Leading economic indicators rose sharply in April, the first increase in seven months.
Strengths among its components exceeded the weaknesses for the first time in one and a half years.
Strengthening were the following.
Stock prices,
Interest rate spread,
Consumer expectations,
Initial unemployment claims,
Average workweek, and
Supplier deliveries.
Negative contributions came from these.
Real money supply and
Building permits.
When the real money supply starts to grow, this expansion will be unstoppable.
Look for continued weakness in long bond prices and the dollar.
Saturday, June 06, 2009
Thursday, June 04, 2009
Economists in Denial?
Yesterday I went to lunch with a group of economists to discuss the recent disaster in the credit markets.
Here are the main concerns we discussed.
1. The effect of the Fed's purchase of more that $1 trillion of securities and the inevitable inflation arising from the injection of all that high-powered money.
2. The possible inflation coming unless the Fed can sell those securities promptly and reduce the monetary base.
3. The inability of the Fed to begin to sell the hundreds of billions of dollars while unemployment surges.
4. The effects on the falling value of the dollar for government borrowing. No one will want to own dollar denominated assets in this environment.
5. The effects on long maturity interest rates of Treasury borrowing, Fed selling, prudent risk managers not buying, and the dollar dropping.
In summary, most agreed that the situation is far from normal and will not return to normality until the economy recovers and the Fed can pull all this high-powered money out of the system.
That is a long way off.
Yet, three surprising opinions emerged.
1. The cause of inflation. Someone repeated the old confusion about inflation being caused by too much growth rather than too much money. It is astonishing to me that this debate has any credibility at the senior levels of macro analysis.
2. The effects of inflation on the bond and dollar markets. There was little concern over the disaster the US economy is facing and and underestimation of the time it will take to solve this problem.
3. The failure to place the blame for this disaster where it belongs: on Congress, Fannie and Freddie, the SEC, Greenspan's Tsunami in the Fed Funds market beginning in 2004, and unregulated Credit Default Swaps. This is most troubling for future disasters.
TACTICS FOR PORTFOLIO RISK MANAGERS
Brace yourself for higher long rates, a falling dollar, and continued high unemployment.
Extend the maturity of your liabilities as much as you can. The cost of borrowing farther out the curve - as much as 450 basis points - will deter many portfolio risk managers, but those who do will be favored when the yield curve flattens and rises.
It's time to tell senior management and the board that we're in for heavy weather.
Here are the main concerns we discussed.
1. The effect of the Fed's purchase of more that $1 trillion of securities and the inevitable inflation arising from the injection of all that high-powered money.
2. The possible inflation coming unless the Fed can sell those securities promptly and reduce the monetary base.
3. The inability of the Fed to begin to sell the hundreds of billions of dollars while unemployment surges.
4. The effects on the falling value of the dollar for government borrowing. No one will want to own dollar denominated assets in this environment.
5. The effects on long maturity interest rates of Treasury borrowing, Fed selling, prudent risk managers not buying, and the dollar dropping.
In summary, most agreed that the situation is far from normal and will not return to normality until the economy recovers and the Fed can pull all this high-powered money out of the system.
That is a long way off.
Yet, three surprising opinions emerged.
1. The cause of inflation. Someone repeated the old confusion about inflation being caused by too much growth rather than too much money. It is astonishing to me that this debate has any credibility at the senior levels of macro analysis.
2. The effects of inflation on the bond and dollar markets. There was little concern over the disaster the US economy is facing and and underestimation of the time it will take to solve this problem.
3. The failure to place the blame for this disaster where it belongs: on Congress, Fannie and Freddie, the SEC, Greenspan's Tsunami in the Fed Funds market beginning in 2004, and unregulated Credit Default Swaps. This is most troubling for future disasters.
TACTICS FOR PORTFOLIO RISK MANAGERS
Brace yourself for higher long rates, a falling dollar, and continued high unemployment.
Extend the maturity of your liabilities as much as you can. The cost of borrowing farther out the curve - as much as 450 basis points - will deter many portfolio risk managers, but those who do will be favored when the yield curve flattens and rises.
It's time to tell senior management and the board that we're in for heavy weather.
Saturday, May 16, 2009
The dollar is doomed
There are three things that make the dollar fall.
