Author: Susanne Trimbath

We Sneezed, They Got Pneumonia

Don’t worry about China taking over the US economy. Despite what all the talking heads on TV and the radio talk shows are saying, there isn’t another country out there that hasn’t been hammered at least as badly as we have by the financial meltdown. The problem with any other country attacking the US dollar, for example, is that they are all holding a lot of US dollars. You probably remember last year they were worried about the fact that we import so many goods that we have big “trade imbalances” – meaning that we buy more of their goods than they buy of ours.

Now remember this: we pay for those imports with dollars. So, again, if the dollar is worth less (or worthless) then they are not going to be getting as much for their imports. Raising the price of their goods, that is, simply charging more dollars won’t do them any good either. We’re in a recession, and Americans are tightening their belts. Demand for imported goods, like demand for all goods except luxury goods, is price sensitive. The more they charge, the less we buy. According to an article on CNN.com, our belt tightening has ended the “Road to riches for 20 million Chinese poor.”

Furthermore, it’s in the best interest of countries around the world that the US dollar stays strong. The door does swing both ways. According to Jack Willoughby at Barrons.com, “European banks provided three-quarters of the $4.7 trillion in cross-border loans to the Baltic countries, Eastern Europe, Latin America and emerging Asia. Their emerging-markets exposure exceeds that of U.S lenders to all subprime loans.”

To support all of that exposure, the European Central Bank has been obtaining dollars from the U.S. Federal Reserve in currency swaps. The value of these swaps, where dollars are exchanged for other currency at a fixed and renewable exchange rate, went from $0 to $560 billion this year.

And the Federal Reserve printing presses keep rolling along.

February 25, 2009
Housing Bail Out Part Deux: Just Another Financial Con Job

Last night I wrote about the Obama Administration’s housing bail out. But, I hate to say, there’s more to tell you – and it’s actually worse. In addition to the giveaways to mortgage holders, we also have to consider the federal government effectively offering to give a credit default swap (CDS, remember those?) to the banks. If one of the lucky homeowners that get a loan modification defaults on their mortgage because home prices fall again in the future, the federal government will make good to the bank for them. There are some differences between this and a real CDS, though – the banks won’t have to pay a premium for the insurance. The federal government is selling CDS for $0. Nice. We taxpayers are putting up $10 billion for this piece.

Then there are the plans to “Support Low Mortgage Rates by Strengthening Confidence in Fannie Mae and Freddie Mac.” There’s that word again: confidence. In a con game, the con man isn’t the one who is confident; he is the one who gives you confidence. You are so confident that you are making a good decision that you give him all your money to be part of his scheme. If you still have any questions about confidence schemes, watch “The Music Man” again.

The Treasury nationalized Fannie and Freddie (F&F) last year – they are now owned by the federal government. If you need more “confidence” than that in the strength of F&F then you should consider moving to another country. Under the assumption that “too big to fail” makes sense, the new Bailout plan is increasing the size of F&F’s mortgage portfolios by $50 billion – along with corresponding increases in their allowable debt outstanding. This part of the Homeowner Affordability and Stability Plan will cost $200 billion, an amount that goes beyond the $2.5 trillion cost of the Financial Stability Plan and the $700 billion in the Emergency Economic Stabilization Act/TARP and the $800 billion Stimulus Plan. The new $200 billion in funding, according to the Treasury’s plan, is being made under the Housing and Economic Recovery Act.

If you can remember back that far, the Housing and Economic Recovery Act was signed into law by the former and largely unmissed resident of the White House back in July 2008 to clean up the subprime mortgage crisis before any of the other bailout money was committed to clean up the subprime mortgage crisis. This legislation established the HOPE for Homeowners Act of 2008 which spent $300 billion to (1) insure refinanced loans for distressed borrowers, (2) reduce principle balances and interest charges to avoid foreclosure, (3) provide confidence in mortgage markets with greater transparency for home values, (4) be used for homeowners and not home flippers or speculators (5) increase the budget at the Federal Housing Administration so they can monitor that all this happens, (6) end when the housing market is stabilized and (7) provide banks with more ways and means to stop foreclosing on delinquent homeowners. Three million homes were foreclosed last year despite this legislation or any of the other bills that passed before and after it.

Each new bill carries with it an increase in the limit on the national debt. The most recent Stimulus Package increased it from $11.315 trillion to $12.104 trillion effective February 17, 2009. The actual debt is currently at $10.8 trillion and rising. With only $1.3 trillion between the actual debt and the limit, Timmy Geithner’s pals back at the Federal Reserve will have to keep the printing presses running overtime.

The “new” Homeowner Affordability and Stability Plan is just a rehash of every old financial sector bailout plan. The definition of insanity, according to a quote attributed to Albert Einstein, is doing the same thing over and over again and expecting different results. Here we go again.

Susanne Trimbath, Ph.D. is CEO and Chief Economist of STP Advisory Services. Her training in finance and economics began with editing briefing documents for the Economic Research Department of the Federal Reserve Bank of San Francisco. She worked in operations at depository trust and clearing corporations in San Francisco and New York, including Depository Trust Company, a subsidiary of DTCC; formerly, she was a Senior Research Economist studying capital markets at the Milken Institute. Her PhD in economics is from New York University. In addition to teaching economics and finance at New York University and University of Southern California (Marshall School of Business), Trimbath is co-author of Beyond Junk Bonds: Expanding High Yield Markets.

