The Great Debate

Toxic asset profits, public liability

James Saft

Oct 26, 2010 11:26 EDT

Hedge funds sponsored by the U.S. Treasury are reporting eye-popping returns, but the costs to taxpayers and households could end up being massive.

Funds created under the Public-Private Investment Program reported annualized net internal rates of return averaging 36 percent through Sept. 30, the Treasury announced on Friday, a figure that could encourage the belief that the banking bailout was a shrewd investment rather than a transfer of wealth.

The PPIP was created in 2009 to allow private investors to partner with the public purse to purchase distressed assets from the banking system, using cheap loans from the government for leverage.

Eight of these funds were created, with the Treasury having a 50 percent equity stake in each but providing all of the debt funding at extremely low rates averaging just over 1 percent a year.

It’s hard to know which to debunk first: the returns of the PPIP, which are the outputs of the “models” we’ve come to know and love; the structure, which privatizes profits and retains for the public the bulk of the risks; or the conception of the whole enterprise, which is aimed at propping up asset values to avoid more direct subsidies to banks.

First off, the return figures. The 36 percent is an average, and an annualized one at that. For the taxpayer, who is earning a leveraged return on half of the equity but who is saddled with all of the debt, the overall return thus far is more like 5.6 percent, according to Linus Wilson, professor of finance at the University of Louisiana in Lafayette.

Also note that the returns are based on opaque mark-to-model calculations by the Treasury, estimates which could turn out to be, as they were for Bear Stearns and so many others, highly optimistic.

Position fatigue prompting short-term dollar rethink

Neal Kimberley

Sep 28, 2009 13:01 EDT

– Neal Kimberley is an FX market analyst for Reuters. The opinions expressed are his own –

Dollar bears have been disappointed by the G20.

Talk of re-balancing remained just talk; the bears can discern nothing substantial. Some risk is being taken off and dollars bought back selectively. While the dollar’s general downtrend is intact, there are risks of a temporary reversal, with some seeing the euro temporarily back to $1.4500/50.

Traders can contrast G20 with the Plaza Accord in 1985 which was driven by U.S. Treasury Secretary James Baker’s persistence. But he only had to convince four peers. G20 is and will be a different story. Dealing with the G20 must be like herding cats.

Disappointment over G20 has come at an inauspicious moment. Extensive short dollar foreign exchange positions have been underpinned by the unparalleled provision of dollar liquidity by the world’s central banks.

The market has used that dollar liquidity to fund purchases of other currencies and assets. Currency speculators raised their bets against the dollar in the latest week to the most since March, 2008, data from the Commodity Futures Trading Commission on Friday showed.

But the market is realising that the major central banks are contemplating the initial steps in their exit strategies, which would naturally reverse the dollar-funded carry trade.

Fishy bailout profits and ephemeral gains

J Saft

Sep 1, 2009 08:40 EDT

(James Saft is a Reuters columnist. The opinions expressed are his own)

There is a long list of outfits which have done well out of the banking bailout, but the U.S. Treasury and Federal Reserve are not among them.

According to calculations made for the New York Times, the Treasury’s Troubled Asset Relief Program (TARP) has reaped profits of about $4 billion, or 15 percent annualized, as eight of the largest banks to participate have fully repaid what they owe.

Meanwhile unnamed Federal Reserve officials told the Financial Times that the central bank’s liquidity facilities have generated a “gain” of $14 billion since August of 2007.

The notion of TARP profits is only true if looked at in the narrowest sense, and even then may prove to be a return as real as those of the Florida condo flippers in the summer of 2007.

The Fed, on the other hand, incontrovertibly has earned more by buying and lending against poorer quality paper, but they did it by taking on more risk – a leaf out of the book of the industry they were helping to rescue.

Wait until the Fed starts making payday loans or gets into the reconditioned small appliance finance business, then you will see what kind of “gains” a bank with a printing press and the power to create money can really generate.

Bonds swamped in fair weather or foul

James Saft

May 29, 2009 05:07 EDT

– James Saft is a Reuters columnist. The opinions expressed are his own –

Come good news or bad, the U.S. treasury market is taking a sell now and wait for inflation later strategy.

Since May 21, Treasuries have been battered, sending the yield on 10-year bonds up by nearly 40 basis points to 3.53 percent, an enormous move in bond market terms.

This is where the real action is, not in speculation about whether credit ratings agencies will cut the U.S. AAA rating in a year or two; by the time they get around to saying what everyone already knows is true, the damage will have been done.

The U.S. is in the process of reflating, really re-leveraging its economy, but this time using the public purse and printing machine to replace private demand.

This may be necessary, it may even work, but what it is without doubt is risky. The Federal Reserve’s massive direct intervention in credit markets will have to be unwound if and when it works, with unforeseeable consequences, and the government’s funding needs are in the meantime intimidating.