1. US trade deficits increase
2. US interest rates fall relative to others
3. US inflation higher than others
Of these three, the last - inflation - is dominant, and the current Fed monetary policy ensures rising inflation in the months and years to come, causing the dollar to fall in value relative to countries with better inflation management.
The explosion of the monetary base, as the chart below shows is sure to cause inflation unless that money can be removed from the system quickly.
The dilemma facing the Fed is the effect of removing this new money on interest rates and economic activity. In order to take money out of the system, the Fed has to sell something, and that something is the securities they hold.
In particular, the Fed has to sell $1 trillion in securities, and that will raise interest rates as sure as the sun comes up.
Put this in perspective.
If the Fed sells $40 billion in securities each month, it will take two years to get all that money out of the system.
If the monetary authorities begin this program quickly, economic activity is certain to fall, and that is not in the Fed's plans.
So, until the Treasury stops selling bonds to fund the explosion in Federal expenditures, and the Fed can begin selling to reduce the monetary base, inflation is building and the dollar is doomed.
Here is the relevant currency chart.
The number of dollars it takes to buy the Euro.
Notice that the general trend is up, meaning the Euro central bank is better at controlling inflation than the US Federal Reserve.
Next, notice that the recent collapse in the US economy has reversed that trend.
Finally, notice that the trend is about to resume.
Unless the Federal Reserve can find a way to pull all that new money out of the system without crashing the US economy, the dollar is in for a long fall.
When combined with the flood of US securities coming, this is disaster for financial institutions unable to extend the maturity of their liabilities.
TACTICS
Extend the maturity of your liabilities. Get as far out the curve as senior management and the board will allow you. Make sure of credit quality as you add assets.
Money market arbitrage will power the institution for the years to come, as the spread between bank paper and everything else widens.
STRAGEGY
It's time to get back to work. We've survived the biggest scare since the Great Contraction of 29-33 and we now have profit opportunities not seen in decades.
Warn senior management and the Board that disaster is coming: inflation and rising long rates are certain.
1. US trade deficits increase
2. US interest rates fall relative to others
3. US inflation higher than others
Of these three, the last - inflation - is dominant, and the current Fed monetary policy ensures rising inflation in the months and years to come, causing the dollar to fall in value relative to countries with better inflation management.
The explosion of the monetary base, as the chart below shows is sure to cause inflation unless that money can be removed from the system quickly.
The dilemma facing the Fed is the effect of removing this new money on interest rates and economic activity. In order to take money out of the system, the Fed has to sell something, and that something is the securities they hold.
In particular, the Fed has to sell $1 trillion in securities, and that will raise interest rates as sure as the sun comes up.
Put this in perspective.
If the Fed sells $40 billion in securities each month, it will take two years to get all that money out of the system.
If the monetary authorities begin this program quickly, economic activity is certain to fall, and that is not in the Fed's plans.
So, until the Treasury stops selling bonds to fund the explosion in Federal expenditures, and the Fed can begin selling to reduce the monetary base, inflation is building and the dollar is doomed.
Here is the relevant currency chart.
The number of dollars it takes to buy the Euro.
Notice that the general trend is up, meaning the Euro central bank is better at controlling inflation than the US Federal Reserve.
Next, notice that the recent collapse in the US economy has reversed that trend.
Finally, notice that the trend is about to resume.
Unless the Federal Reserve can find a way to pull all that new money out of the system without crashing the US economy, the dollar is in for a long fall.
When combined with the flood of US securities coming, this is disaster for financial institutions unable to extend the maturity of their liabilities.
TACTICS
Extend the maturity of your liabilities. Get as far out the curve as senior management and the board will allow you. Make sure of credit quality as you add assets.
Money market arbitrage will power the institution for the years to come, as the spread between bank paper and everything else widens.
STRAGEGY
It's time to get back to work. We've survived the biggest scare since the Great Contraction of 29-33 and we now have profit opportunities not seen in decades.
Warn senior management and the Board that disaster is coming: inflation and rising long rates are certain.
Monday, May 04, 2009
Coming Bear Market in Bonds
WHO'S NOT SELLING BONDS?
First, the US Treasury has hundreds of billions of dollars of bonds to sell to fund the trillion dollar deficits Congress is mandating.
Second, the Federal Reserve will be selling the trillions of dollars of securities they have purchased in the recent expansion of the monetary base.
