Some Opening Comments January 16 2009

January 16th, 2009 8:36 am | by John Jansen |

Prices of Treasury coupon securities tumbled in response to the US government bailout of Bank of America. The United States Government will inject $ 20 billion into the company and will provide various guarantees for $118 billion of assets which BOA acquired in the deal with Merrill Lynch .When I write this morning piece I generally peruse Bloomberg news stories on the global economy and relate the salient facts in my posting. Reading through the overnight reports this morning is a surreal exercise. There is an Alice and Wonderland quality to the endeavor.

Here is a slice of the news. Citibank lost $ 8.29 billion in Q4 and as previously reported will carve itself up into digestible morsels. Bank of America posted a $1.9 billion loss in Q4 and will require a government manufactured crutch to fund its takeover of Merrill Lynch. The $20 billion US government investment in Citibank is provided via the TARP program.

Bloomberg reports that Chrysler will seek slightly more than $ 1billion to fund loans to consumers.

Ireland has nationalized the Anglo Irish Bank.

Bloomberg reports that spreads on bonds of Spain, Portugal Greece and Italy have widened versus German bonds and that widening calls into question some of the bedrock assumptions which underpin the European financial system as presently constituted.

And I failed to mention that the incoming Administration and its Congressional acolytes are closer to agreement on a plan which would provide the economy with a package of $825 billion of new spending and new tax cuts. One Democratic apparatchik suggested that tiny sum might prove to be inadequate and that a second round might be necessary.

From the outset, I have always been a supporter of government intervention as a means to prevent this unique crisis from taking the system down. I have always believed that the consequences of inaction were greater than the cost of government involvement. I question that assumption now.

The bailouts began with the deal in which JPMorgan took control of Bear Stearns with government assistance and continues to this day with the government intervention in the Bank of America union with Merrill Lynch.
The Federal government will now be an integral part of the financial system for a very long time and will influence decision making and risk taking in that sector during the time in which taxpayers are a partner in those businesses.

I now think that we would have been better off with some truly cathartic event which would have curbed the animal spirits of traders but which would have established a basis for a market prescribed recovery. Succinctly stated, the government is not in the business of taking risk and I would argue is in the business of risk avoidance.

In retrospect, the commonweal would have been better served had nature taken its course and allowed for capitalism to travel its natural course. I fear that this new course has placed on us a path to a very slow recovery and one in which innovation and risk taking will be viewed through the narrow and ill begotten prism of some bureaucrat.

In overnight trading yields on benchmark Treasury securities have risen sharply as there has been some sudden epiphany that the US government will soon become a profligate and prodigious purveyor of not so pristine paper to fund its takeover and stimulus activities.

When I last checked the yield on the 2 year note had climbed 5 basis points to 0.76 percent. The yield on the 3 year note had jumped 7 basis points to 1.08 percent. The benchmark 5 year note took a drubbing as its yield increased 11 basis points to 1.47 percent. The yield on the 10 year note jumped 11 basis points to 2.32 percent and the yield on the Long Bond edged higher by 7 basis points to 2.94 percent.

Enough for now. More later.

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  1. 46 Responses to “Some Opening Comments January 16 2009”

  2. By JD on Jan 16, 2009 | Reply

    Thank you, thank you, thank you. You’re the first writer to publicly acknowledge what I’ve believed all along — that the big mistake was NOT to let LEH fail, but to save Bear. That intervention allowed the markets to avoid reality for another 5 months.

    YES, the consequences of Bear BKing would have been terrible — maybe ’08 GDP would have been -5% yoy — but it would have meant maybe we can get a recovery by late ’09. Instead, the govt is going to string along a zombie financial system that might take til 2014 to get healthy.

    Just as the banks should have, the govt should have “kitchen sinked” the problems in 2008 — acknowledged them through bankruptcies/foreclosures — and the country would have started rebuilding from there. Instead, we’ll be coughing and wheezing for a long while to come.

    Great blog, thank you for writing it.

  3. By Alex on Jan 16, 2009 | Reply

    From yesterday’s opening comments:

    I expect the bond market to remain well bid and expect the 10 year note to test the 2.00 percent level.

    Are you going to add to your position?

