One of the problems with out of control government spending is the way it affects the behavior of government itself. Like any other junkie, the government convinces itself it needs "just one more" fix and will do anything to get it. Again like a junkie, the government will prostitute itself and steal from friends and family to keep the drug supply coming.
We see a glaring example of the later when governments simply grab private property in order to pay off their own debts. We have already seen the precedent for pensions being seized by government. Just last week in Hungary the government grabbed $14 billion in private assets. Over the weekend, the Irish government decided to take 15 billion Euros from the future pensions of its citizens to give to the banks. Now France is taking 36 billion Euros from the pension fund to keep its bloated and unsustainable welfare state afloat for just a little while longer.
People need to understand that the United States is not immune to the same financial pressures that caused Hungary, Ireland and France to take these desperate measures. If you are counting on a future pension from the state, you might wish to start making alternate plans. In most states, there is effectively zero chance that you will get everything promised - the state government pension funds are already over $1 trillion in the hole. The gap will only grow as additional obligations are incurred but little new money is available to meet them from the state budget side. It would be completely unsurprising if the more desperate and foolish states attempted to raid these pension funds to "invest" in more unemployment payouts or other attempts to fund general budget spending.
Of course we won't have that problem with Social Security since it is funded entirely by current taxes. Since no such pension fund exists, we don't have to worry about the government grabbing it. Of course that raises the question of which assets the will try to take since the same financial imperatives and the same junkie behavior are at work in Washington as in Budapest, Dublin and Paris. That said, we need to be vigilant for any sign that similar asset seizures are imminent here in the United States since the precedent has already been set. We have been warned by events across the pond.
Showing posts with label deficit. Show all posts
Showing posts with label deficit. Show all posts
Monday, 29 November 2010
Wednesday, 11 August 2010
Bank Debt Spiral
The zero interest rate policy (ZIRP) will kill the banks. Falling interest rates help banks by increasing the value of their bond and loan portfolios. This is the well understood inverse relationship between discount rate and present value of a future sum. But you see keeping interest rates at zero does virtually nothing for the banks as rates cannot fall further. There is a short window where ZIRP is a positive but an "extended period" (in Fedspeak) is just slow death for the banks.
During that short period, the banks are still collecting on portfolios constructed when rates were higher but as those higher-yielding assets mature, there is nothing comparable to replace them. We hear constantly how banks can just borrow at zero and invest in Treasuries - pocketing the difference. That would be fine if yields on Treasury debt were not low and falling along with everything else. The other problem is that this simplistic formula assumes that banks' operating expenses are negligible. Both unstated assumptions fail any sort of reality check.
Back in the real world, T-bills yield virtually nothing. The 2-year note is now at 50 basis points as of today. The 5-year is at 1.43% and the 10-year at 2.68%. Assuming zero borrowing cost (which is overly generous), net interest is equal to gross interest. Large banks generally require a net interest spread of more than 2% to cover their expenses, so they will lose money even buying 5-year Treasuries. If they invest their entire portfolio in 10-year notes, they'll make about a 50 basis point spread on assets pre-tax. But the 10 years is a lot of risk in terms of time for rates to change and also a long time to tie up the money. And banks care BARELY eke out a profit by taking this extreme level of maturity risk. There is a reason why you never see loan portfolios with 10 year average maturities.
For those advocates who think banks can rebuild their balance sheets by buying Treasuries, you might ultimately be correct but there are so many things that can go wrong with that scenario. First consider the size of the hole in bank balance sheets. Recent activity at the FDIC suggests that many troubled banks are overstating the value of their assets by 30% or more - that is the average size of the hit when the FDIC takes them over. At a rebuild rate of 50 basis points annually (with a lot of risk) it would take a literal lifetime to repair the balance sheets via this strategy. It was much easier in the early 1990s when rates for the 10-year started at 9% and never went below 5.5%. There was plenty of room to generate capital gains on bank bond portfolios wit falling rates and still leave a reasonable current yield at the end. Anybody using that era as a template for bank recovery is going to be sorely disappointed. Does anybody still wonder why Japan is trapped despite 20 years of ZIRP?
