Give Me Yield!
A: The fed once again has engineered an insatiable and dangerous 'search for yield'. As the carry trade and risk trade are on again, its clear the fed will do anything and everything to a) try to recapitalize the banks and b) engineer demand for risk assets. There is another term for this, 're-inflate' an otherwise deflating economy. For those following the bond markets, you have to wonder where one goes to find yield these days. Oh, and the 10YR is yielding about 2.6% right now which means record low lending rates are likely to cause some 'broker spin' on how wonderful a time it is to buy a home.
From Business Insider, "John Hussman Warns Investors Against Reaching For Yield In The Corporate Bond Market":
Just as dividends have to be evaluated in relation to the earnings available to cover those dividends, and the stability of those earnings, investors wishing to hold corporate bonds for additional "pickup" in yield should pay close attention to earnings stability, cash reserves, and overall debt burdens. We would emphatically avoid the debt of financials and cyclicals that are prone to massive "extraordinary" losses that can quickly wipe out available liquidity.In other words, beware the 'search for yield'. Companies are taking advantage of these times and piling up cash in an attempt to avoid a future liquidity squeeze should one occur again. By the way, Lutnick had it dead right back in mid-2009, that deflationary pressures "would 'constrain' treasury yields and that talk of a bubble is 4 years early..."
While corporate cash levels may very well reduce liquidity risk for companies that would otherwise need to raise funds in a tight credit market, investors should not ignore that the overall debt burden of U.S. corporations is higher than it has ever been.
Mish recently wrote, "I do think corporate bonds, especially most junk is playing for the greater fool. In regards to treasuries, there is going to be an exit problem for sure, but that could be years away. In Japan, yields stayed low for a decade. Why can't it happen here? This is indeed uncharted territory thanks to the Fed pushing and pulling levers in a manner it does not understand. William Black, a former bank regulator, is one person who does understand."
What Mish refers to is the discussion William Black had with Aaron Task:
Aarron Task: In practical terms, what does the gutting of that rule mean for the banks?That's one way of looking at it. Another way of looking at is saying the fed is engineering a carry trade environment in an attempt to 're-inflate' crappy hidden asset values to levels that are not so damaging. To do so you must engineer an environment where money chases yield - hmmm, sound familiar? Recall what one of my hedge fund buddies told us back in March:
William Black: Capital is defined as assets minus liabilities. If I get to keep my assets at inflated bubble values that have nothing to do with their real value, then my reported capital will be greatly inflated. When I am insolvent I still report that I have lots of capital.
Aaron Task: You can just keep kicking this down the road and have stagnant economic growth?
William Black: Geithner's original estimate was $2 trillion and of course things got much worse that their original estimates. The IMF estimates were in the $3 trillion range. So, there are trillions of dollars of unrecognized losses under these guy's scenarios. There is a huge slug, far more than they can pay for. What they are doing instead is these stupid subsidies for the biggest banks, with essentially no political oversight. It works, for the banks but it's really bad for the economy. It diverts money from small businesses, large businesses, and entrepreneurs.
"The carry trade that's on now has nothing to do with the FX carry of old. It's that a US bank can have illiquid assets on it's books at 40 when they are worth 10. They just make $10 a year for 3 or 4 years and write down the investment a little bit more each time around while still able to show a profit. So long as nothing drastic happens eventually they'll have it written down to market. That's why even if you bid 15 for it you can't get them to sell it. Yes the carry trade is on, but if banks can earn their way out then who cares?"Strange times indeed and I just dont see how the fed gets out of this thing without lots of pain and lots of moral hazard.
Posted by Fred
Mon Aug 16th, 2010 10:30 AM
ot, 225 Rector bites the dust.
Busted NYC Condo on the Block
Holliday Fenoglio Fowler has begun lining up prospective
buyers for a failed condominium-conversion project in Lower
Manhattan that is on the brink of foreclosure.
