10-Yr+ US Treasury and Canada Yields Falling

Monday, December 1st, 2008

During the December 1st liquidation of stocks, the yield on 10-Yr. US treasury securities fell to 2.81%, a level not seen since 1954. Incidentally, during the 1935-1955 period, the yield on these was at levels far below current levels, this being the period following the collapse of the US financial market post circa 1929.

With the bond market rallying in the longer durations, its hard to NOT see how this plays right into the hands of the US government’s needs for long-term funds to pay for a trillion-dollar war and a trillion-dollar plus bailout, not to mention just staying in business.

Bloomberg says: Yields on two-, 10- and 30-year debt dropped to levels not seen since the U.S. began regular sales of the securities after Federal Reserve Chairman Ben S. Bernanke said the central bank may purchase Treasuries and target long-term interest rates to combat the deepening recession.

Which once again begs the question:

What incentive does the US Government have for reviving the equity market, except to levels which keep some hope alive? Not much, right now.

With investors being crowded out of equity markets by continuing volatility and losses surmounting from deleveraging, it should eventually be a snap for Washington to amortize very sizable short term obligations by selling bonds to fleeing investors. Bernanke is merely pointing out the obvious in a roundabout way.

Debt is the new equity. Why would you bet against the Fed? This is the direction they have been moving us in, deliberately.

Canada Long Bond Yields Falling

By the way, the 30-year Canada rates fell from 3.97% last week, to 3.76% today, in the face of the 9% drop in the TSX. Until 5 months ago, the Canadian economy was bolstered nicely by rich commodities prices. Now that commodities prices have fallen sharply and fairly quickly, Canadian investors haven’t yet adjusted to the reality that Canada is in recession too, and given that, it is likely the long-term Canada yields will fall. Our three key industries are now dealing with a slump; autos, financials, and commodities.

Which is the likely scenario over the next one to two years: Long-term Canada Yields go up, sideways, or down, given that Canada is entering a full-blown recession?

Bloomberg says: The yield on the two-year bond declined 12 basis points, or 0.12 percentage point, to 1.59 percent at 4 p.m. in Toronto, the lowest since Bloomberg records began in 1989. The price of the 2.75 percent security due in December 2010 rose 23 cents to C$102.29.

The 10-year note’s yield fell 19 basis points to 3.13 percent, also the lowest since at least 1989. The price of the 4.25 percent security maturing in June 2018 climbed C$1.66 to C$109.18.

“Long-term rates are playing catch-up in terms of the decline in yields we have seen in short-term bonds,” said Mark Chandler, RBC Dominion Securities Inc. “There is limited downside in short-term yields,” he said.

“The relatively greater drop in yields on long-term bonds compared with short-term bonds is a theme that could continue into the first half of 2009,” Mr. Chandler said. “This is known as a yield curve flattener,” as the spread between the short-term and long-term rates narrows.

Currently, Canada’s yield curve is steep, defined by short term rates near zero percent, and 30 year rates, which closed today (12/01) at 3.761%, down 21 bps from last Thursday (11/27) morning.

As Hugh Hendry recently put it:

“I withdrew my hard-earned money from a bank this summer. But it may surprise you to learn that I bought government bonds of long duration. Surely I should have bought gold? Except that I believe the way to make money is to seek opportunities through paradox.

And therein lies our brinkmanship: everyone has skipped our story and read the conclusion. They fear financial anarchy. Gold coins are sold out. Everyone is in. And yet the price of gold has fallen this year. So, for now, I would stick with the bonds. The 18-year British gilt yields 4.8pc but, with the Bank of England likely to follow the Fed and slash rates to 1pc, I believe we could see gilt yields below 3pc.

And I promise you that if bond yields broke 3pc there would be a stampede to buy. At this stage gold might trade close to $500, and those who missed its rally from 2002 would have the solace of schadenfreude when in reality they should be buying the stuff and selling their bonds. What delicious irony: deflationists and inflationists could both claim to be right. But how many will have profited?”

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Joe Stiglitz: Bigger is Better

Monday, December 1st, 2008

Joe Stiglitz writes in the New York Times:

Joseph Eugene Stiglitz (born February 9, 1943) is an American economist and a professor at Columbia University. He was chairman of the Council of Economic Advisers from 1995 to 1997 and was awarded the Nobel prize in economics in 2001, and is the author, with Linda J. Bilmes, of “The Three Trillion Dollar War.” He is also the former Senior Vice President and Chief Economist of the World Bank.

A $1 Trillion Answer, by Joseph E. Stiglitz, Commentary, NY Times: What President-elect Barack Obama will need to do is horribly complicated but also very clear.

