Credit Crisis Fallout: Investors Leery of Buying Government Debt As Calendar Grows

One of the underlying assumptions of the Fed’s and many other central banks’ response to the credit crisis is that it can be halted, and hopefully remedied, by having the government backstop the troubled financial sector. One template is not to repeat the supposed mistakes of the Great Depression and Japan’s post bubble era, where conventional wisdom has it downturn morphed into disasters as a result of the failure of central banks to break glass and supply liquidity aggressively enough. A second model is Sweden. There, the government intervened aggressively to combat a large scale banking crisis by nationalizing failing banks (they had a methodology for doing triage, to determine who could be saved and who needed to be liquidated or merged), spun the bad assets off into a liquidation vehicle, recapitalized what remained, and sold them off when the economy recovered.

However, these paradigms are being applied selectively, with the politically convenient bits being implemented and the harder remedies ignored. The Fed moved quickly to cut rates and then create special vehicles to help provide liquidity to markets that appeared stuck. But this response came out of both Bernanke’s study of (one might say fixation with) the Depression. plus the “if the only tool you have is a hammer, every problem looks like a nail” syndrome. Central banks are in the liquidity business, so they tend to fall back on the tools they have at hand, rather than going to the more difficult process of building political support for other types of solutions.

For instance, a number of observers, ranging from Depression expert Anna Schwartz and the Japanese have taken issue with the heavy reliance on liquidity injections. Schwartz has pointed out, as many others have, that the current financial meltdown is not a liquidity crisis but a solvency crisis. Both Schwartz and the Japanese recommended approaches that put much greater priority on purging bad assets (Schwartz recommended letting insolvent firms fail, while the Japanese urged speedy recapitalizations).

And even the Swedish approach, which is now being given lip service, is largely ignored. One of its key elements was that the banking system had grown disproportionately, unsustainably large, and needed to be shrunk. The US, by contrast, is not only trying to prop up the financial system in place, but also wants it to make more loans to keep the economy going. In other words, they want to make the underlying problem of overleverage worse.

Since the US looks borrowings relative to GDP are higher than Sweden’s were at the time of its crisis, the need to figure out how to reduce indebtedness is crucial. Some analysts have pegged US debt to GDP at 350%; reader Bjornar kindly did some digging, and based on this and this source concluded Swedish debt to GDP in 1990 was roughly 170%. While both estimates are admittedly quick and dirty, the obvious shortcomings in the US estimate suggest it is, if anything, understated.

However, reducing indebtedness means a lower GDP, when the idea of letting growth suffer is anathema. Yet Sweden, which is widely held as a model, did in fact have a very nasty two year recession, but had a strong rebound afterwards. Most analysts believe this was the least costly approach, in terms of long-term consequences. Yet the US seems determined to minimize immediate pain, not matter how great damage to long-term economic health.

Moreover, the US is starting to get warning signs that it may encounter resistance from our friendly foreign funding soruces when we ask them to pick up the tab for our debt party. Willem Buiter, who was a front-row spectator in the Iceland meltdown (he and Anne Siebert were bought in to advise the authorities late in the game, and they evidently didn’t heed Buiter’s and Sieber’s advice) warns that having the government rescue the banking sector does not reduce risk but merely transfers it, and investors are wising up:

Under current circumstances, if the government injects capital into a bank to compensate for past and anticipated future losses, it may not achieve a risk-adjusted expected rate of return on this investment equal to its borrowing cost. The difference will have to be recouped through higher future primary surpluses, that is, higher future government budget surpluses excluding interest payments. If there is doubt in the markets about the ability or willingness of current and/or future governments to raise future taxes or cut future spending to generate the required increase in future primary surpluses, the default risk premium on the public debt will rise. We are seeing such increased default risk premia even for the most credit-worthy sovereigns, including the German government, the US government and the UK government. On Friday October 10, 2008, the spreads on 5 year sovereign CDS were 0.456% for the UK, 0.33% for the USA ad 0.265% for Germany, well above their post-war historical averages. On October 28, 2008, Bloomberg wrote:

Credit-default swaps on [U.S.] Treasuries have risen nearly 40 percent since TARP was signed into law Oct. 3, and are now about the same as Mexican and Thai government debt before the credit markets began to seize up in June 2007.

By bailing out the banks, and other bits of the financial system, the authorities reduce bank default risk but by increasing sovereign default risk. As long as there is sufficient fiscal spare capacity (the technical, economic and political prerequisites are met for raising future taxes and/or cutting future public spending by a sufficient amount to service the additional public debt and maintain long-run government solvency).

One worry about government solvency being compromised by the need to rescue an overly large banking sector.Buiter, unlike Paul Krugman and other prominent US economists, warns that there are indeed limits to how many commitments a a government can take on. Markets can and will exercise discipline (Buiter argues mainly from the UK perspective, but his logic applies to any government):

The key question is, can the government meet all these fiscal commitments, whether firm or flaccid, unconditional or contingent and explicit or implicit ? Does it have the resources, now and in the future, to issue the additional debt required to meet the growing volume of up-front obligations it has taken on?

To be solvent, the face value of the government’s net financial obligations has to be no larger than the present discounted value of current and future primary government surpluses (government surpluses excluding net interest and other investment income)….