All of this assumes that ZIRP is sustainable over decades and that the financial system is sufficiently stable to endure the pressure over the long term. Neither one is proven and the ability to fund the debt implied by ZIRP is particularly shaky. If it works, it will take 60 years As one one of our favorite bloggers Karl Denninger says "the math is never wrong."
During that short period, the banks are still collecting on portfolios constructed when rates were higher but as those higher-yielding assets mature, there is nothing comparable to replace them. We hear constantly how banks can just borrow at zero and invest in Treasuries - pocketing the difference. That would be fine if yields on Treasury debt were not low and falling along with everything else. The other problem is that this simplistic formula assumes that banks' operating expenses are negligible. Both unstated assumptions fail any sort of reality check.
Back in the real world, T-bills yield virtually nothing. The 2-year note is now at 50 basis points as of today. The 5-year is at 1.43% and the 10-year at 2.68%. Assuming zero borrowing cost (which is overly generous), net interest is equal to gross interest. Large banks generally require a net interest spread of more than 2% to cover their expenses, so they will lose money even buying 5-year Treasuries. If they invest their entire portfolio in 10-year notes, they'll make about a 50 basis point spread on assets pre-tax. But the 10 years is a lot of risk in terms of time for rates to change and also a long time to tie up the money. And banks care BARELY eke out a profit by taking this extreme level of maturity risk. There is a reason why you never see loan portfolios with 10 year average maturities.
For those advocates who think banks can rebuild their balance sheets by buying Treasuries, you might ultimately be correct but there are so many things that can go wrong with that scenario. First consider the size of the hole in bank balance sheets. Recent activity at the FDIC suggests that many troubled banks are overstating the value of their assets by 30% or more - that is the average size of the hit when the FDIC takes them over. At a rebuild rate of 50 basis points annually (with a lot of risk) it would take a literal lifetime to repair the balance sheets via this strategy. It was much easier in the early 1990s when rates for the 10-year started at 9% and never went below 5.5%. There was plenty of room to generate capital gains on bank bond portfolios wit falling rates and still leave a reasonable current yield at the end. Anybody using that era as a template for bank recovery is going to be sorely disappointed. Does anybody still wonder why Japan is trapped despite 20 years of ZIRP?
All of this assumes that ZIRP is sustainable over decades and that the financial system is sufficiently stable to endure the pressure over the long term. Neither one is proven and the ability to fund the debt implied by ZIRP is particularly shaky. If it works, it will take 60 years As one one of our favorite bloggers Karl Denninger says "the math is never wrong."
Monday, 7 June 2010
THe Keynesian Comeuppance
During the current economic crisis, most of the major countries have tried to spend their way out - either with government programs funded with new debt or by forcing debt directly into the private economy through guarantees, regulations and action by quasi-government bodies. We discussed the implications for China in Command and Control and for the US in The Federal Funhouse. These initiatives were based on Keynesian economic theory - that government should make up for any shortfall in private demand by spending (likely
incurring deficits) sufficient to stabilize aggregate demand.
This is a temporary band aid at best and the governments and central banks were hoping to buy time and convince everyone that things were OK so they should go out and spend. This was doomed to fail as prior private demand was based on nearly universal lending at suicidal risk levels. One of the key objectives of Financial Jenga was to document the extent of the madness in credit. Enough people have seen through the wishful thinking so that there will be greater caution on the part of both borrowers and lenders for the foreseeable future.
The massive deficits that various governments have run can only be sustained as long as there are lenders out there willing to finance them. Several bond auctions have failed or nearly failed in the last several weeks. Now we see the appetite for debt drying up and some key nations beginning to talk about austerity. A good example is this statement from the G-20 Meeting Communique:
Bux Populi
Austerity is the new watchword and it is showing up first in places where governments either have their backs to the wall or are less under the influence of the banks. Yet even here in the US, where we have the best government the bankers' money can buy, things are starting to change. Actual voters concerned about the rapidly growing deficit seem to be a stumbling block to Congressional spending with less than 6 months until the elections. Web-based My Way News reports:
The difficulty financing our debt led the Obama Administration to float several proposals for major tax increases in an effort to convince bond buyers that there would be enough tax revenue to support the debt. This included a VAT. Notice how little we have heard about that and other taxes since the Euro crisis made the dollar and Treasuries the only game in town. Even so, the easy period of debt finance is coming to an end - even for the US government. Washington had best not expect to fund large deficits easily into the indefinite future.
