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“We’re Going to Have to Pay . . .”

By Larry Doyle on January 22, 2009 at 1:00 PM in Current Affairs

(Bumped up from its early morning slot by Susan.)

MARKET UPDATE** Equity markets broadly speaking are down between 3-4% led down by banks and insurance companies. Bonds are not providing a safe haven as across most sectors of the bond market are down anywhere from .25-1%. We are not surprized by the downward move in the equity markets nor in the government bond sector. We discuss in depth in this piece the global demand for funding driving interest rates …UP!

MARKET NEWS: Senators Schumer and Shelby are proposing $110 million in increased funding for staff at SEC and FBI to oversee fraud on Wall Street especially given the unregulated hedge fund industry. We have highlighted that one of the investors in the hedge fund industry and the fund of funds industry is FINRA, the largest non-governmental regulatory authority for financial services business.

John Thain resigns from Bank of America. Culture clash amidst massive losses will get you every time.

Microsoft announces 5000 layoffs.

LD

In the midst of an interview today, Alice Rivlin — former head of the OMB (Office of Management and Budget) under President Clinton — was asked about the prospects for the ballooning deficit. She responded that unless we are somehow able to control the deficit, “We’re going to have to pay much higher interest rates and face a rapid fall in the dollar.” I concur.

I do not want to throw cold water on a day when we had a 4% upward move in the equity market, but we need to take a step back and assess the market and economy from a wide angle as we try to make sense of it all. To that end, allow me to provide year-to-date changes across sectors with some general commentary as well.

Equities: on average -6% with major concerns about earnings potential for 2009. I do believe we will retest market lows seen on November 20th. Those lows are approximately 9% below today’s closing levels.

Government Bonds: 10yr rates have backed up 30 basis points (rates higher, government bond prices lower)!!! This development is a major issue and we will address why shortly.

Municipal Bonds: on average down 1% . . . be careful about general obligation bonds in the face of potential ratings downgrades.

High Yield Bonds: +7% . . . the big winner!! Investment managers clearly view this sector as having been much cheaper than equities, which are only one rung below them in priority of being paid back.

Mortgage Bonds: unchanged given the Fed and Treasury have been buying a lot of these bonds. IMO, I think mortgage rates may ratchet back up as government rates move higher. If you are thinking about refinancing (if you can get approved), I would do it sooner rather than later.

Commodities: oil is +4% while gold is down 4%

Last week we spanned the globe and saw that trade has slowed dramatically. We know of the massive deficit spending going on here in the U.S., but we need to appreciate the same phenomena is occurring around the world. Many countries have much less access to liquidity than we do. They are facing the prospects of not only an economic slowdown and increased borrowing needs, but also the perils of having their sovereign credit rating being downgraded. What does all that mean? Higher borrowing costs!!! This scenario is playing out in so many countries that it is not worth mentioning them all. Our friends at Bloomberg highlighted a few for us:

I’d rather be in the Greek Isles, but in lieu of that check out the fiscal problems in Greece.

A trip to the coast of Portugal might be nice, but again in lieu of that how about a peek into its financial difficulties..

You say you’d like a trip to the Far East, well this might not be much fun, but the best I can do is give you a whiff of Japanese borrowing needs.

In regards to China, I found a fascinating read on the challenges the Chinese economy may face with a major drop-off in exports. I know you’re thinking a walk along the Great Wall sounds much more appealing. Sorry. Here is a somewhat challenging and technical read by Professor Michael Pettis of China Financial Markets. Developments in China have MAJOR implications for global markets!!

To this point, many may be wondering what these global issues have to do with us here in the United States. We have plenty of our own issues and can’t save the world this time. That’s not the point. The point is that we finance our deficit to a significant extent from foreign lenders. As they have much greater cash needs at home, the cash that has previously worked its way to the U.S. may only get here if our interest rates move higher in order to attract that money. This scenario is a very simple supply/demand equation. Greater global government demand for money along with increased U.S. needs will drive the price of that money . . . UP!

While these other parts of the world may seem distant and foreign, from a financial standpoint they are right around the corner.

