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Yet another legend (or two) slips into the ‘better lucky than good’ category.

They may be right, but it will be for a different reason:

Top hedge funds bet on big yields rise

By Henry Sender

Dec. 22 (FT) —The recent rise in long-term US interest rates comes as good news for several leading hedge fund managers, including John Paulson, who have positioned their trading books to benefit from higher yields on US Treasury securities.

Mr Paulson, who made big gains earlier this decade by betting against the subprime mortgage market and whose firm, Paulson & Co, manages $33bn, has said he believes government stimulus efforts will inevitably lead to higher inflation and a corresponding rise in rates.

“It will be difficult for the government to withdraw the economic stimulus,” Mr Paulson said in a speech. “An increase in the monetary base leads to an increase in the money supply, which leads to inflation.”

Bond prices fall as yields rise, and Mr Paulson told the Financial Times last week that he has been hoping to benefit in the Treasury market by buying options that would become profitable if rates headed higher. TPG-Axon’s Dinakar Singh has been making similar options trades, according to a person familiar with the matter.

Julian Robertson, the hedge fund manager, has pursued a related strategy, hoping to benefit from a bigger difference between short-term and long-term interest rates, known as a steeper yield curve, a person familiar with his trades said.

The yield on the 10-year Treasury, which hit a crisis low of 2.055 per cent last year, has moved from 3.2 per cent last month to 3.75 per cent on Tuesday.

Hedge fund managers, however, have been hesitant to engage in short sales of Treasury bonds to profit from the rising yields – and falling prices – because of the Federal Reserve’s heavy involvement in the market. This has led some to buy options – dubbed “high strike receivers” – that would enable them to profit from sharply higher Treasury yields, hedge fund managers say. These trades, which are relatively cheap to execute because they are so out of the money, are based on the thesis that yields could hit 7 or 8 per cent.

“If they are right, and the world ends, they will make a fortune,” said one fund manager who is sceptical of the idea. “If they are wrong, they haven’t lost much.”

Some traders are cautious because many peers lost large sums betting that rates would rise in Japan in the 1990s – as yields fell to less than half a percentage point. The trade was termed the “black widow” because it left so many victims.

“Nobody understood the extent of deflation and economic weakness in Japan,” said Dino Kos of Portales Partners, a research consultancy, who was then a Fed official. “More money was lost on that trade than on any other single trade. Everyone piled in when rates were at 3 per cent and then at 2.5 per cent and then at 2 per cent.”

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>   
>   (email exchange)
>   
>   On Sun, Oct 18, 2009 at 12:01 PM, Russell wrote:
>   

Plutonomies

>   
>   I don’t know if the very wealthy support consumption.
>   

As a point of logic yes, it can be done, and we’ve been moving in that direction.

>   
>   I was always under the impression it was the mass of the people
>   not the mass of wealth. Gillian Tett supports your thinking on this.
>   

Yes:

The essential thesis is that plutonomies arise when there are factors such as “disruptive productivity gains, financial innovation, capitalist-friendly governments, overseas conquests and dopamine-heavy immigrants, the rule of law, patent protection and great complexity exploited by the wealthy of the time”.

This description has applied to countries such as the US, UK, Canada and Australia recently: in the US, for example, the top 1 per cent control almost a quarter of the wealth. And that has big implications for consumer spending or global financial flows.

For while economists tend to watch factors such as unemployment to predict consumption, Mr Kapur thinks this can be misleading because it is the elite rich – not the middle class – who tend to drive consumption.

Last year, for example, this elite cut spending and raised saving because their assets plunged in value. However, in the next year, Mr Kapur is expecting plutonomists to make a comeback. As a result, he expects spending to reappear.

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Thanks, will distribute and post on my blog.

Known Wynne for quite a while.

He’s been doing sector analysis for maybe 50 years and has often been the UK’s top forecaster because of it.

Immediate cuts to budget deficit will worsen recession

Oct. 9 (FT) — Sir, George Osborne is committing himself unconditionally to making very large cuts in the budget deficit. I think he may be very seriously mistaken.

If these cuts were all to be made immediately he would obviously make the present recession very much worse than it already is.

To make sense of his proposed cuts it must be assumed that there is a rise in private expenditure relative to income (ie, a fall in net private saving) that roughly matches them in both scale and timing. But it is quite likely that private saving will not fall nearly enough. If, as I foresee, it does not do so, then Mr Osborne’s cuts will be much too large.