  4. By Steve on Jan 16, 2009 | Reply

    John, welcome to reality. It’s truly depressing.

  5. By John Jansen on Jan 16, 2009 | Reply

    Alex,

    I will not add and might consider getting flat.

  6. By Van on Jan 16, 2009 | Reply

    Revenge of the hooples….

  7. By Alex on Jan 16, 2009 | Reply

    Thanks John.

  8. By John Jansen on Jan 16, 2009 | Reply

    JD,

    This is bit of simplification but Bear Stearns will be viewed as an historic punctuation point which maks the end of the most recent period of conservative hegemony.

  9. By SG Hammer on Jan 16, 2009 | Reply

    One only need listen to the speeches of our representatives in the House and Senate to realize that these people have absolutely no idea of what they’re talking about. Platitudes and statements of the obvious seem to pass these days for intelligence. We’re doomed.

  10. By Roman on Jan 16, 2009 | Reply

    I have to completely disagree. Doing nothing would not have gotten us out of this faster. In fact doing nothing would send us into the “L” shaped depression that policy makers are so desperately trying to avoid. The belief that if you do nothing the pain will be sharp but the recovery would be fast is wrong and is based on the failed Austrian economics school of thought. (Which is experiencing an undeserved revival)

    The response has not been perfect and frankly it hasn’t been too just either (The management of all these banks should have been fired as a precondition to any of these bailouts). Still, their bailout was necessary because many of these institutions pose a systemic risk if they fail.

  11. By scott on Jan 16, 2009 | Reply

    The other alternative would have been a rapid Sweedish style nationalization ie if the FDIC could (rightly) seize WAMU it could have made the same justification for seizing most other banks. I think it less the end result but the slow bleed, uncertainty is making matters worse.

    The Q4 numbers out from the big guys (and smaller names as well) make it harder to see a plausible scenario where we don’t end up nationalizing the majority of the large banks out there, particularly when you realize the worse of write downs is still ahead of us.

    Separately, can anyone think of an example of worse due diligence than B of A’s due diligence on Merril Lynch?

  12. By Andrew on Jan 16, 2009 | Reply

    Finally Mr. Jansen you are beginning to see the light. FDR’s “programs” in the 30’s did nothing to help the nation and left us with useless stuff like presidents faces on the side of a mountain. Govt intervention only allows for more risk taking and leverage, if they had let LTCM fail in 98/99 then I am pretty sure the banks wouldnt be leveraged 30x. The funny thing is the European banks are worse, DB and Barclays over 50x!!! Why do you suppose that is? Oh yes, the govnt will come in and save me if things get bad! We need to get rid of the Fed Reserve and start the ACH houses once again like we had before 1913. Just look at the panic of 1907, that was a severe recession but the ACH houses and private capitalists took care of the problem not the Govnt.!!!

  13. By texalope on Jan 16, 2009 | Reply

    I have to disagree too. When a business goes through bankruptcy, or restructuring the recovery isn’t a straight line up. There are ups and downs. Also, the plan often requires revisions as circumstances dictate.

    Our financial system went into cardiac arrest. We are in recovery. The weak are falling by the wayside. The stronger are surviving. The government is helping the process.

    Recovery is a moving target and the government is trying things until they get it right.

    I think patience is required.

  14. By K T Cat on Jan 16, 2009 | Reply

    Have you seen the text of the stimulus bill? It’s horrible. All that talk about roads and bridges and the bill is just a monstrous barrel of pork. Roads and bridges get 4% of the total. More than twice that goes to bail out teachers’ unions in states like California.

    It’s everything we feared. It’s like reading a part of Atlas Shrugged excerpted into our newspapers. A bloated, parasitical pack of politicians and academics are handing out $825B worth of goodies to their cronies.

  15. By John Jansen on Jan 16, 2009 | Reply

    andrew,

    Interesting point on LTCM. Because the resolution of that incident led to a complacency and a rush to risky assets which led to the current debacle. It took a decade but the aftermath of that crisis sewed the seeds for this mess

  16. By Andrew on Jan 16, 2009 | Reply

    Roman, i would have to disagree, it is pointless arguing this point with people who believe in Keynes stimulus. I am sure you also think the govnt should regulate everything as well ” like that does any good.” People ALWAYS find a way around any govnt regulations. Aka Madoff, this has been bore throughout history. There are booms and busts in capitalism as well as many many bubbles. I suggest you read Mackey’s, Extraordinary popular delusions and the madness of crowds, then maybe turn your attention to Ayn Rand and her many many very important books. The govnt is just an entity IT can’t save anything, the people are the govnt and as long as we have Greed, Fear, Lust, Love then nothing will change. If we cease to have those emotions then we are not human. The market = every buyer + seller in the world, you cannot control it.