First, he must stop the economy from going deeper into recession. Then he needs to bring about a robust recovery, preferably in ways that support the long-term needs of the United States: by repairing our neglected public works, invigorating our technological leadership, making our society greener, fixing our health care problems, healing our social and economic divide, and restoring our social compact.

It will not be easy. President Bush’s legacy of debt and the opposition of those who benefit from the status quo present major obstacles. There is an emerging consensus among economists that a big — very big — stimulus is needed, at least 0 billion to trillion over two years. Mr.

Obama’s announced goal of 2.5 million new jobs by 2011 is too modest. In the next two years, almost four million workers will enter the labor force — or would if there were jobs. Combined with the loss of employment this year, that means we should be striving to create more than five million jobs.

A large stimulus package can always be trimmed later if it’s not needed…

Faint measures would be foolhardy. A weaker economy will suffer lower tax revenues, more foreclosures and more bankruptcies. Once a firm is bankrupt, you can’t unbankrupt it by providing a stronger stimulus later on.

… But what you do with the money counts… The money needs to be spent carefully to ensure that every dollar provides as much stimulus now as possible while also contributing to long-term growth.

… Americans are rightly afraid of losing their jobs, and with that, their

health insurance and their homes. We need to provide health insurance to the unemployed and to the uninsured, and we need to do it quickly, possibly through an expanded and more efficient Medicare.

We also need to stem the flood of foreclosures. If we help poorer homeowners, banks will benefit, too… And we need to change the bankruptcy laws to help homeowners.

… Deregulation and the failure to adopt regulations to cover risky new financial products have contributed much to the current mess. So far, we have merely given banks more money to spend recklessly. We have done little to change the banks’ incentives or constraints.

… If the asset program is not changed and if regulations are not imposed to change the behavior of those who got us into this situation — who enriched themselves at the expense of their shareholders — then confidence will not return. Those who got us into this crisis cannot have undue influence in shaping the response.

America has great assets, including a productive labor force and the best universities in the world. None of these assets so far has been impaired by Wall Street’s follies. These strengths, coupled with a sensible and fair economic stimulus package and judicious regulation, will help our economy recover.

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Paul Krugman: Lest We Forget

Monday, December 1st, 2008

Paul Krugman opines that financial reform and regulation of the shadow banking system cannot wait:

Paul Robin Krugman (pronounced /ˈkɹuːɡmən/; born February 28, 1953) is an American economist, columnist, author and intellectual.[2] He is a professor of economics and international affairs at Princeton University, and a columnist for The New York Times. In 2008, Krugman won the Nobel Memorial Prize in Economic Sciences “for his analysis of trade patterns and location of economic activity”. Krugman is well-known in academia for his work in international economics, including trade theory, economic geography, and international finance.

Lest We Forget, by Paul Krugman, Commentary, NY Times: A few months ago I found myself at a meeting of economists and finance officials, discussing — what else? — the crisis. There was a lot of soul-searching going on. One senior policy maker asked, “Why didn’t we see this coming?”

There was, of course, only one thing to say…: “What do you mean ‘we,’ white man?”

Seriously, though, the official had a point. Some people say that the current crisis is unprecedented, but … there were plenty of precedents… Yet these precedents were ignored. And the story of how “we” failed to see this coming has a clear policy implication — namely, that financial market reform … shouldn’t wait until the crisis is resolved. …

Why did so many observers dismiss the obvious signs of a housing bubble, even though the 1990s dot-com bubble was fresh in our memories?

Why did so many people insist that our financial system was “resilient,” as Alan Greenspan put it, when in 1998 the collapse of a single hedge fund, Long-Term Capital Management, temporarily paralyzed credit markets around the world?

Why did almost everyone believe in the omnipotence of the Federal Reserve when its counterpart, the Bank of Japan, spent a decade trying and failing to jump-start a stalled economy?

One answer … is that nobody likes a party pooper. While the housing bubble was still inflating, lenders[, investment banks, and money managers] were making lots of money… Who wanted to hear from dismal economists warning that the whole thing was, in effect, a giant Ponzi scheme?

There’s also another reason the economic policy establishment failed to see the current crisis coming. … [T]he crisis of 1997-98… showed that the modern financial system, with its deregulated markets, highly leveraged players and global capital flows, was becoming dangerously fragile. But when the crisis abated, the order of the day was triumphalism, not soul-searching.