Third, and finally, any investor who owns bonds will be selling to avoid the coming bear market.
Paterson is advising its clients to continue to extend the maturity of liabilities past the 5 year mark, and look at 10 year liabilities, or more.
TACTICS
Continue to shorten the maturity of assets and use money market arbitrage to improve earnings.
Consider borrowing long term deposits.
Use extreme caution on long term lending.
STRATEGY
Warn senior management and the board that a disaster is in the offing.
The flood of money recently added by the Fed will either cause inflation or increases in long term interest rates - or both.
First, the US Treasury has hundreds of billions of dollars of bonds to sell to fund the trillion dollar deficits Congress is mandating.
Second, the Federal Reserve will be selling the trillions of dollars of securities they have purchased in the recent expansion of the monetary base.
Third, and finally, any investor who owns bonds will be selling to avoid the coming bear market.
Paterson is advising its clients to continue to extend the maturity of liabilities past the 5 year mark, and look at 10 year liabilities, or more.
TACTICS
Continue to shorten the maturity of assets and use money market arbitrage to improve earnings.
Consider borrowing long term deposits.
Use extreme caution on long term lending.
STRATEGY
Warn senior management and the board that a disaster is in the offing.
The flood of money recently added by the Fed will either cause inflation or increases in long term interest rates - or both.
Friday, March 27, 2009
Recession is Over
March 2009 the NYSE hit bottom at 4,181.75, levels we will not see again for a long time - if ever.
In the decline from more that 10,000 at the end of 2007, more than half the value of the NYSE has been wiped out, leading to a massive decline in consumption, production, employment, savings, investment, and tax revenues.
The nation and the world will suffer from this debacle for years.
MONEY SUPPLY
Except for a short blunder in early 2009, the Federal reserve has performed magnificently, lending on troubled assets, neutralizing monetary injections when needed, and finally pouring high-powered money into the system when it was justified.
The latest program to add primary reserves to the system leads Paterson to conclude the recession is over. The temporary blunder of allowing the base to fall caused the final spike down in stock prices and convinced the Fed that money easing is the right policy.
CREDIT SPREADS
As Fed policy takes hold, and banks continue lending, credit spreads continue to tighten.
Paterson concludes the worst of the credit crunch is over, and lenders can resume longer-term lending.
TACTICS
Money market arbitrage should continue to take advantage of the wide spreads between bank issued paper and other assets.
Longer term lending can also continue, with careful attention to credit quality.
STRATEGY
The Portfolio Risk Management Team should plan some vacations to get away from the office and the grinding pressure of interest rate and credit risk.
Report success to senior management, and encourage a visit from Paterson to explain why it's time to take a breather.
FINAL NOTE
Thanks to those of you who have sent word of thanks and appreciation.
Paterson will be traveling to your town in the next few months, so please plan to spend some time reliving this debacle and our successful performance.
In the decline from more that 10,000 at the end of 2007, more than half the value of the NYSE has been wiped out, leading to a massive decline in consumption, production, employment, savings, investment, and tax revenues.
The nation and the world will suffer from this debacle for years.
MONEY SUPPLY
Except for a short blunder in early 2009, the Federal reserve has performed magnificently, lending on troubled assets, neutralizing monetary injections when needed, and finally pouring high-powered money into the system when it was justified.
The latest program to add primary reserves to the system leads Paterson to conclude the recession is over. The temporary blunder of allowing the base to fall caused the final spike down in stock prices and convinced the Fed that money easing is the right policy.
CREDIT SPREADS
As Fed policy takes hold, and banks continue lending, credit spreads continue to tighten.
Paterson concludes the worst of the credit crunch is over, and lenders can resume longer-term lending.
TACTICS
Money market arbitrage should continue to take advantage of the wide spreads between bank issued paper and other assets.
Longer term lending can also continue, with careful attention to credit quality.
STRATEGY
The Portfolio Risk Management Team should plan some vacations to get away from the office and the grinding pressure of interest rate and credit risk.
Report success to senior management, and encourage a visit from Paterson to explain why it's time to take a breather.
FINAL NOTE
Thanks to those of you who have sent word of thanks and appreciation.
Paterson will be traveling to your town in the next few months, so please plan to spend some time reliving this debacle and our successful performance.
Friday, January 23, 2009
Credit Spreads at 800 Basis Points
The spread between Baa credits and 10 year US Treasuries reached 800 basis points.
