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Low Interest Rates
There is a new phenomenon in the sovereign debt realm. Sovereign debt is much like commercial or even personal debt of a typical by standard because they are all governed by interest rates. The cost of debt (interest rate) is usually higher when there is no collateral or the creditor perceives that there is a great chance of a potential default. Now I won’t talk about the European crisis because it makes U.S.A’s debt issue a joke because the debt to GDP is much higher in Europe and the interest rates are as high as 30% unlike here where the 30 year is yielding less than 3 %.
In http://online.wsj.com/article/SB10001424053111904332804576538363789127084.html?mod=opinion_newsreel, Mr. Ronald McKinnon is basically saying that the bond market is behaving rather unusual to the norm when debt is high and there is little sign of the government making headway to lower or manage it. When there is a lot of debt investors usually want a greater rate of return for the risk but at the moment: the 10-Yr Note Yield (1.92), 30-Yr Note Yield (2.91); and the medium and short term notes 5-Yr Note Yield(.95),2-Yr Note Yield (.24), 1-Yr Note Yield (.10). I do agree with Mr. McKinnon’s assertion that Central Banks are kicking out the Bond Vigilantes and keeping rates so low.
Ben Bernanke is a big player in this but not the only culprit because he bought up a lot of notes with QE 1 and 2 but rates were still higher then. Then came the reemergence of Europe’s fiscal troubles with the Pigs(Portugal, Italy, Greece, and Spain). Investors in a panic sold their holdings and started going into gold for a time which made gold almost reach $2,000 an ounce but all summer it has failed to reach that level. Then the investors came to their senses and realized that gold is only a short term insurance policy and not something long term because it is just a commodity. So the best place to go was to go to the most liquid markets in the world, U.S.A. Stocks weren’t going to do because American banks were tied to those troubled European banks so the debt market was the final destination. Everyone starts buying up U.S. notes which raises the price while lowering the yield. This is the cause of the low yields, even though it makes no sense to buy a bond with a return less than inflation (when inflation is at say 3% and the return on a bond is say 2%….that simply means that the investor is losing 1% of their original investment each year), people have more faith and would rather invest in America than anywhere else.
For the faceable future, Yield’s will remain dismally low and the stock market will remain relatively flat if not drop more than it already has, in my opinion. The 3 reasons most convincing reasons for that to take place are Operation twist, foreign investors, and the current yield levels at the moment.
Operation twist….the Fed’s new magic trick which will cause more harm than the good intentions is built on; the Fed will simply sell the short term notes and buy long term notes. The result would be that short term interest rates will go up while long term should come down, well they are down so how long could they get. The problem with this is that banks usually run their business by buying short term notes and selling short term notes or issuing long term debt like mortgages, the difference makes this profitable but that will be flipped backward by operation twist. And unfortunately the Fed is content on keeping inflation at a “manageable” level than rather let interest rates go up and give consumers the purchasing power they need with a strong dollar.
Foreign investors will stay put because the U.S. stock market is performing poorly even though there is inflation which should bring up stock prices and thanks to the Fed debt financing is at its lowest cost in years. Everything and even oil is performing poorly because no one is buying because of low or low consumer confidence. So even with lots of money floating around (well that is for no main street folks) there aren’t enough investors to keep the markets up. Another reason why they will stay put is because right now emerging markets are doing well, look at Brazil with a growing economy and rates on their government bonds being at average of 12 percent in yield…that still isn’t enough to motivate investors to leave the U.S.
Current yields are the hindrance to the economy’s recovery. The one way for this country to get back to good economic health is through credit without inflation. Right now we have exhausted artificial credit from the fed and created inflation at the cost of both lower purchasing power(the ability for one dollar to buy things like gasoline, right now the dollar buys less than it did 6 months ago) and high unemployment. The best way to restore the economy and release some of the artificial credit is by the fed selling their bond holdings and removing the excess cash out of circulation which will bring back the bond vigilantes. And the increased yields will mean that even the cost of short term notes will go up and with it CD’s at the local bank will also go up. When they go up it will incentivize consumers to think about saving because of a good return and it will cause a further decrease in free floating money which will translate into a stronger dollar.