Time magazine famously named Mr. Greenspan, Robert Rubin and Lawrence Summers “The Committee to Save the World”… who “prevented a global meltdown.” In effect, everyone declared … victory…, while forgetting to ask how we got so close to the brink in the first place.

In fact, both the crisis of 1997-98 and the bursting of the dot-com bubble probably had the perverse effect of making both investors and public officials more, not less, complacent. Because neither crisis quite lived up to our worst fears,… investors came to believe that Mr. Greenspan had the magical power to solve all problems — and so, one suspects, did Mr. Greenspan himself, who opposed … prudential regulation of the financial system.

Now we’re in the midst of another crisis, the worst since the 1930s. For the moment, all eyes are on the immediate response to that crisis. … And because we’re all so worried about the current crisis, it’s hard to focus on the longer-term issues — on reining in our out-of-control financial system, so as to prevent or at least limit the next crisis. Yet the experience of the last decade suggests that we should be … regulating the “shadow banking system” at the heart of the current mess, sooner rather than later.

For once the economy is on the road to recovery, the wheeler-dealers will be making easy money again — and will lobby hard against anyone who tries to limit their bottom lines. Moreover, the success of recovery efforts will come to seem preordained, even though it wasn’t, and the urgency of action will be lost.

So here’s my plea: even though the incoming administration’s agenda is already very full, it should not put off financial reform. The time to start preventing the next crisis is now.

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The Road to Depression

Monday, December 1st, 2008

Brad DeLong says two big mistakes made the crisis worse:

James Bradford DeLong (b. June 24, 1960, Boston) commonly known as Brad DeLong, is a professor of economics at the University of California, Berkeley and a former Deputy Assistant Secretary of the United States Department of the Treasury in the Clinton Administration. He is also a research associate of the National Bureau of Economic Research, and is a visiting scholar at the Federal Reserve Bank of San Francisco.

The Road to Depression, by Brad DeLong, Project Syndicate: For 15 months, the United States Federal Reserve, assisted by the financial regulators of the US Treasury, have been trying…,

above all, to avoid a deep depression.

They have also had three subsidiary objectives:

• Keep as much economic activity as possible under private-sector control, in order to ensure that what is produced is what consumers really want.
• Prevent the princes of Wall Street … from profiting from the systemic risk that they created.
• Ensure that homeowners and small investors do not absorb too much loss, for their only “crime” was to accept bad risks, which they would not have done in a world of properly diversified portfolios.

Now it is clear that the Fed and the Treasury have lost the game. If a depression is to be avoided, it will have to be the work of other arms of the government, with other tools and powers.

The failure to contain the crisis will ultimately be traced, I think, to excessive concern with the first two subsidiary objectives: reining in Wall Street princes and keeping economic decision-making private. Had the Fed and the Treasury given those two objectives their proper - subsidiary - weight, I suspect that we would not now be in this mess…

The desire to prevent the princes of Wall Street from profiting from the crisis was reflected in the Fed-Treasury decision to let Lehman Brothers collapse… The logic behind that decision was that, previously in the crisis, equity shareholders had been severely punished…

But this was not true of bondholders and counterparties, who were paid in full. The Fed and Treasury feared that the lesson being taught in the last half of 2007 and the first half of 2008 was that the US government guaranteed all the debt and transactions of every bank and bank-like entity that was regarded as too big to fail. That, the Fed and the Treasury believed, could not be healthy.

Lenders to very large overleveraged institutions had to have some incentive to calculate the risks. But that required, at some point, allowing some bank to fail…

In retrospect, this was a major mistake. … With that guarantee broken by Lehman Brothers’ collapse, every financial institution immediately sought to acquire a much greater capital cushion…,

but found it impossible to do so.

The Lehman Brothers bankruptcy created an extraordinary and immediate demand for additional bank capital, which the private sector could not supply.

It was at this point that the Treasury made the second mistake. Because it tried to keep the private sector private, it sought to avoid partial or full nationalization of the components of the banking system deemed too big to fail. In retrospect, the Treasury should have identified all such entities and started buying common stock in them - whether they liked it or not - until the crisis passed.

Yes, this is what might be called “lemon socialism,” creating grave dangers for corporate control, posing a threat of large-scale corruption, and establishing a precedent for intervention that could be very dangerous down the road.

But would that have been worse than what we face now? The failure to sacrifice the subsidiary objective of keeping the private sector private meant that the Fed and the Treasury lost their opportunity to attain the principal objective of avoiding depression.

Of course, hindsight is always easy. But if depression is to be avoided, it will be through old-fashioned Keynesian fiscal policy: the government must take a direct hand in boosting spending and deciding what goods and services will be in demand.

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