The Market Ticker - Bonds

Who Bought This Crap?

nospam@example.com (Karl Denninger) — Sun, 15 Nov 2009 10:59:48 -0500

Nov. 12 (Bloomberg) -- Goldman Sachs Group Inc. paid off at face value some junior-ranking slices of two collateralized debt obligations at the potential expense of more-senior classes that now are likely to default, according to Fitch Ratings.

Goldman Sachs, the most-profitable securities firm, applied its “sole discretion” to ignore standard payment priority and use cash in reserve accounts for the Abacus 2006-13 and Abacus 2006-17 CDOs to retire lower-ranked notes, Fitch said yesterday in separate statements.

....

“We are not aware of the use of this feature in other transactions we rate,” Trebach said in a telephone interview.

Let me guess - the inclusion of such a feature didn't factor into the ratings originally issued either, right? Yet this "feature" is, apparently, quite common?

From what I can discern from the article Goldman had every right to do this - even if it was due to their owning the paid-off pieces (thereby receiving full "par" value where other people would get screwed.)

The better question here is why anyone would ever buy something that includes a "feature" that allows the manager to exercise their discretion to screw more-senior holders at any time they wish.

Who, if I may ask, is dumb enough to buy trash like this?

Well, obviously there are some "someones", as it appears that this trash was sold and traded, and now Fitch has blown down the ratings of these un-redeemed tranches to "CCC", well below investment grade.

Some of the debt was originally rated "AAA".

One wonders how, given the presence of this "discretionary" clause in the original deal, since the premise of said "AAA" rating is the presence of excess coverage for the senior tranches provided by the subordinated components! If the manager has full discretion to remove that coverage at any time (as occurred in this case) then the original "AAA" rating, which envisions performance to maturity, was severely flawed at best.

Put bluntly, the so-called "credit enhancement" propounded to be present in the deal was fictitious and any "rating" predicated on same was false.

The Untenable Position of Treasury

nospam@example.com (Karl Denninger) — Tue, 13 Oct 2009 11:28:00 -0400

What did Turbo Timmy and Bendover Bernanke think they were trying to pull?

The Fed's "Quantitative Easing" is now basically defunct, with about $6 billion left out of the original $300. Of course the scam of buying Fannie and Freddie Paper (even though it is not full-faith-and-credit, as I have noted repeatedly) will continue through the first quarter of next year.

But there looms a larger and more immediate problem for Treasury - their incessant "rolling down the curve" activity over the last few years has led to some real trouble, although Treasury has started to recognize this issue. Currently average maturity is approximately 50 months (down from 70 months in 2000) and is starting to edge back upward.

But this belies the underlying reality - all of the debt, on average, must be rolled every four years, or about $3 trillion a year that must be rolled over PLUS net issuance!

How Treasury thinks they will be able to continue to do this on "favorable" terms is simply beyond comprehension. Indeed, I'd go so far as to suggest that it is highly likely that there is only one way to avoid a major coupon spike upward - intentionally crash the stock market, just as was done last fall.

And do not be confused about the consequences of a coupon spike - something as "mere" as a 2% increase in the average interest rate on Treasury debt could result in a near-doubling of interest owed, sticking more than $300 billion of additional red ink into the budget instantly. That in turn could result in a perception of inability to pay which in turn could provoke another coupon spike! This ends the same way it does if you miss a credit card payment.....

Nobody likes to talk about the insane amount of interference between Treasury, The Fed and the equity markets, but to deny it is present is to deny reality - liquidity games played at "critical" times in the market in order to get a desired outcome from Congress or the marketplace.

Nobody has called Bernanke to account over that, just as they won't this time around. Today these machinations are better-hidden due to the alphabet soup that The Fed and Treasury are maintaining - but hiding something doesn't mean that the effect doesn't happen, it just makes anticipating the effect harder.

Unless, of course, you're one of the chosen few who is tipped off in advance (cough-goldman-cough), as John Crudele (and I) have documented repeatedly.