In addition to the debt that has been and will be issued to finance asset purchases by the government, there are the future debt issuance associated with the large cyclical and structural government deficits that will be a feature of the coming recession. If GDP falls peak-to-trough by, say 3.5 percent and recovers only slowly, we could have a seven percent of GDP or higher government deficit for 2009 and 2010. Together with the explicit or implicit fiscal commitments made to safeguard the British banking system, the numbers are likely to spook the markets.
With the true net public debt to GDP ratio probably already well above 100 percent of GDP and rising, and with massive public sector deficits, partly cyclical and partly structural, about to materialise, the markets will question the fiscal-financial sustainability of the government’s programme with increasing vehemence. The CDS spreads on UK public debt will start rising. The notion that, except for currency, there may not be a safe sterling-denominated asset may come as a shock. But the same is true in the US. In 2009, the US government will have to sell (gross) at least $ 2 trillion worth of government debt (the sum of the Federal deficit plus asset purchases plus refinancing of maturing debt). The largest such figure ever in the past was $550 billion. In the US too, the markets will have to learn to do without a US dollar financial instrument that is free of default risk.

Buiter’s comments on the US raise a second issue: even if investors are not worried about the risk of a sovereign default, there is going to be so much government debt for sale that yields will rise, merely based on supply and demand. We are seeing signs of that now. Consider this warning sign from Germany, the unheard of specter of the failure of a government bond auction of a highly credit-worthy state, via the Financial Times (hat tip readers Chris and Don):

For any government looking to raise money in the capital markets in the next few months, there was an ominous development in Germany this week.

A German 10-year bond auction failed – something more or less unheard of until this year – as cash-strapped banks and investors snubbed the government offering.

It is a clear sign of straitened times when a benchmark bond in one of the most liquid markets in the world cannot attract enough bids to reach its target amount.

Crucially, it raises serious doubts about whether governments can raise the vast amounts of debt needed to fund fiscal stimulus packages and bank recapitalisations in the current tough market conditions.

Any sign of waning demand may force up bond yields – putting further pressure on public finances when they are already under strain.

Nowhere is the issue more pressing than in the US.

Tony Crescenzi, strategist at Miller Tabak, says: “In a world with finite capital and where sovereign nations everywhere are in need of capital to finance their financial and economic stabilisation efforts, the substantial increase in Treasury supply could become manifested in higher long-term interest rates.”

Rick Klingman, managing director at BNP Paribas, adds: “There is no doubt that supply will matter at some point as the financing needs are staggering [in the US]. At the moment, supply is not a large factor with stocks in freefall”….

US Treasury bond supply is expected to hit record levels, in a range from $1,400bn to $1,750bn in the 2009 financial year, starting in October. In Europe, bond supply is forecast to rise to more €1,000bn ($1,247bn) next year – also a record high, according to Barclays Capital.

The extraordinary thing is that, in spite of this huge supply, most analysts expect bond yields will fall. This is because many analysts are now anticipating a deep and protracted global recession, and talk of deflation is even stalking bond markets.

Yields have fallen particularly sharply at the shorter-end of the bond curve, which is most sensitive to interest rate movements, because of the accelerating slowdown in the world’s economies.

Analysts say the economic backdrop is the key determinant of where yields will trade. At the moment equities are so unappealing to investors that bond markets appear more attractive, offsetting supply concerns.

Some government bond yields are also historically low, around levels last seen in 2005, and much lower than in June when inflation concerns dominated trade. For example, German 10-year Bund yields are trading at 3.63 per cent, compared with 4.68 per cent in June.

Riccardo Barbieri, a strategist at Bank of America, says: “In the unlikely event that yields should rise, which I would not expect, they are coming from a fairly low level.”

Germany – in spite of its fourth 10-year Bund failure this year – and the US are likely to be more successful in attracting investors and depressing yields, should the difficult conditions persist, than other countries as they have the most liquid markets and are seen as safe havens…

Another problem for the governments is the competition from banks and financial institutions, which have sovereign guarantees yet offer much higher yields.

For example, this week the UK’s Nationwide priced a three-year deal at close to 100 basis points over gilts.

“The simplistic question is, why buy government paper when you can buy government-backed paper such as this for a much greater return?,” says Sean Shepley, fixed income strategist at Credit Suisse.

With an expected €1,600bn of bank guaranteed issuance in Europe alone next year, this could have a significant impact on investor appetite for government bonds.

Mr Chapman says: “In spite of the prospect of this huge issuance, yields are not being forced higher. This shows just how gloomy people are about the economic outlook.”

Personally, I think investors are so shell-shocked by the crisis that they are only thinking about what to do this quarter, and not about the longer term. Just as during the waning days of the bubble, Citi’s Chuck Prince talked of dancing as long as the music was playing, and assuming he and Citi could exit risky positions when the time came, so to many investors may recognize the risk of a rise in government bond yields, but similarly assume they can sell if that comes to pass without taking too much of a loss.

In another, more widely reported sign of stress, the US 30 bond auction this week saw a big drop in demand from central banks, a crucial group of buyers. From Bloomberg:

Treasuries fell, led by 30-year bonds, after investors shunned the government’s $10 billion sale of the securities amid concern that U.S. debt sales will grow….

The bond auction followed yesterday’s sale of $20 billion in 10-year notes. The $30 billion total of the two auctions is the biggest amount of the securities sold in a week since at least 1990…

“In the current market environment there are still too many unknowns,” said William Larkin, a portfolio manager at Cabot Money Management in Salem, Massachusetts, which manages about $500 million in assets. “People are looking for the safety of the shorter-term securities.”

Today’s bond auction forecast to draw a yield of 4.224 percent, according to the average estimate of seven bond-trading firms surveyed by Bloomberg News. The bid-to-cover ratio, which gauges demand by comparing the number of bids to the amount of securities sold, was 2.07, below the average of 2.19 times in the nine auctions since the bond was revived in 2006.

Indirect bidders, a class of investors that includes foreign central banks, bought 18 percent of the securities offered, down from 43 percent at the last sale.