Mistakes of Politicians and Fed Governors Come Center Stage
“Stocks Nose-Dive Amid Global Fears” was today’s headline on the Wall Street Journal which should be rewritten as “Realization of Failed Stimulus”. All indices in western and Asian economic powers except China were down on an average of 3 to 4% points. Now the article by Tom Lauricella would suggest that the markets are simply on correction mode(as though the markets a collective of intelligent agents) or that fear is what lead to the equities tumbling or even more crazy that it is due to economic slowdown. The collective efforts of Central Banks to both lower interest rates and stimulating their economies was a mistake.
A correction would imply that there was a mistake and that the indices are overvalued just slightly but that’s not the same as a global drop of 4% in a single day. The financial crisis was due to a mortgage bubble that popped then everything dropped in value whether it was commodities, equities and even bonds, but come the end of 09 into 2010 markets rose as high as 30 percent. In my opinion that was correction because even though the drop was greater than what occurred yesterday, the drop happened because the securities were overly valued and not sufficiently backed. Now yesterday’s drop dropped the equities slightly above the 2010 highs, this point will be tied in further down into the conclusion.
The drastic decline in value commodities and other securities across the board isn’t due to fear or an economic slowdown. The debt ceiling was met before the deadline and that was because America faced the threat of not meeting its obligations and a downgrade in credit rating. The fear was that if it wasn’t met then the U.S.A. would default, no since it hasn’t defaulted then why is it that rumormongers are claiming the restriction in spending might limit growth and on the flip side the debt will be too high warranting a down grade? With the debt ceiling met then the government will run and obligations will be met. Growth of the economy will only occur if more debt is incurred, but merely increasing the debt in of itself will not collapse the economy. Take for an example when a couple is taking up a mortgage, it is very feasible in fact common to buy it with only 5 percent down payment and the other 95% incurred in debt but still the debt is paid in full with in the 30 years max. Now the U.S.A.’s debt is at around 75 percent but that doesn’t mean it can’t meet its obligations, in fact the debt ceiling agreement allows that and also more money for it to spend. The way I see it, even if the debt to GDP is 100% there is no problem as long as that money loaned to the government is spent on things that will be profitable and conducive to economic growth much like a business owner can incur as much debt as possible if the incoming revenue exceed the interest payments resulting in a profit. So fear isn’t a valid argument.
There economic slowdown is not the cause of the drastic decline in markets worldwide. The major corporations are sitting on a lot of cash and for some even more that the U.S.A. government, like Apple with more than 75 Billion Dollars. This strange decisions by executives show could mean that corporations have come to the realization that the economy is going to grow slowly and so there is no need for example or even acquisition in the time when credit is very cheap with interest rates being so low which would mean a greater likelihood of successful mergers with low default on high interest junk bonds used as a means of financing.
And so why did the markets drop so quickly when there is even a chance for more stimulus and so many plans to either increase sovereign debt or restructuring debt? The Stimulus( be it QE 1 or 2,central banks purchasing government bonds to keep interest rates low or some other form )and lowering of interest rates simply inflated the markets with too much money and now investors and speculators alike are removing money out of the markets. The problem isn’t liquidity anymore because there is plenty of money; instead the money is too much. If the money wasn’t added to begin with then bonds would be cheaper and their interest would be higher but that was subverted buy bond buying actions by central banks. If money wasn’t added to the economy commodity prices would have remained low allowing consumers to have more discretionary funds to spend and the consumer sentiment that was bleak would have recovered by now. And finally the manageable inflation that Central Banks preferred over deflation is here and isn’t manageable any more instead it is lowering consumer purchasing power and further prolonging true economic recovery.
For reference to the above mentioned article go to:
http://online.wsj.com/article/SB10001424053111903454504576488581593391582.html?mod=WSJ_Home_largeHeadline
Debt Crept In Big U.S.A.
So what is the world turning into? Jobs aren’t there, education is expensive with no guarantee of a better future, the American dream is a pipe dream and we are all just going to hell with nothing there to stop it….oh no what will do? There I tried but I just can’t do it as good as the WSJ even Marketwatch but give me credit I am not a journalist, at least they are great at writing gossip since when they stop reporting business news. It’s easy to move from one rumor to the next like how EU has no future with Greek Debt but now its all mighty USA which won’t raise its debt ceiling so the world will come to a halt. Well that’s a bleak vision of things to come, I’d look at it positively because US debt will be curbed and more wealth will be built if U.S. defaults. Ms. Sjolin of marketwatctch wrote a quote ‘“Investors prefer to wait until after the deadline when there’s more certainty to buy Treasurys.” in http://www.marketwatch.com/story/weak-debt-auctions-highlight-investor-worries-2011-07-28. That sounds like speculators are actually taking logical steps to protect themselves from lendee who might not pay up yet its just an example of how there is a lot of hysteria which is backed up with nothing but rumors. First of all America is special because unlike Greece the problem is that some politicians don’t want to increase the debt while the other country was riddled with debt that it can’t pay. Picture John(Greece) who has a has a lot of credit card debt and can’t pay it back and the things he owns can’t cover the debt even if it was sold. Then there is Tom(U.S.A) which can has little debt and is just refusing to get another credit card because he can’t make up his mind. Clearly the two are so far apart in their dilemma that they can’t even be compared but all newspapers are trying to compare them and speculators are equating them. The reason why America will not die off even after the financial crisis two years ago is because it has the largest economy and it is filled with very industrious citizens who can’t stop creating wealth that all Europe can’t compete with.
