PrefBlog

The Congressional Budget Office released its Ten Year Outlook for the US Economy, and my-oh-my, but it’s gloomy:

Under an assumption that current laws and policies regarding federal spending and taxation remain the same,
CBO forecasts the following:

• A marked contraction in the U.S. economy in calendar year 2009, with real (inflation-adjusted) gross domestic product (GDP) falling by 2.2 percent.
• A slow recovery in 2010, with real GDP growing by only 1.5 percent.
• An unemployment rate that will exceed 9 percent early in 2010.
• A continued decline in inflation, both because energy
  prices have been falling and because inflation excluding energy and food prices—the core rate—tends to ease during and immediately after a recession; for 2009, CBO anticipates that inflation, as measured by the consumer price index for all urban consumers (CPI-U), will be only 0.1 percent.

• A drop in the national average price of a home, as measured by the Federal Housing Finance Agency’s purchase-only index, of an additional 14 percent between the third quarter of 2008 and the second quarter of 2010; the imbalance between the supply of and demand for housing persists, as reflected in unusually high vacancy rates and a low volume of housing starts.
• A decrease of more than 1 percent in real consumption in 2009, followed by moderate growth in 2010;
• the rise in unemployment, the loss of wealth, and tight consumer credit will continue to restrain consumption—although lower commodity prices will ease those effects somewhat.
• A financial system that remains strained, although some credit markets have started to improve; it is too early to determine whether the government’s actions to date have been sufficient to put the system on a path to recovery.

There is more commentary by Paul Krugman of the NYT and Menzie Chinn of Econbrowser.

And there are some straws in the wind regarding the future of US bank regulation:

The biggest U.S. banks may face the threat of lower profits or pressure to break up under greater regulation following the financial crisis.

Federal Reserve officials have made tackling the issue of firms that are too big to fail a priority. Options may include banning or restricting activities that could threaten the stability of the financial system, analysts said.

I continue to suggest that there needs to be a clear delineation of the difference between banking and investment banking. We want a rock-solid banking core, a somewhat more exciting layer of investment banking around that, surrounded by a wild-n-wooly world of hedge funds and shadow banks.

To that end, I suggest that capital rules be modified to emphasize the functionality of these layers. Banks buy-and-hold assets. Therefore, trading should attract a higher capital charge for them. Investment banks buy-and-sell assets. Therefore, aging assets should attract a higher capital charge for them. And, perhaps, hedging inefficiencies should be recognized such that a long and short hedge will attract a small, but non-zero, capital charge on the gross position.

There are indications that the CP market in the US is recovering:

Corporate borrowing in the commercial paper market expanded to the highest level since before Lehman Brothers Holdings Inc. filed for bankruptcy in September as companies took advantage of the lowest rates on record.

U.S. commercial paper outstanding rose $83.1 billion, or 4.9 percent, during the week ended Jan. 7 to a seasonally adjusted $1.76 trillion, the Federal Reserve said today in Washington. That’s the highest since the week ended Sept. 10, five days before Lehman’s filing.

Julia Dickson, OSFI Superintendent, gave a speech on regulatory pro-cyclicity, but there is not much substance to it.

Watson Wyatt has released some cheerful analysis:

Market declines caused by the global financial crisis have left the solvency of Canadian defined benefit (DB) pension plans at historical lows and defined contribution (DC) plan members with shrinking retirement savings, according to an analysis by Watson Wyatt Worldwide, a leading global consulting firm.

The pension solvency funded ratio (the ratio of market value of plan assets to plan solvency liabilities) of the typical pension plan declined 27 percentage points in 2008, dropping from 96 percent at the beginning of the year to 69 percent at year-end. Watson Wyatt’s Pension Barometer, which reflects the combined impact of investment performance and interest rates on the solvency funded ratio of a typical Canadian pension plan, indicates that the funded status of the typical pension plan decreased 11 percentage points in the fourth quarter alone.

PerpetualDiscounts managed to stagger to another gain today, with some evidence that the market is becoming a little (just a little!) less sloppy. To my surprise, Fixed-Resets also did very well.