The skittish may due in part to the G20 meeting this weekend, which could be a negative for the dollar if China’s pet theme, the need to move away from the dollar as reserve currency, gets a hearing. The dollar and Treasuries tend to move together. But this is not the first weak Treasury auction we’ve seen, and if they become more than isolated events, it bodes ill for the strategy many central banks are taking.

Print Friendly, PDF & Email


  1. cent21

    Sort of like trying to stop a bullet speeding towards you by rapidly inflating a balloon?

    Let’s suppose, first, that we would suffer a deflation and many bond defaults if we don’t do anything at all. It would be led by a deflation of bubble assets (has already been?) but would come to include, well, what?

    So govt would like to prevent that, and might as well inflate at least to the extent that defaults would impact govt’s balance sheet. But I tend to agree – it’s likely simply to drive up interest rates – and hence induce more solvency defaults when combined with mega excess capacity.

    We do have a demand issue, certainly, much more stuff could be produced and consumed this year and probably next – who knows, things are changing so fast. But perhaps classic govt stimulus would do at least as well as buying up troubled assets. They went for bank capitaization seeking to use leverage and avoid the mess of figuring out how to buy garbage, but with how many god-trillions of derrivatives at even higher leverage all over the world, do govts even have the capability of having the biggest sticks?

    Still, I think, at worst, if the finance sector is going to use even 1% of the bailout funds to pay for bonuses this Christmas, that program ought to be short circuited. They say bonus funds are necessary to keep top people, but that’s zero sum for the industry as a whole, except to the extent that there are too many top people in finance, and not enough in the rest of the economy. So if the sector can’t pay its bonuses out of profits, lets at least do a democratic stimulus plan that has a broader aim. A bit for the middle class. A bit of bridge building. A bit of block grants to the states.

    Even at 10% of the amount they’ve borrowed this year that would be a pretty big stimulus, I think. And probably with no more risk. Gnite.

  2. hbl

    Excellent and important post…

    I have not seen an analysis of Japan’s experience with respect to fears of sovereign default. If memory serves, their government debt has tripled from 60% of GDP to 180% of GDP in the almost two decades since the start of their crisis. Yet it would appear that cost to insure Japanese government debt is only around 36bp. Does this offer hope, or are there crucial differences for the US/etc? (I know there are future US government obligations already, for example, but don’t know their magnitude).

  3. Francois

    The lack of a cogent and “bite the bullet” response from our political authorities could be our undoing from a nasty recession to a severe deflationary depression. Truth be told, it couldn’t have happened at a worst moment, ie. presidential election and transition to a new administration.

    Furthermore, just listening to the Congressional testimonies thus far is enough to make one consider suicide or seek asylum elsewhere. Politicians just can’t help themselves in failing to educate themselves properly on economic matters, and avoiding the tough measures needed. The Swedish model appears to be unthinkable here, since the FIRE sector of the economy is such a huge contributor to the electoral slush funds. It is as if they were trying to save the banks, instead of the banking system.

    I’m at the point that I harbor no hope of a quick and DECISIVE solution a la Swede. It’ll be uglier before it gets better…assuming it does get better someday.

  4. hbl

    Also, with respect to the sustainability of low treasury yields, I agree that the risks of such a large increase in supply could be serious, however I wonder if some partially mitigating factors are often overlooked by some commentators (not suggesting Yves is one of them):

    1. Most of the new supply of treasuries resulting from the Fed’s actions (via Treasury Supplemental Financing Program) are simply replacing other toxic assets that are being absorbed by the Fed. So the composition of assets in the system is being changed but not the total quantity, so in this respect specifically, asset supply on aggregate should not be impacted.

    2. On the other hand, two big factors WILL add to treasury supply (and hence aggregate assets in the system looking for funding): (a) new funding needed to cover losses on toxic assets acquired by the fed as they deteriorate, (b) fiscal stimulus spending by Congress. However, let’s say the Fed’s losses are $2 trillion and fiscal stimulus is $2 trillion. Then in an ongoing flight to safety and non-negative returns, $4 trillion in new bonds and bills/notes looking for funding is not too huge relative to other asset markets. (Pre-crisis $20 trillion US stock market, $20 trillion US bond market, $6 trillion existing treasury float, other asset markets.)

    3. The fed is widely expected to begin monetizing assets at the longer end of the yield curve — in effect both increasing demand and reducing supply for treasuries relative to no monetization. This does not have to be inflationary if broad money supply still contracts faster than “printing”.

    4. CPI inflation has been high, but this measure is backward looking, is falling, and according to Mish, is currently overstated

  5. Tom Bombadil

    Why does FT say that short bonds are most sensitive to interest rate moves? I always thought the sensitivity was proportional to the bond duration. Can somebody straighten me out?

  6. Anonymous

    This is what happens when you apply a gaming math model to the stock/security’s market for a profit.

    Any one for a Quantum model?


  7. doc holiday

    Gads, that post is like a chapter of War & Peace!

    Re: "In other words, they want to make the underlying problem of overleverage worse.

    Yah, My take on this, is that there is simply too much excess, i.e, too many homes, too many derivatives connected to bad collateral, too much fraud, just too much excess crap. Every county, city and nation supported the notion and fraudulent nature of explosive growth, which was related to a pyramid scheme that had zero relationship to realistic supply and demand. Then, banks and lenders packaged financial instruments that were literally based on thin air to support fraud — so what is the current solution being offered — — MORE THIN AIR, More shit loans, more credit for more homes, more funding for more shit derivatives, more of the same fuel that started the fire. How about some easy credit for people that screw up, maybe a tsunami of credit for corporations that can't keep their noses out of the cocaine machine of synthetic addiction, blah, blah, blah…. (hair pulling and screaming).