Time for playing devil’s advocate. Now rumor mongers might say that if America defaults that interest rates will go up and the dollar will lose its value. And guess what that will happen to some degree and what is wrong with that. It’s not like the Fed is raising interest rates and aggressively trying to sustain the purchasing power of the dollar instead they are trying to maintain a reasonable percentage of inflation which is stealing wealth from the lowest earners. Stealing because they can’t buy the same today as they did yesterday and to make matters worse that isn’t helping the job front. Now on interest rates will go up and guess what that is the best thing that can happen right now for the few who can investors but it will heart the poor. Interest rates go up will mean that U.S.A will pay a higher interest rate which will attract investors. And this will surely happen because at the interest rates right now of less than the highest earning debt of 4 percent is so low that it is pointless to own treasuries. And it will also counter the Fed’s QE 1 and 2 actions that kept the rates artificially low for so long which will eventually raise the dollar value. Now people talk about if the debt ceiling isn’t met that there will be a default. The default might happen but there is insurance for that, credit default swaps, just like insurance for homes or cars or floods, so there is no reason why people should dump U.S. Debt. And to bring the point home for how special America is just look at Brazil with a robust economy which wasn’t touched by the financial crisis and its currency appreciating against the dollar and economy thriving and the debt is paying an astonishing 12 percent. Now why would people stick with The US debt and ignore Brazilian debt if things are so dire? They wouldn’t so things will be good once more.
Now the picture of U.S.A if the Debt ceiling is increased is nothing different from what is going now. Well more debt will be printed and interest rates won’t go up cause things will be the same. Bill Gross the bond king who won’t touch U.S. Debt still won’t use any money from his behemoth Pimco to boy any U.S.A debt cause the returns are so much lower than what he can get from corporate debt even after taxes. And markets will go up and down like they have been for weeks and oil will still be expensive and the unemployment rate will still be high. So basically it isn’t a rosier picture. So why worry?
Peer2Peer Lending Replaces Good Old Banking
Banks are there to hold the money for its customers and when the need arises to facilitate credit through loans whether it is through credit cards or mortgages or even other more complex products. But it would appear that banks are no longer able to carry out such duties to all of their customers, instead banks provide credit to big business and high net worth clients leaving out small businesses and individuals (dependent on high interest credit cards). A few weeks back Google was able to sell issue bonds valued at $3Billion dollars while it had over $35 billion dollars in cash in its books. And the main reason for Google to do this is because interest rates are at an all-time law yet when it comes to individuals, interest rates on credit cards haven’t gone down at all. In fact investment grade bonds (loans to large corporations with god credit history) fetch an interest of no more than 7 percent; somehow it’s hard to find a credit card with interest that low.
According to Jeffrey Sparshott’s Wall Street Journal (wsj) article from June 22, 2011, “U.S. President Barack Obama signed the Small Business Jobs Act in September 2010. The law’s centerpiece is a $30 billion small business lending fund, meant to spur more loans to smaller companies”….further down the article it states “The Small Business Jobs Act defines small business lending as loans of up to $10 million to businesses with up to $50 million in annual revenues. Lenders must have less than $10 billion in assets to participate” The new funds set aside for small businesses is a necessity for improving the current state of the economy because large businesses aren’t exactly hiring at the moment and aren’t incentivized to either, but instead are changing their management to produce goods with a leaner labor pool of employees.