The 23-story building, at 225 Rector Place in Battery Park
City, has 304 units. But less than a quarter of those units have
sold since developer Yair Levy began the conversion project in
2007. Last year, Levy defaulted on a $117 million loan from
Anglo-Irish Bank, which now plans to sell the property via an
auction next month. The building is expected to fetch bids of
Posted by Noah
Mon Aug 16th, 2010 10:34 AM
link Fred? Thanks
Posted by Fred
Mon Aug 16th, 2010 11:07 AM
it's in this week's real estate alert. i only have the PDF. here's the full article:
Busted NYC Condo on the Block
Holliday Fenoglio Fowler has begun lining up prospective
buyers for a failed condominium-conversion project in Lower
Manhattan that is on the brink of foreclosure.
The 23-story building, at 225 Rector Place in Battery Park
City, has 304 units. But less than a quarter of those units have
sold since developer Yair Levy began the conversion project in
2007. Last year, Levy defaulted on a $117 million loan from
Anglo-Irish Bank, which now plans to sell the property via an
auction next month. The building is expected to fetch bids of
about $90 million, or $343,000 for each of the unsold units.
HFF began distributing initial marketing documents last
week. Investors are being told that the broker already has
heard from a slew of potential bidders willing to sign confidentiality
agreements in order to obtain more information
about the property. The building has 232 unsold units. Of
those, 63 are being rented at market rates and 41 others are
being rented as affordable-housing units. The remaining 158
units are empty.
The loan from Anglo-Irish is secured by two apartment
buildings that Levy bought from Related Cos. in 2005 for the
purpose of converting them into condominiums. Levy went to
court to block the bank from foreclosing on the other property,
an 87-unit building at 101 West 87th Street. But a judge last
week rebuffed the developer. The court action clears the way
for the bank to market that property as well, though it likely
will be several months before an auction is scheduled.
Levy’s company, YL Developers of New York, paid $160 million
for the two properties. At the time of the purchase, Levy
valued 225 Rector Place at $115 million and 101 West 87th
Street at $45 million. The mortgage from Anglo-Irish had an
original balance of $165 million, which financed the acquisitions
as well as the conversions from apartments to condos. It’s
unclear how many units at 101 West 87th Street have been
converted.
Levy is now the subject of an investigation by the New York
State Attorney General’s Office. The probe began last year after
residents of 225 Rector Place complained that the developer
misused millions of dollars in a reserve account earmarked for
maintenance and improvements.
A judge has since removed YL Developers as manager of the
buildings and handed the assignment to Related Cos. As of
January 2009, Levy’s company had managed to sell only 46
units in the Battery Park City property. Since then, Related has
sold another 26 units.
Posted by AvUWS
Mon Aug 16th, 2010 01:37 PM
The irony is that everything will work out, but with a whole bunch of "given"s that can't be guaranteed.
The problem is that no one can guarantee the status quo. If something comes along that tips the scales the whole thing can fall apart, and it can do it quickly and disastrously. That is the flaw of an unstable system.
When that something comes along it will most likely be unforeseen simply because those who constructed this will have tried to protect from the foreseen issues.
Will this structure survive bond vigilantes? An Israeli strike on Iran? A US strike on Iran? Slower growth? greater deflation? Some regulation as yet unforeseen?
Even worse, it might NOT work out. The bogus structure, instead of being a temporary solution to the problem becomes some sort of new normal a la Japan's last 20 years.
Posted by Mike
Tue Aug 17th, 2010 12:22 PM
@AvUWS
You forgot to add to you're vigilantes list: the world may end.
In which everything you mentioned before wouldn't matter anyway.
Shouldnt we include all unquantifiable doomsday unknowns if we consider it as part of our risk equasion?