    These TARP engineers are retarded dumbasses, and if I need to, I can come back and friggn pound that out in CAPS — but who cares???

  8. Don

    “Sweden spent 4 percent of its gross domestic product, or 65 billion kronor, the equivalent of $11.7 billion at the time, or $18.3 billion in today’s dollars, to rescue ailing banks. That is slightly less, proportionate to the national economy, than the $700 billion, or roughly 5 percent of gross domestic product, that the Bush administration estimates its own move will cost in the United States.

    But the final cost to Sweden ended up being less than 2 percent of its G.D.P. Some officials say they believe it was closer to zero, depending on how certain rates of return are calculated”

    I don’t know if this helps. This post depresses me. I fear Buiter is right, but, as I’ve argued on his blog, we’re in a political bind now which might not let us pull back. I don’t think it will, so it’s just a matter of triage. Anyway, here’s what I believed as of early last month. I feel that the predictions have gone pretty well. If this continues, I feel that we will have a huge stimulus plan and more bailouts, so, practically, all we can do is try and help people choose the least awful plan. Too bad.

    Thursday, October 2, 2008
    How I’ve Approached The Plans Being Put Forward

    I am a libertarian Democrat. As such, I’m interested in working within a party which can actually change our government over time. Perhaps I am also simply more comfortable culturally in the Democratic Party Coalition.

    In any case, I accept that there is a difference between politics and political theory. Politics is the art of the possible. Political Theory is the view of the government that you would ideally like to see.

    In the current crisis, I acknowledged two plans as having some merit, and fulfilling my requirement that any plan be clear and understandable:

    1) A totally free market plan.

    2) A version of the Swedish Plan.

    In my mind, there are three points that are informing my views on which plan to favor:

    A) There will be a government intervention of some sort, undoubtedly large.

    B) Because crises such as these bring about government intervention.

    C) If there is government intervention, it should be for as broad a purpose as possible and be as thrifty with the taxpayers money as possible.

    Based on these assumptions, I favor a version of the Swedish Plan.

    It’s not that I don’t see other plans as possibly working, but hybrid/compromise plans are generally:

    1) Easier to manipulate by special interests.

    2) Harder to determine what worked and what didn’t.

    3) Riskier financially.

    That’s how I’ve approached this crisis.

    Don the libertarian Democrat

  9. Anonymous

    so, can I conclude this is what will happen?

    1. real economy will continue to slide at least another 3-6 months. Therefore nobody is making money, let alone has money to spare.

    2. US has mismanaged the bail out money. And in the near future will need to issue MASSIVE amount of bond. (Who will buy them? PBOC? Saudi?) The US public certainly doesn’t have the money.

    3. So it comes down to some sort of currency debasing.

    4. The world suddenly notice and start dumping dollar.

    5. default.

  10. mundanomaniac

    a piece, that was written by a jewish german philosopher, walter benjamin (+1940)seems to me fitting in this picture.
    I tried my best in translating it:
    In capitalism one has to realize a religion, e.g. capitalism serves essentially to satisfy the same kind of sorrows, misery, unrest, which formerly the so called religions provided with an answer … […]
    We cannot pull the net, we are standing in, but later on there will be a view of it.
    But there are three features, that are even now about to be realized concerning this religious structure of capitalism. For the first capitalism is a plain cult religion, maybe the most radical which has ever been. Everything in it has meaning only immediately referring to cult; it knows no special dogmatics, no theology. The utilitarianism (“everything for the happiness of the most”) gains its religious color under this point of view.
    With this gaining of concreteness there is connection to a second feature of capitalism: the permanent duration of the cult […] there is no weekday, no day, that wouldn’t be a holiday in the dreadful meaning of unfolding of all sacred pomp, the utterly strain of the worshipper.
    This cult is, for the third, running into debt. Capitalism is probably the first case of a non-expiative but indebtive cult. In here this religious system is standing in the collapse of an immense movement.
    An immense sense of guilt, which has no notion how to deexpiate, grasps for cult, not to expiate in it, but to let it become universal, to hammer it into consciousness and finally and above all to include God himself into this debt to at last have him being interested in the expiation of the debt.
    It is in the essence of this religious movement, which is capitalism, to endure until the end, until the finally entire indebtedness of God, the reached world condition of desperation, which is just still hoped for.
    The historical outrageous of capitalism is lying in this, that religion is no longer the reformation of being but its smashing. The extension of desperation into a religious world condition out of which the salvation is to expect. Gods transcendence has fallen. But he is not dead; he is embedded in human fate.
    This passage of the human planet through the house of desperation in the perfect isolation of its orbit is the ethos that is determining Nietzsche. This human being is the “Übermensch” (Superman), the very first beginning to meet capitalistic religion by realization.
    The fourth feature is, that its God has to be concealed, may not be articulated until reaching the zenith of his indebtedness. The cult is celebrated in front of an unmatured deity. Every imagination, every concept on her hurts the secret of her maturity [ …]
    The concept of the “Übermensch” transfers the apocalyptic “jump” not into turning back, expiation, purification, penance, but into the apparent constantly, but in the last space of time bursting intermittent increase. […] The Übermensch is that historical human that has without turning back arrived by growing through heaven.
    This blasting of heaven by increased humanity, which is and remains religious […] indebtedness …
    Capitalism is a religion of naked cult, without dogma. Capitalism has parasitically emerged […] on Christianity in the occident in such a way, that finally its history in essence is the history of its parasite, the capitalism.
    (Walter Benjamin, Ges. Schriften, VI, S. 100, Frankfurt/M., 1991)

    more for those of you who read german

  11. Richard Kline

    One of your best posts, Yves, as the entire issue of sovereign systemic risk is put in current context, with some historical comparables.

