On April 14 we posted a discussion entitled “How Deficits Are Financed Does Matter”
(see link below). We pointed out that the government was missing an opportunity to finance its deficits and stimulus measures at once in a lifetime 30 year long term rates in favor of cheaper short term levels. We suggested that that rate rises were inevitable, could come quickly and that waiting would have significant incremental costs to the US taxpayers as well as US corporate debt issuers whose bonds are priced at a spread to US Treasuries. The analogy of Americans who are using ARMs rather than financing long today is an apt comparison that most Americans can readily comprehend. They would not do what the Treasury is doing!!
At the time of our April post, 30 year Treasuries were trading at approximately 3.6%. Today 10 year treasuries are at 3.93% and 30 year Treasuries are now at 4.69%! A 100 basis point or 30% rise in six weeks is bad news. Worse yet, the 10 years are only at that level due to intervention by the Fed and treasury to keep yields below 4%.
That 100 basis point swing alone would result in an annual financing cost of an incremental annual cost of $10billion on $1trillion of debt. Even if we were to just finance for 10 years rather than the previously suggested 30 years, the cost would be $3billion more annually than had we financed for 30 years 7 weeks ago. To make matters worse, Brazil and Russia are making serious noises about dumping upwards of $10billion in treasuries in favor of new IMF bonds. This could be a leading example for other foreign governments to diversify their foreign reserves away from US Govt. obligations. India and China frequently follow in tandem with the actions of Brazil and its Central Bank wizard, Henrique Meirelles. The cost to taxpayers and US corporates would be huge and could significantly impair prospects for economic recovery.
I find it tragic that a socialist nation like Brazil is exhibiting far more economic discipline in financing its deficits and managing its reserves that the United States.
They are not confused between acting in their economic best interests vs. using the Treasury or Central Bank as an instrument of social policy. Likewise, they are very careful to evidence a strong respect for lender rights and the rule of law as it impacts their access to the capital markets.(
Add to these problems is the fact that investors at home and abroad are increasingly worried about the US Government’s lack of respect for the rule of law regarding lender rights in bankruptcy (e.g. GM and Chrysler). America won’t go the way of Weimar Germany but stagflation (inflation without growth) is a real possibility. Savings will be diminished and businesses will become less and less competitive globally. As an investor, government policy leads me to buy mostly foreign securities and inflation hedged companies with assets like oil and iron ore. As a card carrying Democrat, I am troubled for my country’s economic future. We can and must do better.
Follow the links below for copies of prior posts on financing the Treasury and Brazil’ Central Bank President
Liberty University recently announced that it is banning the College Democratic Club from its campus. As has been reported, Liberty’s Vice President for Student Affairs, Mark Hine, advised the student group that the Democratic Party violated the University’s principles because it supports abortion, socialism and the agenda of gay, bisexual and transgender people. The basis for the ban is the non-binding Democratic Party Platform from the 2008 Presidential campaign.
Many registered Democrats and elected Democratic officials would dispute the decision on the basis of fact. For proof of this assertion, one only needs to examine the views of pro-life Senator Bob Casey or gay groups who are angry at President Obama for his failure to invalidate “Don’t ask don’t tell” in the US Military. They know first hand that the Democratic Platform is neither enforceable nor something that is universally supported by leading elected Democrats.
This action represents a dangerous step for an educational institution. Depending on one’s perspective, issues can range from the denial of free speech to jeopardizing the University’s not for profit status by directly engaging in partisan politics as opposed to taking positions on individual issues. Unlike a recent decision by Brigham Young University-Idaho to ban both the Democratic and Republican clubs in order to protect its tax exempt status and eliminate any potential charge of the institution supporting one or another political party, Liberty is singling out the Democrats as a group and taking no action against the Republican College Club.
The loss of tax exempt status could have a material adverse impact on Liberty’s economic condition. Loss of not for profit status would jeopardize funding from public and private programs for research, scholarships and other essentials. It could also hurt fundraising from contributors who would no longer be able to claim a tax deduction for their gifts.
As a self proclaimed “conservative” institution with strong supporters in segments of the Christian community, they should question whether a significant potential economic loss is worth any perceived benefit in denying the rights to free speech for what is likely to be an insignificant number of students at the school. Such an action to deny a liberty by a school named Liberty raises the specter of both losing moral standing and making its name synonymous with something new; hypocrisy.
Libertarians (as opposed to Liberty alumni) and civil libertarians alike should come to the defense of the Democratic Club at Liberty University. Likewise, the federal government should take action to revoke Liberty’s tax exempt status if it does not withdraw this edict. Regardless of one’s political affiliation, defense of freedom of expression is critical to the American way of life. It is what separates us from the radical theocratic thinking of our enemies in Al Queda.