The problem with all of this is of course timing and the madness of crowds. The "get up and dance while the music is playing" meme is back out in force, with mutual fund managers now chasing returns lest they be fired for not being invested. This is the perversion of Fraud Street writ large, as what happened last month or quarter is of no relevance to what is going to happen next quarter. All prospectuses contain "past performance is no guarantee of future results", but what is a foregone conclusion is that while past performance may not guarantee future results it is a certainty that fund managers will chase past performance and thus, when mean-reversion happens, under-perform the market.

We continue to see no or little evidence of actual improving business conditions in terms of top-line revenues. Alcoa beat only on an insane per-ton price increase; shipped volumes fell. Johnson & Johnson saw net up a percent but revenue fell 5.3%. More ominously the company was hurt, not helped, by the dollar's destruction, with about half of it coming from currency effects. US Sales fell 8.1% - not the sign of an improving economic picture. Drug sales were down 14% with most of that coming from generic competition, but consumer health care was also off - in this case, 2.7%, and was hurt by dollar devaluation (can you say "import sensitive"?)

Then there is the mysterious case of the SDRs. As Zerohedge pointed out there was a sudden and unexplained "boost" in the Treasury's "International Reserve Position", with essentially all of it ($50 billion or so) comprised of a huge increase in IMF SDRs.

Now I may be missing something here but Treasury doesn't appear to have that power without an explicit act of Congress. To wit, The US Constitution Article I, Section 7 provides:

To coin money, regulate the value thereof, and of foreign coin, and fix the standard of weights and measures;

CONGRESS has sole authority to approve (or not) the acquisition and disposal of SDRs, which are nothing more or less than a foreign currency - in this case, one comprised of a basket of other currencies. The Executive has no power to engage in this sort of transaction on its own initiative.

But it did, and thought it wouldn't be noticed.

Well, it was.

The dollar continues to rattle around at key support. If it breaks then our import-based economy will be decimated. Oil will skyrocket and so will input costs to American business. Bye-bye profits - and businesses.

Congress, Treasury and The Fed are all counting on not only you being stupid but everyone in the International Markets being stupid. That's a bad bet, and I believe the time to buckle up is close at hand. While the "can kicking" of the last six months might seem to have been a good thing at the time, and might even look good now, I suspect that when we look back on it in a year or two we will recognize it as the disaster that it in fact was.

No Folks, It's Not Over... (Junk Bonds)

nospam@example.com (Karl Denninger) — Fri, 18 Sep 2009 09:07:00 -0400

Let me guess - record levels of junk bond defaults are positive for the economy going forward?

NEW YORK (Reuters) - About 40 percent of all U.S. junk bonds outstanding in late 2008 will likely default by 2013 as government aid measures end and a wall of corporate debt comes due, Bank of America Merrill Lynch said on Thursday.

By contrast, the cumulative five-year default rate was about 30 percent in the last two default cycles, Bank of America said in a report.

But the real damning part of analysis isn't the front-line - its the last paragraph:

Many so-called distressed debt exchanges are only postponing defaults and will also contribute to the second wave, the bank said. In a distressed debt exchange, companies buy back debt at steep discounts, usually replacing it with longer-maturity debt. About 40 percent of distressed debt exchanges typically default anyway within three years, the bank said.

No, really? You mean that we can't "extend and pretend" and actually fix anything? It's all a game to try to claim that something that has blown up really hasn't blown up?

Yes, that is what the bank said - this is nothing other than a thinly-disguised game - yet another means of gaming the accounting (which should be illegal, but heh, we don't bother prosecuting stuff like that, right?)

The better question is this: If the economy is healing, if demand is improving, if corporations have seen the bottom and business conditions are in fact improving as final demand is rising, then why are defaults going up?

Debt defaults when the cash flow is inadequate to meet service requirements. But cash flow is a "high frequency" thing - it rises immediately when final demand increases.