Wynne Godley,
King’s College,
Cambridge University, UK

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Don’t think markets are ready for this:

Exporters warn of German credit squeeze

by Ralph Atkins

June 26th (Bloomberg) — Germany’s powerful export industry is warning of a credit squeeze in Europe’s largest economy even after the European Central Bank’s injection this week of one-year liquidity into the eurozone banking system.

The German BGA exporters’ association on Thursday forecast a “dramatic deterioration” in credit conditions in coming months, which would result in “massive financing squeeze”.

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It is something they want but seems there is no viable plan yet.

It is harder than it sounds and what they do come up with if short of a government guaranteed market will have similar risks.

The ‘answer’ is the repo markets add no value to the real economy and therefore there is no public purpose behind creating a ‘better one.’

I would just let the banks continue to price risk for secured lending as they are doing and let the interest spreads (and disintermediation when borrowers and lenders find each other directly) fall where they may due to competitive pressures.

Fed plans repo markets revamp

by Henny Sender and Michael Mackenzie

June 21 (FT) — The US Federal Reserve is considering dramatic changes to the giant repurchase – or repo – markets where banks around the world raise overnight dollar loans.

The plans include creating a utility to replace the Wall Street banks that handle transactions, people familiar with the matter say.

The Fed’s deliberations are partly motivated by concerns that the structure of the US overnight repurchase market may have exacerbated the financial turmoil that accompanied the failure of Lehman Brothers in September last year.

Fed officials plan to meet next month with market participants to discuss reforms.

People familiar with the Fed’s thinking say it is looking into the creation of a mechanism to replace the clearing banks – the biggest of which are JPMorgan Chase and Bank of New York Mellon – that serve as intermediaries between borrowers and lenders.

“The Fed is raising questions about whether the system really protects the interests of all participants,” says one person familiar with the Fed’s thinking.

In the repo markets, borrowers, such as banks, pledge collateral in return for overnight loans from lenders, such as money market funds.

The clearing banks stand between the parties, providing services such as valuing the collateral and advancing cash during the hours when trades are being made and unwound.

Fed officials fear this arrangement puts the clearing banks in a difficult position in a crisis. As the value of the securities falls, clearing banks have an obligation to demand more collateral to avoid losses. But in doing so, they could destabilise a rival.

“The clearing banks fear the positions of the investment banks are so large that a default would be difficult for them to manage,” the person familiar with the Fed’s thinking said.

“[Everyone] is thinking about how to remove conflicts of interest of the clearing banks and the investment banks so that the investment banks aren’t vulnerable to a sudden restriction of credit.”

The system’s complications were evident during Lehman’s collapse. JPMorgan, one of Lehman’s biggest trading partners, acted as its clearing bank in the repo market and – along with BoNY Mellon – served as the clearing bank for the New York Federal Reserve’s credit facility for securities ­companies.

Lawyers for the Lehman estate and for creditors have raised questions about whether JPMorgan acted too aggressively in seizing and marking down Lehman’s collateral.

Hedge funds have bought Lehman debt on the theory that the estate can claw back some of that collateral in court.

Citing confidentiality concerns, JPMorgan declined to comment.

The Fed hopes to have a new repo system in place by October, when its credit facility for securities companies is to close.

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>   Karim writes:

>   Surprising comments show political difficulties of QE in Europe. With fiscal policy constrained
>   and the Euro strong, that means more pressure on ‘conventional’ monetary policy: ECB to
>   keep o/n rate low for long.

Yes, agreed. Shows no understanding of monetary operations whatsoever.

With the old German model they had tight fiscal to keep domestic demand and costs down to drive exports. And they also bought $US to keep the mark at ‘competitive’ levels.

With the euro they are also keeping fiscal relatively tight to keep a lid on domestic demand and costs to drive exports, but can’t buy $US for ideological reasons (that would look like the euro is backed by dollars, etc.) so instead of exports rising the currency appreciates to levels where exports remain stagnant.

Merkel attacks central banks

by Bertrand Benoit and Ralph Atkins

June 2(FT) —Angela Merkel, the German chancellor, criticised the world’s main central banks in surprisingly strong terms on Tuesday, suggesting that their unconventional monetary policies could fuel rather than defuse the economic crisis.

The attack on the US Federal Reserve, the Bank of England and the European Central Bank is remarkable coming from a leader who had so far scrupulously adhered to her country’s tradition on never commenting on monetary policy.