  17. By Andrew on Jan 16, 2009 | Reply

    John, it wasnt just LTCM that is just a recent example. The bailout of Mexico in 98/99 the Savings & Loan bailout of the early 90’s. This is a over 30 year credit bubble that is bursting the catalyst was just the housing market. If you trace where capital has gone in extremis the last 30 years you can tell that the housing market was the last one it could go to. The last 10 years we have had a bubble in ALL asset classes except T-bonds which is unprecedented in world history. Normally we have 1 bubble in an asset class that burts, not true now. The only 2 bubbles currently are in treasuries and the Yen. Early 80’s was junk bonds, then savings & loans, then the internet BS stock market of the 90’s then the capital moved into structured finance, now it has no where to go. Thus a 30 year credit bubble bursting. The govnt wants inflation it needs inflation to inflate the FIRE economy assets. In 1980 it took 1 dollar of debt to create 1 dollar of GDP, today it takes 5 dollars of Debt to create 1 Dollar of GDP, in 2015 we will reach the marginal value in that equation where creating more debt will create NO GDP!

  18. By Moruobai on Jan 16, 2009 | Reply

    John,

    This is the first time I find myself completely disagreeing with you.

    If the government had allowed the banks to fail, we would have had: 1) a total collapse of the money supply (which is reflected in lower prices we now see); and 2) total bank failure–I mean every single one of the banks/financial institutions would have gone bust. The last time we saw this happen was during the GD.

    I think our government’s actions are well justified given our understanding of the GD.

  19. By Roman on Jan 16, 2009 | Reply

    Actually Andrew I read her two most famous books: Fountainhead and Atlas Shrugged. I think I’m actually an interesting case because at one point I was a super-libertarian but this crisis has actually made me question my beliefs.

    One of the first things that made me stop and think a little was the crash in commodity prices and the rise of the dollar. According to Austrian economics, this is impossible. How can we have deflation when the government is printing so much money?

    Once you start poking holes like the one above into the Austrian economics school of thought you find out that its for the most part wrong.

  20. By Andrew on Jan 16, 2009 | Reply

    Roman, You don’t know why we had a crash in commodities and the US dollar went up in value? What deflation are you talking about? The market is reverting back to the mean, that clearly is not deflation. The historical mean for the DOW should be somewhere between 4500 and 7100. The Stock Market as a whole has been credit driven since we went off the gold standard completely in the 70’s. Investors realized the global economy was dead, thus the crash in commodities coupled with worldwide panics and the flood into treasuries (supposedly safe asset) which pushed the value of the dollar up artificially. The dollar is going to crash and crash hard, the best currencies to have are the Yen and Swiss Franc. As of right now i see NO deflation happening only reversion to the mean, crap doesnt go up forever as the Japanese have found out in the last 18 years. For you see, in 1989 the Nikkei was at 39000, today it is at 8000. Is that deflation or reversion to the mean? Thats why buy and hold (hope) is a horrible strategy because markets do not trend up forever as evidence in Japan. If you had bought in 1988 at 35000 then you would see yourself get crushed the next 19 years and no one can afford that. Sorry you would not be from the Austrian school if something as simple as commodities crashing and the dollar going up in value deters you! Commodities have gone up and crashed throughout history, I really do not get your point.

  21. By John Jansen on Jan 16, 2009 | Reply

    When I wrote this morning I had no idea i would stimulate so many comments

  22. By Alex on Jan 16, 2009 | Reply

    http://blogs.cfr.org/setser/2009/01/16/a-few-quick-words-on-the-november-tic-data/

    The ongoing reallocation of central bank portfolios toward short-term Treasuries. That reallocation has been huge. Central banks held $$276.8b of t-bills at the end of September. They hold $427.2b at the end of December. And judging from the Fed’s custodial data there is every reason to think that total rose in December. Foreign central bank demand for safe and liquid assets rose at the same time as private demand rose.