The cost of long-term corporate debt has declined more than 100 BPs, but is still at historic spreads to Treasuries.
MONEY CONTINUES TO GROW
The Fed's policy of adding reserves to the system continued in the past two weeks, and the monetary base is now twice it's value in September of 2008.
Here is the raw data.
Paterson is confident that the Fed's action to support the fixed income markets with massive purchases of securities will shorten the recession by many years.
REAL ESTATE LENDING RESUMES
Even as the economy continues to deteriorate from the collapse in wealth in the stock and property markets, the business of lending is stabilizing.
In California the number of homes sold last month increased nearly 200%.
As this trend continues, the housing market will stabilize.
However, do not expect the trend of the last 20 years to resume. Growth in the value of real estate was caused by the decline in interest rates due to the elimination of inflation. That game is over.
SUMMARY
The Fed's actions to stabilize money growth are succeeding, suggesting a resumption of economic growth in months, not years.
Residential real estate lending - at prudent underwriting standards - is safe again. It is unlikely we will see much more of a sell-off in residential real estate.
Commercial real estate is in much worse shape and should be avoided except for unique situations. The economy has much farther to go to see a bottom.
New lows in stocks. As the magnitude of the disaster grows, there is a significant probability we will see new lows in the stock markets. If this happens, it will probably present a buying opportunity. Look for record volume in shares traded as the signal we've seen the bottom.
However, do not expect a quick rebound. Paterson expects a double or triple bottom in stocks before all selling is done.
TACTICS
Continue money market arbitrage. Paterson is advising clients to take advantage of the double digit yields in high quality short term paper. These assets can be funded profitably with deposits and the book matched nearly to the day.
Do not run a mis-matched book.
Avoid commercial real estate.
Expand prudent residential real estate lending and sell all long-term assets in the secondary market.
Balance sheet lending is extremely risky.
STRATEGY
Make senior management and the Board aware of the successes of the risk management team. Suggest bonuses for continued excellent performance.
Cooperate with regulators to understand their concerns and allay their fears.
The cost of long-term corporate debt has declined more than 100 BPs, but is still at historic spreads to Treasuries.
MONEY CONTINUES TO GROW
The Fed's policy of adding reserves to the system continued in the past two weeks, and the monetary base is now twice it's value in September of 2008.
Here is the raw data.
2008-09-10 874.703
2008-09-24 939.395
2008-10-08 1014.655
2008-10-22 1174.106
2008-11-05 1265.015
2008-11-19 1506.539
2008-12-03 1502.872
2008-12-17 1689.661
2008-12-31 1728.184
2009-01-14 1773.924
Paterson is confident that the Fed's action to support the fixed income markets with massive purchases of securities will shorten the recession by many years.
REAL ESTATE LENDING RESUMES
Even as the economy continues to deteriorate from the collapse in wealth in the stock and property markets, the business of lending is stabilizing.
In California the number of homes sold last month increased nearly 200%.
As this trend continues, the housing market will stabilize.
However, do not expect the trend of the last 20 years to resume. Growth in the value of real estate was caused by the decline in interest rates due to the elimination of inflation. That game is over.
SUMMARY
The Fed's actions to stabilize money growth are succeeding, suggesting a resumption of economic growth in months, not years.
Residential real estate lending - at prudent underwriting standards - is safe again. It is unlikely we will see much more of a sell-off in residential real estate.
Commercial real estate is in much worse shape and should be avoided except for unique situations. The economy has much farther to go to see a bottom.
New lows in stocks. As the magnitude of the disaster grows, there is a significant probability we will see new lows in the stock markets. If this happens, it will probably present a buying opportunity. Look for record volume in shares traded as the signal we've seen the bottom.
However, do not expect a quick rebound. Paterson expects a double or triple bottom in stocks before all selling is done.
TACTICS
Continue money market arbitrage. Paterson is advising clients to take advantage of the double digit yields in high quality short term paper. These assets can be funded profitably with deposits and the book matched nearly to the day.
Do not run a mis-matched book.
Avoid commercial real estate.
Expand prudent residential real estate lending and sell all long-term assets in the secondary market.
Balance sheet lending is extremely risky.
STRATEGY
Make senior management and the Board aware of the successes of the risk management team. Suggest bonuses for continued excellent performance.
