Friday, February 26, 2010

The Anatomy Of A Failed T Bill Auction

So, the auction didn't actually "fail", per se. But this excellent Seeking Alpha piece breaks down a very strange Treasury Bill auction earlier this week. Very little buying from traditional sources forced primary dealers and - perhaps - The Fed to step into the breach. Here is an excellent breakdown on what was a very weak Bills auction yesterday.

We recommend clicking the above Seeking Alpha link and reading the article in its entirety, in order to understand how a Treasury auction works and what makes for a "strong" vs. a "weak" auction. What happened on February 23rd was unquestionably "weak", though to be fair, zero percent interest rates wouldn't drive me to bid either.

Here is a partial description from his article:
Now here’s where things get odd.

Of the competitive bids (meaning those bids coming from folks who care about yield), roughly 70% went to Primary Dealers (investors who HAVE to buy the debt and who usually turn around and try to sell it afterwards). To put this number into perspective here is the percentage of competitive purchases made by Primary Dealers in the last four 4-week Treasury issuances:

Date of 4-Week Treasury Auction
Primary Dealers as % of Competitive Buys

January 5 2010

January 12 2010

January 20 2010

January 26 2010

February 2 2010

February 9 2010

February 17 2010

February 23 2010 (yesterday)

You’ll note that during the stock market correction that took place during the end of January/beginning of February, Primary Dealers didn’t need to buy many Treasuries since investors were fleeing stocks and buying short-term Treasury debt as a safe haven.

You’ll also notice that yesterday’s auction featured MORE buys from Primary Dealers than almost any of those occurring in 2010. Remember, Primary Dealers HAVE to buy Treasuries. So to see them buying a high percentage of Treasuries at debt auctions means that few investors who can pick and choose what to buy are actually looking to buy US debt.

In plain terms, a debt auction that features a high percentage of competitive buys coming from Primary Dealers is BAD NEWS. It means investors generally aren’t buying US debt. It also means that foreign governments (those who have funded US debt auctions for decades) aren’t buying much anymore either.

So the fact we’ve have three short-term auctions in which more than two thirds of competitive buys came from Primary Dealers is worrisome to see the least.

Now here’s where it gets even worse.

Of the remaining competitive buys (about $8.86 billion), only 32% came from Direct Bidders or those who bought debt directly from the Treasury: orders that can easily be tracked. The other 68% ($5.9 billion) came from Indirect Bidders: folks who we cannot track.

Even more bizarre, only $5.9 billion in Indirect Bidder competitive buys were ACTUALLY OFFERED. So we had a 100% acceptance rate for Indirect Bidder competitive buys.

Let’s put this in perspective:

Date of 4-Week Treasury Auction
Indirect Bidder Acceptance Rate

January 5 2010

January 12 2010

January 20 2010

January 26 2010

February 2 2010

February 9 2010

February 17 2010

February 23 2010 (yesterday)

This means that the Treasury took up EVERY single cent of competitive bids coming from indirect buyers. Remember, indirect buyers are usually assumed to be foreign governments (even the Treasury website admits this).

If this was the case yesterday, then foreign governments barely bought much of anything in yesterday’s auction (only 19% of total debt issued). Moreover, it implies that Primary Dealers (those having to buy) had to gorge on the auction to make up for the fact that few if any foreign governments are interested in buying our debt anymore (including even short-term debt).


One could potentially argue that this indirect buying came from the Fed covertly buying under the guise of an indirect bidder (the Treasury recently changed the definition of what qualifies for an indirect bidder to make it more vague). It IS rather odd that every single cent of competitive bidding coming from indirect buyers was filled. It’s almost as if the indirect buyers knew precisely WHAT yield to accept… OR were simply trying to take up the slack in what was already a VERY weak auction.

I cannot tell you which of the above is true. Heck, neither of them could be and something completely different could be happening. But regardless, something very, VERY strange is going on in US debt auctions.

I wrote earlier this year that bonds, not stocks, would be the big story of 2010. We’re only into February and there are already some very unusual things happening on both the long (30 year) and the short (4 week) ends of the Treasury curve. And with the Fed’s Quantitative Easing Program scheduled to end in March, things are about to get a whole lot more interesting (barring of course an extension of the QE or QE 2.0).