Other Points of Interest

1. The state of California is facing an imminent downgrade in its credit rating. This development will drive its borrowing costs higher.

2. Jamie Dimon, CEO of JP Morgan, put his money where his mouth is as he purchased 500,000 shares of JPM today. While many CEOs will tell you things are positive, Dimon’s purchase is a strong vote of confidence in JPM.

3. eBay’s earnings disappointed, while Apple’s earnings far exceeded expectations.

4. Prospective Secretary of Treasury Tim Geithner’s hearing was devoid of any major developments. He offered a mea culpa on his tax “mistake.” Senator Bunning was relentless on questioning him on that topic. Senator Cantwell (D-WA) was exemplary in questioning Geithner about the failures that occurred by FINRA (Financial Industry Regulatory Authority) in the Madoff debacle. I do think that bank stocks rallied today because Geithner was not harping on the topic of nationalization, but emphasized the idea of more capital injections and buying toxic assets into an aggregated bad bank. I honestly view that as a quasi-Japanese approach and forestalling the ultimate reality of recognizing losses. I did like the fact that Geithner indicated more funds should be directed to community banks so that these institutions can lend more freely.

When things do settle, perhaps we can take a real trip around the world.

LD

  • wodiej

    the problem is we are going to have to endure some pain before we can get back on our feet but people don’t want to make sacrifices. Don’t be inconvenienced, don’t take away their luxuries, don’t worry about the country as a whole…just GIVE ME WHAT I WANT AND NOW.

    gimme, gimme, gimme…..

    we are drowning in debt. who is going to step up to the plate and use fiscal responsibility? I’ll be waiting.

  • fiscalliberal

    Historically the financial advice was to buy and hold. Recently it was: if near retirement, get to safe investments like cash. So those who did that are now going to be rewarded with higher interest rates.

    The good news is that Tip O’Neil (Blarney Irish) and Reagan (Scotch???) forced us to save into the Social Security reserves which are drawing interest. Despite the right wing rhetoric, the Social Security Trustee’s report says it is solvent untill 2042. It starts drawing from its reserves ( really savings of our generation) about 2017.

    When you go to the Social Security Website, it says the reserves are backed by the full faith and credit of the Federal Government. The Federal Government used to budget for 10 years, Bush couldn’t see beyond 5 years. In a short while, we will see if the government can start paying back what it borrowed versus always borrowing.

    Do you think they will “default” on their obligations?

    • BernieO

      I think that is what the Republicans have been trying to set the stage for – with tht compliance of the media and the acquiescence of Dems – for years. We are constantly told that there is nothing there. You don’t hear anyone explain that we have been paying extra into the system since the fix of the 80′s, when the system was pay-as-you-go. That money is held in Treasury Bonds backed, as you said, by the “full faith and credit of the Federal Government” just as all Treasury debt. No one has ever suggested that our government default on its debt – except for this one. But of course most people don’t have a clue. What we are repeatedly told is how the evil, selfish baby boomers will ruin this country when they retire. The same selfsh baby boomers who have been paying for the retirement of the “greatest generation” while also kicking in extra for themselves.

      As for deficit spending, I agree with economists like Krugman that now is not the time to worry about the deficit. When FDR did that prematurely in ’37 he set the economy back. It was the deficit spending of WWII that got us out and we had a great economy in the ’50′s.

      As for the interest rates, there is plenty of money available for lending right now and inflation is low so deficits are not a threat at this time. Money from the bailout, money that people have parked in safe places. The problem is not the deficit but the unwillingness of banks and other lenders to take a chance. Also, we will need to run deficits until we are sure we are not going into a deflationary spiral, something which is extremely difficult to stop. It is easier to stop inflation.

      • Mo from Texas

        I worry, though, they fail to understand innovation, the true economic engine needed to spur the economy forward in a more permanent manner.

        Cheney and Bush thought they could simply blow monetary bubbles (in addition to building houses), supply side a COMPLETE fiasco.

        Traditionally, this was in part WHY small business was funded, to help all those engineers and developers working in their garages, to produce, and create new products, and hence, businesses. I think it was Bill Clinton who said small business is the backbone of the American economy.