Investors in Treasuries rightly fear the risks of inflation and of being left, eventually, holders of what the Fed is selling rather than what it is, at least for now, buying.

Uncertain Fed support sinks bonds

John Kemp

Apr 30, 2009 08:48 EDT

– John Kemp is a Reuters columnist. The views expressed are his own –

The bond market’s adverse reaction after the Fed announced no new asset purchase facilities or bond buyback programs highlights the fundamental difference between interest rates and quantitative easing (QE).

Rate cuts provide ongoing support for an indefinite period until the Federal Open Market Committee chooses to reverse them. In contrast, QE programs provide a one-off, time-limited boost that has to be continually reapplied to have the same effect.

With interest rates a decision to leave rates alone represents “no change” in policy; with QE, a decision to leave the scale and duration of the buyback program unchanged is a “tightening”.

QE is time-limited because it drives up bond prices and cuts yields only as long as buybacks continue, or are expected to do so. Once planned buybacks have been completed, or are not expected to be extended, the market will revert to its natural clearing equilibrium. Repeated doses of QE are needed just to keep yields unchanged.

This creates something of a dilemma for policymakers in both the United States and the United Kingdom. The Bank of England’s program to buy 75 billion pounds worth of government and corporate bonds will be completed in mid-June. The Fed’s program to buy $300 billion of medium and long-term U.S. Treasury securities finishes in September.

Once the current round of purchases are complete, both central banks will have to decide whether to embark on another one (intensifying criticism about inflationary financing of public debt) or end it (triggering a sharp yield increase).

Obama and flawed logic on Cuba

Bernd Debusmann

Apr 14, 2009 10:25 EDT

– Bernd Debusmann is a Reuters columnist. The opinions expressed are his own –

The U.S. case for isolating Cuba and keeping it out of international meetings such as this week’s Summit of the Americas sounds simple: the country doesn’t have democratically elected leaders, it holds political prisoners, it violates human rights and its citizens can’t travel freely. All perfectly true.

But if the logic used for isolating Cuba were applied consistently, neither China nor Saudi Arabia, for example, should have taken part in the London G20 summit. The U.S. State Department estimates China has “tens of thousands” of political prisoners and describes it as “an authoritarian state in which the Chinese Communist Party … is the paramount source of power.”

That has made little difference to the close relationship of mutual dependence between the U.S. and China, the largest creditor of the United States. During U.S. Secretary of State Hillary Clinton’s February visit to China, pragmatism triumphed over human rights concerns as she urged the Chinese to keep buying U.S. treasury bonds.

In comparison to China’s “tens of thousands,” the State Department’s latest human rights report quotes a Cuban human rights group as saying the government there held at least 205 political prisoners at the end of 2008, down from 240 at the end of 2007.

The Saudi monarchy, according to the State Department report, denies its citizens the right to change the government peacefully, holds political prisoners, curbs free speech, restricts religious freedom, tolerates violence against women, and sanctions corporal punishment. The list goes on and includes lack of due process in the judicial system.

Bond market vigilantes saddle up

J Saft

Apr 10, 2009 08:00 EDT

– James Saft is a Reuters columnist. The opinions expressed are his own –

Efforts to reflate the economies of the U.S. and Britain are running into one potentially major problem; the bond market.

Appetite for government debt in recent sales has been very poor, raising the cost to the two governments of borrowing and blunting their efforts to bring down market interest rates by buying back their debt.

This is a big risk for British and U.S. efforts to rescue their economies, and could be yet another self reinforcing downward force if holders of government debt get the frights.

Both countries are running hugely expansionary fiscal stimulus programs that will need to be paid for by gargantuan sales of government debt. At the same time both have such low official interest rates, 0 to 25 basis points for the U.S. and

50 basis points in Britain, that they are engaging in purchases of their own debt, or quantitative easing, in the hope that this lowers rates for consumers and businesses and encourages money to be spent or invested.

It is impossible to know exactly how effective the policy is, after all we don’t know what rates would be without it. We can though see two things clearly; there are lots of sellers when the U.S. and Britain seek to buy their own bonds, but when it comes to the far larger operation of issuing bonds to fund ongoing needs, investors are markedly less enthusiastic. The U.S. Treasury got a very poor response on Tuesday when it auctioned $6 billion of 9-year, 9-month inflation-indexed notes at a yield of 1.589 percent, better terms for investors than similar issues on the secondary market at the time. Of particular note was the fact that so-called indirect bidders, mostly foreign central banks, stepped up for just 26.1 percent of the sale, as against 47.2 percent at the last such auction in January, which was before the policy of Fed purchases of Treasuries was announced.