    “Some analysts have pegged US debt to GDP at 350% . . . .” This is the Nidhogg gnawing at the root. Debt never sleeps, it compounds in the dark. We already have a bunch of debt of all types out there relative to our ability as a country to _keep current on it_ to say nothing of paying it down into tolerable levels. Our ability to pay is going to be impaired for years. The solution? Double our outstanding debt. At least. Buiter does a fine summary, and having watched a country go down he is far more current on this than Ben and Hank.

    It is anything but certain that the US Guvmint will even be able to _sell_ its impending $2T. Failure to sell will force risk reappraisals which will have the direst of consequences given the volume of our outstanding debt. Not that I necessarily agree with hbl at 1:33 above, but he/she does at least propose a credible scenario that the debt could get sold. —But what of it? It is very hard to conceive of a scenario where yields DO NOT RISE in floating that kind of debt over the next two years. Which will have an extremely negative effect on outstanding, lower yielding government and corporate debt.

    We are boxing ourselves into a sovereign bond bubble; there is no other way to read this scenario. Perhaps we raise taxes massively, boom exports with a devaluation of the dollar, and cut zombie financials off at the window in the interests of the parts of the banking system we can salvage. It is conceivable that by such means we might, with the cooperation not to say connivance, of other sovereign financial actors, keep out of default. If we do not get exports and taxes well up, and quit wasting the money _in advance_ pushing money into insolvent apex financials, we are croaked, because we are going to issue that debt.

    . . . And despite this, the important decision makers in DC just do not act as if we are in a crisis of magnitude, let alone THIS crisis of THIS magnitude. The Beltway suits act as our crisis involves banks of their friends going bust and homes of a certain percentage of their local electorates going into foreclosure. And those are crises of their kinds, but not THIS crisis. But in trying to fix those crises, they will back into THIS crisis without ever believing that they are so at risk. Crisis typically go from problems to explosions because folks capable of influencing the situation focus on small familiar things at their feet rather than large unfamiliar things coming at their heads. Thus it is that the beltway suits seem so far behind the curve on this problem set that they really could slam their own redshifting asses propping up assests into their own blueshifting faces pushing out debt. With the citizenry briefly wedged between the impact surfaces. This is what worries me.

    In 1780 France was a rich and powerful nation with an unstable fiscal and financial system, busily issuing ever more debt. In 1800, France was a rich and powerful nation with a stable fiscal and financial system—and at war with the rest of the world. In 1790, France was _not_ rich, _not_ powerful, and _very much not_ stable. This is a situation which I doubt that Ben Bernanke has fully analyzed, in no small part because it would appear that he limits his analysis to examining money rather than examining contexts. This is what worries me.

  12. River

    Yves…great post.

    Perhaps another aspect of treasury debt issuance is the perceived use of the capital gained. If foreign purchasers suspect that the US Gov is channeling capital received from treasury sales into unproductive uses which will impede recovery of the economy then treasury yields will indeed increase. More risk is perceived.

    Paulson has placed the AAA credit rating of the US at risk for the benefit of investment banking…A type of banking that is largely no longer needed with the rapid decline of the securitization model. Golden parachutes continue to be provided for those that least deserve them. Banks that should have been left to fail have been rescued (for now).

    Once again we see that the psychology of the treasury buyers will enter into the success of the sales. In another psychological environment, one more positive, the treasury sales might be accomplished with ease. In the current environment and the next couple of years, I doubt it. It is always easier to borrow money when one doesn’t need it.

  13. Anonymous

    Sovereign debt is not such a bad thing when other countries are not in recession. When you have a global recession investors get to pick a choose the sovereign debt they like as all countries try to issue debt. There is of course an alternative and that is to print the money, which the US has sort of started down the road with as quantative easing takes place.
    Greece’s, Austria’s, and Ireland’s devts are ones to watch because they may cause mayhem in the euro zone. As for US debt then there would appear to be a bubble, but it could just deflate gently. Triggers for a rush away from US debt could be sovereign debt default by generally reliable countrues in Europe, but equally very bad economic news could. Watch GM closely this week as insurers have withdrawn insurance for suppliers of goods to them. All ready there are rumours of som larger gloabl suppliers refusing to supply GM.

  14. Matt Dubuque

    Yves, this was worth reading.

    I remain disappointed however that in your repeated discussions of the Swedish model I have never seen you mention what the Executive Director of that program has stated was the KEY element. You are not alone in this omission.

    He stated that once the Swedish government acquired the assets it ACTIVELY managed and improved them before selling them.


    He says this is THE most important point of the program.

    I’m perplexed why Americans steadfastly omit mention of this critical element in their discussions of it.

    It shortchanges the discussion of it.

    Matt Dubuque

  15. Anonymous

    sounds to me its more a crisis of our political system than economic system. Politicians don’t dare to tell people the truth anymore, instead they hope central bankers can turn the tide with some tricks.

  16. john bougearel


    First let me say thank you.

    This post and the link to FT on the 4 Bund failures this year are very important developments.

    The fact that Bund Yields continue to go lower in spite of failed auctions in the Bund signals capital preservation trumps demand for higher returns in a deflation spiral.

    How long this deflation spiral lasts is a doozy. My own models suggest anywhere between 2009 to 2011, which leaves plenty of room for the ugly economic collapse to get a whole lot uglier. It is possible that we just ain’t seen ugly yet. That is the downside risk we face.

    Yves, you do a masterful job at capturing the many different faces of the economic collapse we face.

