurers that sell annuities, Anne Mathias, policy research director for Washington Research Group, a policy analysis unit of Concept Capital, said in an interview.

Retirement plans, including 401(k) accounts, held $3.6 trillion in assets at the end of the second quarter of 2009, while annuity investments of all kinds totaled about $2.3 trillion, according to figures from the Washington-based Investment Company Institute, a trade association for asset managers.

The top sellers of individual annuities in the U.S. include AIG, MetLife Inc., Hartford Financial Services Group Inc., Lincoln National Corp. and New York Life Insurance Co., according to figures from the American Council of Life Insurers for 2008. The top group-annuity sellers include ING, Prudential Financial, MetLife and Manulife Financial Corp.

Under Fire

Asset managers are concerned the government may go too far in encouraging annuities, said Mike McNamee, a spokesman for the Investment Company Institute. Seven in 10 U.S. households would object to a requirement that retirees convert part of their savings into annuities, according to a survey the group released today.

“Households’ views on policy changes revealed a preference to preserve retirement account features and flexibility,” the institute said in a report.

The institute also said annuities have received support from academic research and “it is unclear why individuals usually forego the annuity option” even when it is available. The survey didn’t ask about potential efforts by the government to encourage voluntary use of annuities.

Annuity sales to individuals have come under regulatory scrutiny in recent years over the size of sales commissions and whether some varieties are suitable for older investors.

Social Security

John Brennan, the former chairman of Vanguard Group, the Valley Forge, Pennsylvania-based mutual-fund company, criticized annuities today as often expensive and offering little inflation protection. Americans already benefit from “the best annuity in the world, which is Social Security,” Brennan said in an interview on Bloomberg Television.

AARP’s Certner said policy makers could avoid many of those pitfalls by encouraging the use of group annuities, which are bought by employers rather than individuals and often carry lower fees, or using approaches that provide retirement income without commercial annuities.

Adding lifetime income to 401(k) plans won’t be sufficient for many workers because they can’t, or don’t, save enough to live on in old age, and Social Security often proves inadequate as more than a safety net, said Karen Ferguson, director of the Pension Rights Center in Washington, D.C.

Senate Bill

“It’s a great idea, but how much are people really going to get out of it?” she said. A better approach would be to give employers incentives to revive defined-benefit pensions, which have languished as employers have focused on cheaper and more flexible 401(k) plans, Ferguson said.

One proposal raised by Iwry as co-author of a paper while at the Retirement Security Project, before joining the administration, has reached Congress. A bill requiring employers to report 401(k) savings both as an account balance and as a stream of income based on an annuity was introduced on Dec. 3 by Senators Jeff Bingaman, a New Mexico Democrat, Johnny Isakson, a Georgia Republican, and Herb Kohl, a Wisconsin Democrat.

On CNBC this morning, Rick Santelli from the CME had this to say:

The floor is a bit abuzz. There is published reports out that I am getting from many of my sources about something the Obama administration is going to put towards a public comment period. This is very early in the process, but it goes something like this – avg Americans were hurt big during the big givebacks in their IRAs when the credit crisis pushed stocks down. So remember how IRAs are formulated, they are thinking of changing that and allowing more of an annuity scenario. Now if you think this thru what it means is instead of a bit of your paycheck going into equities every week, it will probably be going into things like Treasuries it would be a little bit lower return but it would be safer and this is very early but you want to pay attention to any new stories coming out about this annuity conversion they are going to put out for public comment.

Sue Herrera and Tyler Mathiesen comment about (a) isn’t this the wrong time to go into treasuries since folks coming on CNBS are saying it is, and (b) people can already put their IRA monies into Treasuries if they want.

Rick responds: The difference is that it is going to be something that is going to be more of a large scale program a very simple one and more of a conversion as well. Like I said early stages, but the range of opinions is “hey it is not a bad idea” to very cynical that we are worried about who is going to buy treasuries ad infinitum.

Rick’s a pretty sharp guy and most importantly, he tells the truth.  So, what does this all mean?  We shall translate:

US Treasury To Americans:  To Prevent Treasury Market Collapse, We Will Force YOU To Buy Treasuries In Your Retirement Accounts

The U.S. Treasury and Labor Departments will ask for public comment as soon as next week on ways to promote the conversion of 401(k) savings and Individual Retirement Accounts into annuities or other steady payment streams, according to Assistant Labor Secretary Phyllis C. Borzi and Deputy Assistant Treasury Secretary Mark Iwry, who are spearheading the effort.   Business Week

In other words, Social Security Trust Fund II.   As of last month Fund I is broke.   Summary of 2009 Annual Reports Social Security Board of Trustees    The government already stole all this money, and has not been refunding it for years.  With all the deficit expenditures heaped on top of this, which have gone exponential in the last two years, Social Security ran out of money completely last year, more than 5 years ahead of the previously projected date.  This means that retiree’s checks only go out through DAILY sales of Treasuries.  So, if they sell them to YOU, perhaps you can fund the retirees.  Heh.  Talk about a Ponzi scheme that is doomed to go the way of Bernie Madoff.

