It's Not Inflation That is the Danger - It is Interest Rates

As reported on Bloomberg.com by Daniel Kruger and Bryan Keogh the government now has to pay a higher interest rate than the top U.S. companies. Obama Pays More Than Buffett as U.S. Risks AAA Rating.

Last year the money center banks could borrow from the Fed at rates below ½% and use that money to buy Treasuries and keep the 1% for nothing. Since the Fed has raised their discount window rate to 1 % some of the fun is out of the game but what-the-hell, where else can you get paid to take money. That’s why the money center banks have been cleaning up in a bad economy.
From the article:

“The $2.59 trillion of Treasury Department sales since the start of 2009 have created a glut as the budget deficit swelled to a post-World War II-record 10 percent of the economy and raised concerns whether the U.S. deserves its AAA credit rating. The increased borrowing may also undermine the first-quarter rally in Treasuries as the economy improves.”

 “Last year’s $2.1 trillion in borrowing by the government exceeded the $1.08 trillion issued by investment-grade companies, the biggest gap ever, Bloomberg data show.

Moody's states that interest payments this year will be 7% of the governments revenues and will increase to 11% in three years.  That is a 63% increase in three years.  And that's assuming interest rates don't go crazy.

Social Security Goes The Way of China and Japan

At present the Social Security Administration holds 20% or $2.4 trillion of the $12 trillion that the U.S. now owes. That means that the government will soon lose its single biggest customer of U.S. debt. No one is saying exactly when this will occur but I’ll guess that the party is winding down and will end in the next two years. At the same time the next two largest purchasers of U.S. debt, China and Japan, are trimming their purchases of U.S. debt by 15% a year.


As I wrote last May in, The Honeymoon Is Over And I Want A Divorce - Obama’s Interest Rate Quagmire, there are pressures coming from all directions that will push interest rates up. The dollar has been losing value against all currencies except the Euro and the Pound, which are having their own fiscal problems. As soon as the problems in the EU start to subside the demand for the safe-haven dollar will also decrease.

When the above circumstances are combined with the need to fund an extra trillion a year in spending, interest rates have to move and move big. The first casualty will be a housing market that, because of government intervention, has not been able to work through its current downturn. Higher mortgage rates mean less affordability putting pressure on both home sales and home values that have little room for bad news.

The major money center banks like Goldman and Chase-Morgan have been thriving because the fed has kept the money flow to these guys at full blast and at little or no cost. They have been using that flood of short term money for everything but small business lending. For them it has been the perfect storm. When their interest rates raise the major money center banks will be in the exact place that stated this mess; an immediate cash squeeze.

As the government issues massive amounts of debt, corporate debt will also be entering the peak of their debt cycle. As stated in the Times article below, corporations will be bringing $700 billion of debt to the market. Competition for money is another factor for an increase in rates.

Currently the only positives for the future of interest rates would be if a if the U.S. has a phenomenal economic turnaround or if a war breaks out somewhere leading to another flight-to-safety.
 Posted on HOT AIR by ED MORRISSEY: Social Security starts cashing in US debt

An AP article by STEPHEN OHLEMACHER: Social Security to start cashing Uncle Sam's IOUs

An AP article by MARTIN CRUTSINGER: China trims holdings of Treasury securities

A New York Times article by NELSON D. SCHWARTZ: Corporate Debt Coming Due May Squeeze Credit

The Great American Write-Down

The business of mortgages.
In The Mortgage Meltdown Part 1 I wrote “The widespread closures and layoffs in the mortgage industry is more than just a slow down or a shakeout, it directly points to a flawed business plan.” When you start doing No-Money-Down, Interest-Only, 100 Percent Financing, qualifying applicants on the lower “Teaser-Rates” and doing so on inflated home prices, leaves absolutely no room for error. The mortgage companies pile on significant fees and then sell those mortgages to various investment groups, many of which are listed below. Those banks sort and package those mortgages in order to either resell or issue bonds to recoup there expense. At each step the mortgage company or the bank takes their profit upfront adding to the cost of the mortgage. When the packages are funded they roll those funds into new mortgages and start all over.