    It is almost xmas time girlfriend, so bring out the figgy-pudding, I mean tip jar, and have a happy new year!

  17. john bougearel

    As a footnote, Chris Whalen is one of the many along with Anna Schwartz who have pointed out that the liquidity crisis of August 2007 has morphed into a solvency crisis.

    You are right to point out that the US has too much of a vested interest in saving the flawed financial system, and this should scare the bejeezus out of the public. I know it scares me. As you have pointed out before, “broke is broke.” And Paulson’s latest redirect or reform of the TARP plan to “rescue consumer lending” will only put the consumer even further under-water than he already is.

    Paulson simply does not get the fact that the consumer is broke, so his insistence that they go and borrow more signals he does not get the fact that crisis for the consumer has moved beyond liquidity to that of solvency. I quote Paulson on Nov 12: “Illiquidity in this sector [consumer credit]is raising the cost and reducing the availability of car loans, student loans, and credit cards.” Paulson mistakenly sees the distressed debt-burdened consumer as starving for even more credit “This is creating a heavy burden on the American People,” he added.

    The model is broken, you

  18. john bougearel

    Yves, you also point out the US is “determined to minimize immediate pain, no matter how great the damage to long term health.” I think about this determination often, and in my reflections I have to believe this is rooted in our deep-seated fears stemming from the Great Depression. Never wanting to fall into another one, our policymakers have determined to “never let it happen again.” Their policies of accommodation at any cost whatsoever, indicates just how fearful they are of the business cycle when it begins to contract.

  19. john bougearel

    Re: the 30- year auction: the 2.07 bid to cover was not that horrible. The 18% participation from indirect bidders is more alarming given that their participation was 43% in the last 30 year auction. The three and ten year auctions went far better than the 30 yr auction this week.

    Cabot money manager William Larkin is right, “people are looking for the safety of shorter term securities.” And that includes foreign central banks.

  20. Anonymous

    So how do you solve a solvency crises? I am talking one of global proportions with a massive and unsustainable debt.

  21. john bougearel


    Thank you, the refusal of our political authorities to “bite the bullet” as you say, “could be our undoing” And unfortunately, our lawmakers collective refusal to “educate themselves properly on economic matters” is a very sore point with me. When I read statements from Frank et. al. about this economic collapse, I find them by and large so offensive that sometimes I wish we could take Frank out behind the barn and put him out of “our” misery.

    Frank’s comments in recent weeks/months are of the worst sort precisely because he chairs the Senate Finance Committee. If anyone should be up to snuff as a representative/watchdog for the american public, it should be him, but he fails us miserably. Frank is not an overrated asset to the American people, he is to be blunt, a liability.

  22. luther

    danke schoen for the benjamin mundanomaniac. unfortunately my deutch ist nicht so gut.

    browardhome over @ CR shared another gem yesterday by Ravi Batra along the same lines.

    “Human beings all seek unlimited joy, but material objects, being limited, can never offer that. The limited cannot yield the unlimited.”

    with all the doomgloomers abound now, why this man is not more widely quoted in the blogosphere is curious to me.

    perhaps because he offers a way out thru the gloomdoom and most gloomdoomers can only reinforce darkness so they can continue profiting from the gloomdoom (even if the profit is only their self-identity).

    much like capitalists actually…

  23. john bougearel

    @ Richard, we love ya man for your incisive wit “debt never sleeps it compounds in the dark.” Cha-ching!

  24. john bougearel

    Paulson’s redirect of his TARP plan to feed over-levered American citizens even more debt is another fine example of the “if the only tool you have is a hammer, every problem looks like a nail” syndrome.
    The model of force-feeding even more debt to the over-levered American citizenry is a broken model. It is like Paulson is feeding a baby with a flying spoonful of food saying “here comes the plane” (substitute helicopter if we are referring to Ben Bernanke) It will be best if the American people simply make a god-awful scrunched up face, put their hand over their mouths and cry “Wah!”

  25. Tortoise

    “A German 10-year bond auction failed …” This raises the question: what stops the Federal Reserve from buying these bunds? It would indeed be a fantastic opportunity for the Federal Reserve to obtain reserves in euros or a stream of reliable income, provide dollar liquidity, and devalue the dollar.

  26. doc holiday

    Here is a small LHC footnote to ignore:

    Total nonperforming assets (NPAs) were $6.29 billion (1.53% of total loans) at
    September 30, 2008, compared with $3.87 billion (1.01%) at December 31, 2007, and
    $3.18 billion (0.88%) at September 30, 2007. Foreclosed assets were $1,240 million at
    September 30, 2008, $1,184 million at December 31, 2007, and $1,090 million at
    September 30, 2007. Foreclosed assets, a component of total NPAs, included $596 million, $535 million and $487 million of foreclosed real estate securing Government National Mortgage Association (GNMA) loans at September 30, 2008, December 31, 2007 and September 30, 2007, respectively, consistent with regulatory reporting requirements. The foreclosed real estate securing GNMA loans of $596 million represented 14 basis points of the ratio of NPAs to loans at September 30, 2008. Both principal and interest for GNMA loans secured by the foreclosed real estate are collectible because the GNMA loans are insured by the Federal Housing Administration (FHA) or guaranteed by the Department of Veterans Affairs. Until conditions improve in the residential real estate and liquidity markets, we will continue to hold more nonperforming assets on our balance sheet as it is currently the most economic option available.
    Increases in commercial nonperforming assets were also a direct result of the conditions in the residential real estate markets and general consumer economy.

    That is from the fine folks @

    FORM 10-Q
    For the quarterly period ended September 30, 2008

    … But wait, there's more on GNMA….