 Although this proposal will be presented shortly by the administration as being a ‘frugal choice,’ maybe even the ‘patriotic choice.’  And this will actually sound good to the people who were scrambling around in 2008 trying to find a safe-haven for their retirement accounts during the stock market sell-off.   Indeed, historically speaking,, there has never been a safer asset class in which to be invested.  The problem is, this time we aren’t talking about just a stock market (equities) crash, we’re talking about a potential crash in the Treasury market.  The reality is that there is no one left to buy Treasuries and they need YOU to fund their debt.  After all, China stopped buying Treasuries (funding our debt) in October 2009, but of course no one is talking about this. 

 Press Release:  Treasury International Capital 

 Major Foreign Holders of Treasury Securities 

You see, if they force people to buy Treasuries now, at the current price, when more and more foreigners stop buying, like China did, the price goes down as the yields (interest rate) goes up.  Thus, all the people forced to buy in here will LOSE a tremendous amount of money. 

 Expect the procedure to look something like this:

Step 1 – Make this ‘option’ available
Step 2 – Listen to crickets
Step 3 – Crash stock market
Step 4 – We’re the government and we’re here to help. All your IRA are belong to us. Or of course, you can risk it in stocks if you want.

It’s step 5 they wont’ tell you about:  Treasury market crashes, after all your money has been allocated into it.  It’s exactly like herding sheep.

At this point, anyone expecting the government to be honest about their true intentions about this proposal, or anything for that matter,  is woefully misguided.

Congress Raises Debt Ceiling By $290 Billion On December 27, Blows Through It On December 31

You just can’t make this stuff up.   DAILY TREASURY STATEMENT

On December 27th, Congress agreed to raise the debt ceiling by (a mere) $290 Billion in order to fund those, you know, pesky unfunded liabilities like Social Security and keep from officially going over the debt limit. 

Note that Treasury immediately ”issued” $316B worth of those IOUs that day, and “redeemed” $234B.  Of course, this is entirely on paper.

The “debt held by the public”, representing actual T’reasuries sold increased about $90B net.

Total Public debt now stands at $12.311 Trillion.  The official ‘ceiling’ stands at $12.254 Trillion.   Woops.

It’s also worth noting that they made a $15 Billion transfer to the Fannie and Freddie that day as well….but of course, there’s no longer any cap on the taxpayer liability for Fannie and Freddie.

Treasury uncaps credit line for Fannie, Freddie

WASHINGTON (Reuters) – The Obama administration pledged on Thursday to back beleaguered mortgage finance giants Fannie Mae and Freddie Mac no matter how big their losses may be in the next three years.

Housing Market

Treasury also said it would not require the two agencies to reduce their portfolio size next year, in a move that would allow them provide even greater support for the housing market as it begins to recover from its worst slump in decades.

The Treasury Department said it made the changes to assure markets it was fully behind both Fannie and Freddie and to give the agencies more time to reduce the size of the portfolios.

The two agencies each had a credit line of $200 billion. Combined, the two have thus far tapped about $111 billion.

Under the arrangement established under the previous administration, Treasury Secretary Timothy Geithner had until the end of this year to increase the limit without asking Congress for approval.

Treasury said it still hopes that Fannie and Freddie will reduce the size of their portfolios “in the future.” Under the newly announced rules, Fannie and Freddie will have to reduce their portfolio to $810 billion by the end of 2010 and annual increments of 10 percent thereafter.

The two agencies each hold portfolios in the high $700 billion range, officials said, meaning that they would not be forced to sell assets next year.

The 2010 reprieve was designed in part to avoid putting too much strain on the mortgage finance companies just as Treasury and the Federal Reserve were wrapping up their purchases of mortgage-related securities.

As part of Thursday’s announcement, Treasury said it was ending its mortgage-backed securities purchase program as of the end of 2009, and will have bought around $220 billion.

The Fed had previously said it would winding down its more than $1 trillion in mortgage asset buys in the spring of 2010.

The government’s hope is that private sector buyers will step in. By putting an unlimited guarantee behind Fannie and Freddie through 2012, the Obama administration hopes investors will feel more confident and will step up to fill the void left by the end of the Treasury and Fed buying programs.

Without healthy demand for mortgage-backed securities and the finance companies’ debt, mortgage interest rates would likely spike, sending a chill through the still-shaky housing market, which could derail the economic recovery.

(Reporting by Corbett B. Daly and Emily Kaiser; editing by Leslie Adler)