Monday, February 23, 2009

Our Arrows will Block out the Sun!

I'm fond of using the title of this post when exorting them to ever greater feats of internet marketing -- hey, what kind of marketer would i be if i couldn't even sell my own troops on hyperbole! :)

But, lately I've been talking about another kind of overwhelming force in the money markets. The specter of "government guaranteed" money is rising to such great quantities as to effectively crowd most other forms of debt out of the financial markets.

What do I mean by this?

Well, in the first phase of the "crisis" people were worried about getting a return OF capital. The answer (of course, said the financial cognescenti) was to just guarantee it. What? Apparently, nearly everything.

Well, the knock on effect of this is that coupled with a global deflationary collapse, funding needs for govts rising everywhere, and more and more crap getting "government guarantees" that anything withOUT a govt guarantee is more and more expensive to fund. During the "freeze" this fall it got nearly ridiculous with wireless carriers reportedly paying more than 25% for short term corporate borrowings (fortune 500 companies NOT involved in banking).

Well, clearly, govt guarantees on money are a "bubble". And, it will work really well, until it doesn't. What's the solution to things costing too much to fund without a govt guarantee? Why of course, guarantee that too!

Credit card debt, school debt, commercial real estate, commercial paper, etc etc etc etc. Of course, when it does break now, we can be assured of having all many of commerce grind to an immediate halt. No problem though, almost all food and energy is locally grown/produced and consumed right? What? You say those things are delivered to customers at the end of long international supply chains that depend on shipping and the free flow of commerce and credit to ensure payments for delivery of goods???? ooops. nevermind.

To wit, here is a story about the chinese wising up to the game. I blogged about this a couple of years ago, saying that anyone investing in mortgage products for hundredths of a point over treasuries was an IDIOT given the risk they were assuming. hey, if they really weren't assuming any more risk were they really idiots? (assuming a govt guarantee to backstop all losses). and, on the other hand, if the govt guarantees fannie/freddie can they really sell the treasuries they'll need to to continue to run the govt? me thinks not.
Feb. 20 (Bloomberg) -- Asian investors won’t buy debt and mortgage-backed securities from Fannie Mae and Freddie Mac until they carry explicit U.S. guarantees, similar to those given on bonds issued by Bank of America Corp. or Citigroup Inc.

The risks are too great without a pledge that the U.S. will repay the debt no matter what, according to Hideo Shimomura, chief fund investor in Tokyo for Mitsubishi UFJ Asset Management Co., and other bondholders and analysts in Japan, China and South Korea interviewed by Bloomberg. Overseas resistance may hamper U.S. efforts to hold down home-loan rates and shore up the nation’s largest mortgage-finance companies.

Even after President Barack Obama vowed on Feb. 18 to sink as much as $400 billion of capital into Fannie Mae and Freddie Mac, double the original commitment, “there is still a concern that there is no guarantee” from the government, said Shimomura, who oversees $4 billion in non-yen bonds for the arm of Japan’s largest bank.

“Looking at the risk, they’re not so attractive,” he said. “We need a guarantee before we’ll buy.”

Foreign investors sold $170 billion of agency debt and securities in the second half of 2008, the largest amount since the Treasury began tracking sales in 1977, according to the most recent data. Asians, the biggest non-U.S. block of owners in the category, unloaded $70 billion worth from July through December, after scooping up $55 billion in the second quarter and being net buyers during much of the last decade.

Lack of Confidence

The sell-off and calls for a guarantee reflect a continuing lack of confidence among foreign investors five months after the U.S. seized control of Fannie Mae and Freddie Mac. The takeovers followed the biggest surge in mortgage defaults in three decades.

Without restoring foreign demand, Federal Reserve Chairman Ben S. Bernanke will find it more difficult to cut rates on housing loans, which depend on the ability of the finance companies to attract investors for their securities at the lowest possible yield. Fannie and Freddie sell debt to fund their purchases of mortgage assets and also guarantee home-loan bonds sold by lenders.

