Friday, October 03, 2008

We feared the worst

The question is, of course, now what? First, what’s happening in the bond market.

Treasury bonds, which were down around ½ point all day are now flat. I am very surprised, as it seems like the most obvious impact of the TARP is that Treasury issuance will rise significantly. I do not like the Treasury market here at all. I am also surprised the dollar remained stronger. For what its worth, I'm not shocked the stock market sold off.

Credit spreads, at least in CDS, were mixed. Goldman, GE Capital, American Express, all about 40bps tighter. Interestingly Merrill Lynch is about 30bps tighter while Bank of America is unchanged, indicating an increasing odds on the merger being completed. Currently BofA is around +165 and Merrill is around +400, so there is plenty of room there. The CDX was 2bps wider.

Citi and Wells Fargo both a little wider. I would bet on Citigroup prevailing in the Wachovia thing. Citigroup has apparently been the only thing standing between here and a run on Wachovia since Monday. I think the FDIC wants to reward banks who are “first responders” on failed banks. Allowing Wells Fargo to step in now would create a bad precedent. The FDIC does not want to see other banks hesitate to step in to buy deposits in future bank failures.

Swap spreads were also tighter. 2-year swaps were 13bps tighter, while 10-year swaps were 5 tighter. I do not know exactly what to make of it, but the 13bps move in 2-year swaps is consistent with recent volatility, but the 10-year is an outsized move.

Agency spreads moved in context of swaps. MBS spreads were unchanged after being significantly tighter through most of the day. Still like MBS and agencies over corporates here.

Fed funds futures have now priced 100% chance of either a 50bps or 75bps cut at the October meeting. I think other liquidity measures, like extending liquidity to ABCP or some such, would be more effective. But I’m not going to fight the Fed if they want to cut. The play is to bet on the curve steepening and dollar weakening.

I am remaining defensive in credit. I would say I am closer to buying finance paper than industrial paper, though not buying either at the moment. The bailout and all the Fed’s liquidity measures are much more likely to help large financials to survive, but nothing is going to stop the coming recession. But I need to see some better trading volume before even considering any corporate bond trade here.

9 comments:

Doug said...

What do you think of California's inability to raise $7 billion? I mean what's up with that? Heck, Arnold, float an offering of short-term bonds and I'll be glad to pony up some bucks.

Rajesh said...

The Treasury may issue a lot of debt, but banks are lapping it up like gravy. Probably the only good thing about the Paulson "rescue" is that it is going to provide a lot of collateral for banks to hold in case they need to borrow from the central banks. Clearly foreign banks have a lot of dollar liabilities that they want to offset with ultra-safe dollar assets. This is pulling the dollar up against the Euro.

DJ said...
This comment has been removed by the author.
DJ said...

So, your wall st folks are merrily going back to your old ways.
Congratulations!
I am so glad my tax dollar is put to good use.
You feared the worst? Well, you surely deserve the worst.

Mako said...

DJ -

While everyone speaks of the "tax payer" - this is a misnomer; no one (that I know of) is talking about a tax increase or spending cuts (maybe McCain's "freeze"?) in order to fund this.

This is a printing press operation pure and simple. The Fed seems unwilling to openly monetize these assets, so is letting the Treasury do it in its stead.

Personally do have some problems with the bail out, the way it`s structured does not seem, to me, to get at the heart of the issue, which is that asset prices are all topped out and need to go down.

The other problem is that US Treasury is not really able to handle this situation. If the Fed did not exist, it would have taken out all of Wall Street in a little over a year. Treasury is not the invincible Treasury of yesteryear and would not be able to deal with this, nor will Main Street as problems continue.

Too bad, but I think deserving or not, we are all going to see the "worst" of this.

CrossProfit said...

"more likely to help large financials survive"

This is almost like saying how the $700B bailout will somehow help main street.

Asian markets are taking a dive and this could well be an indicator for U.S. markets this coming week.

The Market realizes that over 50% of the $700B will eventually go to buying back 'bad dollars with good dollars' from overseas banks and institutions. These CDO and CDS holders are none U.S. investors that are being bailed out with U.S. tax dollars.

The bottom line is that in one fell swoop we have increased our trade deficit by at least $350B. This is what happens when you bail out non U.S. investors. The chain reaction is that asset values at home go down and then these same institutions, now armed with 'good dollars', come back and buy U.S. assets at depressed prices.