Posted by rootless cosmopolitan
Tue Aug 17th, 2010 02:38 PM
@Mike:
Appeal to ridicule. Straw man. What are the possibilities mentioned by AvUWS supposed to have to do with "doomsday unknowns" or world-end scenarios? None of them implies any world-end scenario. The end of the world is highly unlikely. Slower growth than generally anticipated by investors or economists, for instance, is highly likely, instead. It's even quite likely that the economy has already been in a recession again or will be soon in one again, whereas the "recovery"-meme is still largely intact, currently.
Posted by AvUWS
Tue Aug 17th, 2010 05:06 PM
My point is that if something can't go on forever, it won't. That doesn't mean that we know when it will stop, how it will stop, or what it will look like when it stops, only that we know it can't keep going infinitely in the same direction.
That was obvious to me with the .COM bubble in the latter '90s and with interest-only, 110% LTV, and other whacky loans in 2005/6. But no, I didn't invest against them. The reasons for that are above: you can't know when it will fail, nor how much further the irrationality will carry things before it does. So if it is irrational that it is as high as it is, that also means that you can't rationally know when it comes back to reason, and you could lose your shirt in the meantime.
The strategies being used by the Fed is fraught with dangers. It might play out ok. It might deflate gradually and with no panics. Unfortunately that isn't usually the way with markets since humans are involved.
Posted by Easy Bank Loan
Thu Aug 19th, 2010 02:24 PM
The vast majority of government student loans cannot be gotten rid of easily, even filing for bankruptcy will not resolve these debts.
Posted by Conscience of a Conservative
Fri Aug 20th, 2010 07:43 AM
Very important story. I saw the Hussman piece when it came out. Pension funds have a bench mark return of 8% and with the Fed engaged in ZIRP, not only does the present value of liabilities increase the assets have a duration mismatch(most bonds are short the call option) and consequently pensions are forced to take on excessive risk.
Add to this that retirees are being starved of income which goes to the banks bottom line(the banks are not lending but investing in treasuries).
Lastly the low yields are not really reducing leverage in the system since corporations are taking the idle cash and buying other government obligations. Net basis we're even more leveraged.
All we've done is set ourselves up for the next crisis.
Posted by In Debt We Trust
Fri Aug 20th, 2010 11:45 AM
There's reason to expect a continued decline in the averages from here.
Earnings season is behind us, so the only 'push' available going forward is economic news, and that's looking anything but bullish these days.
Unemployment figures will continue to climb - especially now that the Census firing figures are included. (Census hiring was responsible
for the overly optimistic figures in Q1 and first part of Q2).
Looking forward, we are also approaching retail sales season for back to school and then the Xmas holidays. And the industry chatter among
orders placed with Chinese factories is HORRIBLE. Retailers will use the back to school sales as a gauge of consumer sentiment. After
buying up stuff in late August/September, expect to see a tapped out weary consumer unable or unwilling to buy more in November-December.
So, where does that leave investors with? Bonds? Is there a bond bubble? Eh, not really. Unlike the stock market bubbles, people aren't so much trying to speculate as they are seeking to preserve wealth. That makes a huge difference in the behavioral finance.
Posted by UPennAlaskan
Fri Aug 20th, 2010 01:50 PM
Does anyone think the bond market is a little forthy, right now? To me seems if could easy pull back 5% - 10% and remain on its long term projectory.
Banks/hedge funds are pushing yields down for spec only...nothing to do with wealth perservation.
Posted by Fred
Fri Aug 20th, 2010 02:23 PM
bond prices in general seem to be at an inflection point. the trend is in and china is rolling less over with the deficit being made up by the UK. it won't take much to move it 10% the other direction, in particular with M&A heating up. there are plenty of equities that are very competitively priced relative to current interest rates. they just aren't the good old fashioned US blue chips.....