A lot of bankers have to be asking themselves a question. If governments are cutting back, who is going to bail me out?
incurring deficits) sufficient to stabilize aggregate demand.
This is a temporary band aid at best and the governments and central banks were hoping to buy time and convince everyone that things were OK so they should go out and spend. This was doomed to fail as prior private demand was based on nearly universal lending at suicidal risk levels. One of the key objectives of Financial Jenga was to document the extent of the madness in credit. Enough people have seen through the wishful thinking so that there will be greater caution on the part of both borrowers and lenders for the foreseeable future.
The massive deficits that various governments have run can only be sustained as long as there are lenders out there willing to finance them. Several bond auctions have failed or nearly failed in the last several weeks. Now we see the appetite for debt drying up and some key nations beginning to talk about austerity. A good example is this statement from the G-20 Meeting Communique:
The recent events highlight the importance of sustainable public finances and the need for our countries to put in place credible, growth-friendly measures, to deliver fiscal sustainability, differentiated for and tailored to national circumstances... We welcome the recent announcements by some countries to reduce their deficits in 2010 and strengthen their fiscal frameworks and institutions.Clearly, the finance ministers are signaling a new mood of fiscal responsibility here - in sharp contrast to the "stimulus" measures that have previously reigned. This change in emphasis is further reinforced by the recent statements from two key European governments. From the UK we have (Prime Minister) "Cameron warns of painful cuts to tackle debt" as a headline. In Germany, Chancellor Merkel is cutting the budget by nearly $100 billion according to Bloomberg. This is not only a sharp contrast with the Keynesian program here in the US, it is a direct slap in the face of Tim Geithner at Treasury and the entire Obama Administration:
German Chancellor Angela Merkel’s Cabinet approved levies on banks, air travel and nuclear-power plants as part of what she called an “unprecedented” round of budget cuts, rejecting U.S. calls to spur growth.
Bux Populi
Austerity is the new watchword and it is showing up first in places where governments either have their backs to the wall or are less under the influence of the banks. Yet even here in the US, where we have the best government the bankers' money can buy, things are starting to change. Actual voters concerned about the rapidly growing deficit seem to be a stumbling block to Congressional spending with less than 6 months until the elections. Web-based My Way News reports:
Obama's proposed $250 bonus payment to Social Security recipients was killed by the Senate. Also gone is an $80 billion-plus Senate plan that promised money to build roads and schools, help local governments keep teachers on the payroll and stimulate hiring in the home improvement industry with rebates for homeowners who make energy-saving investments.The Federal Government has been able to finance large deficits so far. Partially this results from capital flight as Europe's problems become more apparent. Part of the equation is an increased preference for Treasury bonds over stocks and lower-grade private bonds. Finally, there is the large-scale purchases of MBS by the Fed, which has indirectly funded Treasury auctions by putting more money into the hands of bond buyers and Primary Dealers. Despite a very favorable environment for Treasury bond demand, huge issuance pushed yields upward until the recent resurgence of Europe's problems.
Just last month, deficit concerns killed $24 billion in fiscal relief to prevent state workers from being furloughed. It was a measure that earlier had won initial votes in both the House and Senate.
The battle over extending jobless benefits for up to 99 weeks for the long-term unemployed typifies how the Democrats' jobs agenda has foundered. What originally was a $200 billion measure combining the jobless benefits with renewing popular business and family tax breaks was cut to $115 billion by House leaders after moderate Democrats who are particularly vulnerable in November refused to support it.
The difficulty financing our debt led the Obama Administration to float several proposals for major tax increases in an effort to convince bond buyers that there would be enough tax revenue to support the debt. This included a VAT. Notice how little we have heard about that and other taxes since the Euro crisis made the dollar and Treasuries the only game in town. Even so, the easy period of debt finance is coming to an end - even for the US government. Washington had best not expect to fund large deficits easily into the indefinite future.