So what is this, along with the default rates on credit cards and FHA mortgages telling you?

The claims of final demand improvement are in fact false.

A Warning To America From The East

nospam@example.com (Karl Denninger) — Wed, 02 Sep 2009 08:11:00 -0400

Ambrose Evans-Pritchard writes the following:

Democrat leader Yukio Hatoyama, who won a landslide victory over the weekend, has pledged that there would be no increase in debt to fund his $180bn boost for child allowances and social policy by 2013, but his advisors are already back-tracking as they examine the dire tax figures.

While Japan pulled out of recession in the second quarter, it has barely begun to make up for the 11.7pc contraction of its economy over the preceding year. Industrial production was still down 23pc in July. Exports were down 39pc to the US.

Uh huh. These are great promises, but Japan's tax receipts are down 27% over the last year. This sounds oddly familiar.... our government's tax receipts are down huge as well, as are the tax receipts of the states.

Michael Taylor from Lombard Street Research said Japan made a strategic error during its Lost Decade by waiting too long to pull the monetary levers. "They failed to boost money supply the way the Fed and the Bank of England are trying to do through quantitative easing. Their fiscal packages led to a massive deterioration in public finances."

Oh nonsense.

Japan tried to avoid the truth. They tried to sweep the bad debt under the rug instead of forcing it out of the system. They attempted to apply the Keynesian "fix" that seems to be the tonic to all that ails the economy - spend spend spend and loosen loosen loosen monetary policy.

Did it work? No.

Nor will it work here, because just like in Japan the lies have not been flushed from the system and those who have hidden boluses of garbage have not been forced to admit to and clear them.

"IMF studies show that as public debt rises above 60pc of GDP fiscal stimulus loses it effect. People anticipate the consequences: higher taxes, and eventually higher interest rates. The bond vigilantes will always get you in the end," he said.

Hmmm.... Public debt in the US is about $11 trillion, GDP 14ish, so where does that leave us?

Here's a hint: But for Bernanke's machinations, we'd be forcing the bad debt into the open and clearing it now. Since we have refused for political purposes (read: bribes in the guise of "lobbying" and "campaign contributions") to force the exposure and resolution of bad debt, and instead have chosen to "extend and pretend" (lie), "mark to model" (tell damned lies) and not close banks immediately that are demonstrably insolvent (stick your head in the sand like an ostrich) we have a clogged credit system that is incapable - not unwilling - of properly performing its function in the economy.

The Crescendo Is Getting Deafening....

nospam@example.com (Karl Denninger) — Fri, 21 Aug 2009 11:00:00 -0400

Buffett, iStockanalyst, PIMCO and of course myself....

“No government, or central bank, is bigger than the bond and currency markets. Foreign bondholders aren’t going to sit idly by while any government … even the government of the U.S. … openly decides to trash its currency by printing it with reckless abandon. And they aren’t going to sit by while the government manipulates prices higher.

Yep.

Look, I'm no fan of Buffett and PIMCO, as anyone who's read my column for more than a week knows. Both have been the subject of many a barb, with both profiting mightily from what amounts to unbridled Government Largess and the intentional overlooking of fraudulent activity in the financial markets.

Profiting from Fannie being backstopped, for example, is obscene. Its not illegal, but it is obscene. So is profiting from banks that are allowed to jack interest rates to 30% to cover their own sin of writing loans without a prayer in Hell of the borrower being able to pay.

But this belies the point here, which is that as I have outlined in today's treatises we as a nation are at a crossroads.

We can defend the dollar which will cause interest rates to rise significantly, choking off false growth and forcing the defaults being hidden to the surface, or we can continue an economic policy that fosters fraud and deceit. If we do the latter we will continue to see revulsion for all forms of dollar-denominated debt and like a creeping case of gangrene it will travel from the corporate and agency space, eventually infesting US Treasuries as well.