Essentially, Paulson has sold out to the European banks, though few actually make the connection. This is his way of making good on his promises to the European investors that bought the CDO's and CDS's while he was at GS. I find it unbelievable that I am the only one connecting the dots. I haven't seen anyone else write about this. If you have, please leave a comment with a link.

Some estimates put the NON U.S. holding positions at around 80% of all outstanding debt, meaning that as much as 80% of the $700B will end up going to overseas investors. To date, I have no way of assessing the estimates as banks (such as CS) have not disclosed their holdings.

Let's keep a cool head about this and scrutinize every deal that Paulson makes using the $700B. Assuming the above is the entire game plan (perhaps there are a few twists yet to be unveiled), we can still mitigate the damage. Gaining press coverage and traction by calling the foul when it becomes more transparent is the key.

At first I didn't think that Paulson would do such a 'criminal act' (harsh, but this is how I now see it). The deceit is almost perfect, however, if he tries to purchase the "bad overseas dollars" directly, it will become too obvious. The CDO's and CDS's will have to be transfered from a European investor back home to a U.S. holder and then sold / swapped with Paulson.

One thing that we (the public) have going for us is that being that these are public funds as opposed to private money (publicly held corporations would be categorized as private as well), we can demand full disclosure. We will probably have to fight (injunctions, class action etc.) for Paulson to comply. Naturally, the information should be made public as a matter of proper procedure. Don't hold your breath! I can tell you now, this is not going to be the case. Paulson has already announced that he is creating another level of opacity, calling in private companies to manage the 'disbursements', that will slow down the disclosure process.

If it turns out otherwise and I totally misread the sequence of events, I apologize.

Saul C. Sterman
CEO
CrossProfit

Thai said...

Now what about at least admitting that we uber bears were not so wacko after all?

It seems to me the bailout is little more than rearranging deck chairs on the Titanic. It does nothing to solve the underlying total debt (household + business + state + federal) problem and to the extent more money is diverted to unproductive endeavors, it will actually harm the economy.

On the other hand IT WILL hamper the ability of the government to borrow funds in the future when people are in trouble.

In fact the only way I can really see one ascribing to the bailout is IF one were to subscribe to the idea that increasing federal debt is a kind of ’starve the beast’ agenda designed to ultimately force fiscal discipline by pushing the US government closer to a default ‘end game’…. I realize some fiscal conservatives believe this; I reject the approach as immoral.

Notice that the CBO’s own projections suggest we are accelerating towards this ‘end game’ of US federal insolvency faster and faster. (The Federal Reserve has already said we are moving towards insolvency fast– not even including the unfunded $55 Trillion Medicare liability) And then realize these projections are based on the overly rosy assumption that federal tax receipts will continue to increase- an assumption I think everyone can agree is wildly optimistic at best (California is learning this fallacy right now).

FYI- even if the US stops ALL activities in Iraq and Afghanistan tomorrow (est. annual savings $185-200 billion/year), the US government will still run a deficit… I suspect our deficits will be MUCH larger than these projections with dropping tax receipts from increasing unemployment/falling asset prices and increasing entitlement spending.

Personally, I think we have passed the tipping point and after the US dollar carry trade unwinds, foreigners will increasingly realize that the US population is politically unable to make the tough rationing choices needed to prevent a cross boarder capital flight- California’s inability to reach a budget compromise is but one example of what I think will increasingly be played out all over the country… remember American foreign borrowing as a % of GDP is likely to INCREASE if we do not make tough choices soon.

And if we do not cut unproductive uses of capital and unproductive uses of tax revenues (the combined state, local and federal government represent almost 50% of all economic activity in America), but instead continue to focus tax dollars on preventing human suffering- at first interest rates will increase as we try to persuade foreigners to lend us money (of course this will further contract the economy as productive capital is crowded out for unproductive ‘compassionate’ capital) but eventually, our dollar will collapse. And when that happens, our suffering will be just like Argentina’s in 2001.

We can pay now or pay later but (imo) either way we will pay.

ilexpert said...

hey,Am not too sure Citi will have it easy in the Wachovia thingy; Think that Coz Wells fargo has made an offer without seeking (implicit) credit enhancements from the fed/treasury ( more generally, the Government) re Wachovia, as a natural extension of the "least cost" approach that FDIC is mandated to take, Wells fargo should be the White Knight. Presently the injunction still holds though but I will punt on the Spread on CITI gettin wider going forward!

ilexpert said...

But I agree with you... might as well buy Financial paper than Industrial and get a hedge against recession...The Survivors are " Too Big To Fail" and there is no way the Treasury and the Fed are going to let them go belly up!