Harvard Law School Professor Mark Roe made some extremely thoughtful observations in a Friday “Op Ed” piece in the Wall Street Journal (“A Chrysler Bankruptcy Won’t Be Quick”). Central to his discussion are the following key questions:
• Are Chrysler’s secured lenders receiving fair value for their claims as is their legal right in bankruptcy?
• Was the 70% lender vote to accept $.32 on the dollar valid or was it coercively tainted by government influence on banks who had received TARP funds? The law requires a 2/3 vote of secured creditors to accept a settlement. TARP banks make up the vast preponderance of the lenders who accepted the govenment’s proposal. Non-TARP lenders can reasonably ask if TARP lenders would have voted to accept if the government did not have an ability to influence their operations.
Professor Roe makes it clear that there is a reasonable basis for lenders to resist the settlement “mandated” by the Obama Administration. If so, creditor claims may make the final outcome less than clear and the process long and contentious.
What is not said but also must be considered is the generally heavy hand of the government to obviate the contractual rights of secure lenders. This does not begin to address the issue of unions gaining majority control of the Company.
The overall process raises significant and pernicious issues for our national economic future. If lenders rights are not protected, the appetite for U.S. corporate debt will diminish significantly. This will have severe adverse implications on economic growth, employment and our national standard of living. We have already seen how unilateral government interference has caused a significant measure of investor reluctance to play in TALF programs to buy “Toxic Loans”. The Chrysler bankruptcy could make matters worse. Fears of government intervention against indenture terms will not necessarily be reduced by higher interest rates, though higher rates will be one possible outcome. They will more than likely result in reduced lending until fears abate. The government will find that it has a hard time forcing lending by any institution that it does not control (ie foreign banks etc). If the over arching goal of Treasury policy is to get credit flowing, the government’s role in Chrysler is a major step backward.
Just as the American government was wrong in condoning torture against the laws of the nation and the civilized world, so too are actions which disregard freely negotiated loan terms which are critical to financing American industry. If we learned anything from the disastrous policies of the Bush administration, we need to understand and believe that our laws can’t be selectively followed or enforced.
Fortune magazine’s Allan Sloan poses some excellent questions and raises some ugly issues in his piece “Structuring the Treasury’s bet for a Long-Term payoff.” His central thesis is that the Treasury makes a mistake financing the majority of its new debt in the short term debt markets at .2% today rather than locking in long term (30 year) rates at about 3.6%. It is his belief that long rates are likely to rise as the US deficit increases. While he makes no judgment on the merits of a deficit driven stimulus plan, financing such long term deficits in the short term markets may make the near term savings extremely expensive in the long run.
Rates may rise regardless of what action the Treasury takes today, however, the actions taken today may make tomorrow worse than it need be. Rising rates are usually what happens when business conditions improve from recessionary levels. Financing an increasing deficit in the short term market today exposes the Treasury to greater refinancing risk in the future in what most likely will be a higher rate environment. Laws of supply and demand will also have an impact on the US Treasury’s cost of capital. The larger the amount to be financed, the more leverage the buyers will have in terms of rate demands. The Chinese are already talking about holding less dollar debt. Is this a precursor for a “Sino-Hold-Up” that would make John Dillinger proud? While there is still faith in the United States Treasury, that faith could have an unattractive price tag attached!
The implications for a rise in long term rates and strategies to minimize the long term interest cost do more than just add varying levels of incremental debt to our national balance sheet. Corporate bonds are usually priced on the basis of a “spread” over Treasuries. Higher Treasuries, regardless of the maturity, mean higher corporate borrowing costs unless spreads decrease; the exact opposite may happen in a rising rate environment. Weaker and smaller less-than-investment-grade companies can expect to be hit the hardest. In a worst case scenario, it is possible that no spread would be sufficient to compensate investors. To put hard numbers to this, in today’s market, B rated companies’ 8-10 year bonds are trading in the 14-15% range. Similar bonds of BB rated businesses are in the 10-12% range. Were ten year Treasury rates to rise 2.5-3% and spreads to remain constant, the cost of ten year bonds for B rated businesses would rise to 16.5-18% and BB rated bonds to 12.5-15%. Any upward movement in spreads would make rates higher, taking them to potentially prohibitive levels. Though such rates would not impact the cost of pre-existing bonds, they would be a severe impediment to the refinancing of maturing bonds and/or to finance growth or capital projects.
Dick Cheney was famous for saying that “deficits don’t matter.” Time will tell if he was right. What is for sure is that how deficits are financed can make a big difference!