The only remaining question is whether the monetary and fiscal authorities will amputate the gangrenous hand or whether they will allow sepsis to set in and kill the entire nation - including its currency and potentially the government.

Before you dismiss me as some off-the-wall Internet kook, you might want to consider that in addition to those of us who have been pounding the table for the last couple of years on these points, we now have both PIMCO and Warren Buffett adding their voices to our chorus.

These individuals may not be someone who you like, but they are people who appear to have come to the same conclusion - even if they got there via a different, more-circuitous route.

Treasury Insanity In Support Of Grift

nospam@example.com (Karl Denninger) — Thu, 20 Aug 2009 11:29:00 -0400

*U.S. TREASURY TO AUCTION $27 BILLION IN 52-WEEK BILLS
*U.S. TREASURY TO AUCTION $42 BILLION IN TWO-YEAR NOTES
*U.S. TREASURY TO AUCTION $31 BILLION IN THREE-MONTH BILLS
*U.S. TREASURY TO AUCTION $28 BILLION IN SEVEN-YEAR NOTES
*U.S. TREASURY TO AUCTION $30 BILLION IN SIX-MONTH BILLS
*U.S. TREASURY TO AUCTION $39 BILLION IN FIVE-YEAR NOTES

This is the price of supporting the grift and fraud in our banking system.

I count $207 billion, coming two weeks after a $250 billion dollar week.

Let's annualize - that would be about $5 trillion a year in annualized issuance. My-oh-my how long can this continue?

Who knows. What I do know is that this is absolutely unsustainable, it is approaching 40% of GDP annually, and yet this is what is required to keep all the balls and plates in the air as a direct consequence of our government's decision to sponsor and permit massive financial system fraud to continue.

The world's tolerance for this will eventually end and before it does our government had better have changed their tune and cleaned up the mess, because if that has not taken place first the economic consequences will be catastrophic.

Wake up America (and Mr. President); your choice is to heed the alarm clock or you will still be asleep when the ceiling comes crashing down on your head.

Whistling Past The Graveyard?

nospam@example.com (Karl Denninger) — Wed, 19 Aug 2009 13:11:00 -0400

Better have a look over here folks...

Note that the PDs (that's the big banks that deal directly with The Fed) took basically all of the auction, and they were willing to loan all that money to the Treasury at an annual interest rate of 0.145%.

That is essentially zero.

So what is it that these big primary dealers see happening (or more importantly, have been told and thus know will happen) in the next two months that leads them to think parking $22 billion of money with Treasury at zero interest will provide them with the best possible return on their investment? Oh, and they bid for nearly 5x as many bonds as were sold too.....

I know, I know, its "a new bull market", and you should buy stocks, right? We're going to the mooooooon!

Care to re-examine that thesis given that these huge banks, all of whom make a lot of money trading equities (and commodities) are falling all over themselves to park their money with Treasury at zero interest for the next two months?

PS: If that doesn't look like a bunch of guys running away from a big jug that has a lit fuse leading into it you're certifiably insane. You can bet this won't get mentioned on ToutTV either.

US 5yr Bond Auction Effectively FAILS

nospam@example.com (Karl Denninger) — Wed, 29 Jul 2009 22:52:00 -0400

That's right, FAILS.

No, you didn't hear it reported this way and won't, but that's the math.

Here you have the results:

And here's the math:

1.923 BTC X 61.59% Primary Dealer bid = 1.18 BTC (PD), greater than 1.0. Or to put it a different way, but for the primary dealers the bid-to-cover was less than one, meaning that some of the issue would have been left on the table.

Thats a fail; but for the primary dealers the issue would not have subscribed.

Primary dealers are required to bid. That's the deal in exchange for their being named as "primary dealers." For this reason short of thermonuclear war you will never see an actual (BTC < 1.0) "fail" on a US Treasury Auction - Treasury has rigged the process so as to insure that cannot be reported.

Therefore, the question is this: Less the primary dealer "bid" (forced by agreement) was there sufficient interest to subscribe the issue, and the answer is NO.