Posted by Noah
Fri Aug 20th, 2010 04:15 PM
read this interesting piece today, link from Yves site.
http://pragcap.com/the-myth-of-the-great-bond-bubble
Basically dissing the whole bond bubble idea and how the dynamics of the bond market and what a bubble really is makes the comparison unfair. interesting read.
either way, if 10yr yields make a move to 4% or 5%, I think many will call that a unwinding of a mini bond bubble..but that seems years away
Posted by Conscience of a Conservative
Fri Aug 20th, 2010 04:58 PM
The conundrum of course is that asset prices are declining while staple goods are increasing. And the ultimate frustration is watching the Fed fight a solvency problem as if it's a liquidity issue.
Posted by Noah
Fri Aug 20th, 2010 06:10 PM
Hey, I dont like to sound like a broken record, but readers of this site for years (especially since mid 2007 when the crisis really started) know my stance on the forms of inflation that will hurt us..here is just a quick search I did with an article from mid 2009 - basically agreeing with what you are saying Conscience:
http://www.urbandigs.com/2009/06/nenner_deflation_now_inflation.html
"This is not your ordinary recession and there are no free lunches. Any inflation that does show up at first will be in the form of higher food, energy, metals, commodities, health care, types of costs. Basically the stuff we need to live will see the first wave of inflation and it will be the form of inflation that squeezes consumers wallets and pressures corporate margins, at first. The policy makers will have to shift their policy to combat this form of inflation and that means higher rates. The cycle's endgame in full effect. Of course this has not happened yet and is only my opinion on the topic. Because of the nature of what we experienced, how the world has changed, I do not see inflation sending house prices surging. But it should kick in at some point down the road to help stabilize the downfall. I think Nenner might be on to something here. "
Posted by MeekSheep
Fri Aug 20th, 2010 06:27 PM
It ain't pretty over there. Germany is soaring while weaker parts are suffering. That's the real ticking time bomb. This talk of "I need yield" is disregarding the dire strait that Europe is in and the interconnectedness we still face as a global economy.
You know, all that needs to happen to send us all into a tailspin and actually create a real "treasury bond bubble" is Greece finally blowing up. Look at the bond spreads compared to Germany. Or the liquidity concerns of their banks. Read this Der Spiegel article: http://www.spiegel.de/international/europe/0,1518,712511,00.html It just ain't pretty over there.
Posted by Sechel
Sat Aug 21st, 2010 08:45 AM
Another follow-up Noah,
In some sense, this is also a war between economic principles and which effect is stronger substitution or income. The government is in part gambling that by lowering interest rates we will be coaxed into consuming and the effect of seeing our incomes decline will be relatively minor.
If you come at this from the viewpoint that the consumer and the banks have an impaired balance sheet then you must assume they will not be coaxed into borrowing or consuming.
It's really scary the thinking that's going on in the white house and the fed.
Posted by Fred
Sat Aug 21st, 2010 12:34 PM
If we continue to see an increase in M&A coupled with more commercial real estate sales/resolutions, money velocity will pick up steam, quickly. M2 appears to be in a bottoming process here. M3 is distorted because of the Fed's intervention, so I tend to look mainly at M2. if velocity does in fact pick up, we will be in the stagflation cycle as the Fed will be powerless to raise rates until employment picks up and growth resumes. look at the base metals and ore, they show no signs of pulling back and indicate nothing more than price inflation. when and how that comes back into the US economy we'll have to wait and see, but when housing does recover and consumers comes back, you will see prices much much higher. I like to think of it as a Rip Van Winkle period; the US and Europe will simply come back on line but will have to compete with massive deficits, unless serious progress is made in the interim to reduce government spending. CA is already talking IOUs again. Yesterday, the teacher's union picketed a day care on our our street because they are trying to organize day care workers. The confrontation between interest groups is only getting louder. Organizing day care workers? What's next? Organized nannys??????
Posted by Conscience of a Conservative
Sat Aug 21st, 2010 12:51 PM
BIS did a great piece on the dangers of a zero interest rate policy. check it out.
http://www.bis.org/publ/arpdf/ar2010e3.pdf
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