This weekend American Jews and Christians of various denominations will celebrate high holy days of their respective faiths. As they do so, they should also remember and give thanks to the wisdom our our nation’s founding fathers that they chose to distinguish our nation as one with a clear separation of religion from governmental law. One of the great principles of our nation is that individuals can be free to practice, or not practice, the religion of their choice. To those who would suggest otherwise, we would urge that they re-read their American history.
The attached cartoon and a copy of Thomas Jefferson’s word to Baptist ministers in Danbury, Ct. make clear the values of our founders and the author of the Decration of Independence.
Happy Easter and Happy Passover to all who celebrate. God bless America to everyone!!
Who’s kidding who? The fact that PAC contributions fell only 6% in the first two months of 2009 vs. 2007 is remarkable. Big banks which are receiving TARP funding have been virtually out of the PAC business. Add to this the facts that businesses are facing tight liquidity, major losses and an administration espousing squeaky clean policies on political giving. Down ONLY 6% is the new up! The Wall Street Journal and others can write all they want about how political giving is way down. Anything in the range of a 10% or less decline in PAC giving says to this author that PAC giving is actually deemed as an important business priority for the givers’ employers. Anyone who has been in any significant role at a major US corporation knows that PAC giving is voluntary in name only. Whether you are a Democrat or Republican, you never want to receive a call from your boss asking why you have not given to the firm’s PAC! If employers are making such calls today, they must really mean business.
Is the Wall Street Journal in cahoots with business to mask this story or do they just not get the joke?
As my mom often tells me, “many a truth is told in jest”. Tom Toles captures the estate tax argument in a cartoon. What is hard to believe, in times like these, is that there is substantive Republican discussion about the estate tax. For those in the Republican leadership who have gripes about the $7million limit before taxation that President Obama proposes, they and their constituents should be happy if they can still pass that level of tax free capital to their children. They may not realize that many who might have been able to do so can no longer do it due to the financial crisis. Likewise, when they had a chance to increase the limit, they overreached and sought to completely eliminate it on a permanent basis. Fighting over this issue now raises a serious issue of certain leaders’ priorities in a conflagration!
Recently Katrina Vanden Heuvel, Editor of the the Nation, has been suggesting that Treasury Secretary Tim Geithner should be replaced by Elliot Spitzer. We know that she and her husband have been his friend since their days at Princeton but her suggestion is an embarrassment. Perhaps she is letting friendship cloud her judgment. Aside from the fact that Spitzer pleaded no contest to several of the crimes (Mann Act violations, illegal currency wire transfers, aiding and abetting prostitution etc.) that he often used to coerce his targets when he was New York Attorney General, he may have been the root cause of AIG’s demise. His actions, which forced out AIG’s long time CEO, Hank Greenberg, led to new management which took the company in the wrong direction. Greenberg’s successors had a difficult time maintaining his earnings record. They went for what they saw as easy money in credit default swaps and other esoteric insurance products. This was a large and real deviation from the way Greenberg ran the company. We all know the rest of the story.
The laws of unintended consequences really can be punishing when you act in a vindictive manner rather than as a result of a deliberate strategy.
As a secondary question, does Katrina expect an easy confirmation for her friend Elliot? Larry Summers was kept away from the Senate confirmation process because he spoke out about the gap between women and men in scientific fields of study. Imagine if he had broken multiple laws to hire $5,000 per hour hookers! At least Elliot paid his taxes.
From the attached article, one can see that Attorney General Andrew Cuomo is using a little gentle persuasion along the line of thinking we suggested earlier this week. Let’s hope he is not afraid to push harder and work with the leaders of the New York congressional delegation to develop a Black List that makes it tough for those who do not pay back to find gainful employment with any firm that does business with TARP recipients. Punish the guilty, not the innocent who must stay at their jobs to clean up the mess!
Whither the dollar? That is the question. As the attached article points out, the Chinese government is worried. If they are worried, we should be too! A cheaper dollar certainly debases their investment in dollar denominated securities, particularly the Treasury obligations which they already own. Equally significant, a cheaper dollar will likely force us to pay higher rates on the Treasuries which we will sell to finance the large stimulus package that will be unfolding in the coming months. The only silver lining is that China is as addicted to a high dollar as we are. As we are their largest market for all sorts of goods, and because their currency is basically pegged to ours, their income and purchasing power erodes as the dollar declines. One answer for them is to allow their currency to trade more freely like other currencies do. While it sounds reasonable, they know that freeing their currency to trade on a “market basis” is the proverbial slippery slope. It is a slope that they will find pock marked with speed bumps and other hidden dangers that they have, to date, assiduously avoided. This is a relationship that bears watching closely and must be handled with deft skills by the Obama administration