Ten Notes on the Current Markets

1)  Great minds think alike.  Fools seldom differ.  Remember my post on AIG’s subsidiaries?  Well, now in the New York Times, much of the same.

2)  Fed Independence! (spit, spit)  Come on, Bernanke, you argue against the Fed being audited because it might compromise Fed independence, and yet you regularly have lunch with leaders of the Executive branch.  You compromise the independence of the Fed more than any audit could by acting cooperatively with the Treasury.  If you were really independent, you would do what is best for your explicit mandate — fighting inflation and unemployment, rather than tinkering with non-bank credit markets, and rescuing companies.

3) Manus manum lavat. One hand washes the other.  Banks that have been bailed out are buying more Treasuries.  Some of that is lower spreads — lack of lending opportunities.  The rest is implicitly paying back the government.

4) The government may be increasing its sales of TIPS.   I’ve been less bullish on TIPS of late, and this does not encourage me to change.  Further, farmland values may be falling.  Given growth in demand for food in the world, that should not be so, but maybe that is wrong.  Maybe depressionary conditions are that strong.  I also offer up the piece from UBS, via FT Alphaville, that suggests that deflation is more likely to minimize the total cost of debt to the US government.

All of this depends on the current length of US government debt.  If all of it were nominal (not inflation-indexed) 30-year debt, the US Government would gladly inflate.  Their financing is locked in.  But if it were all short-dated, the US government would have to manage the powder keg.  After all that was Mexico in 1994 — the government was financed in the short-term interest rate markets.

Thus, governments that have not been prudent, and have financed short-term can face a run on the currency.  The US government finances to an average of 4-5 years, so it is not apparent whether they could face a run or not.

The more TIPS that are issued as a fraction of the total debt, the less valuable the inflation guarantee becomes.  If China, or any other creditor thinks that TIPS are the solution to loss of value on US debt claims, let them realize this:

  • Yes, if the US inflates its currency, there will be protection.
  • No, if the US defaults on its obligations, you won’t be materially better off.
  • If the US decided to selectively default on foreigners, paying them back in a different US dollar than the domestic one, TIPS won’t help you much.

5)  Bye, bye, Fannie and Freddie?  Sending them into runoff was my proposed solution when the crisis hit.  Now that the reality of the humongous losses from mortgage lending and guarantees has become apparent, the government faces reality, and may wind them down.  As it is now, we know that F&F are unlikely to pay back their aid from the government in full.  In my opinion, better that the government would have let the companies go into Chapter 11 without interference. Instead, the taxpayers bail out much of the capital structure that did not deserve a bailout.

6)  Should Ben Bernanke be reappointed as Fed Chairman?  It doesn’t matter.  There is no significant variation in ideas among likely candidates that would make a significant difference in how the Fed behaves.  I don’t think Ben should be reappointed, but I don’t see any worthy replacements.  Ron Paul is out of the question, sadly.

These articles argue that Ben Bernanke should not be reappointed, and they make some good arguments:

All that said, what is the option?  Is there someone stunningly good standing in the wings, with a materially different view of monetary policy from Bernanke, who would be acceptable to the activist Obama administration?  I don’t see one available, so perhaps the devil you know is better than the devil you don’t.

7)  The corporate bond market has been on fire of late, with higher prices, tightening spreads and greater issuance.  We had several episodes like that in 2002, before facing reversals.  The first time is not the charm, and I would expect more of a backup in prices because corporate loss rates have not peaked yet.

8)  Let me just point out that “cash for clunkers” is another version of the “broken window fallacy.”

9)  As for AIG, I don’t expect the government to be paid back in full.  Sales of AIG subsidiaries have gone at cheap prices, and only the simple subsidiaries have been able to be sold.  Investment banks will make money on the deal, though.

10)  Even if GDP shrinkage is slowing due to government spending, that still means that the private sector is weak.  GDP ex-government growth will be a statistic to watch in the future.