“What other central banks have been doing must stop now. I am very sceptical about the extent of the Fed’s actions and the way the Bank of England has carved its own little line in Europe,” she told a conference in Berlin.

“Even the European Central Bank has somewhat bowed to international pressure with its purchase of covered bonds,” she said. “We must return to independent and sensible monetary policies, otherwise we will be back to where we are now in 10 years’ time.”

Ms Merkel’s decision to ignore one of the cardinal rules of German politics – an unwritten ban on commenting monetary policy out of respect from central bank independence – suggests Berlin is far more concerned about the route taken by the ECB than had hitherto transpired.

Berlin is concerned that the central banks will struggle to re-absorb the vast amount of liquidity they are pouring into the markets and about the long-term inflationary potential of hyper-lose monetary policies.

The ECB’s efforts have been focused on pumping unlimited liquidity into the eurozone banking system for increasingly long periods. But last month (May), it followed the US Federal Reserve and Bank of England in announcing an asset purchase programme to help a return to more normal market conditions.

The ECB announced it had agreed in principle to buy €60bn in “covered bonds”, which are issued by banks and backed by public sector loans or mortgages.

The covered bond purchases, however, were only agreed after extensive discussions within the 22-strong ECB governing council. According to one version of May’s meeting, the council had discussed a €125bn asset purchase programme that would also have included other private sector assets, but only the purchase of covered bonds was agreed.

Axel Weber, ECB council member and president of Germany’s Bundesbank, has been among those who expressed scepticism about direct intervention in financial markets. In a Financial Times interview in April he expressed “a clear preference for continuing to focus our attention on the bank financing channel”.

Mr Weber has also been among the most proactive council members in warning that the monetary stimulus injected into the economy will have to be reduced or even reverse quickly once the economic situation improves.

Details of the covered bond purchase scheme will be unveiled by the ECB after its meeting on Thursday. One likely solution is that the package will be split according to eurozone countries’ capital shares in the ECB, which would result in Germany accounting for about 25 per cent of the €60bn programme. Meanwhile, the ECB is widely expected to leave its main interest rate unchanged at 1 per cent, its lowest ever.

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He’s public enemy #1 and senior spokesman for all the deficit terrorists.

He’s also an intellectually dishonest, paid propagandist.

I’ve got the recording posted on my website from the Mike Norman show where he agrees government solvency is not a risk.

If anyone has his email address feel free to email this to him.

The ratings agencies, however, don’t understand the monetary system, and it is indeed possible they will downgrade the US much like they have downgraded Japan.

While this did no harm to Japan and won’t hurt the US, it could be damaging for eurozone nations who are institutionally dependent on funding. However, even in Europe, the ECB has already stretched the limits of the Treaty and would likely go further as needed (though that is not a certainty.)

America’s Triple A Rating is at Risk

by David Walker

May 12 (FT) — Long before the current financial crisis, nearly two years ago, a little-noticed cloud darkened the horizon for the US government. It was ignored. But now that shadow, in the form of a warning from a top credit rating agency that the nation risked losing its triple A rating if it did not start putting its finances in order, is coming back to haunt us.

That warning from Moodys focused on the exploding healthcare and Social Security costs that threaten to engulf the federal government in debt over coming decades. The facts show we are in even worse shape now, and there are signs that confidence in America’s ability to control its finances is eroding.

Prices have risen on credit default insurance on US government bonds, meaning it costs investors more to protect their investment in Treasury bonds against default than before the crisis hit. It even, briefly, cost more to buy protection on US government debt than on debt issued by McDonald’s. Another warning sign has come from across the Pacific, where the Chinese premier and the head of the People’s Bank of China have expressed concern about America’s longer-term credit worthiness and the value of the dollar.

The US, despite the downturn, has the resources, expertise and resilience to restore its economy and meet its obligations. Moreover, many of the trillions of dollars recently funneled into the financial system will hopefully rescue it and stimulate our economy.

The US government has had a triple A credit rating since 1917, but it is unclear how long this will continue to be the case. In my view, either one of two developments could be enough to cause us to lose our top rating.

First, while comprehensive healthcare reform is needed, it must not further harm our nation’s financial condition. Doing so would send a signal that fiscal prudence is being ignored in the drive to meet societal wants, further mortgaging the country’s future.

