PrefBlog

Bill Gross of PIMCO (whose forecast of FedFunds at 3.50% was mentioned here on October 29) has called for rough justice for the monolines:

As long as the illusion lasted, however, it is clear that monoline guarantees fostered an expansion of our modern shadow banking system and therefore an extension of US and even global economic prosperity.
…
…authorities through both official and backdoor channels now endorse a rescue effort. What is good for Ambac, they reason, is good for the country – and by extension the world.
…
As stock markets rise on optimistic workout developments, it is clear that it is – in the short run. But like General Motors a half century back, the sense of stability imparted to an oligopolistic industry with visible flaws is not likely to last, nor may the hope for a return to economic growth of recent years. The modern US financed-based economy has a striking resemblance to Barney Fife, guaranteeing global prosperity without the productive industrial-based firepower to back it up. Neither ultra-low interest rates or tax rebates, nor investor-led and authority-based monoline bailouts are likely to change that significantly during the next few years.

I’m inclined to agree with him … as far as I can tell – without specializing in such matters – the monolines are better characterized as hedge funds than anything else. Let them fail!

Treasury trading is showing increasing nervousness:

Traders drove two-year note yields to 172 basis points below 10-year rates, the widest gap since September 2004. The spread signals increasing demand for shorter-maturity debt in anticipation that interest rates will fall. Longer-dated securities are more vulnerable to speculation that rate cuts will revive the economy, spurring inflation and eroding the bonds’ fixed payments.

Two-year notes are poised for the longest stretch of weekly gains since October 1998, while 10-year notes are headed for their biggest weekly loss in almost two months. Thirty-year yields have risen this week by the most in nine weeks.

I am fearful of US inflation, but it takes two to make a market! Janet Yellen, president of the Federal Reserve Bank of San Francisco, takes the other view:

I expect core inflation to moderate over the next few years, edging down to around 1¾ percent under appropriate monetary policy. Such an outcome is broadly consistent with my interpretation of the Fed’s price stability mandate. Moreover, I believe the risks on the upside and downside are roughly balanced. First, it appears that core inflation has been pushed up somewhat by the pass-through of higher energy and food prices and by the drop in the dollar. However, recently, energy prices have turned down in response to concerns that a slowdown in the U.S. will weaken economic growth around the world, and thereby lower the demand for energy.… Another factor that could restrain inflationary pressures is the slowdown in the U.S. economy. This can be expected to create more slack in labor and goods markets, a development that typically has been associated with reduced inflation in the past.

We shall see! 

I’ve added another blog to the blogroll … Across the Curve. As with Accrued Interest, I don’t know the guy (John Jansen) and haven’t verified any of his claimed credentials … but I’ve read his posts and yes, he’s been a player.

I discussed the effect of the TAF on bank reserves – and hysterical reactions thereof – on January 29. Naked Capitalism is now republishing a UBS research note that, frankly, I don’t understand at all:

What if the Fed’s rate cuts aren’t motivated by the desire to stave off recession, rather they’re to prevent a major banking crisis. Not one of escalating subprime losses or monoline downgrades, but actually a sheer lack of cash. The Fed’s not telling anyone what it’s up to because it doesn’t want to cause panic, but the evidence is actually there in its own data…

Ok, so things might not be quite as bad as that, but the situation isn’t far off. That’s because of the TAF. ….a savvy bank can put down lesser quality paper that it can’t generally do very much with (and certainly no one else really wants it), raise funds through the TAF, then use those funds to put down as reserves, and then conveniently gets paid a modest rate of interest against those reserves (which acts as a partial offset against the TAF). While there’s a small net cost to the banks, the real loser here is the Fed, what it gets stuck with is an ever growing pile of collateral.

Now consider this – that collateral is actually what’s backing the entire US banking system by way of its conversion to dollars and then the flow of those same dollars back to the Fed….

All this changes the complex of the US banking system somewhat. From the gold standard to the subprime standard perhaps?

In the first place, there is no interest paid on reserve balances. In the second place, the monetary effect of the TAF was neutralized by the Fed’s sale of T-Bills. I note Caroline Baum’s column and say: one may take a view on the advisability of the TAF, one may take a view on capital adequacy, and one may take a view on inter-bank lending; but any hullaballoo over “negative non-borrowed reserves” is hysterical nonsense:

The writer of the e-mail directs his readers to the most recent H.3 report, which shows total reserves ($41.6 billion) less TAF credit ($50 billion) less discount window borrowings ($390 million) equals non-borrowed reserves (minus $8.8 billion). The negative number is really an accounting quirk: If banks borrow more than they need, non-borrowed reserves are a negative number.

This gentleman is overlooking the fact that the Fed is “a monopoly provider of reserves,” said Jim Glassman, senior U.S. economist at JPMorgan Chase & Co. “This is a non-starter. There is no such thing as a banking system short of reserves. The Fed has absolute control over the supply.”

[Update: See also Felix Salmon at Why Non-borrowed Reserves Don’t Matter] 

On the Better-Living-Through-More-Rules front, SEC Chairman Christopher Cox made a speech today:

Among the proposals that the Commission may consider in the spring are rules that would require credit rating agencies to make disclosures surrounding past ratings in a format that would improve the comparability of track records and promote competitive assessments of the accuracy of past ratings. In addition, the Division may propose rules aimed at enhancing investor understanding of important differences between ratings for municipal and corporate debt and for structured debt instruments.

I have also asked the Division to present proposed rules to the Commission that begin to address the significant shortcomings that we’ve identified in the municipal market. The recent financial stress on monoline insurers has heightened the importance of timely and rigorous disclosure that investors can understand. We have had ample illustration already of what happens when investors fail to look past an AAA rating to do independent analysis themselves — a problem that was exacerbated when important information was not supplied to the market in real time.

Well, I don’t have any problems with the transition analyses that the agencies currently publish, but I suppose if a standard format for these is defined it’s not horrible. I fail to see the point of the other stuff, though: “may propose rules aimed at enhancing investor understanding”; “what happens when investors fail to look past an AAA rating to do independent analysis themselves”. Seems to me these are due diligence issues, to be addressed at the SEC/Advisor level; with performance issues to be Client/Advisor.

I love the way that Mr. Cox assumes that advisors at fault in the sub-prime debacle will actually read additional information if it is available. All the rules in the world won’t make a genius out of a bad advisor.

It was a very quiet day for prefs. PerpetualDiscounts had their first down day since January 28 – they have gained 3.1% since then.

This entry was posted on Friday, February 8th, 2008 at 9:21 pm and is filed under Market Action. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.