I’m almost finished fiddling with the format of the performance table, and am about to commence fiddling with the volume table. Once I’m happy with the machine-generated tables, I’ll be adding the occasional comment, as I did way back in 2008. Assiduous Readers will have no idea how happy I am that the drudgery of table preparation is now computerized …

There is speculation that huge issuance may saturate the market for government bonds in the UK. Reception of a €6-billion issue of 10-year Bunds was sufficiently poor that the auction is being labelled a failure:

Germany’s sale of 10-year bunds lured the least demand in six months as investors shied away from a flood of government securities.

Investors bid for 5.2 billion euros of the bonds offered today, a level of demand that prompted the Bundesbank to retain 32 percent of the securities, according to the central bank’s Web site.

The press release tells the tale. A momentary blip? Or a sign of a turn in the tide from the flight-to-safety? Across the Curve notes “flight from risk-averse assets” and a tightening of credit spreads. Place yer bets, gents!

The Fed announced today that the Money Market Investor Funding Facility is being expanded:

the set of institutions eligible to participate in the MMIFF was expanded from U.S. money market mutual funds to also include a number of other money market investors. The newly eligible participants include U.S.-based securities-lending cash-collateral reinvestment funds, portfolios, and accounts (securities lenders); and U.S.-based investment funds that operate in a manner similar to money market mutual funds, such as certain local government investment pools, common trust funds, and collective investment funds.
…
the Board authorized the adjustment of several of the economic parameters of the MMIFF, including the minimum yield on assets eligible to be sold to the MMIFF, to enable the program to remain a viable source of backup liquidity for money market investors even at very low levels of money market interest rates
…
The MMIFF is designed to serve as a source of liquidity to money market mutual funds and other eligible money market investment vehicles, thereby increasing their ability to meet redemption requests and their willingness to invest in money market instruments, particularly term money market instruments. Under the MMIFF, the Federal Reserve Bank of New York provides a credit facility to a series of special purpose vehicles (SPVs) established by the private sector. The SPVs will purchase certain U.S. dollar-denominated, highly rated, short-term certificates of deposit, bank notes, and commercial paper from eligible money market investors

Speaking of the US, Across the Curve has some interesting colour today:

I had an interesting conversation with a relative value trader in the Treasury market. He loves the 2 year note at 80 basis points. With a zero handle, they would seem like an instrument which should have step child status.

However, he notes that with the ride down the yield curve and the positive carry from financing them at virtually zero, it is as if you own them at 1.75 percent one year from now.

That is the breakeven on a one year coupon. He makes the valid point that for that 1.75 percent to lose money one would need to posit a funds rate close to one percent. Given the tenor of comments from the central Bank, that does not seem likely.

Wild. Riding the yield curve from a 80bp starting point at a time when Treasury auction issuance is at record levels and there is fear of auction failures. This situation is not sustainable.

There’s an interesting development in US distressed mortgages:

Private National Mortgage Acceptance Company LLC, an investor in troubled mortgages run by a former president of Countrywide Financial Corp., bought $558 million of home loans that the Federal Deposit Insurance Corp. acquired last year after First National Bank of Nevada collapsed.

Known as PennyMac and led by Stanford Kurland, the firm is paying an average of 30 cents to 50 cents on the dollar for the loans and the FDIC is sharing some of the risk, spokesman Andrew Chang said.
…
“This asset sale did not provide any loss-sharing,” said FDIC spokesman David Barr in an interview about the PennyMac deal. “It is a participation sale, however, which means the FDIC benefits from cash-flow generated from these loans.”

The FDIC will receive 80 percent of the loan’s cash flow until a certain, undisclosed level of payments are received, then 60 percent thereafter, he said.

David Barr’s comments are disingenuous. “Participation” is equivalent to “Loss Sharing” – full stop.

PerpetualDiscounts managed to eke out another gain today – and, much to my surprise, so did fixed-resets! I would have thought that continued issuance would have pounded down the sector, but it is showing significant resilience. And I still have to fiddle with the damn programming of the damn tables.