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Happy Anniversary

“They have learned nothing, and forgotten nothing.”
  • Attributed to Talleyrand.

Since everybody else in financial media has been indulging in an orgy of self-reflection, selective recollection and brazen virtue-signalling on the back of the 10 year anniversary of Lehman Brothers’ bankruptcy in September 2008, and in steadfast keeping with our principle of ‘no bandwagon left unridden’, we reproduce below, word for word, our commentary first published on 1st October 2008. A brief update then follows..

Armageddon outta here !

“Last night, Mr Brown made it clear he was ready to increase the level at which savers’ deposits were guaranteed from £35,000 to £50,000 but indicated he did not want to act until the markets had calmed.”

– From The Financial Times, 1st October 2008.

As part of my O-level history course back in the mid-1980s, I wrote an extended essay on the topic of the atomic bombing of Hiroshima in 1945. My teacher made the useful suggestion of comparing the Hiroshima experience and related issues with those of the Dresden fire bombings earlier that fateful year. Even now I’m not sure whether either action could be easily or wholeheartedly justified and as a non-combatant (and non-civilian, for that matter) of the time in question, it still seems somewhat presumptuous even to try. What I do recall is that I concluded my study with the words of historian A.J.P. Taylor:

“War suspends morality.”

I recall these words because I am now reminded of advice given me a year ago when the crumbling of the credit markets first became manifest to a financially less literate world. While I was personally wrestling mentally with the moral hazard issues surrounding banking bailouts and the like, a South African fund manager friend made the following pertinent observation: in a shooting war, don’t waste time scrupling over moral hazard – the objective is survival.

…click on the above link to read the rest of the article…

This is What it Looks Like When Credit Markets Go Nuts

This is What it Looks Like When Credit Markets Go Nuts

Pricing of risk kicks bucket in record central-bank absurdity.

As the days pass, the perverse effects of central bank policies on the financial markets are getting more and more amazing. This includes the record-setting nuttiness now reigning in the European bond market, compared to the mere semi-nuttiness in the US bond market.

The 10-year yield of US Treasury Securities closed at 2.34% yesterday and at 2.33% today. This is low by historical standards. It’s barely above the rate of consumer price inflation as measured by CPI, which was 2.2% in September. This means that coupon payments barely make up for the loss of purchasing power. If inflation ticks up just a little, bondholders will be left in the hole. And a yield this low doesn’t compensate bondholders for any other risks, including duration risk, which can be significant. In other words, this is a bad deal.

But in this strange world, it looks practically sane, compared to the Draghi-engineered negative-yield absurdity that has overtaken the Eurozone, where the average yield of euro junk bonds – the riskiest bonds out there – dropped to 2.16%.

This chart, based on the BofA Merrill Lynch Euro High Yield Index via the St. Louis Fed, shows how the average euro junk-bond yield (red line) has plunged so far this year, on the way to what? Zero? The 10-year US Treasury yield (black line) has started rising in past weeks and, in late September rose above the euro junk bond yield for the first time ever:

This average junk-bond yield is based on a basket of below-investment-grade corporate bonds denominated in euros. Among the issuers are European subsidiaries of junk-rated American companies. For them, it’s nearly free money.

…click on the above link to read the rest of the article…

The Three Headed Debt Monster That’s Going to Ravage the Economy

“The bank is something more than men, I tell you.  It’s the monster.  Men made it, but they can’t control it.” – John Steinbeck, The Grapes of Wrath

Something strange and somewhat senseless happened this week. On Tuesday, the price of gold jumped over $13 per ounce.  This, in itself, is nothing too remarkable.  However, at precisely the same time gold was jumping, the yield on the 10-Year Treasury note was slip sliding down to 2.15 percent.

In short, investors were simultaneously anticipating inflation and deflation.  Naturally, this is a gross oversimplification.  But it does make the point that something peculiar is going on with these markets.

Clear thinking and simple logic won’t make heads or tails of things.  For example, late Wednesday and then into Thursday the reverse happened.  Gold gave back practically all $13 per ounce it had gained on Tuesday, while the yield on the 10-Year Treasury note climbed back up to 2.19 percent.  What to make of it?

Gold and treasury yields have been inversely correlated for some time. This is probably due to inflation expectations driving expectations about interest rate policy – click to enlarge.

With a little imagination one can conceive of where the money’s coming from to buy Treasury bonds.  More than likely, it has something to do with central bank intervention into credit markets.  Though, the Federal Reserve is not the only culprit.

If you recall, the Federal Reserve’s quantitative easing program concluded in late 2014.  The Fed even says it plans to start shrinking its balance sheet later this year.  So if the Fed’s not the source of liquidity for Treasury purchases, who is?

…click on the above link to read the rest of the article…

Junk Bonds Under Pressure

There are seemingly always “good reasons” why troubles in a sector of the credit markets are supposed to be ignored – or so people are telling us, every single time. Readers may recall how the developing problems in the sub-prime sector of the mortgage credit market were greeted by officials and countless market observers in the beginning in 2007.

oil rigPhoto credit: Getty Images

At first it was assumed that the most highly rated tranches of complex structured products would be immune, as the riskier equity tranches would serve as a sufficient buffer for credit losses. When that turned out to be wishful thinking, it was argued that the problem would remain “well contained” anyway. After all, sub-prime only represented a small part of the overall mortgage credit market. It could not possibly affect the entire market. This is precisely the attitude in evidence with respect to corporate debt at the moment.

1-HYG weeklyA weekly chart of high yield ETF HYG (unadjusted price only chart) – click to enlarge.

The argument as far as we’re aware goes something like this: there are only problems with high yield debt in the energy and commodity sectors. This cannot possibly affect the entire corporate credit market. We should perhaps point out that in spite of this sectoral concentration, problems have recently begun to emerge in other industries as well (a list of recent victims can be found at Wolfstreet).

The argument also ignores the interconnectedness of the credit markets. Once investors begin to lose sufficiently large amounts of money in one sector, the more exposed ones among them (i.e., those using leverage, a practice that gains in popularity the lower yields go, as otherwise no decent returns can be achieved), will start selling what they can, regardless of its relative merits. This will in turn eventually make refinancing conditions more difficult for all sorts of industries.

…click on the above link to read the rest of the article…

 

At the Fed in 2009, Rolling Dice in a Crisis

At the Fed in 2009, Rolling Dice in a Crisis

Ben Bernanke and his colleagues at the Federal Reserve Board have earned accolades from all corners for the extraordinary actions they took to rescue the financial system in 2009. While 2008 was the Fed’s annus horribilis, exposing how unaware the central bank had been of the risks building in the financial system, 2009 was its year of redemption.

So it was interesting, last week, to read the newly released transcripts from Federal Reserve Board meetings in 2009, which include some of the darkest days of the mess.

With the economy now on a sound footing and the stock market near a record high, the decisions made by the Fed to shore up credit markets in the aftermath of the 2008 crisis look even better.

 

But the transcripts also reveal for the first time what critics within the Fed were saying about some of the trillion-dollar programs. And even though the critics’ worst fears did not come to pass, their concerns are worth exploring. For this reason alone, the transcripts make for fascinating reading.

There were two basic camps within the Fed. On one side were the reserve bank presidents who wanted to throw anything and everything at the crisis. For the most part, these officials came from regions — like New York and Boston — that are home to big financial firms. They contended that the financial system was in such peril that big substantive action had to be taken, pronto.

…click on the above link to read the rest of the article…

 

 

Olduvai II: Exodus
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