Cooperate with regulators to understand their concerns and allay their fears.
Tuesday, January 06, 2009
Money Explosion Continues
Growth in the monetary base continues.
Since September, 2008 when the monetary base stood at $870 billion, the Fed has added more than $800 billion to the base.
With stimulus like this, the recession will be shortened by years, bringing the return to growth in the next year or two.
OTHER MONEY NUMBERS
MZM which had been stagnant, is now growing.
Here is the raw data.
Here is the rate of growth data.
M2 Growth Signals Economic Recovery
M2 is a leading indicator, signaling both financial and commercial expansion.
The rate of growth in M2 is soaring, approaching 10%
COMMERCIAL AND INDUSTRIAL LOANS
The problem now is to get banks to lend.
Though flush with cash, thanks to Fed actions, Banks are reluctant to lend to Commercial and Industrial companies for two reasons.
One, the uncertainty of every company's balance sheet in this world of Interest Rate and Credit Default swaps. Until this confusion is cleared away, very few financial institutions will take the risk of lending.
Two, economic uncertainty also brings a halt to lending. As economic activity collapses, even good companies might not be able to pay back their loans.
REAL ESTATE LOANS
The surprising fact is real estate loans are holding up well.
INTEREST RATES AND SPREADS
Credit spreads have stopped widening.
Of all the signs that the credit crisis is ending, this is the one most watched by forecasters.
The drop in BAA yields by 100 basis points is a sign that lower quality credits are finding buyers.
SUMMARY, TACTICS, AND STRATEGY
In summary, the Fed's aggressive expansion of the monetary base has shortened a 10 year depression into a 3 year recession.
Though it is not time to invest or lend yet, that time will soon be here.
Tactics
Continue money market arbitrage, extending deposit maturities to 2 years, and adding high-yield assets.
Spreads of 1,000 basis points on AAA quality credits are not uncommon.
Stragegy
Prepare senior management and the board for continued earnings enhancement thanks to the investment department. Focus attention on finding high-yield assets.
Since September, 2008 when the monetary base stood at $870 billion, the Fed has added more than $800 billion to the base.
With stimulus like this, the recession will be shortened by years, bringing the return to growth in the next year or two.
OTHER MONEY NUMBERS
MZM which had been stagnant, is now growing.
Here is the raw data.
Here is the rate of growth data.
M2 Growth Signals Economic Recovery
M2 is a leading indicator, signaling both financial and commercial expansion.
The rate of growth in M2 is soaring, approaching 10%
COMMERCIAL AND INDUSTRIAL LOANS
The problem now is to get banks to lend.
Though flush with cash, thanks to Fed actions, Banks are reluctant to lend to Commercial and Industrial companies for two reasons.
One, the uncertainty of every company's balance sheet in this world of Interest Rate and Credit Default swaps. Until this confusion is cleared away, very few financial institutions will take the risk of lending.
Two, economic uncertainty also brings a halt to lending. As economic activity collapses, even good companies might not be able to pay back their loans.
REAL ESTATE LOANS
The surprising fact is real estate loans are holding up well.
INTEREST RATES AND SPREADS
Credit spreads have stopped widening.
Of all the signs that the credit crisis is ending, this is the one most watched by forecasters.
The drop in BAA yields by 100 basis points is a sign that lower quality credits are finding buyers.
SUMMARY, TACTICS, AND STRATEGY
In summary, the Fed's aggressive expansion of the monetary base has shortened a 10 year depression into a 3 year recession.
Though it is not time to invest or lend yet, that time will soon be here.
Tactics
Continue money market arbitrage, extending deposit maturities to 2 years, and adding high-yield assets.
Spreads of 1,000 basis points on AAA quality credits are not uncommon.
Stragegy
Prepare senior management and the board for continued earnings enhancement thanks to the investment department. Focus attention on finding high-yield assets.
Saturday, December 20, 2008
Base Growth Continues
Monetary Base Doubles in 3 months.
The following table shows the growth in the monetary base since August.
2008-07-16 870.637
2008-07-30 870.659
2008-08-13 870.775
2008-08-27 869.886
2008-09-10 874.703
2008-09-24 939.395
2008-10-08 1014.662
2008-10-22 1174.141
2008-11-05 1265.079
2008-11-19 1506.630
2008-12-03 1502.996
2008-12-17 1689.771
Since October 2008 the monetary base has doubled, going from $800 to $1600.
