Make Sure the Wheelbarrow is Ready

By Mike WhitneyFebruary 11, 2011 “Information Clearing House” — The game is on. Two years of zero rates, limitless guarantees, and a $2 trillion drip-feed from the Fed, has lifted Wall Street from the canvas and put the speculators back in the thick-of-things. It’s a miracle. Who would have thought that Bernanke could engineer another bubble this fast. But he has. Mergers and Acquisitions (M&A) are increasing, LBO’s (Leveraged  buyouts) are on the rise, revolving credit (“plastic”) is expanding, and investors are scarfing up low-yield junk bonds wherever they can find them.

Still can’t believe it? Then, take a look at this from Businessweek:

   “Home loans that inflated the U.S. housing bubble…are fueling the fastest gains in the mortgage-bond market….Prices for senior bonds tied to option adjustable-rate mortgages, called “toxic” by a government commission, typically jumped 6 cents to 64 cents on the dollar in the past month, according to Barclays Capital.

    Rising values show Federal Reserve efforts to stimulate the economy by purchasing an additional $600 billion of Treasuries and holding interest rates near zero percent are driving investors into ever-riskier securities…..

    The market is pricing in defaults on option ARMs of about 75 percent, according to hedge fund Metacapital Management LP in New York. As the worst housing slump since the Great Depression deepened, assumptions reached as high as 90 percent, said Whalen, who’s based in Los Angeles.”(“‘Toxic’ Mortgages Rally as Resets Accelerate: Credit Markets”, Businessweek)

Got that? Investors are loading up on these garbage bonds even though they expect 75% of them will go belly-up. That’s what you call a Bernanke gold rush!  And the author even points to Bernanke’s QE2 as the proximate cause for the feeding frenzy.

And then there’s this from dailyfinance.com:

 ”The New York Stock Exchange released data  showing that margin credit — money investors borrow to buy shares — increased to $276 billion in December, up from $233 billion at the start of the year. That reflects a sharply higher stock market but also an increased appetite for borrowing.” (“With Consumer Credit Up Sharply, Is America Releveraging?”, dailyfinance.com)

Yup, it’s bubble-time again.

 But, you’re probably wondering how consumer credit can expand when households and consumers got whacked for $11.4 trillion in the meltdown and their debt-to-disposable income is still way off trend? Well, just go to Google News and take a peak at all the zero-down intro offers on auto loans. That will explain the whole thing.  We’re back to Square 1; selling products to people with shaky credit who can’t come up with a couple hundred bucks for a down payment. Credit expansion is easy when you offer people something for nothing.  It’s getting repaid that’s hard.

The other big area of credit expansion is student loans, the government-backed scam of the century. The banksters have figured out how easy it is to swindle college-age kids with promises of hefty 6-figure salaries when the finish their 5-year stint at the for-profit Bunko University. Of course, when they finally graduate–drowning in red ink–they discover that their job has been outsourced to Bangalore and they’re left with the prospect of either cleaning bedpans at the local retirement center or moving back in with the parents. Here’s more from student loan expert Alan Nasser:

“The student loan industry is huge. It was announced last summer that total student loan debt, at $830 billion, now exceeds total US credit card debt, which is itself bloated to the bubble level of $827 billion. And student loan debt is growing at the rate of $90 billion a year….It estimated that over their lifetime between 19 and 31 percent of college freshmen and sophomores will default on their loans (depending on the type of loan and when it was taken on). For community college students, the prospects were grimmer still: between 30 and 42 percent were expected to default. And the future was most discouraging for students at for-profits: between 38 and 51 percent were anticipated to default.”

 Whoa.  Some of these turkeys will default at a rate of 51% and we are allowing this swindle to continue?!?  Remember, even at the height of the housing bust, the subprimes only defaulted at a 20% rate.  Student loans are much worse. Our kids are taking a sheering so Wall Street can pad the bottom line…and no one seems to give a hoot!

So, where else is Bernanke’s Bubblenomics working?