  23. By Andrew on Jan 16, 2009 | Reply

    Thanks Alex! just wait until all that floods out of the dollar!!! crash ka-poom!

  24. By sachin desai on Jan 16, 2009 | Reply

    John, when I read your post in the morning, I was sure that it would ignite a spate of comments. 🙂

    I trade Indian treasuries and we have a nice little bubble out here that is showing signs of blowing up. I track UST quite closely (helps to know what the big daddy of all mkts is upto) and it feels like an accident waiting to happen. Its just an outsider’s perspective for whatever it is worth.

    Sachin Desai

  25. By John Jansen on Jan 16, 2009 | Reply

    Thanks for writing.

  26. By Alex on Jan 16, 2009 | Reply

    Brad Setser’s ‘Follow The Money’ is an excellent blog for analysis of capital flows into and out of Treasuries.

  27. By John Jansen on Jan 16, 2009 | Reply

    Brad’s analysis is always insightful and thought provoking. I have him on my blogroll and he was very generous in the early days of this blog.

  28. By TraderX on Jan 16, 2009 | Reply

    The curtain has finally been pulled aside to reveal that everyone…from the politicians, to business leaders, to Wall Street, to FINRA/SEC, Ratings Agencies, to the Fed, to the Treasury, and the incoming President….everyone….is just making it all up as they go along. Our so-called “leaders” response to the current crisis has proven this once and for all.

  29. By kmw on Jan 16, 2009 | Reply

    We seem to have reached the point I mentioned last week at which both good and bad news will send long yields higher. Notice that we didn’t even come close to testing the year-end levels despite the fear present over the past 2 days.

    Now that the market (and even our esteemed author, a committed Keynesian) appears to have awoken to the reality of the situation, it’s probably time for this bubble to burst. You’ve got another trillion dollars in porky “stimulus” on the way, which will roughly triple supply. The tax receipts for 2008 are terrible and refund season will make things even worse. There will of course be more supply for TARP-II, and already we’re all here wondering when the next round of stimulus and/or bailouts will be passed and for whom. And don’t overlook the fact that Treasury CDS have been rising; that makes the true risk-free interest rate even lower than it looks.

    As I said before, the world ends, or it doesn’t. Either way, long yields are going higher.

  30. By Andrew on Jan 16, 2009 | Reply

    Yep KMW, the CDS is going higher on the US govnt and we risk going bankrupt even though that would be the best thing for the nation in the long run since the govnt wants to screw our system up by nationalizing everything in sight. It won’t pay to be in the dollar or even have dollar assets, hello singaporeeeeeeeeeeeeeee

  31. By Anonymous Monetarist on Jan 16, 2009 | Reply

    All hail the Nancy Capitalists
    (Citizen Jensen nails it. The era of Nancy Capitalism will not be short-lived. Socialized guts will lead to diminished glory. That is not to suggest that prudential regulation isn’t important, it most certainly is. Without prudential regulation Marx(not Groucho) looks prescient. But fear of loss is quickly becoming fear of risk … that does not bode well for future growth. As stated in the introduction to this blog:

    They will destroy the village (dollar and markets) in order to save it. After the deflation is overwhelmed, the West will never be the same.-AM)

    January 16th, 2009 8:36 am
    Across the Curve blog
    From the outset, I have always been a supporter of government intervention as a means to prevent this unique crisis from taking the system down. I have always believed that the consequences of inaction were greater than the cost of government involvement. I question that assumption now.

    The bailouts began with the deal in which JPMorgan took control of Bear Stearns with government assistance and continues to this day with the government intervention in the Bank of America union with Merrill Lynch.
    The Federal government will now be an integral part of the financial system for a very long time and will influence decision making and risk taking in that sector during the time in which taxpayers are a partner in those businesses.

    I now think that we would have been better off with some truly cathartic event which would have curbed the animal spirits of traders but which would have established a basis for a market prescribed recovery. Succinctly stated, the government is not in the business of taking risk and I would argue is in the business of risk avoidance.