A lot of bankers have to be asking themselves a question. If governments are cutting back, who is going to bail me out?
Saturday, 1 August 2009
The Federal Funhouse
Washington DC has now become the linchpin of lies regarding the US economy. When one looks at the numbers, it is easy to see why this must be so. The Federal budget deficit is now running at somewhere between 14% and 15% of GDP. Because the administration has postponed the budget update past the mandatory deadline, we do not have any official figures so we must estimate based on other data but Americans should be quite used to that by now.
The latest Monthly Treasury Statement through June 30 gives us a lot of very useful data. Tax receipts are falling rapidly; for the fiscal year to date, taxes are down from $1,934 billion to $1,589 billion - a drop of 17.8%. The trend has been for the monthly numbers to get worse as the FY has gone on but if that applies to the full year then revenues will be $2,073 billion. The current budget estimate is just under $4,000 billion but will likely be higher as unemployment and related expense rise with a tanking economy. This leaves the US government with a $2 trillion deficit in a $14 trillion economy. In other words deficit spending is on pace to equal 14.3% of the economy.
Looked at another way, approximately one-seventh of the economy should not exist, currently exists only due to Washington spending money it doesn't have and will cease to exist as soon as that spending stops. The spending can continue only so long as creditors are foolish enough to supply more capital for the Federal government to destroy. Once the funhouse mirror of massive deficit spending is removed, we will likely see at least a 10% further decline in the economy within 6 months - taking huge chunks of other nations' economies with it.
Wall Street Wacko
We have also now seen the "confidence" return to Wall Street. What this really means it that speculators have put aside their fully justified fears and returned to blind, stupid buying. The "reasoning" behind this is that they managed to rob the taxpayers to cover their last set of enormous losses so their is no longer any such thing as risk. Heads they win, tails the taxpayer loses. As we have pointed out before, the Fed has aligned themselves with the speculators and is feeding such delusions. But these folks obviously haven't been paying any attention to the political climate at all. Congressmen that voted to bail out Wall Street at our expense are facing hostile crowds in their home districts. Many of them are now cancelling public appearances. Politicians now fear for their safety as their victims are beginning to realize what has happened. Even if the bond market allows this foolishness to continue, there is unlikely to be any support for another bailout when the next bubble bursts - which is likely to be either commercial real estate or commodities (again).
The latest Monthly Treasury Statement through June 30 gives us a lot of very useful data. Tax receipts are falling rapidly; for the fiscal year to date, taxes are down from $1,934 billion to $1,589 billion - a drop of 17.8%. The trend has been for the monthly numbers to get worse as the FY has gone on but if that applies to the full year then revenues will be $2,073 billion. The current budget estimate is just under $4,000 billion but will likely be higher as unemployment and related expense rise with a tanking economy. This leaves the US government with a $2 trillion deficit in a $14 trillion economy. In other words deficit spending is on pace to equal 14.3% of the economy.
Looked at another way, approximately one-seventh of the economy should not exist, currently exists only due to Washington spending money it doesn't have and will cease to exist as soon as that spending stops. The spending can continue only so long as creditors are foolish enough to supply more capital for the Federal government to destroy. Once the funhouse mirror of massive deficit spending is removed, we will likely see at least a 10% further decline in the economy within 6 months - taking huge chunks of other nations' economies with it.
Wall Street Wacko
We have also now seen the "confidence" return to Wall Street. What this really means it that speculators have put aside their fully justified fears and returned to blind, stupid buying. The "reasoning" behind this is that they managed to rob the taxpayers to cover their last set of enormous losses so their is no longer any such thing as risk. Heads they win, tails the taxpayer loses. As we have pointed out before, the Fed has aligned themselves with the speculators and is feeding such delusions. But these folks obviously haven't been paying any attention to the political climate at all. Congressmen that voted to bail out Wall Street at our expense are facing hostile crowds in their home districts. Many of them are now cancelling public appearances. Politicians now fear for their safety as their victims are beginning to realize what has happened. Even if the bond market allows this foolishness to continue, there is unlikely to be any support for another bailout when the next bubble bursts - which is likely to be either commercial real estate or commodities (again).
Subscribe to:
Posts (Atom)