FedUpUSA

Archive for the ‘ZIRP’ Category

I thought Seniors were the “third rail” of American politics?

When are they going to rise up and de-throne this clown-car brigade?

Watch this clip folks, and pay particular attention to how you, the Seniors and those on Fixed Incomes are dismissed as unimportant by The Federal Reserve.

Really.

The Market-Ticker

I hope you’re ready.

This, incidentally, is one of the items in my Year End Ticker due out in a few days.

The Chinese raised rates over the holiday, and their market sold off to the tune of 2%, after being reasonably-stable in early trade.  The futures this morning are down fractionally, with Europe getting hit a bit.  A foot of snow isn’t bringing people into work on the East Coast, of course, which will certainly mute trade some today during a week that is usually very light in volume to begin with.

The fatal error that Bernanke has committed is about to become clear: ZIRP can only “work” in a world where the entire world is ZIRP, or close to it.  If it’s not then you get capital flight.  Japan found this out the hard way and became a funding currency for a “Carry Trade”, but they had a huge buffer in the form of personal savings.  That’s now gone, and yet they have been unable to exit their zero interest policy, and in fact have continued to “buy” (monetize) various “financial assets” in a futile and desperate effort to “normalize” their economy.

Ultimately lawmakers and citizens may figure it out: ZIRP, and indeed all of Fed Policy for the last three years, has had nothing whatsoever to do with the general economy or the common weal of our nation, and has been focused on only one point – attempting to prevent recognition of the insolvency of virtually every large financial institution in The United States.

Incidentally, for those who think I’m nuts, it is a matter of record that the same thing happened under Volcker – and he explicitly told the big banks (especially Citi) that he’d let them lie – for a while.  But he also told them that if they didn’t clean up their crap that he’d eventually run out of the ability (or willingness in Congress and elsewhere) to do that, and if he did before they cleaned up their act they’d be toast.  They did, and he did, and the deception remained “hidden” for more than a decade.

Today it’s different.  The banks have been given no timeline to clean up their crap.  Instead Bernanke has engaged in the most-outrageous action of any central banker in the last 100 years and perhaps of all time, literally monetizing more than two trillion dollars of government debt as a means of trying to keep the grand Ponzi Scheme alive.

He will fail.  He must fail for one reason above all others – the banks have refused to take down their leverage and sell off their crap.  Instead they have gone back to their old compensation metrics, paid out over $100 billion in bonuses and wages in the last year, and have extorted Congress and FASB to make legal intentionally-bogus marks on assets that have no relationship to their current value (or any reasonable expectation of future value!)

Tom Coburn has raised the spectre of what he claims is a “8-9% decline in GDP” if we “don’t tackle our unsustainable fiscal situation.”  Uh huh.

Tom ought to pay attention to this:

-8% GDP eh?  We’ve been running that now cumulatively for three years on, faking economic “growth” via debt issuance (just like whipping out the credit card after losing one’s job) and there is no sign that the government intends to stop it.

8-10%?  You’re insane Tom.  There’s a nearly 30% embedded GDP distortion in the system right now!  I warned of this back in 2007 but then, of course, nobody wanted to hear it.  Nobody still wanted to hear it in 2008, or 2009.  No, we were too concerned about making damn sure that a handful of rapacious banksters that, I’d argue, should all be in the dock facing multiple felonies got to keep not only their past “bonuses” but also (and far worse) got to keep up with their BS games!

The record in this regard in terms of the facts, and that I’ve been publishing them for the last three years, is clear.  And no, Tom, we don’t have “three or four years” to deal with it – we’re already in the hole 30% in terms of where our GDP needs to contract to in order to come into balance with our actual productive output, and if we don’t cut this crap out now we’re not going to face 18% unemployment and a 10% contraction in GDP, we’re going to face an economic collapse with “official” unemployment north of 20%, U6 north of 30% and we’ll be lucky if our economic and political system do not fail outright.

Cut the crap Tom.  The forced choices are here now, not three or four years out.