The Fed, which promised to buy as much as $100 billion of Fannie Mae, Freddie Mac and Federal Home Loan Bank corporate debt, may need to spend more, according to Margaret Kerins, an agency-debt strategist at RBS Greenwich Capital in Greenwich, Connecticut.

Buying Programs

The central bank last month indicated that it may increase this buying program as well as a second $500 billion one for mortgage-bond purchases. The Treasury has bought $94.2 billion worth of mortgage bonds under its own continuing program.

“You’d be back to the situation that prompted them to act” if the purchases of Fannie and Freddie debt were discontinued before foreign investors return, Kerins said. The agency-debt market has recently improved as the “crowding out effect” from sales of government-guaranteed bank debt has proven less than expected, something that may lessen the need for government buying, she added.

The Fed’s buying program resulted in a yield of 2.06 percent on Fannie Mae notes maturing May 2012 at the close of trading Feb. 18 -- 0.15 percentage point less than government-guaranteed Bank of America bonds maturing a month later and 0.12 percentage point less than similar Goldman Sachs Group Inc. debt, according to RBS Greenwich data.

Yield Spreads

Yield gaps between Fannie Mae’s 10-year debt and Treasuries have narrowed from the record of 1.75 percentage point set in November, after countries worldwide announced plans to back bank bonds and offer buyers more federal guarantees. At 0.64 percentage point, it is now 0.27 percentage point above what the spread averaged in 2006, according to data compiled by Bloomberg.

The average 30-year fixed mortgage rate fell to a record low of 4.96 percent last month from 6.47 percent in the last week of October, according to Freddie Mac surveys. It rose to 5.04 percent during the week ended yesterday.

Fannie Mae, based in Washington, and Freddie Mac, in McLean, Virginia, have about $1.7 trillion of corporate debt outstanding and $3.7 trillion of their guaranteed mortgage-backed securities held by other investors. The two mortgage companies finance almost half of the $12 trillion of residential loans outstanding.

The government-run conservatorship won’t end until the mortgage market recovers and the companies regain profitability, Federal Housing Finance Agency Director James Lockhart said yesterday on Bloomberg Television. He took charge of Fannie and Freddie last September and describes the companies’ U.S. backing as “effective,” though not “explicit.”

‘Full-Faith’ Guarantee

That’s not enough for foreign investors these days, said Laurie Goodman, a senior managing director at Austin, Texas-based Amherst Securities Group LP. Goodman was a former head of fixed- income research at UBS AG.

“Overseas investors are looking for the full-faith-and- credit clarification,” Goodman said. Such a pledge would essentially about double the U.S.’s debt, potentially boosting the country’s own borrowing costs.

“The U.S. government is worried about the agency market, and market participants feel the same way,” said Kei Katayama, head of the foreign fixed-income group in Tokyo at Daiwa SB Investments Ltd., who oversees $1.6 billion of non-yen bonds for the arm of Japan’s second-biggest brokerage.

Katayama sold all of his agency debt on Sept. 16, the day after Lehman Brothers Holdings Inc. filed the biggest bankruptcy ever, taking it as a sign to get out of riskier assets, he said.

Difficult to Sell

The bonds also have been difficult to sell after credit markets froze last year, according to Jaemin Cheong, who trades U.S. securities in Seoul at Industrial Bank of Korea, South Korea’s biggest lender to small and mid-size companies. He said he won’t touch them.

Sellers in the fourth quarter included Caribbean-based investors, often hedge funds, which dumped a net $35.8 billion of the agency debt and securities after buying $15.7 billion in September. China sold $10.4 billion in the period after unloading $8 billion in September, while South Korea got rid of $10.5 billion.

“China’s demand for U.S. agency bonds will gradually decrease because China has drawn lessons from the credit crisis and learned to invest smarter,” said Yi Xianrong, a researcher at the Beijing-based financial research institute of the Chinese Academy of Social Sciences, which advises the government. “We will try to stay away from these types of bonds.”

Freddie Mac Treasurer

Freddie Mac Treasurer Peter Federico connects the sales to certain institutions and doesn’t think it is part of “a broader liquidation,” although “it kind of felt like that for a couple of weeks or months later in the year.