    In retrospect, the commonwealth would have been better served had nature taken its course and allowed for capitalism to travel its natural course. I fear that this new course has placed on us a path to a very slow recovery and one in which innovation and risk taking will be viewed through the narrow and ill begotten prism of some bureaucrat.

  32. By Anonymous Monetarist on Jan 16, 2009 | Reply

    By Moruobai on Jan 16, 2009

    This is the first time I find myself completely disagreeing with you.

    By texalope on Jan 16, 2009

    I have to disagree too.

    By Roman on Jan 16, 2009

    I have to completely disagree.

    Sunday, December 7, 2008
    Nancy capitalists
    The naysaying nabobs of nancy capitalism are at it again.

    For folks who have made a living saying that ‘it’s different this time’, that ‘we’re turning a page’- why they sure have suddenly found a special affinity for history.

    As of late, the chattering is on property rights and visiting the Roosevelt age – I have never heard so many right-wingers use the term ‘economic royalists’ then I have as of late.

    This reminds me of when the Dems took the majority in 2006, all the ideologues in unison lept up and declared ‘the subpoenas are going to be flying’ to which I retorted ‘What’s all the concern? Did someone do something wrong?’

    The cold hard fact of our age is that the bankrupt ideology of the rich that had greatly succeeded in drafting the inner monologue of regular folks so that they would vote against their self-interests is colliding head-on with a Mr. Market that is a bit pissed off that we’ve inflated it out of the business cycle for the last quarter century.

    Regular folks who don’t as a matter of course lie find it hard to believe that the the lies told over and over again to them are actually lies. It is just hard to process for it is from a place-of privilege and power and entitlement-that is foreign to them.

    However, the alarm clock is now starting to ring and people are getting a bit skeptical as to what the nice man on TV is saying.

    I have created jobs, have met a payroll for many years, but it was not done by the benefit of an elite education nor the spelling of my last name.

    It was done by having a dream, taking action to make that dream a reality, defying all the odds -even when my net worth was in my wallet-, and embracing my failures.

    America will survive not by bailouts but by bail-ins. Success not because of government nor in spite of government but success oblivious to government.

    In America you can accomplish whatever you set your mind towards, if you believe you can, and have the guts to take the chance. By your hands and by your mind you can create the reality you want from clay. That is America.

    No government program can give or take away from us that uniquely American quality.

    Maybe we need to be collectively punched in the face to understand we can take a punch instead of perpetually gorging at the punch bowl.

    If you believe you can you will.

    If you believe you can’t you won’t.

    How do you get it done?

    Just do it.

    Why?

    Because you can.

    When?

    Right now.

  33. By Greg on Jan 16, 2009 | Reply

    THANK YOU!!!

    I think you are the first well read blogger to acknowledge this government bailout nonsense is worse than the disease.

    Uncle Sam “bailed out” Chrysler decades ago… is Chrysler better off? Absolutely not — its back for more bailouts. While accountants might argue that the government got “its” money back (isn’t it our **OUR** money?), the calculation failed to take into account lost GDP and lost taxes that should have been earned with a more vibrant auto industry.

    In the end, the bailout allowed Detroit to avoid needed reform and ironically guaranteed its collapse

    How anyone in the financial industry could wish that fate upon themselves has been a mystery to me for more than a year.

    Whatever perceived short term benefits there might be, the long term effect of all this nonsense is higher taxes for all taxpayers (because the government cannot manage risk), and stagnated employment opportunities for Wall Street.

  34. By bsetser on Jan 16, 2009 | Reply

    Andrew wrote:

    “FDR’s “programs” in the 30’s did nothing to help the nation and left us with useless stuff like presidents faces on the side of a mountain.”

    Really? I am not sure my father’s family could have afforded to send my father to college in the 50s if not for FDR’s programs in the 30s. Maybe that didn’t help the nation but it helped one of its constituent parts. An example: Depression era shelter belts (lines of trees planted at the edge of fields to break up the wind) in Central KS stabilized the soil and helped to end the dust bowl, making farming there marginally profitable. I am sure there are other examples. Jobs even bad ones helped families make it through some very very hard times. And if you believe Keynes, the alternative in situations of inadequate aggregate demand to public spending is not more private jobs, it is just even less aggregate demand and less private activity.

    thanks by the way for the plug!