We’re able to choose serious pain (as opposed to collapse) today. 

In three or four years, that choice will have expired.

Again, I must say……

The same principal has left the nation’s public and private pension funds badly underfunded.

“We are actually more underfunded than we were at the end of 2008 because of the drop in interest rates since then,” said John Ehrhardt, who tracks fund performance for benefits consultant Milliman.

That “same principal” is The Fed’s ZIRP policy.

By picking winners – in this case the banks who made imprudent loans and should have been forced out of business, along with “protecting” the imprudent buyers of bonds in institutions that made those imprudent loans, the prudent are getting hammered.

There is no solution to this other than to stop doing that.  And this means withdrawing liquidity and forcing the borrowing of money to have a reasonable cost, so that those who lend money through the purchase of bonds can earn a reasonable inflation-adjusted return.

The initial “impact” of low interest rates appears seductively good.  It’s not – it’s always bad.  It forces people to take imprudent risks (how do you think we got a housing bubble in the first place?) and destroys the prudent investor, lender of capital and saver.

As these people are eviscerated their ability to contribute positively to the economy is likewise destroyed, and in particular, capital formation is critically damaged.

This is the real story on how Japan lost two decades. 

We will follow them unless we stop this insanity, and soon.

(PS: Are the unions still sheep on this issue, more than two years after I started sounding this alarm?)

The Market-Ticker

The zero interest rate policy (ZIRP) will kill the banks. Falling interest rates help banks by increasing the value of their bond and loan portfolios. This is the well understood inverse relationship between discount rate and present value of a future sum. But you see keeping interest rates at zero does virtually nothing for the banks as rates cannot fall further. There is a short window where ZIRP is a positive but an “extended period” (in Fedspeak) is just slow death for the banks.

During that short period, the banks are still collecting on portfolios constructed when rates were higher but as those higher-yielding assets mature, there is nothing comparable to replace them. We hear constantly how banks can just borrow at zero and invest in Treasuries – pocketing the difference. That would be fine if yields on Treasury debt were not low and falling along with everything else. The other problem is that this simplistic formula assumes that banks’ operating expenses are negligible. Both unstated assumptions fail any sort of reality check.

Back in the real world, T-bills yield virtually nothing. The 2-year note is now at 50 basis points as of today. The 5-year is at 1.43% and the 10-year at 2.68%. Assuming zero borrowing cost (which is overly generous), net interest is equal to gross interest. Large banks generally require a net interest spread of more than 2% to cover their expenses, so they will lose money even buying 5-year Treasuries. If they invest their entire portfolio in 10-year notes, they’ll make about a 50 basis point spread on assets pre-tax. But the 10 years is a lot of risk in terms of time for rates to change and also a long time to tie up the money. And banks care BARELY eke out a profit by taking this extreme level of maturity risk. There is a reason why you never see loan portfolios with 10 year average maturities.

For those advocates who think banks can rebuild their balance sheets by buying Treasuries, you might ultimately be correct but there are so many things that can go wrong with that scenario. First consider the size of the hole in bank balance sheets. Recent activity at the FDIC suggests that many troubled banks are overstating the value of their assets by 30% or more – that is the average size of the hit when the FDIC takes them over. At a rebuild rate of 50 basis points annually (with a lot of risk) it would take a literal lifetime to repair the balance sheets via this strategy. It was much easier in the early 1990s when rates for the 10-year started at 9% and never went below 5.5%. There was plenty of room to generate capital gains on bank bond portfolios wit falling rates and still leave a reasonable current yield at the end. Anybody using that era as a template for bank recovery is going to be sorely disappointed. Does anybody still wonder why Japan is trapped despite 20 years of ZIRP?

All of this assumes that ZIRP is sustainable over decades and that the financial system is sufficiently stable to endure the pressure over the long term. Neither one is proven and the ability to fund the debt implied by ZIRP is particularly shaky. If it works, it will take 60 years As one one of our favorite bloggers Karl Denninger says “the math is never wrong.”

JengaFinance