Paterson will have more to say about this in future posts.
The following table shows the growth in the monetary base since August.
2008-07-16 870.637
2008-07-30 870.659
2008-08-13 870.775
2008-08-27 869.886
2008-09-10 874.703
2008-09-24 939.395
2008-10-08 1014.662
2008-10-22 1174.141
2008-11-05 1265.079
2008-11-19 1506.630
2008-12-03 1502.996
2008-12-17 1689.771
Since October 2008 the monetary base has doubled, going from $800 to $1600.
Paterson will have more to say about this in future posts.
Monday, December 01, 2008
Monetary Base Explodes
The explosion in the monetary base is historic.
As the money numbers shown below indicate, money growth is not signalling a continued recession.
However, credit spreads indicate profit opportunities for institutions with portfolio risk skills.
PROFIT OPPORTUNITIES
Recently a Paterson client locked in 22% on AAA rates securities for 9 months, bringing in a profit of nearly $2 million. If your institution is interested in Paterson's Money Market Arbitrage program, please contact us right away. Sellers are looking to clean out their portfolios by the end of the year.
10 Years of Growth in 10 Weeks.
Without this addition to reserves, money would not be growing as fast.
MZM
M2 Growing as Well
Loan Growth Slows
SUMMARY OF FED ACTION
Without the prompt and resolute action by the Board of Governors of the Federal Reserve System, the US and world economies would be collapsing.
With Fed action, the recession will likely last only a few years.
Money growth is a reassuring fact in this convoluted world.
Keep an eye on the monetary base in the months to come. If the Fed stops adding to the base, it's a sign that the markets are healthier.
INTEREST RATES
There is no sign of inflation in the bond market.
For the last 10 years there has been little change in long-term rates and none is expected in the future.
TACTICS
Money market arbitrage has become the most profitable thing for financial institutions.
Continue to fund at the short end of the curve, and match the book with high yeilding paper guaranteed by the Fed.
A billion dollar portfolio of deposits will purchase $100 million in profits in one year on AAA rated paper.
STRATEGY
Brief the board on the profit opportunities in short term paper and obtain authorization to expand the Money Market Arbitrage program.
As the money numbers shown below indicate, money growth is not signalling a continued recession.
However, credit spreads indicate profit opportunities for institutions with portfolio risk skills.
PROFIT OPPORTUNITIES
Recently a Paterson client locked in 22% on AAA rates securities for 9 months, bringing in a profit of nearly $2 million. If your institution is interested in Paterson's Money Market Arbitrage program, please contact us right away. Sellers are looking to clean out their portfolios by the end of the year.
10 Years of Growth in 10 Weeks.
Without this addition to reserves, money would not be growing as fast.
MZM
M2 Growing as Well
Loan Growth Slows
SUMMARY OF FED ACTION
Without the prompt and resolute action by the Board of Governors of the Federal Reserve System, the US and world economies would be collapsing.
With Fed action, the recession will likely last only a few years.
Money growth is a reassuring fact in this convoluted world.
Keep an eye on the monetary base in the months to come. If the Fed stops adding to the base, it's a sign that the markets are healthier.
INTEREST RATES
There is no sign of inflation in the bond market.
For the last 10 years there has been little change in long-term rates and none is expected in the future.
TACTICS
Money market arbitrage has become the most profitable thing for financial institutions.
Continue to fund at the short end of the curve, and match the book with high yeilding paper guaranteed by the Fed.
A billion dollar portfolio of deposits will purchase $100 million in profits in one year on AAA rated paper.
STRATEGY
Brief the board on the profit opportunities in short term paper and obtain authorization to expand the Money Market Arbitrage program.
Sunday, November 16, 2008
Portfolio Risk Management
There is no way to minimize the disaster that has befallen the US and world economies, and no way to repair the damage done by Credit Default Swaps.
In the coming months, it will become clear that the disaster of Greenspan's Tsunami has ruined the lives of three generations of US taxpayers. Current students will find no work when they graduate, their parents have lost half their wealth and can't access much of the remainder; their grandparents retirement will be cold and dark with pensions, health care, and real estate values tumbling.