Second, failure by the federal government to create a process that would enable tough spending, tax and budget control choices to be made after we turn the corner on the economy would send a signal that our political system is not up to the task of addressing the large, known and growing structural imbalances confronting us.

For too long, the US has delayed making the tough but necessary choices needed to reverse its deteriorating financial condition. One could even argue that our government does not deserve a triple A credit rating based on our current financial condition, structural fiscal imbalances and political stalemate. The credit rating agencies have been wildly wrong before, not least with mortgage-backed securities.

How can one justify bestowing a triple A rating on an entity with an accumulated negative net worth of more than $11,000bn (€8,000bn, £7,000bn) and additional off-balance sheet obligations of $45,000bn? An entity that is set to run a $1,800bn-plus deficit for the current year and trillion dollar-plus deficits for years to come?

He knows as per the recording on my website that the US government spending in USD is not constrained by revenues, and that any default would be due to a political decision not to pay, and not financial circumstances per se.

James Galbraith and I recently testified at the gao/fasb hearings on sustainability immediately following Walker.

Our presentation is on my website.

The panel agreed with us and reportedly has changed their report, including the elimination of the concern over intergenerational transfers.

I have fought on the front lines of the war for fiscal responsibility for almost six years. We should have been more wary of tax cuts in 2001 without matching spending cuts that would have prevented the budget going deeply into deficit. That mistake was compounded in 2003, when President George W. Bush proposed expanding Medicare to include a prescription drug benefit. We must learn from past mistakes.

Fiscal irresponsibility comes in two primary forms - acts of commission and of omission. Both are in danger of undermining our future.

First, Washington is about to embark on another major healthcare reform debate, this time over the need for comprehensive healthcare reform. The debate is driven, in large part, by the recognition that healthcare costs are the single largest contributor to our nation’s fiscal imbalance. It also recognises that the US is the only large industrialised nation without some level of guaranteed health coverage.

There is no question that this nation needs to pursue comprehensive healthcare reform that should address the important dimensions of coverage, cost, quality and personal responsibility. But while comprehensive reform is called for and some basic level of universal coverage is appropriate, it is critically important that we not shoot ourselves again. Comprehensive healthcare reform should significantly reduce the huge unfunded healthcare promises we already have (over $36,000bn for Medicare alone as of last September), as well as the large and growing structural deficits that threaten our future.

One way out of these problems is for the president and Congress to create a “fiscal future commission” where everything is on the table, including budget controls, entitlement programme reforms and tax increases. This commission should venture beyond Washington’s Beltway to engage the American people, using digital technologies in an unparalleled manner. If it can achieve a predetermined super-majority vote on a package of recommendations, they should be guaranteed a vote in Congress.

Recent research conducted for the Peterson Foundation shows that 90 per cent of Americans want the federal government to put its own financial house in order. It also shows that the public supports the creation of a fiscal commission by a two-to-one margin. Yet Washington still sleeps, and it is clear that we cannot count on politicians to make tough transformational changes on multiple fronts using the regular legislative process. We have to act before we face a much larger economic crisis. Let’s not wait until a credit rating downgrade. The time for Washington to wake up is now.

David Walker is chief executive of the Peter G. Peterson Foundation and former comptroller general of the US

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looks a lot like the recommendations Karim emailed to them:

An article in the Financial Times:

Fed officials have dusted down this proposal and adapted it to address the current credit market crisis.

Vincent Reinhart, a fellow at the American Enterprise Institute and former chief monetary economist at the Fed, says this kind of auction facility would allow the Fed to provide funds directly to a much larger group of banks than the limited number of primary dealers who participate in open market operations, against a wide range of collateral, without the stigma of the discount window.

“I think it would be very positive,” he says. Banks in need of liquidity could acquire funds relatively anonymously, while the large number of participants with direct access to Fed money would encourage arbitrage to exploit the gap between cheap Fed money and high interbank rates.

Moreover, the Fed could auction funds at whatever term it wanted to in order to target liquidity at particular term markets – for instance, the market for one-month loans. It would have the option of either auctioning a fixed amount of funds, or offering to supply whatever funds were needed at a target rate.

The intended interest rate spread over the Fed funds rate is not known. If the Fed decided to auction loans at or only slightly above the Federal funds rate, it would risk subsidising weaker banks, which normally pay a premium to borrow in the interbank market.