“There are a couple of institutions who continue to sell agency debt,” he said in a Feb. 18 telephone interview. “I think their reasoning for doing that is not related to their comfort with our credit. It’s their own monetary-management and currency-related issues. Apart from those institutions, I don’t believe there is a lot of demand to sell going forward.”

Federico spoke after the company completed a record $10 billion, three-year note sale at yields of 2.24 percent, or 0.02 percent more than JPMorgan Chase & Co. offered in a sale of government-guaranteed, three-year debt of the same size.

Asian investors bought 12 percent of this week’s sale, and North American investors purchased 72 percent, according to the company.

More U.S. Buyers

The U.S. share was high in comparison to recent years, “but it’s very consistent with what we’ve seen over the last six months, where the U.S. domestic investor who probably understands the conservatorship status better than foreign investors has really been supporting the market in a big way,” said Drew Ertman, head of financial-institutions debt coverage at Morgan Stanley, one of the underwriters.

Amy Bonitatibus, a Fannie Mae spokeswoman, declined to comment.

Sales of agency debt and securities may be more closely tied to the availability of better returns in corporate bonds than a lack of faith among investors, according to Andrew Harding, chief investment officer for fixed income at Allegiant Asset Management in Cleveland. Those include bank debt with explicit U.S. guarantees offering higher yields, he said.

“I don’t think the credit quality or housing market has precluded people from buying agency debt right now,” said Harding, who helps manage $20 billion for Allegiant. “There are just more attractive alternatives.”

Fukoku Mutual Life Insurance Co. spent last year trimming “risky assets,” and it sold all agency holdings in the third quarter, said Satoshi Okumoto, general manager at the company in Tokyo, which has $63.5 billion in assets.

“It’s not really the same credit” as government debt, Okumoto said. “It’s one step below.”


Carolina said...

What is going on in Uruguay, economywise?

My husband and I are thinking of moving there in the next 5 years or so ---of course, things may change in that time, but I am interested in how things are going there now. We thought we were doing extremely well financially ---but, oops! down went the 401k and IRAs. We are retired, but haven't need to tap into them ---yet.

I visited Uruguay when I lived in Brazil. We are hoping for the "adventure" of living elsewhere, and we are looking for milder winters and a lower cost of living.

fuBarrio said...

hmmm...well, look at it this way. in another 5 years, living in the US could be an "adventure", or like "living elsewhere" :)

UY hasn't been slammed...yet...but there is a lot less personal debt here so there is not nearly as far for UY to fall.

Regardless, they still thrive on beef exports, some soybean and other ag, banking and tourism. None of these (even beef as we've seen) is completely immune from global economic fubars.

Sorry about your 201k's, er, I mean 401k's. it's a very very treacherous time to be in the markets, obviously.

I had a similar experience back in the tech wreck (2000-ish). Fortunately, I was younger back then (obviously) and the dear experience made this latest bubble incredibly easy to identify...back when people were still arguing with me that california real estate only goes up (lol).

Good luck to you.

Mark said...

Fubarrio -- I'm very happy to have found your blog. My wife and I are currently living and working in China, but are very close to "going China crazy" (something that seems to be an inevitable fate for expats here) and are looking for a place in South America to live and work. With all due respect (and a little trepidation) to your description of Uruguayan winter (sounds a lot like winter here in Chengdu), we're still interested in Uruguay. The major problem we've been having is that there's not a lot of Uruguay presence online. I realize you're probably a busier man than I am, but, if you have the time and-or patience, I'd appreciate it if you could answer a couple of questions:

Is there currently a market for English as Second language teachers in Uruguay? That's what we do here in China, together making more or less $1000 US per month and living in modest comfort, sometimes even saving a little.

If there is a market, do we need to jump through visa hoops or is there a chance we could get a job with a language school on a tourist visa, by knocking on doors?

I know ESL isn't what you do, but if you know anything or anybody, such information would be a fantastic help in making our decisions for the coming (Northern hemisphere) summer.


Mark Hossfeld

PS -- My econogenius wife thinks your crisis analysis is dead on (Feb. 23rd post).