        And it is, Cheney thought it was the corporation, or something. (According to the Daily Show clip from the other day, Cheney also thought Jim Leher was responsible for the economy, too, so, who knows? )

        Cheney was simply hopeless, intellectually, the DUMBEST I have ever observed, I’m hoping Obama’s crew is a little smarter.

        But who knows?

    • cynic

      High interest rates? The annual yeild of my savings account has been forced down to a bit over 1%. Presumably this directly relates to the need of the government to keep its own profligate borrowing cheap. Unlike people such as myself, the government seems to think it’s possible to spend more than one takes in indefinitely, without inevitable disaster.

      I blame the damn Bush tax cuts, which neatly and predictably inverted years of a projected budget surplus into a more-than-doubled national debt. Let’s be frank about this: He took the surplus and diverted it to the very rich, and left everybody else holding the bill. Were it not for that, we’d be facing our current economic downturn with a debt that had been halved, not doubled. The downside would have been that the wealthiest among us probably wouldn’t own 80% of the total wealth of the nation. They might be scraping by on a mere 60%.

      • LD

        Cynic….I shoudl have been more explicit in stating that longer term interest rates (5yrs on out) have been moving up.

        As I mentioned to another reader I do think that CDs will gradually start to move higher later this year as bank demand for cash continues to grow even greater.

  • bart

    Excellent piece. Thanks for keeping our eyes on the big picture. It’s so easy to get lost in the “finance news du jour” and forget the wider implications. I really appreciate the pull back.

  • rayve

    LD, your posts and radio show always provide useful information and great insight.

    I see our government’s situation like the individual who has been spending more than he makes year after year. He doesn’t worry enough to cut up the credit cards until he finds himself deathly ill and with no insurance during a pandemic. He doesn’t have a good choice at this point–die, or borrow hundreds of thousands of dollars in the hope of saving his life, that is, if he can find somebody well enough to loan him the money. But after the crisis, he may find himself questioning whether life is worth living as he tries to pay back the mountain of debt. Bankruptcy might help the individual, but what is the answer for the government?

    As an optimist-wanna-be, but a pessimist in reality, I’ll hope that our grandchildren will be able to afford a trip around the world.

    • LD

      Rayve….thanks for the plug. I am glad that you like my work.

      We’re all about sharing so spread the word.

  • MPC

    Another great piece, LD.

    With this whole nationalization of banks business: Do you think it will actually happen? Can you give a general description of how that might be carried out and what the desired result would be? It’s hard for me to see what the benefit would be since I’d rather not put people like Chris Dodd and Barney Frank, self-described financial experts of Congress, in charge of bank(s). It seems clear as day to me that the government cannot possibly run a bank as well as the private sector. That’s why communism doesn’t work, and China has become a more mixed economy the past few years. Do my thoughts on this make sense, or is this way over my head?

    • LD

      MPC….glad that you find my work informative. I actually received this question from your counterpart MBC on my thread yesterday.

      Additionally the WSJ wrote a piece on this in today’s paper.

      Are they getting ideas for their work from reading NQ???

      In any event, can I be so bold as to direct you to the last question on yesterday’s thread, “Will Be Held to Account…”

      Please check what I wrote adn the WSJ piece as well.

      In short, we are in uncharted waters….

      Please let me know if those two posts answer your questions fully?

      • MPC

        Thanks for pointing me towards your post yesterday and the WSJ link. Definitely helps clear things up. I guess what sticks in my mind now is that by nationalizing a banking institution, the idea should be to close up shop as quickly and smoothly as possible. I hope that would be the case, rather than the government getting sidetracked into trying to turn the bank around and get it back on it’s feet or something similar.

        • LD

          MPC….yes, I think we want the Swedish approach vs the Japanese approach.

  • Baba Rum Raisin

    Run those printing presses at Bureau of Engraving TOO fast and we have another replay of the Lyndon B. Johnson Memorial Inflation; or, maybe, the Idi Amin Ugandan Monetary Policy.

    Won’t be pretty. Stockpile those canned goods and buy a good bicycle and two pairs of sturdy shoes NOW.

  • Intersted party

    You nay want to add to your list of trouble economies throughout the world one closer to home; England.