It was too much money aggressively searching for deals, which ultimately drove the appreciation in housing.
There was so much pressure to produce mortgages that brokers were working every possible angle to get someone to take their money; bad credit was no problem, no money down and we’ll find a way, payment too large and we’ll up the price and get the seller to cover some of the interest, need some cash out of the deal our appraisers know the true value of the property and we love speculators because they’ll bring us lots of deals. Everyone was happy as long as they could take their profit and pass it on. There was so much stuffed on top of an already bad deal that any speed bump in the housing market could cause a crash.

Mortgages are available to qualified buyers with conservative appraisals.
Now that both the property and the financial speculator are washed out of the system, mortgages are still available to qualified buyers and at good terms. Fannie Mae and banks that didn’t handle subprime products are getting burned because of their investments into the bonds, CDO's and SIV's that were secured by these blotted mortgages.

What’s next?
Bob Janjuah, the head of credit research at RBS, Royal Bank of Scotland, has estimated that the total asset value lost by the subprime mess will end up between $250 billion and $500 billion. So far the total write-downs from the 23 American companies listed below is about $71 billion just in the past eight weeks.

Everyone but Mozilo of CountryWide agree that next year will be more of the same. These numbers are only from a handful of our largest financial corporations. As listed in my article, Mortgage Industry Producing Lots of Unemployed, hundreds of smaller companies have closed and approximately 40,000 have lost their jobs in the mortgage industry. Those costs have been enormous but don’t attract the headlines and aren’t included in the headline numbers. There are also losses like CapitalOne who had a negative $670 million turn around in the third quarter when compared to the third quarter last year. These losses are also missed in the tallies.

These huge losses also ignore some very large companies like New Century, First Magnus, American Home Finance and NovaStar. The mortgage insurance industry has been devastated; most of the companies in that sector are near death like Radian, MGIC, PMI, Balboa and First American. With losses mounting in these bond portfolios, bond insurers are facing losses beyond anyone’s imagination. The rating agency Fitch has said that bond insurers have a $2.5 TRILLION problem. Ambac, ACA Capital, Security Capital, Assured Guaranty and MBIA could be looking at hundreds of billions in losses.

If you have a pension account then you have probably lost money.
Accounts in most major pension and mutual funds have lost value. Even names you wouldn’t consider when talking about mortgages like Prudential, AIG, H & R Block and E-Trade are taking losses because of their involvement into mortgages backed securities. This spreads across all spectrum's of companies that held investments because the bonds were considered safe and paid a slightly higher dividend.

When you mention to someone that CitiBank will write-off another $10 bil this year, they look at you funny and say so what. It’s not CitiBank’s money that is being lost; it’s the money from investors and pension funds. At the low end of the above prediction the average American household will lose $2,244 in asset value (investment and pension) and that number doubles to $4,488 if we hit the higher estimate.

The problem doesn’t stop at our borders.
The following banks have all had major losses and write-downs because of their U.S. investments: Deutsche Bank –Germany $3.2 billion, Credit Suisse-Switzerland $1.9 billion, UBS-Switzerland $3.6 billion, Societe General SA-France $920 million, AMP-Australia $1.4 billion, RBS-Scotland $2.7 billion, Barclays-Great Britain $2,7 billion, HSBC Holdings-Great Britain $3.4 billion and in Canada the Bank of Montreal, National Bank of Canada, Royal Bank of Canada, Scotia Bank and CIBC all had losses due to their holdings of US mortgage securities.

Take a look at the following 23 profiles of the losses recently taken by our financial community. I’ve listed them separately so individual companies can be identified and additional resources are listed for each one.

There is one who called it right; Pimco Financial. Take a look, I’ve put him first. (Just above)

Goldman Sacks

Part of a series The Great American Write-Down

Goldman Sacks (GS) wrote off $2.4 billion in the third quarter and no estimates have been made for the future.

The overall opinion is that Goldman is best positioned and have made the correct moves to weather this storm.