Keep your eye on US Treasuries. Stocks, despite being so popular with investors are usually the LAST to get what’s coming down the pike. And investors just parked $30 billion for a month with Uncle Sam at virtually NO YIELD yesterday.

Put another way, someone(s) is/are willing to not make money just for the sake of insuring return OF capital (the US can always print money to return it) rather than any return ON capital.
[HT: TD]

Thursday, February 25, 2010

Japanese Collapse: The Pending Sovereign Ruin

As we have been saying for some time, Japan is well past the point of no return. The country faces financial collapse brought on by two decades of unbelievable profligacy. With 10 year JGB rates at 1.5% or so vs 3.5% for the rest of the G-7, Japan's cost of financing is unbelievably cheap despite having debt to GDP of nearly 200% (vs. just over 100% for Greece and about 80% for the US, both of whom are wildly over indebted). Japan has managed to pull this off for a variety of reasons including a) they've run a large trade surplus; b) they've been dealing with price deflation that has allowed even very low nominal interest rates to still be positive real interest rates; and c) 95% of Japan's sovereign debt is financed internally.

Japan's population began shrinking a few years ago and the demographics are such that new retirees are outnumbering new workforce entrants, leading to a dis-savings trend (you save during your working years and spend during your retirement years), meaning that the ability to internally fund Japan's debt is evaporating (simply rolling the existing debt will be increasingly difficult, much less continuing to run deficits, which Japan's is >10% of GDP). Replacing that internal funding with external funding is a non-starter because if Japan's cost of funding were to exceed 3%, nearly 100% of Japanese federal tax receipts would be consumed by interest expense. So going to the external market and competing at G-7 type interest rates would quickly lead to total collapse.

As such, Japan's central bank (the BOJ) will almost certainly have to monetize the debt, leading ultimately to a hyper-inflationary depression. Japan knows this. It has burned through six ministers of finance in the past 18 months (akin to Secretary of the Treasury), the fifth of which committed suicide rather than resigning. On top of that Japan's currency has stayed remarkably strong, staggering its export oriented economy.

We predict much higher rates (ultimately greater than 10%) and a much weaker Yen (surpassing 150 to the dollar and possibly 200). This will devastate Japanese savings, force austerity and likely make Japan default or rework its sovereign debt. Assuming this happens, hopefully it happens soon enough that the US has enough time to reflect on Mad Scientist Bernanke's experiment as conducted by Japan and we choose to retrench and not pursue these horrible, suicidal crippling policies of deficits and inflation.

The piper will ask to be paid someday. Be ready.

Anyway, enjoy the slide deck.

Japan - Past the Point of No Return - Katsenelson


Monday, February 22, 2010

The Fabian Socialists Are Winning

The Fabian Socialist movement, first begun over one hundred years ago, is moving faster today than ever before. The success of their slow evolutionary drive toward central planning was highlighted a few days ago when we presented our Depressing Chart of the Day, shown to the right. It shows that the total of federal, state and local government spending as a percent of GDP has skyrocketed over the past few years, approaching 50% of all GDP.

By coincidence, your intrepid author is in the midst of Hayek's "The Road to Serfdom". In the excellent book is the excerpt that follows. TILB highlighted several points below [all emphasis added], but most important is the emphasis on Germany in 1928 (immediately prior to Nazi rule).

Of additional note is the description on how socialism is most effective in a republic or democracy - by taking the power away from elected leaders and handing it to non-elected bureaucrats (a modern day example would be the Federal Reserve's central planning role in determining the amount and price of money).

The words that follow are from Hayek published in 1944.
We can rely on voluntary agreement to guide the action of the state only so long as it is confined to spheres where agreement exists. But not only when the state undertakes direct control in fields where there is no such agreement is it bound to suppress individual freedom. We can unfortunately not indefinitely extend the sphere of common action and still leave the individual free in his own sphere. Once the communal sector in which the state controls all the means, exceeds a certain proportion of the whole, the effect of its actions dominate the whole system. Although the state controls directly the use of only a large part of the available resources, the effects of its decisions on the remaining part of the economic system become so great that indirectly it controls almost everything. Where, as was, for example, true in Germany as early as 1928, the central and local government authorities directly control the use of more than half of national income (according to an official German estimate then, 53 per cent), the control indirectly almost the whole economic life of the nation. There is, then, scarcely an individual end which is not dependent for its achievement on the action of the state, and the "social scale of values" which guides the state's action must embrace practically all individual ends.