Those who think this is "no big deal" need to have their head examined. In general any BTC under 2.0 indicates a serious problem, and the perverse nature of the primary dealer system is the reason.

The United States' Credit Card (issued by China and Japan) is being slowly cut off. That the stock market "recovered" after this ridiculously bad auction (bow-wow is the best way to describe it) speaks to the vacuum between the ears of both the cheerleaders in the mainstream media and those in the equity markets.

There is only one other time in recent memory that we've had a bond market auction fail like this. You might want to go have a look at your charts - with dates - for what followed shortly thereafter.

They're going to try to sell 7yrs tomorrow, and then the real fun begins with the quarterly refunding.

That ought to be a real riot.

President Obama, you might want to have a chat with Bill Clinton about the Bond Market and Hillarycare, lest you wind up learning this lesson the hard way.

HOLY !@#!! Treasury Auction Schedule

nospam@example.com (Karl Denninger) — Thu, 23 Jul 2009 11:37:00 -0400

Oh My......

Let's see if I can count this up....

70 day CMBs, $30 billion (tomorrow)
13 week Bills, $32 billion (July 27th)
26 week Bills, $31 billion (July 27th)
52 week Bills, $27 billion (July 28th)
2 year Notes, $42 billion (July 28th)
5 year Notes, $39 billion (July 29th)
7 year Notes, $28 billion (July 30th)
19 year, 6 month TIPS (reopened), $6 billion (July 27th)

That's two hundred thirty-five billion dollars over the next week!

Almost one quarter of a trillion....... geejus.

I guess you should get while the getting is good, but this is going totally parabolic. That money has to come out of somewhere, by the way, in order for the sale to succeed, which is going to get rather interesting at some point - but exactly where it matters is impossible to know.

I expected that when we crossed the $100 billion threshold in a week the market would throw up all over it, but it didn't. Now we've got the government trying to sell a quarter of a trillion dollars in debt over the next week, the announcement is out there, and while the bond market is selling off to a material degree equities could care less!

This is flat-out insane. At this run rate we would be trying to sell twelve trillion dollars over one year's time, an obviously ridiculous and impossible-to-peddle amount of debt at any price.

When does the rest of the world wake up (not to mention the primary dealers) and say "NO!"? Never? Is there a truly insatiable demand for our government's debt, despite the fact that President Obama got up on the national stage last night and promised to spend another trillion dollars we don't have?

How do equities power higher into this sort of debt issuance? Is it simply that the market has deduced that the government will hand all of this zero-interest money out - indefinitely?

Guess what - that which is impossible won't happen, and the stock market is now telling you that the impossible will become reality. There has been and will not be any amount of fiscal sanity on the part of our government until the market imposes it, and when it does it is going to happen in exactly the same way it happened to Bear Stearns, Lehman, Fannie and Freddie. May I remind readers that it was said that Fannie and Freddie "couldn't" get in trouble due to their implicit government guarantee? Well guess what - they both effectively failed, but when the US Government finds itself in the same situation it has nobody who can take it into conservatorship and as such we're just going to have to deal with the consequences of failed debt auctions - that is, dramatically increased funding costs across the board in the economy, including the government, which will choke off any hope of economic anything.

Folks, this is how you get detonation of a nation's monetary and political system. Timing the "event" it is not easy, but the certainty of outcome given this sort of outrageously irresponsible activity is not in doubt.

I'm increasing my stock of things that "will never go to zero" and keeping my ear to the ground. The "short the phone book but make sure you get out fast before you get trampled" moment approaches - mark my words.

SEVERELY Bearish Treasury Development

nospam@example.com (Karl Denninger) — Fri, 26 Jun 2009 13:03:00 -0400

From Marketwatch:

NEW YORK (MarketWatch) -- Dresdner Kleinwort Securities has withdrawn from the Federal Reserve's primary U.S. government security dealers, the U.S. central bank said Friday.