  27. doc holiday

    Re: Agency Close

    "Additionally, I spoke with a research analyst whose domain is the GSEs and he noted that the GNMA 10 Q released with their earnings this week was rather harsh and conservative. In the forward looking section in listing the bad things which could happen suggested that losses might be so large that $100 billion from Uncle Sam might not be quite a tidy enough sum to cover their problems."

    > Ginnie Mae is a wholly-owned government corporation within the U.S. Department of Housing and Urban Development.

    Ginnie Mae does not buy or sell loans or issue mortgage-backed securities (MBS). Therefore, Ginnie Mae's balance sheet doesn't use derivatives to hedge or carry long term debt.

    What Ginnie Mae does is guarantee investors the timely payment of principal and interest on MBS backed by federally insured or guaranteed loans — mainly loans insured by the Federal Housing Administration (FHA) or guaranteed by the Department of Veterans Affairs (VA). Other guarantors or issuers of loans eligible as collateral for Ginnie Mae MBS include the Department of Agriculture's Rural Housing Service (RHS) and the Department of Housing and Urban Development's Office of Public and Indian Housing (PIH).

    FYI: Ginnie Mae
    Report to Congress
    Fiscal Year 2007
    November 13, 2007

    Ginnie Mae receives no appropriations from general tax revenue. Operations are self-financed through a variety of fees. In FY 2007, Ginnie Mae generated total revenue of $791.3 million. This included $308.5 million in program income and $482.8 million in interest income from U.S. Treasury securities. It should be noted that Ginnie Mae is required by the U.S. Treasury Department to invest any excess revenues in U.S. Treasury securities.

    Ginnie Mae’s operating results are subject to fluctuation each year, depending on the frequency and severity of losses resulting from general economic conditions, mortgage market conditions, and defaulting issuers.


    As of September 30, 2007, the Investment of U.S. Government was $12.6 billion after establishing
    reserves for losses on credit activities, compared with $11.9 billion as of September 30, 2006.

    Over the past three years, Ginnie Mae has increased its capital adequacy ratio (investment in U.S. government securities, plus loan loss reserve as a percentage of total assets and remaining principal balance) to 2.98 percent in FY 2007 from 2.74 percent in FY 2006. To assess the strength of its capital position, Ginnie Mae uses a “stress test” methodology that measures the agency’s ability to withstand severe economic conditions.

    Mortgages Held for Sale: Mortgages held for sale, which are purchased out of MBS
    pools, are carried at the lower of cost or fair value, and with any unrealized losses
    included in current period earnings. The related allowance for loss is established to
    reduce the carrying value of mortgages held for sale to their estimated fair value, which is
    based on the amount Ginnie Mae expects to realize in cash upon sale of the mortgages.

    Properties Held for Sale: Foreclosed assets are recorded at the lower of cost or fair
    value, less estimated costs to sell. The related allowance for loss is established to reduce
    the property carrying value to fair value, less cost to sell. Property related expenses
    incurred during the holding period are included in MBS program expenses.

    Ginnie Mae establishes a reserve for losses through a provision charged to operations,
    when, in management’s judgment, defaults of MBS issuers become probable. The reserve
    for losses is based on an analysis of the MBS portfolio outstanding. In estimating losses,
    management utilizes a statistically based model that evaluates numerous factors,
    including, but not limited to, general and regional economic conditions, mortgage
    characteristics, and actual and expected future default and loan loss experience.

    On September 30, 2007, the amount of
    securities outstanding, which is guaranteed by Ginnie Mae, was $427.6 billion, including
    $52.8 million of Ginnie Mae guaranteed bonds.

    Note M: Subsequent Events

    On October 25, 2007, Ginnie Mae defaulted a single family issuer with a portfolio of
    $235 million. Estimated losses on this default are not readily determinable and
    management believes that the reserve for loss estimate of $535.8 million (Note F) is
    adequate to cover any losses incurred by Ginnie Mae due to this default.

    On August 1, 2007, Ginnie Mae defaulted a single family issuer. On September 20,
    2007, the U.S. Bankruptcy Court approved the agreement to allow until October 9, 2007,
    for this defaulted issuer to find a buyer agreeable to Ginnie Mae to transfer the portfolio. The defaulted issuer found a buyer on October 9, 2007.

    >> That was one year ago, where is the next report?? I can't find it anywhere, any ideas or links?

    HUD doesn't seem to have it, so who has it; shouldn't it be due this week?

  28. doc holiday

    Off topic hell?

    > Some foreclosed houses being sold for a dollar

    Dollar homes are part of HUD’s growing inventory of foreclosed properties, the result of defaults on FHA-insured mortgages.

    HUD homes in Georgia grew 39 percent from September 2007 to September 2008. Sixty percent of HUD’s 3,000-plus Georgia homes are in six metro Atlanta counties.

    HUD decides a buck is better than nothing after waiting at least 180 days. The government has owned the Sims Street house since July 2007, courtesy of Wells Fargo.

    The lender gave the house to HUD when the borrower, who had bought the property in 2000 for $84,000, quit making payments.

    HUD paid Wells Fargo the loan balance, then had an appraisal done, which turned out to be $50,000. After that, it tried selling the house through PEMCO Ltd., the company contracted to dispose of HUD homes in Georgia.

    If HUD could kick itself, it probably would.

  29. Anonymous

    I have to say, the one real element that needs to happen is that the idiocy needs to get shaken out of the system and that people are actually buying CDS on US default is just ludicrous, who is going to be able to pay? Seems like were still a long way.

    I do think the one thing you can count on is the US will not default, but even if it did what would that mean, revaluing the bonds or more likely lack of buyers leading to higher interest rates and slower economy. All in all I think were in for a very protracted global slow down, and the longer we refuse to take out the bad paper, the longer it will be.