It is not difficult to see what must be the consequences when democracy embarks upon a course of planning which in its execution requires more agreement than in fact exists. The people may have agreed on adopting a system of directed economy because they have been convinced that it will produce great prosperity.

In the discussions leading to the decision, the goal of planning will have been described by some such term as "common welfare," which only conceals the absence of real agreement on the ends of planning. Agreement will in fact exist only on the mechanism to be used.

But it is a mechanism which can be used only for a common end; and the question of the precise goal toward which all activity is to be directed will arise as soon as the executive power has to translate the demand for a single plan into a particular plan. Then it will appear that the agreement on the desirability of planning is not supported by agreement on the ends the plan is to serve.

The effect of the people's agreeing that there must be central planning, without agreeing on the ends, will be rather as if a group of people were to commit themselves to take a journey together without agreeing where they want to go: with the result that they may all have to make a journey which most of them do not want at all.

That planning creates a situation in which it is necessary for us to agree on a much larger number of topics than we have been used to, and that in a planned system we cannot confine collective action to the tasks on which we can agree but are forced to produce agreement on everything in order that any action can be taken at all, is one of the features which contributes more than most to determining the character of a planned system.

It may be the unanimously expressed will of the people that its parliament should prepare a comprehensive economic plan, yet neither the people nor its representatives need therefore be able to agree on any particular plan. The inability of democratic assemblies to carry out what seems to be a clear mandate of the people will inevitably cause dissatisfaction with democratic institutions.

Parliaments come to be regarded as ineffective "talking shops," unable or incompetent to carry out the tasks for which they have been chosen. The conviction grows that if efficient planning is to be done, the direction must be "taken out of politics" and placed in the hands of experts-permanent officials or independent autonomous bodies [TILB - see the Federal Reserve for a modern day socialist example].

The difficulty is well known to socialists. It will soon be half a century since the Webbs began to complain of "the increased incapacity of the House of Commons to cope with its work."' More recently, Professor Laski has elaborated the argument:

"It is common ground that the present parliamentary machine is quite unsuited to pass rapidly a great body of complicated legislation. The National Government, indeed, has in substance admitted this by implementing its economy and tariff measures not by detailed debate in the House of Commons but by a wholesale system of delegated legislation. A Labour Government would, I presume, build upon the amplitude of this precedent. It would confine the House of Commons to the two functions it can properly perform: the ventilation of grievances and the discussion of general principles of its measures. Its Bills would take the form of general formulae conferring wide powers on the appropriate government departments; and those powers would be exercised by Order in Council which could, if desired, be attacked in the House by means of a vote of no confidence. The necessity and value of delegated legislation has recently been strongly reaffirmed by the Donoughmore Committee; and its extension is inevitable if the process of socialisation is not to be wrecked by the normal methods of obstruction which existing parliamentary procedure sanctions."
And to make it quite clear that a socialist government must not allow itself to be too much fettered by democratic procedure, Professor Laski at the end of the same article raised the question "whether in a period of transition to Socialism, a Labour Government can risk the overthrow of its measures as a result of the next general election"-and left it significantly unanswered.

It is important clearly to see the causes of this admitted ineffectiveness of parliaments when it comes to a detailed administration of the economic affairs of a nation. The fault is neither with the individual representatives nor with parliamentary institutions as such but with the contradictions inherent in the task with which they are charged.

They are not asked to act where they can agree, but to produce agreement on everything--the whole direction of the resources of the nation. For such a task the system of majority decision is, however, not suited. Majorities will be found where it is a choice between limited alternatives; but it is a superstition to believe that there must be a majority view on everything.
We are fast approaching a tipping point. In the course of a decade, we have gone from the government representing an already egregious one third of economic outpoint to one that represents 44% of our economy. It seems likely not to shrink as the current administration clearly believes in its just and beneficent wisdom and will impose that wisdom upon us, whether we want it or not.

To be fair, the trend of the graph at the top of this page is party neutral - both donkeys and elephants share the blame - having built over the course of 80 years. The acceleration, though, is perhaps most frightening of all. TILB is not sure what will cause a secular shift back toward freedom and away from centrally planned oppression. We suspect that, in the end, the will of the people must exert itself and reclaim lost liberty.

Lord hear our prayers...