Greenspan's Tsunami
Like an unexpected wave of disaster, the increase in Fed Funds from 1% to 5.25% caused the flood of defaults in the adjustable loan market, leading to the collapse in Fannie Mae, Freddie Mac, and AIG.
Bad Loans in the Mortgage Industry
Following the decision to relax loan standards in 1999 lenders flooded Fannie and Freddie with low quality paper: borrowers with insufficient downpayment, low income, and poor credit quality. As interest rates rose, these adjustable-rate loans fell into default, and foreclosure sales began.
As the assets behind these loans fell in value, investors in Fannie and Freddie paper looked to the agencies to make good on their promise to guarantee principal and interest. As the magnitude of the disaster became clearer, the markets knew the resources of Fannie and Freddie would not be adequate to make good the losses on mortgage-backed paper.
Credit Default Swaps
Standing behind Fannie and Freddie were sellers of Credit Default Swaps (unregistered insurance), but their capital proved insufficient too, and they failed. AIG and others are now wards of the US Treasury.
The lack of registration of CDSs meant that the risk of default, now spread throughout the system, was unknown and unknowable, leading prudent banks to shun all enterprises not protected by the Federal Reserve. Lending slammed to a halt.
For example, US exports now sit on the piers waiting for a letter of credit from a qualified lender so that the seller will release the goods.
Summary
In the months to come, the credit disaster will grow, and economic activity will collapse. Consumption, production, employment savings, investments, and tax revenues will all decline much more than the markets anticipate.
The stock market has anticipated most of the disaster, but not enough. There is still one more significant decline coming.
TACTICS
Continue money market arbitrage. Take advantage of low deposit costs and pick carefully through the wreckage of the market.
Lend only to solid companies or profitable residential real estate with good spreads.
STRATEGY
Tell the board we are in a long and deep depression and we will not recover soon.
In the coming months, it will become clear that the disaster of Greenspan's Tsunami has ruined the lives of three generations of US taxpayers. Current students will find no work when they graduate, their parents have lost half their wealth and can't access much of the remainder; their grandparents retirement will be cold and dark with pensions, health care, and real estate values tumbling.
Greenspan's Tsunami
Like an unexpected wave of disaster, the increase in Fed Funds from 1% to 5.25% caused the flood of defaults in the adjustable loan market, leading to the collapse in Fannie Mae, Freddie Mac, and AIG.
Bad Loans in the Mortgage Industry
Following the decision to relax loan standards in 1999 lenders flooded Fannie and Freddie with low quality paper: borrowers with insufficient downpayment, low income, and poor credit quality. As interest rates rose, these adjustable-rate loans fell into default, and foreclosure sales began.
As the assets behind these loans fell in value, investors in Fannie and Freddie paper looked to the agencies to make good on their promise to guarantee principal and interest. As the magnitude of the disaster became clearer, the markets knew the resources of Fannie and Freddie would not be adequate to make good the losses on mortgage-backed paper.
Credit Default Swaps
Standing behind Fannie and Freddie were sellers of Credit Default Swaps (unregistered insurance), but their capital proved insufficient too, and they failed. AIG and others are now wards of the US Treasury.
The lack of registration of CDSs meant that the risk of default, now spread throughout the system, was unknown and unknowable, leading prudent banks to shun all enterprises not protected by the Federal Reserve. Lending slammed to a halt.
For example, US exports now sit on the piers waiting for a letter of credit from a qualified lender so that the seller will release the goods.
Summary
In the months to come, the credit disaster will grow, and economic activity will collapse. Consumption, production, employment savings, investments, and tax revenues will all decline much more than the markets anticipate.
The stock market has anticipated most of the disaster, but not enough. There is still one more significant decline coming.
TACTICS
Continue money market arbitrage. Take advantage of low deposit costs and pick carefully through the wreckage of the market.
Lend only to solid companies or profitable residential real estate with good spreads.
STRATEGY
Tell the board we are in a long and deep depression and we will not recover soon.
Apology
For the past three months Paterson has been busy working with existing and new clients to avoid the disaster in the credit markets.
My apologies to students, casual readers, and potential clients for the absence of this weblog.
Paterson is back, explaining the situation and suggesting tactical and strategic plans for dealing with the extended downturn.
My apologies to students, casual readers, and potential clients for the absence of this weblog.
Paterson is back, explaining the situation and suggesting tactical and strategic plans for dealing with the extended downturn.
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