  30. doc holiday

    November 13, 2008

    On August 27, 2007, Ginnie Mae published a final rule in the Federal Register (Docket No.
    FR-5063-F-02) notifying the public of its intent to eliminate the use of physical certificates with respect to Ginnie Mae securities. Therefore, effective immediately, Ginnie Mae will no longer allow securities held in book-entry form to be converted to physical securities. Ginnie Mae will only consider exceptions where the requester can demonstrate that issuance of a physical security is in the best interest of the government.

  31. Dave

    Yves – Once again you prove through your integration of widely dispersed data points and systemic analysis the great value your blog creates for thinkers to consider, a well thought and reasoned analysis/summary of where the crisis is. Thank you.

    And to most of the commentators, thank you and keep it up. (;-)>

    In our shop we continue to analyze the situation with growing concern that the conflicting interests of politically driven nation-states vs. spheres of interest and interdependence in the global banking/corporatocracy will not reach an amenable, workable solution. This is primarily due to inherent and understandable self interest of the largest financial actors on the world stage, be they nations or businesses or other money interests.

    To view the increasing financial disorder correctly, in our opinion, one must look to the Misesean view of Money and Credit, wherein, in the long run, credit and debt based inflation ultimately result in systemic failure, crackup-boom.

    More debt and borrowings to prop-up existing and defaulting debts, prevents the free markets from clearing, and healing.

  32. doc holiday

    Slight follow up related to other posts today:

    FHA/MBA Industry Meeting Notes September 18, 2008

    The following was covered relating to FHA and HERA: Review recent mortgagee letters, M.L. 8-22 Moratorium on Risk Based Premiums for FHA Mortgage Insurance and M.L 8-23 Revised Downpayment and Maximum Mortgage Amounts Hope for Homeowners New HECM restrictions What to expect from upcoming mortgagee letters FHA Secure,2008.pdf

    When the FHA loan limit is reduced on 1/1/09, will FHA loans with mortgage amounts above the new 2009 limits be eligible for an FHA streamline refinance?

    The loans will be eligible for FHA Insurance. Ginnie Mae is currently evaluating if the loans will be eligible for Ginnie Mae securitization

  33. Richard Kline

    So john bougearel, I’m good with words. But even so, I chuckled myself when I typed that one. *heh*

  34. cap vandal

    I suppose that you might be interested in something other then the “me too” responses.
    Regarding the Swedish plan, you state that it cost 4% GDP and much less after the stakes in the banks had been sold –2%.
    So far, in the US, we have hundreds of banks rather then the small number in Sweden. It appears to me, with a couple of exceptions, we have practiced a triage of sorts, with the weakest banks WaMu, Wachovia being liquidated and merged with the strongest banks. At the moment, we have a couple of “too big to fail” banks (C and BAC), the former perhaps in bad shape and the latter unknown. However, in general, the money is going to buy preferred shares in the better 1/3 of the banking universe.
    The money was provided at favorable terms – 5% with a small equity kicker. This seems to have caused enormous hand wringing. However, a number of entities have raised additional outside capital after the government infusion. For example, Wells Fargo raised $12.6 billion in a common stock offering AFTER the federal infusion of $25 billion which facilitated the purchase of Wachovia. The government could have gotten much tougher terms (with the possibility that WFC would have skipped both the WB merger and the Federal infusion), but the additional $12.6 billion would have been impossible if the dividend had been eliminated, like the British and Swedish model. The equity issue was oversubscribed and it is possible that WFC could raise additional outside capital.

    If one looks at the costs and benefits of this, assuming that WFC is indeed solvent and remains solvent, the Government has increased its debt by $25 billion. The government is paying 2.71% on 5 year money (Nov 3), and lending to WFC @ 5%. If the TARP preferred isn’t redeemed within 5 years, it resets at a penalty rate. So, the government is getting a spread of over 2%, in spite of the fact that it lent on favorable terms. It will make 1/2 billion/year on this loan. It has also eliminated Wachovia as a FDIC potential expense.

    In the future, the combination of WFC and WB will be more efficient and profitable — giving the government additional tax revenue of 1/3 of the increased profits in perpetuity.

    WFC will write of $60 billion in mortgages as part of its merger. This may or may not be enough to clear the decks, but is a significant percentage of WB’s loan portfolio.

    The net result is that this is a potentially profitable transaction, and far from throwing money down a rat hole. There has been an additional $12 billion of private capital betting that it isn’t going to fail.

    This isn’t necessarily representative of all the TARP capital infusions, but it is reasonable to say that the money is generally going to the strongest banks, that the mergers have cleared up a lot of debris, allowed huge chunks of debt to be written off, taken the FDIC off the hook for a mega bank (WB), among other things.

    Right now, the national debt is roughly 10 trillion, or 70% of GDP. If the US has a debt problem, it is with private debt and various unfunded liabilities.

    I realize that this point of view is not popular, but the idea that the Swedish model is inherently better is not convincing to me. People also want to see bankers suffer, which I am sympathetic to. However, the US plan of triage and fairly lenient terms seems just as likely, if not more likely, to be the lowest cost way to clean up the banking mess.

    As far as the notion of looking at credit default swaps on US debt and making inferences, I find the idea of both a US default AND a default swap paying off to be extremely remote. I can’t understand the reason for a CDS market that seems designed almost entirely for speculation. If people want to bet on extreme events, I suppose as long as it involves consenting adults, it isn’t a problem. However drawing inferences from spreads on US government debt is idiotic. In my humble opinion.

Comments are closed.