Sunday, February 21, 2010

The Borg, I Mean Obama Administration, Proposes Federal Price Controls On Health Insurers

Good lord, our president has no shortage of self-assuredness in his ability to control all aspects of society. Thomas Sowell preciently warned us of this prior to the 2008 election.

The Administration is apparently going to take another crack at health insurance reform (rather than healthcare reform) by imposing federal price controls on the insurance industry. The modicum of respect that I retain for the man declines everyday as his populist exploitations accumulate.

I mean, federally imposed price controls have worked so well in other areas of the economy. Fortunately, this effort is unconstitutional and clearly impedes states' rights and oversteps constitutionally limited federal authority. Unfortunately, we all know that Obama views the constitution as a simple set of best practices recommendations rather than the fundamental underpinning of the relationship between man and his servant government.

If it is not yet screamingly obvious that price controls reduce competition, reduce service quality, and impair productivity, then it never will be. There is not one sector of the economy that the government has ever successfully improved through price controls.

Here is the New York Times article on the topic of The Administration's efforts to set prices.

What's ironic is that every industry the government is heavily involved subsequently earns a terrible reputation: public schools, health care, banking, insurance, defense, etc. These are businesses that have costs that rise in excess of inflation and productivity gains that lag it. However, industries that are relatively more free such as high tech, retail, and consumer goods reflect the opposite: improving productivity, declining costs, and increasingly customer friendly prices and products.

The obvious answer is to free the health care and insurance sector of governmental interference and watch them blossom. Sadly, this will not happen under the rule of a man that believes he can impose better outcomes than individuals would receive through freedom (or, in the case of insurance, local judgement).

Sunday, February 14, 2010

Harrisburg. Pennsylvania Makes Official Its March Toward Default

As we discussed last week, Pennsylvania's state capitol city - Harrisburg - is insolvent. This week, Harrisburg makes it official by passing a budget that excludes paying their financing obligations. Chapter 9 feels right around the corner...

Reuters provides the story. Article included below [emphasis and comments added]:
PHILADELPHIA, Feb 14 (Reuters) - Harrisburg, Pennsylvania, moved a step closer to defaulting on a bond payment when its city council passed a 2010 budget that does not include $68 million in debt repayments on an incinerator.

Without the debt provision in the $65 million budget, the state capital may miss a March 1 payment of $2.072 million, a rarity for a municipal bond issuer. [TILB: a "rarity" indeed, although we suspect that like homeowner mortgage default, this will become less rare over the next few years]

Joyce Davis, a spokeswoman for Mayor Linda Thompson, confirmed the council's decision -- taken at a special session on Saturday -- and said the mayor is not commenting for now on the implications of exclusion of the debt payments from the budget.

The council also defeated a plan to sell city assets to help pay down the debt which is guaranteed by the city on behalf of the Harrisburg Authority, a separate municipal entity that owns the incinerator. Council members also rejected Thompson's plan to raise property taxes and water rates.

The $2.072 million payment is the latest installment on a $300 million bond owed on the construction of the incinerator. An additional $637,000 is due on April 1.

City Controller Dan Miller said last year's payments on the incinerator were made from a debt service reserve fund that is now depleted.

Debt payments on the incinerator total $68 million in 2010, or more than the city's general fund budget of about $60 million, Miller said.

Miller said on Feb. 9 he would "not be surprised" if Harrisburg fails to meet the March 1 payment.

Asked whether the city may file Chapter 9 bankruptcy as a way to get its debts under control, Miller said that was a "possibility."

The tax-exempt municipal bond market, which states, cities and municipalities use to raise the funds to build roads, schools and hospitals, is viewed as very safe with a far lower default rate than the corporate bond market.

Just 54 municipal bond issuers rated by Moody's Investors Service defaulted on their debt between 1970 and 2009, the agency said on Thursday. The average five-year historical cumulative default rate for investment-grade municipal debt was 0.03 percent in the period, compared with 0.97 percent for corporate issuers.

The recession has raised concerns of an increase in defaults as states, cities and towns struggle to balance budgets as required by law in all states except Vermont.

So far, however, those fears have not been realized and ratings agencies have played down the likelihood of a spike in defaults.

Fitch Ratings in January cautioned cities against using the threat of bankruptcy as a weapon to win concessions from labor unions. Even talk of bankruptcy can become self-fulfilling and undermines investor confidence in the market, it said.