    This from the Telegraph, UK:

    http://www.telegraph.co.uk/comment/columnists/iainmartin/4295219/Gordon-Brown-brings-Britain-to-the-edge-of-bankruptcy.html

    Although some commentators say Britons will tough it out (alone), Gordon Brown is being scorned as a second Bush, a savior gone bad.

    It would be totally appropriate if the Obama’s call for and eventual implementation of transparency in government extended to the financial sector. The buying of “bad” debt by government is a rehash of the Japanese economic woes of the 90′s, not a sign of openness by any public or private entity.

    Read also this morning, housing starts are off today (worst since 1982) and unemployment claims are up.

    Thanks LD for the other updates. I’m not completely clued in on your use of “equities”. I believe its just another term for the market?

    • LD

      Interested….

      Thanks for the link to the situation in the U.K.
      They are actually in as bad if not a worse situation than the U.S.

      Equities is synonymous with stocks.

  • truthorconsequences

    I have been paying all my life but I don’t think I should have to pay for the Wall Street fuck-ups or the Fanny Maes or the Freddie Macks or the ACORN heists. The only investments I have ever had are my home , and a few cars over the several decades plus several years of military service (volunteer). But I suppose I am one of those greedy white men who are resonsibile for all the world’s problems as per Obama’s book which states “A world in need run by white men’s greed” and then he publicly states “we are all going to have to have a little skin in this”. This is change??????????? Bring on the depression.

  • athy

    LD,

    another good article. Thanks.

    If I may go on a tangent here, what is your opinion regarding the US Federal Reserve System?

    Should it be abolished or no?

    IF…if a decision is made that US banks need to be nationalized (temporarily or permanently owned by our government) what role do you think the Federal Reserve Bank (which is a quasi-independent entity that -thanks to the 1913 Federal Reserve Act- does not need prior approval from Congress or the President before taking any action) will play?

    Who will be responsible for oversight of our banking system-including both the nationalized banks and the Federal Reserve?

    In my mind, it is frightening as to how much power the Federal Reserve has in our economy.

    I know that I am oversimplifying this -possibly too much -however- I am not an expert in Finance. I am a consumer and as such I tend to look at the forest and work my way down to the trees.

    Also, from a macro standpoint, many wealthy individuals are buying up depressed US assets (including real estate and corporate stocks ).
    There are many wealthy US and foreign investors that are going to make a killing off of our hard economic times-as long as these investors can ride it out until the economy stabilizes a bit. So…there is money being injected into the US economy but it may not be going into the bond market. Do you have any thoughts on this?

    I apologize in advance if I am being too naive but I am repeating what I am hearing from average working people who are trying to stay one step ahead of this economic crisis.

    Thanks again…

    • LD

      Athy,

      I will admit that I have not dedicated much of my career to the finer points of financial history.

      My sense is that many people believe in conspiracy theories when it comes to large moneyed institutions. I know for a fact that there are improprieties that occur but I categorically do not believe that any institution, including the Fed, are trying to manage affairs so as to promote one class or group vs another. I know that some people feel that way. I do not.

      Against that backdrop, I do not think that the Fed should be abolished. I think that our government works best when there are checks and balances and plenty of qualified people of integrity involved at all levels.

      Your question about oversight is spot on. As I have asked if the U.S. is guaranteeing all these institutions, then “Who is guaranteeing the guarantor?”

      Honestly I have a whole host of reasons for writing so much here at NQ, but one of them is to provide a forum for people to voice thoughts and opinions on these topics. My sense is that many people feel the same way that you do. I share those feelings.

      Ultimately OUR government needs to be accountable to US.

      In regard to the transferral of assets, very simply those assets will be transferred from those who purchased with borrowed funds to those who can purchase with “real” money (unborrowed). Do not forget though that plenty of people who own assets also did not purchase those assets with borrowed money. These assets are down in value but the holders can afford to hold them because they do not have to pay debt service.

      What are all the lessons for people?

      I always try to maintain that people “need to control their finances instead of having the finances control them.” How is that done? Live within if not below your means. This is much more easily accomplished for younger people than those who are already established and have debt that needs to be serviced. For these people who have debts to pay, save save, save, and continue to learn about money and finance so that they understand risk.