Well, traders are still making beaucoup off currency swaps, derivative contracts and high-frequency trading (HFT). But there’s also a resurgence in private equity that’s worth noting. The big firms like Blackstone Group and Kohlberg Kravis Roberts (KKR), who appeared to be down-for-the-count less than a year ago, have come roaring back to life. Here’s a clip from Bloomberg:

  “With previous buyouts back from the dead, the world’s largest private equity funds are planning a new round of takeovers. KKR is seeking to raise $8 billion to $10 billion for a new fund. In an interview with Bloomberg TV at the World Economic Forum in Davos, Switzerland, Blackstone co-founder Stephen A. Schwarzman said that there is capital to fund leveraged buyouts of as much as $10 billion as debt becomes more available.

“We’re all absolutely shocked at how fast leverage snapped back from where we were, say, two years ago,” says William G. Welnhofer, a managing director at Robert W. Baird & Co. in Chicago. “I don’t think anyone who’s honest would have expected such a move.” (“Easy Money Is Bringing Buyouts Back to Life”, Bloomberg)

Indeed, we are all shocked. Private Equity is having its Lazarus moment while all of Wall Street is begins to releverage. Yipee. And we can only thank Ben Bernanke for his outstanding work in reflating the bubble and nudging us ever-closer to the next big crash. Only next time, it won’t just be the financial system that takes a drubbing, but the cornerstone upon which all of this speculative activity now rests; the dollar.

Get those wheelbarrows ready.

Latest Monetary Policy Proposal From the Fed Puts Your Money Market Fund At Risk

The Federal Reserve is discussing the possibility of using “reverse repo” transactions with money market funds that would be aimed at draining liquidity from the financial system.  The transaction would involve swapping the toxic assets on the Fed’s balance sheet for part of the $3 trillion sitting in investor money market funds.  Typically a repo transaction is a policy tool used by the Fed and executed with the Fed’s primary dealers in order the “fine tune” systemic liquidity and regulate the Fed Funds rate.   They are short term in nature and involve swapping short term Treasuries in exchange for cash, with the Treasuries being the collateral in order to “guarantee” that the short term trade can be unwound with little or no risk.

Here’s the link to the article that revealed this proposal:  Fed Wants To Drain Money Market Funds

The current Fed proposal is based on the fact that the primary dealer system only has enough cash to drain $100 billion from the system.  Here’s what is really going on with this proposal (without getting into the technical details of how repos work):  

The Fed has purchased trillions of dollars of toxic assets from banks.  We don’t know what price the Fed paid and we don’t know how corrupted the underlying collateral is (the Fed refuses to disclose both pieces of valuable information).  Most of the securities involve severely distressed underlying collateral like credit card receivables, subprime mortgages, auto loans and now commercial real estate mortgages.  Most of these assets will eventually be worth less than 10 cents on the dollar.  If the Fed were to hold onto these assets, the Fed, and the banks that ultimately are the shareholders of the Fed, stand to lose trillions. 

What the Fed proposal would do would move these toxic nuclear waste assets from the Fed’s balance sheet and into money market funds, in exchange for cash sitting in the money market funds.  The biggest problem is the Fed has no basis for valuing these assets other than the price it paid the banks for them, so at what price will the Fed value these securities in order to establish the market value basis for the repo transaction?   In other words, the Fed can stick a random price on these assets and swap them for the cash in the money market funds and say “trust us, we’re Fed – we’ll make you whole.”  

Without going in-depth into the problems that could occur which might make the Fed’s promise wothless, this proposal, if made effective, would expose money market funds to a significant, if not catastrophic level of risk.  To be sure, each fund individually has charter limits which would put a cap on the amount of cash the Fed could “repo” out of the individual fund and replace it with garbage assets.  However, these assets were fraudulently rated AAA in the first place and have no business being put into money market funds.  Money market funds are supposed to be basically risk-free funds in which investors “park” cash and earn a small amount of interest.

At best, this is a move by the Fed to justify draining a large amount liquidity from the system by using one of its monetary tools to drain cash from money market funds.  This has never been done before and is well outside of the traditional boundaries of repo/reverse repo tool used by the Fed with primary dealers. At worst, I believe this is a veiled attempt by Bernanke to move toxic assets from the Fed’s balance sheet and onto the public, under the false pretenses of using money market funds  to drain liquidity from the system, rather than putting these near-worthless assets back on to the balance sheets of the Fed’s primary dealers.

Hopefully this idea goes away. If it does become reality, I would not, under any circumstances trust this situation and would withdraw all funds from any money market funds you own and either move the cash into gold or into a short term Treasury bond fund.