Hayek Vs. Keynes

DJ Freddy Hayek b-slaps DJ Maynard, in this rap video.

Wednesday, February 10, 2010

TILB Depressing Chart Of The Day: Government Spending As A Percent Of GDP

This basically speaks for itself. It is all government spending: federal, state and local. The data series can be found here.

Another way to think of this is that 45% of your productive effort goes to supporting The State. While you may say, "but that's impossible because the sum of the average tax rate we pay doesn't get to 45%", then you just figured out what government borrowing allows for.

Paying off that debt (without defaulting) means one or a combination of higher explicit taxes, higher implicit taxes (money printing), or massively reduced government spending in the future. Guess which one of these is unlikely.

If you just vomited in your mouth and subsequently swallowed it, you're not alone.

Sunday, February 07, 2010

Pennsylvania's Capital City, Harrisburg, Faces Bankruptcy

Somehow we missed this news during January. Hopefully it continues to develop toward a filing.

Awesomely, Pennsylvania's capital city - Harrisburg - is insolvent and on the brink of filing for Chapter 9 bankruptcy.

As reported in this link to WGAL's website, you can see that Harrisburg's new mayor is dealing with all sorts of tough decisions in her first few weeks in office.

TILB's advice to Mayor Thompson: take a page from Arnold's book and start issuing your own scrip. Seems like s no-brainer.

Emphasis added [and comments added in brackets]
Harrisburg Facing Bankruptcy; Mayor Proposes Tax Hike, Leasing Assets
Official: Incinerator Primary Cause Of Financial Woes

HARRISBURG, Pa. -- After just a few weeks in office, Harrisburg Mayor Linda Thompson is facing financial problems that could put the city in bankruptcy before the year is out.

City officials blame the incinerator facility, now over $228 million in debt, for the city's financial troubles.

That's not an option she even wants to consider at this point, but any successful plan must solve the financial drain of the city's incinerator.

The incinerator is currently $288 million in debt and is the primary cause of Harrisburg's financial problems.

Officials said it doesn't begin to produce the revenue needed to pay off the debt of repairing and operating the facility over the years.

Former City Council vice president Dan Miller said it's been a financial drain for decades.

"It's such a problem because for 25 years, the true problem of the incinerator has never been addressed," said Miller. "It's been refinanced repeatedly and pushed down the road, always waiting for someone else to solve the problem."

Now, he said, the city must solve the problem.

Miller said he believes the city should consider going into Act 47, the first step before bankruptcy. That would allow the city to negotiate with the people it owes to come up with realistic plans to settle debts.

Miller said raising taxes and other fees, or selling off revenue-producing city assets like the parking garages and water and sewer operations, will only create new problems.

Mayor Thompson Proposes Budget Amendments
Thompson addressed City Council Tuesday night with her own plans to fix the financial crisis.

City council member Wanda Williams said Thompson's proposed tax hike is "an outrageous amount" to increase any taxes. [TILB - I love this! "We can't cut spending" and "we can't sell our precious assets" and "we can't raise taxes"! Guess what you can do, loser: File BK.]

Thompson is proposing to increase water rates by 40 percent and cut overtime funding for the police and fire department.

At the meeting, Thompson also proposed what she called tough decisions, which include:
A 20 percent property tax increase
Cutting costs for trash collection
Merging Harrisburg dispatch with the Dauphin County 911 center

Thompson said her cuts would save the city about $8 million. She said her proposals will close the nearly $4 million gap in the budget, allow the city to make payroll next month and help ease the financial pain of the incinerator debt.

But not everyone is happy with the mayor's recommendations.

"I'm disturbed by it," said one taxpayer. "To me, a property tax increase as well as a water rate increase would be something I find objectionable." [TILB - while we totally agree, Johnny Taxpayer needs to recognize that these are symptoms of the debt and spending problem. It's like getting herpes from unprotected but enjoyable sex and then saying you find the sores "objectionable".]

Thompson said she is also considering selling or leasing the city's assets, including parking garages and City Island. [TILB - Honestly, this is a great idea...I mean, other than the fact that this is a horrible time to sell these sorts of assets. Maybe some public REIT with overpriced equity financing will provide the necessary bid. Why should municipalities be in the business of managing parking garages anyway?]

City council will look into the mayor's budget proposal at Thursday's budget and finance committee meeting.
Expect more of this sort of thing.