Five Notes on the Current Market Situation

1)  It seems that the US Government is determined to dilute its creditworthiness, and extend a large amount of credit to Fannie and Freddie.  My view is that it will not lower yields for Fannie and Freddie as much as raise yields for Treasuries.  The debt level of the US Government is rising — they haven’t absorbed the debts of Fannie and Freddie yet, but they might.  Articles:

2) The Health bill… Senate bribery is rarely so blatant.  This bodes ill for our republic.   One consolation is that the reconciliation process will be tough, and will possibly result in a bill that one chamber or the other cannot pass.

3) When I was a corporate bond manager, the bulge-bracket firms would approach me with novel investments.  I would buy a modest number of them.  Why not more?  Wall Street is always looking for patsies to lay off risk to.  When you are dealing with the big guys, the way to win is to avoid losing.  They aren’t your friends.  Avoid complexity and novelty, particularly when spreads are tight.

But I have little sympathy for those who were chasing yield and now say that they were cheated.  Pigs.  Yield is never free in tight spread environments.  As Buffett has said, “Be greedy when others are fearful, and fearful when others are greedy.”

4) The Treasury curve continues to widen.  We are in “interesting times.”  How much debt can the US Government issue before the debt markets choke?  I don’t know but keep putting more straw on the back of that camel.

5) So the 2000s were a rough decade, the worst that we can remember.  Many think that means the next decade must be good.  But as I commented at Abnormal Returns: Too many people think we couldn’t have another negative decade in the 2010s. I don’t think it is likely, but opinion is too universal there. After all, consider Japan — it has had two lost decades in a row, and we are following something close to their monetary and fiscal policies, minus the fact that Japan at present self-funds their debt and we don’t.

That’s all for now.  We are in an ugly situation where most investors do not grasp the gravity of the troubles we are in.


  • Greg says:

    Re: Fannie and Freddie … Just as Paulson was covering his tracks in bailing out AIG, so Congresman Barney Franks is covering his actions with FNMA. Franks was instrumental in getting Clinton to appoint Franklin Raines (a politician with zero banking knowledge) to run FNMA. Under Raines, FNMA was transformed from a sleepy mortgage insurer into the most levered mortgage hedge fund in the world. Barney Franks never stopped pushing for more and more housing ownership, even when the country ran out of people who were able to pay

    It got so bad that Alan Greenspan and several earlier Bush Treasury Secretaries pointed out the need to better regulate FNMA. Once again, Barney Franks intervened and blocked reform efforts. He made sure that OFHEO (FNMA’s regulator at the time) was kept weak and ineffective.

    2) Is the US a republic? If Congress represents the population as a whole, then 60% of the population (according to democratic party pollsters) thinks government health care is bad. Thats a larger majority than what elected Obama into office

    Its funny that Chuck Schumer is now in trouble back in NY state, because he backed the health debacle without getting any NY directed payouts in return. Both NYC Mayor Bloomberg and NY Governor Patterson say the bill will cost the city/state billions… meaning Schumer (and many other fraudsters) will have to demand payoffs for their states to get the bill any further. The cost is going to skyrocket, but no doubt the crooks in DC will just change the accounting rules

    3) Of course Goldman wanted to pawn off its risks on AIG. Hardly a surprise or a crime. What was a crime is when those hedges failed, and Henry Paulson bailed out Goldman by having the taxpayer buy out the hedges out 100 cents on the dollar. And he did it behind closed doors, with only Goldman execs and Tim Geithner present. Secret deals between the politically connected never bodes well for a democracy

    4) I think 2010 may be the year where we all learn that sovereign risk is about as AAA as CDO debt — and for many of the same reasons.

    There is a limit to how high (as a percent of GDP) government spending can go (Federal + State + local + agency). Its not a hard and fast number, but somewhere around 50% has been the tipping point for the last 2000 or so years.

    Both the US and the UK are at the redline already

    The Chinese (and OPEC) can limit their risk only one way (everything is is outside their control) — they must stop buying additional US debt. Otherwise, we will just drag them down with us, and they know it.

  • James Dailey says:

    Hello David,

    I hope you and your family had an enjoyable Christmas holiday.

    I have two comments. The steep yield curve seems to be attracting a ton of attention – so much so that I suspect it is likely to head towards continuously confounding levels in 2010. Seemingly everywhere I look/read, there are people I think are very good analysts claiming that the curve “must flatten” and that it will occur in 2010. I agree it will eventually end in disarray, but I think there is such uniformity in opinion, and likely positioning, that there could be one heck of an irrational squeeze that causes the curve to steepen further. One proxy I own and continue to monitor is Annaly Capital Management, who just announced a $3.00 annualized dividend for the 4th quarter. The stock closed Friday at $17.84 now that it went ex-dividend this past week, for an annualized yield of over 18%. The company has extremely low leverage and has entered into swaps to protect against rising rates in order to protect book value, so that 18% is being generated with a very conservative profile (at least for a leveraged entity). The stock is obviously reflecting market consensus that the spread NLY is earning will not sustain for any length of time. I think the stock is headed to at least the mid $20’s while the squeeze unfolds…and NLY’s dividend heads even higher in 2010. Chimera (CIM) is an affiliated company to NLY (though takes more credit risk with less leverage) and is also yielding over 16%. CMO and others are similarly valued.

    The second comment I have is regarding the next 10 years. Using basic long term valuation methods (whether it is Shiller’s P/E 10 or using price to peak and/or normalizing profit margins) the stock market is once again back to pervasive over valuation at a generational level. So many investors today have spent most of their careers during a period of systemic overvaluation. At present, the overvaluation is pervasive with a couple of exceptions – high quality (names like LLY and T) and POTENTIALLY commodity related names IF commodity prices move higher (seem large integrated oil like COP and XOM) due to structural supply/demand issues combined with fiat money devaluing globally. Even after the past 10 years of horrendous returns, most market segments are at valuation levels comparable to the 1929 peak and the 1966/1968 peaks – from where 15-20 year bear markets BEGAN!!! In real terms, the SPX peaked in the mid 1960’s and wasn’t eclipsed until the early 1990’s. It is quite possible that the late 1990’s inflation adjusted peak won’t be eclipsed for another 20-40 years given the insanely high valuation levels reached in the late 1990’s.

  • Prieur, I don’t follow you closely, but what I have seen of you I think is high quality. Keep up the good work, and thank you for mentioning me.