However, Mr Reinhart says this could be dealt with by varying the amount of collateral required in return for loans based on the creditworthiness of the bank seeking funds.

Oil - Rise in costs puts pressure on returns RISE IN COSTS PUTS PRESSURE ON RETURNS By Javier Blas in Abu Dhabi
Published: December 4 2007 01:08

Exploration companies need oil prices of $70 a barrel to match the returns they made at $30 a barrel just two years ago because of the sharp increase in costs and higher government licence fees, according to analysis by a leading consultancy. The research, from Wood Mackenzie, the Edinburgh-based oil consultants, helps explain why non-Opec oil production is failing to accelerate its annual growth significantly in spite of record prices. Oil prices have been above $70 a barrel only since September.

This article can be found at: http://www.ft.com/cms/s/11ca6bb6-a1cd-11dc-a13b-0000779fd2ac,dwp_uuid=81

Published November 14, 2007 in the Financial Times

From Mr Adrian Binks.

Sir, Warren Mosler (Letters, November 12), reveals the level of hysteria that affects even intelligent western economists when it comes to oil prices.

First, economists need to understand the facts. Saudi Arabian crude oil is sold at prices directly linked to market values. Sales to Asia are linked to the price of Oman and Dubai crude, with exports to Europe based on ICE Brent futures prices, and sales to the US ultimately linked to West Texas Intermediate crude price levels. The Saudis set monthly differentials to these benchmark market prices that reflect the different quality of their crude, taking into account their customers’ refinery configurations.

Mr Mosler is equally confused when he writes that President Vladimir Putin “seems to have gained control over pricing of Russian oil”. Most Russian crude oil is sold at market-related prices. In the case of the second largest private-sector Russian producer, TNK-BP, next year’s sales will be based on the average of market assessments by Argus and Platts, two international specialist reporting agencies.

The trend within Russia is to greater market-related pricing, not less. The Kremlin proposed that an oil exchange be established at St Petersburg to set the price of Russian oil, although this has not yet come into being.

Rather than producer price setting, the cause of the upsurge in oil prices is new demand in China and India, coupled with the inability of western oil companies to invest in new low-cost reserves because of state control of crude oil extraction in key exporters. This is nothing new. Saudi oil production has been closed to western oil companies since the 1970s.

What is new is the drive for cleaner-burning transport fuels that require massive investment by the oil industry in more sophisticated refining. At the same time, there is a huge increase in product demand in markets to which western companies have little access.

These are the facts that economists in western countries should be focused on, and not conspiracy theories about price-setting cartels.

Adrian Binks,
Chief Executive,
Argus Media,
London EC1V 4LW

Copyright The Financial Times Limited 2007

Published November 12, 2007 in the Financial Times

From Mr Warren Mosler.

Sir, As crude oil prices continue to rise, the media continue to assume that competitive market forces are behind the increase, including political tensions, weather, supply disruptions and demand pressures. Completely overlooked, however, is the fact that the Saudis post their offered prices for the oil they sell to their refiners, and let the quantity they deliver vary with demand. It is a simple case of monopoly price-setting. The Saudis are acting as “swing producer” and setting the world price.

As a point of logic, the Saudis have no choice but to set the price of oil. At the margin, they are in fact the sole supplier of about 8.5m barrels of crude that the world currently needs from them every day. As all economics students are taught, any sole supplier is necessarily a “price-setter”.
Of course, the Saudis boldly deny that they set prices. However, they do say they do not sell in the spot markets, but that they do (publicly) post their desired prices to the refiners who buy their oil.

The Saudis will continue as price-setter until net world supply increases sufficiently to cause Saudi sales to fall and production to drop to unsustainably low levels. This is what happened in the early 1980s and persisted until the last several years when a decrease in net available world supply put the Saudis back in the driver’s seat.

Additionally, President Vladimir Putin seems to have gained control over pricing of Russian oil, making him a world “price-setter” as well. This means that either the Saudis or the Russians can raise prices at will, and the rest of the market automatically follows.

The bottom line is that the price of oil will rise to the higher of any price Russia or the Saudis desire, with no relief unless there is a drop in net world demand that reduces the demand for both Saudi and Russian output to unsustainably low levels.

Warren Mosler,
Chairman,
Valance,
St Croix, USVI 00820
(Senior Associate Fellow, Cambridge Centre for Economic and Public Policy, University of Cambridge, UK)

Copyright The Financial Times Limited 2007