Back in June 30, 2011 Emily Maltby wrote a wsj article “Small Businesses Seeking Loans Still Come Up Empty” and more importantly there two interesting bits of date found. The first, by the Fed of Kansas City, “….big banks’ outstanding loans to small businesses dropped 14% between March 2010 and March 2011, while loans by smaller lenders fell 3%.” Secondly, by the Pepperdine study, “ In the past six months, only 17% of loan-seeking businesses with less than $5 million in annual revenue landed bank financing, the study found.” And “about 37% of respondents from privately held companies with revenue greater than $25 million have successfully secured bank loans in the last six months…” it is clear that the same big banks which got a bailout from the Government and additional large loans in the billions (Goldman Sachs got a $15Billion dollar loan at 1.16% interest rate) with a negligible interest rate for repayment, aren’t using the money for the utility of the economy as they should.
A better use of the $35Billion set aside for small business lending should perhaps be contracted to Peer 2 Peer lenders. Mr. Angus Loten’s wsj article, Peer-to-Peer Loans Grow, of June 17, 2011; would suggest that Peer2peer lending is filling the vacuum that banks have created by ignoring small businesses and individuals seeking loans. Mr. Loten’s article points out “Based in San Francisco, Calif., LendingClub.com’s small-business lending rose 40% in 2010 and is expected to grow an additional 80% by year’s end, according to Scott Sanborn, the site’s chief marketing officer.” And “San Francisco-based Prosper.com recently reported a 38% increase in total loan volume over the first quarter”. This new growing industry will continue to thrive because banks are just not willing to spend money in servicing such clients. Whether it be credit history or no good collateral, such arguments are frivolous because lending.com and prosper.com can’t be growing at such a high rate if delinquencies were very high. Banks and the SBA aren’t capable to service the needs of the new growing demography and so it is time for the government to assist peer2peer lending institutions so that the economy will grow quicker out of the recession.
Higher bank capital requirements
After the financial crisis that happened about two years ago, the BIS(Bank of International Settlements, based in Basel, Switzerland) decided to raise the capital requirements: The the first 3 requirements are there to make sure banks are well capitalized. Then the requirement 4, is to minimize the impact of loan losses to the balance sheet of banks whether it be the typical loan defaults by customers or times of recession and other economic hardships the economy may have to endure. Sufficient capitalization for a bank isn’t the same as any ordinary business because unlike other enterprises, the assets and liabilities of a bank can increase without an increase in new capital. For example when a customer deposits money in a checking or a savings account the capital does in fact increase. But when a bank uses that money to make a loan to another customer and it keeps a fraction of the deposit, the assets and liabilities of the ledger increase without any capital, that’s the minor difference that sets banks apart from other enterprises. All assets are given a risk weight: then in turn the values of each asset is multiplied by the appropriate risk weight and then all the new values are added up then multiplied by the percentages of the Common Equity, Tier 1 Capital, and Total Capital. The eventual number is the amount of capital the bank should always have. In my opinion all these new requirements sound well on paper but can only mean that the central banks of the G20(who mostly compose and influence the BIS) members are coming up with these new standards due to political pressure.The idea that these rules will prevent another financial crisis is very ludicrous because first of all the capital is so low and can’t be used to cover all the banks obligations if they were to all default. The only banks that did collapse from the crisis were those who had poor management. The most famous one being BearStearns then the other ones which were found wanting by the Fed after the “Stress Test” were bought by the more healthier banks. Further more with the Fed continuing its operations through the Federal Reserve Bank Window(http://www.frbdiscountwindow.org/mechanics.cfm?hdrID=14 ), the new capital standards would only be diverting capital from lending operations to sitting in a vault. If there is a short term emergency then banks can get money from each other or even get money from the Fed through the discount window. To get a loan at the Fed Funds rate(http://www.bankrate.com/rates/interest-rates/prime-rate.aspx) would only cost .25 which is a far cry from what the typical credit card customer would pay. And finally the the banks that weren’t healthy either collapsed or were bought by the healthy ones so why increase the capital requirements when they have enough money left over to buy the band banks and absorb their toxic assets too? The Financial crisis only shows that the Fed was too eager to loan money to banks out of political pressure and not to help the economy per say. If it was concerned with helping the economy it could have used that money to absorb the mortgages and increased the lending its credit to the SBA which makes loans to small businesses, they are the ones who create jobs which intern grows a healthy economy. So the new capital requirements imposed to the big banks are more restrictive than beneficial. links for further reading: http://wfhummel.cnchost.com/capitalrequirements.html http://online.wsj.com/public/resources/documents/ZubrowHFSC.pdf http://www.bis.org/press/p100912.htm