Fed sets out exit strategy

John Kemp

Mar 26, 2009 09:04 EDT

– John Kemp is a Reuters columnist. The views expressed are his own –

Intense criticism of the Fed’s role in the financial rescue program and the decision to triple its balance sheet, including monetizing a portion of the Treasury’s debt, has forced the central bank to issue an unusual defense of its actions (http://www.federalreserve.gov/newsevents/press/monetary/20090323b.htm).

It attempts to placate critics by acknowledging the real risk of inflation, and marks the Fed’s first attempt to set out an “exit strategy” for ending quantitative easing and other credit programs once the crisis is safely passed.

The joint statement issued with the U.S. Treasury reflects “the common views of the Treasury and the Federal Reserve on the appropriate roles of the Federal Reserve and the Treasury during the current financial crisis and in future.”

The last time the Fed and Treasury were forced to reach such an agreed statement defining their respective responsibilities was in 1951. Over the previous 15 years, monetary and fiscal policies had largely become fused as a result of the Great Depression (with interest rates kept artificially low to support recovery, then abandoned as a tool of monetary management in favor of reserve requirements) and World War Two (with rates repressed to help finance the government’s massive borrowing program).

Even after the war had finished, the Fed held short-term interest rates at just 1 percent. Rates did not begin to rise until the start of 1948, and they were still at just 2 percent by the end of 1952 (https://customers.reuters.com/d/graphics/WARTIMEFINANCE.pdf).

Crucially, the Fed also enforced a 2.5 percent ceiling on long-term Treasury yields through open market operations to hold rates down and support the federal government’s massive wartime borrowing program and the need to refinance the debt at low cost. Precisely what the Bernanke Fed is now doing through its Treasuries purchase program.

U.S. government borrowing runs into resistance

John Kemp

Mar 26, 2009 08:57 EDT

– John Kemp is a Reuters columnist. The views expressed are his own –

Investors have started to balk at absorbing large quantities of U.S. government debt, taking on substantial inflation and devaluation risk in return for little reward. While the government has no trouble placing short-term debt with a maturity of up to 2 years, longer-dated securities are proving much harder to sell.

Increasing resistance from the market explains why the Federal Reserve felt it had no choice but to announce it would start buying back longer-term U.S. Treasury securities last week, in a $300 billion program of direct quantitative easing and monetization.

The attached chart (https://customers.reuters.com/d/graphics/TREASAUCTIONS.pdf) shows the amount of 10-year U.S. Treasury debt placed at each of the auctions since the beginning of 2008, the interest rate which the government offered (coupon yield), and the range of rates (high, low, median) the market actually accepted through the auction process.

The government has been steadily cutting the coupon rate on offer from 4 percent in September 2008 to 3.75 percent in January 2009 and 2.75 percent at the auctions held in both February and March. But the market’s appetite for longer-term debt at such low interest rates has been waning.

The median yield which the market has demanded in the auctions has risen steadily from 2.35 percent in January to 2.71 percent in February and 2.98 percent in March. The high yield is up from 2.42 percent in January to 3.04 percent in March.

The March auction results show the government’s borrowing program was in increasing trouble. The median yield the market accepted (2.98 percent) was 23 basis points above the coupon the government was offering (2.75 percent); the government was forced to place the issue at a substantial discount (the debt was sold for an unusually large discount of 2.49 percent to its face value, or just 97.50 cents on the dollar).

Playing chicken with the Fed

John Kemp

Feb 4, 2009 09:01 EST

– John Kemp is a Reuters columnist. The opinions expressed are his own –

Yields on long-term U.S. Treasury debt continued to surge higher yesterday as the market braced for a future upturn in inflation and a tidal wave of long-dated issues that will be needed to fund the bank rescues and the emerging stimulus package.

Yields on three-year notes are up by around 47 basis points from their mid-December low. But yields on ten-year paper have soared 82 points and rates on the 30-year long bond have surged 114 points. Long-bond rates have retraced more than half their decline since the autumn (https://customers.reuters.com/d/graphics/USTREAS.pdf).

Back-end yields would probably have risen even further were it not for persistent hints the Federal Reserve is thinking about buying longer-dated issues to cap them. But the market has started to call the Fed’s bluff.

MANIPULATING THE FRONT END

In the press statement accompanying its most recent interest rate decision, the Federal Open Market Committee (FOMC) gave a clear commitment it will keep short-term rates at “exceptionally low levels for some time.” In practice, the Fed will probably hold rates close to zero for the next two to three years until a cyclical recovery is well underway. But thereafter rates will need to rise to more normal levels to contain inflationary pressures.

The steepening yield curve reflects an assumption the Fed’s zero-interest rate policy will dominate the whole yield on debt maturing in 2009-2011, but have a diminishing effect on securities which mature further in the future.