The change is net neutral in terms of numbers as a new dealer just came online, but in general this is a major net negative for the Treasury market.

Why? Because being a primary dealer is, in general a license to print money. You get to field customer orders for Treasuries and make your spread, and you have a privileged trading position with The Fed.

There's only one fly in the ointment, and that is that the position comes with a requirement that you bid. This is distinct from most other nations where no such system exists, and essentially guarantees that there can never be a "failed" Treasury auction.

There was no reason cited for the withdrawal but one can surmise that the issue is that they're stuffed to the gills with Treasuries and are finding it difficult or impossible to earn their spread, think there is a material safety risk in their participation (e.g. getting stuck long with a deteriorating position), or both.

Either way there is no possible means to read this as bullish. While the issue may be with their liquidity demands and thus not reflect severely on the Treasury market with the issuance that has gone on this year and will for the foreseeable future I wouldn't take that bet.

The "Chosen" or "Protected" dealers will of course never withdraw but if the changes made to reporting of indirect bid are in fact concealing deteriorating demand and these folks have detected a potential problem in the offing we are fixing to get a severe spanking in our government debt issuance in the near future.

Beware.

More Intentional Misdirection

nospam@example.com (Karl Denninger) — Thu, 25 Jun 2009 08:38:00 -0400

About a week ago I wrote a Ticker about my astonishment that foreign central banks would want 50% of a 30 year Treasury issue, and mused that these foreigners must be expecting (and might be intending to impose) crushing deflation.

It turns out that my skepticism was well-warranted, for a different reason:

But in a little-noticed switch on June 1, the Treasury changed the way it accounts for indirect bids, putting more buyers under that umbrella and boosting the portion of recent Treasury sales that the market perceived were being bought by foreigners.

....

The new definitions are deep in the arcane world of Treasury auctions. The change involves buyers who place orders through primary dealers. Those had been counted as direct buyers, but as of June 1 they were classified as indirect buyers, making that group larger than before. Because investors view that group as being dominated by foreign buyers, they assumed foreign demand was higher.

Very nice.

So now we have the Treasury Department changing the rules so that the investing public cannot determine what sort of actual appetite foreigners have for our Treasury Debt by obscuring what had, up until then, been a very reliable gauge of their sentiment.

This sort of intentional game-playing is obscene and pervasive in our financial system and government over the last twenty years, with this being just the latest insult.

Treasury, of course, knows the interest level of foreigners in our government debt.

Why are they suddenly afraid of letting every market participant see the same information?

Do we have a "little problem" here that someone doesn't want to talk about?

Who Are They Trying To Fool? (TNX)

nospam@example.com (Karl Denninger) — Thu, 18 Jun 2009 15:44:29 -0400

I mean, c'mon, $165 billion in Treasuries for sale in the next week?

$31 billion in 3-month bills
$27 billion in 7-year notes
$40 billion in 2-year notes
$37 billion in 5-year notes
$30 billion in 6-month bills

Annualized this is $8.58 trillion dollars!

Now obviously they won't keep doing that for the next 52 weeks (one hopes) but you have to be smoking something if you think the market can continue to absorb this sort of supply and shrug it off.

Today the TNX was up over 5%, undoubtedly on this announcement, almost erasing the benefit from the recent stock market decline.

So Ben's liquidity games have bought him about 15 basis points of improvement in the TNX, but he's given up 35 handles on the SPX.

At this rate to get the TNX down to 3% he'll have to sacrifice 230 points on the SPX, taking it down to about the March lows.

Rock, meet hard place.

I told you so.

To the government: Stop spending or the TNX will continue to ramp and you will be forced to crash the market outright to keep mortgage rates from going to 8%.

Disclosure: They won't stop spending so I am of course short the broad market - the only logical trade to have on with this sort of stupidity coming out of Washington DC. We break a couple of key technical levels and I'm going to get so short I will be able to walk under my Suburban and not hit my head.