  35. By Andrew on Jan 16, 2009 | Reply

    Trust me Greg, John is not the first well read blogger to go agaisnt the bailouts, shoot I know plenty of guys who have been calling everything that has happened almost word for word. I know quite a few people who have predicted this outcome for 10 years…

  36. By Franklin on Jan 16, 2009 | Reply

    “Separately, can anyone think of an example of worse due diligence than B of A’s due diligence on Merril Lynch?”

    BofA’s due diligence on Countrywide?

  37. By Comrade on Jan 16, 2009 | Reply

    just make me think about a comment I made @macroman on september 14th

    “MER board voting on 29$ BOFA offer, sounds like the worst investment decision I’ve ever witnessed myself. Tomorrow BOFA could get MER for 5$”

  38. By Andrew on Jan 16, 2009 | Reply

    Mr. Setser, if it is you, I never said that “all” the programs from FDR were bad, of course if you through enough mud at the wall something will stick. Marginally profitable to farmers in Kansas? Marginally profitable business’s usually do not last. Isn’t capitalism about allocating money to the “most” productive areas of the economy and comparative advantage with other states/nations? College is not all its cracked up to be and I have learned more “out” of college on my own then I have in my many years of university studies. No, what helped families make it through very very hard times was their self-reliance not the government. Back in the 30’s most families could still go out and grow their own food, I would love to see these kids of today try and go do that in their backyards haha. Those weren’t very convincing arguments Mr. Setser.

  39. By John Jansen on Jan 16, 2009 | Reply

    Brad,

    You are welcome. Thanks for your help.

  40. By Love the Blog on Jan 16, 2009 | Reply

    Great job man. I’ve been subject to ridicule for years to saying similar. Now who’s laughing. Nobody. I don’t even feel vindicated these days, just sad.

    btw Roman said “based on the failed Austrian economics school of thought. (Which is experiencing an undeserved revival)”

    HA HA HA

    Spoken like a Doctorate from Keynes U. The truth hurts, don’t it. A small sip of Austrian at first, you’ll get to like it in time.

  41. By bsetser on Jan 16, 2009 | Reply

    profitable enough farms — if the soil was stabilized, which it wasn’t prior to the planting of the shelter belts — to support a family and even finance (with a bit of gov. help) a college education. w/o the government program to protect the soil, the top soil literally would have blown away. I don’t quite see how that facilitates the global reallocation of capital.

    and frankly, these programs didn’t substitute for self-reliance — farms out in central kansas then grew their own food, etc. but sometimes a bit of help — planting shelter belts, scholarships for those of limited means, jobs when jobs are scarce b/c there is a global shortage of aggregate demand — can make a huge difference.

  42. By Jenny on Jan 16, 2009 | Reply

    Roman:
    “…crash in commodity prices and the rise of the dollar. According to Austrian economics, this is impossible. How can we have deflation when the government is printing so much money?”

    Who says we are having deflation? Money supply is up. Cost of living is up. Core CPI & PCE are up.

    To a man with a hammer, everything looks like a nail. To Bernanke, who wrote his thesis on the Fed induced Depression, everything looks like deflation. Bernanke is a failed Fed Chief, appointed by a failed President. The smart money already has Larry Summers replacing him in 2010 (if he isn’t pushed sooner)

    Just because a failed central banker says there is deflation doesn’t make it so.

  43. By Jenny on Jan 16, 2009 | Reply

    Roman said “based on the failed Austrian economics school of thought. (Which is experiencing an undeserved revival)”

    Its good that we have people like this in the markets so the rest of us can make money!!!

  44. By Bond newbie on Jan 17, 2009 | Reply

    JJJ, thank you for having the wisdom and courage to change your position and discuss it publicly. The American system’s greatness is our entrepreneurism, that we have a legal process (bankruptcy) to deal with business failures in an orderly way. And our culture is one that loves a good comeback story — having started, run or worked at a failed business doesn’t mean you’re doomed to life in a shack in the woods.

    So we should date our government’s policy misakes from — when? 3/16/08 (BSC bailout)? 1998 (LTCM)? At least with Fannie and Freddie they were called Government-Sponsored Enterprises.

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