      To that end, I hope we continue to build our audience.

      Hope this helps.

      • athy

        LD,
        Thanks for your response. It is informative.

        Helps put a couple of things in different perspective for me.

        It is easy to digest facts in your articles.

        Many average people (and even journalists) are intimidated when it comes to dealing with ‘business news’.

        When it comes to economic and/or financial information, people can no longer afford to ‘tune out’ or to behave like parrots-merely repeating what they hear without really getting a grasp on things (just ask people who invested with Madoff). Too much at stake.

        Thanks for helping to make things clearer for us.

        • LD

          Athy…I very much appreciate your kind words.
          I share your feelings and I am happy to be able to help.

          We are always trying to build audience, so please bring a friend.

  • Maria3

    Thank you for the well written and researched article, Larry. If the times where not scary enough…

    Did you see this?

    Obama adviser: White males need not apply

    Robert Reich tells House panel stimulus package should emphasize ‘social return’ over worker skill

    A top economic adviser to President Obama has told a congressional panel the billions of dollars in the proposed economic stimulus plan should be allocated with social issues in mind, to make sure the money doesn’t go to just “white male construction workers” or the highly skilled.

    http://www.worldnetdaily.com/index.php?fa=PAGE.view&pageId=86827

    FIRST ORDER OF BUSINESS… LET THE WHITE MEN WILLING TO WORK GO HUNGRY??????

    • LD

      Maria3….WOW!!

      I did not see this nor hear about it which indicates to me that the administration knows that they need to be VERY careful in promoting this concept.

      When the government tells business how to run things, that is not good.

      Given that Obama and team have talked about the stimulus package as “investing” in America, I wrote a piece which I will share with you here about some of the procedures that should be implemented so that fraud and corruption do not run rampant. I fear that the back room, old style cronyism will occur once again.

      Here is the piece from early December,

      http://www.noquarterusa.net/blog/2008/12/07/obamas-economic-stimulus-planbig-dig-deja-vu/

      I hope that link was attached. I wrote this on December 7th.

  • HARP

    The only thing I ever got from the Government free was an unrequested all expense tour of Vietnam.

    • http://noquarter foxyladi14

      well Harp we are glad that you got home safe..
      a lot of our kids didn;t.

  • justsomeone

    HARP, Welcome Home!

  • justsomeone

    LD, when do you think we can start getting better rates on CDs?

    • LD

      Just…

      While longer term rates are starting to rise and IMO will continue to rise, the very shortest term rates (1 mo, 3mo, 1yr) rates will likely stay low for a longer period (remember how the Federal Reserve indicated that they would leave the Fed Funds overnight rate at 0-.25% for an “extended” period.

      CDs are a bit of a mixed bag. They are typically shorter term although some CDS do go out to 5yrs.

      As shorter term instruments they are more tied to the short end of the yield (Tsy interest rate) curve. The other factor at work, though, is that banks are going to have increasing needs for cash. That need will likely start to push up rates on some CDs. I thnk that as we go through the year you will see rates slowly but surely move higher as the banks cash needs grow.

      Hope that helps.

  • rw

    Thank you, JD.
    Could you give a quick forward look on currencies, dollar vs euro
    dollar vs pound

    • LD

      In my estimation. The dollar will continue to outperform the pound but will EVENTUALLY underperform the euro. I believe that simply given the size of the deficits here in the U.S. and the likelihood that the Europeans will raise rates quicker to stave off incipient inflation in 2010 and beyond.

      • rw

        thanks.
        and,if possible, could you include currencies in your writings from time to time.

  • CG
  • TeakWoodKite

    You are a very gifted author LD. It is not an easy thing to “translate” your many years of experience into a sentence stucture that is easly understood by people of varying degrees of financial “awareness”.

    Thanks.

    To your point of retaining humility;

    I am am wondering about the level of market speculation and its impact. In the last 4 years it has been a Wild Wild West. With the current scenario, I am wondering how much of a head wind it will create for creating stability in in the financial markets, or is this much of a concern?

    • LD

      Teak….you’re hired!! Flattery will get you everywhere. In all seriousness, I appreciate your remarks as I am trying to make “sense” of this madness for “everyman” in middle America.

      Your point about the headwinds is of MAJOR importance. Why do I say this? Simply because in the ’80s and early to mid 90s Wall Street was structured with a wide array of firms and fairly plain vanilla type clients. Included in those clients were: state funds, bank portfolios, mutual funds, insurance companies, money managers. The business was to a large extent fairly simple and straightforward.

      Starting in the latter part of the 90s we saw an EXPLOSION of what the street called “fast money.” These types of accounts were hedge funds, proprietary trading groups housed within the Wall Street investment banks, and other types of heavily levered investors (REITS, Real Estate Investment Trusts). With all due respect to many great people at these types of clients, IMO there were also plenty of enormous egos (Masters of the Universe) who thought they were smarter than everybody and smarter than the market itself.

      I am all for smart people playing the game the right way and making money. That said, there were more than a handful who were simply large egos run amok and used massive leverage to grow portfolios. These entities are now being unwound because they no longer have access to the funding needed to manage their business. What have a lot of these accounts done? They have restricted the ability of investors to redeem their money. As a result, a lot of their investments are overhanging the market. I empathise for plenty of peopel on and off Wall Street. For some of these other individuals, though, I have no empathy.

      Does that make sense?

      • TeakwoodKite

        Yes it does, LD.

        I don’t know why, but the image of an “overhanging” reminds me of a Road Runner cartoon with Wiley Coyote holding a box from ACME standing at the edge of the ‘overhang’…and it is starting to crack…

        Road Runner is in true form.

  • getfitnow

    Thanks LD. I’m here trying to understand. You’ve made that possible.

  • justsomeone

    LD, Please tell us what you think Pres Obama means when he says, “we want to reward work not wealth”. Higher taxes on dividends? interest? cap gains in general? Speaker Pelosi is demanding an immediate tax increase on high income earners & it seems Obama wants to hold off. I thought tax rates for 2008 were already set, can they raise them between now & this April 15th retroactively?

    • LD

      Just….that would seem to be a veiled way of saying that he plans on implementing policies to support the “working” people in the lower to middle class vs those who have generated “wealth” in the upper incomes….

      How about if we ask him to merely increase taxes on the members of the “lucky sperm society” who were born into wealth?

      My question would be, “what about the people who worked to generate wealth?” Where do they fit into the equation?

      In any event, I personally do not see how Obama can raise any taxes on anybody this year in light of the economy.

      However, in light of the deficit I do believe that taxes will be going up in the future. He should start by taxing those who work in hedge funds at the ordinary income level versus allowing them to put earnings into the fund and then only paying long term capital gains. Now that is a joke and has been paid for by a lot of donations from the hedge fund community to people on both sides of the aisle.

  • Hot Librarian

    I think USA ought cut back 30% of its overseas military bases & move the forces back to oversee the civilian projects . if they can “build infrastructur in Iraq allegedly -they can direct it at home.

    It would be cheaper & more efficient if the military did it ll & civilians were paid to watch!

  • MBC

    I agree with Teak, you are a gifted writer. Thanks for what you do here!

  • CG

    In response to an opinion piece by David Gergen entitled “In the midst of celebration, darkening clouds”, I found a comment I with which I could wholeheartedly agree.

    JC- Los Angeles January 22nd, 2009 4:00 pm ET

    When the new President requires a do-over on the oath of office, it is anything but a smooth, smart and successful start.

    Our nation has been run into the ground by the connected few who spent that last eight years looting the country without any fear of oversight.

    When the nation needs a $700 billion do-over, how can Paul Volcker be considered “one of the most respected economic figures in the country?” where was he before?

    When the new Treasury Secretary nominee fails to pay taxes, how is this a break from the morally bankrupt leadership of the past eight years?

    When an octogenarian like Greenspan dispenses cheap money time and time again to an instant gratification, glutonous consumption society, how could none of our leaders see that this was a bad idea?

    Rather than closing Guantanamo Bay, how about freeing many of the questionably detained and replacing them with our failed leadership?