February 22, 2009

Responsible Home Buyers, Why Be Frugal?

I was laying in bed this morning, listening to discussions of the Homeowner Affordability and Stability Plan, the 2009 version of a Homeowner Bailout. (The 2008 version was spent on the banks.) I listened closely because I had to decide if it was worth getting out of bed to earn the money to pay my mortgage or not. Like all those bankers that got a bailout, I was wondering if it might be worth more to me to default on my mortgage than to pay it. I mean, what if the only people getting bailed out are the ones who truly screwed up? Being right doesn’t mean being rich and I didn’t want to miss out.

I realized that I’d have to get out of bed and get to the office anyway if I was going to make sense of this Plan. Radio sound bites are no substitute for real research. Timmy Geithner put several documents up on his website. Much like his plan to print $2.5 trillion, it’s still more rhetoric than reality but at least this time they included lots of number, so I’m happy to rifle through it.

Step one in the Fact Sheet is “Refinancing for Up to 4 to 5 Million Responsible Homeowners to Make Their Mortgages More Affordable.” The Plan offers an example of a family with a $207,000 30-year fixed rate mortgage at 6.5%. The house value has fallen 15% to $221,000 so they have less than the 20% home equity needed to qualify for current mortgage rates (close to 5%). The lower interest rate would save this homeowner $2,300/year in mortgage payments.

First of all, this homeowner’s monthly mortgage payment is $1,308 –about 8.6% of all mortgages fall into this range. About 60% of mortgages are below that level. If the mortgage is too much bigger than that, they are into “jumbo” territory in a lot of areas, so we’ll say this plan is directed at the lower 60%. The example of a $260,000 home is a little pricey – the median new home in 2008 was $226,000 and the median existing home price was $202,000.

The lower price isn’t just because home prices are falling. The US median has never been higher than $247,900 except in places like New York and California. But the median home price has not skyrocketed in vast swaths of middle-class, middle-America. Finally, reducing your payments by $2,300 in a year means a monthly savings of about $200 – enough to cover a northern winter utility bill.

If they reach the 4 million homeowners that they say they will, that’s 5.3% of all homeowners. But only 1.19% of all mortgages are in foreclosure and only 1.83% are 90 days past due. Maybe they are going to help the slow-pays, because 6.41% of all mortgages have some past due payments. President Obama specifically said that he was doing this to help regular, middle-class homeowners. That should not mean those who have homes worth more than the national median.

Then there’s this 15% drop in home value in Geithner’s example. The national median fell 8.6% from 247,000 at the beginning of 2007 to $225,700 in the third quarter of 2008 (latest available from HUD). In the West, where California homes have a higher median than middle-America, the median new home price rose from $320,200 in 2007 to $414,400 at the end of 2008. That’s a whopping 29.4% increase in the median price for a new home! Eastern US median home prices did fall, but by 12.6% not 15%. Still, I wouldn’t be hard pressed to find a city or two or three where home prices fell by 12%. But it doesn’t appear that they will be middle-class homes in middle-America. Existing home prices have fallen across the board. But only in the West did these prices fall at an alarming rate. The average for the other regions was only 8.7%.

Median Existing Home Price
Period*	US	Northeast	Midwest	South	West
2007	219,000	279,100	165,100	179,300	335,000
2008	191,600	246,800	152,500	167,200	253,600
% change	12.50%	11.60%	7.60%	6.70%	24.30%
* 2008 is for September, latest available from HUD. 2007 is full year figure.

Let’s look at the rest of the bill: “A $75 Billion Homeowner Stability Initiative to Reach Up to 3 to 4 Million At-Risk Homeowners.” This part is for those with adjustable-rate mortgages (“have seen their mortgage payments rise to 40 or even 50 percent of their monthly income”) and excludes those slow-pays (“before a borrower misses a payment”) that appear to be getting help from Part One. This Part is only available to those who have a high mortgage-to-income ratio and/or whose mortgage balance is higher than the current market value. Under the “Shared Effort to Reduce Monthly Payments” the federal government would step in to make some of your interest payments after the bank can’t reduce your interest rate any further.

There’s nothing here that says you’ll have to pay the government back that money – ever. But if the interest rate reduction isn’t enough, and having the government make some of your interest payments still doesn’t get you down to a mortgage payment that is no more than 31% of your income (one of the definitions of affordable), then the government will even pay down some of your principal.

But wait, that’s not all you get! If you and your bank can work out a deal here’s what else Uncle Obama will throw in for you:

If you take this action	The government pays Your Bank	The government pays You
Do a loan modification	$1,000	Reduced interest costs and principal balance
Do it before you miss a payment	$500	$1,500
Stay current	$3,000 (over 3 years)	$5,000 (over 5 years)

Wow! I’m really beginning to regret being a responsible person. I comment on Part 3 of the plan tomorrow. But this is really discouraging. I’m ineligible because I bought responsibly, before the Stimulus Bill gave out incentives to buy. I suspect there are about 70 million households out there just like me. Trillions of dollars running around the economy and all I can see is that the responsible majority will be paying for it while irresponsible bankers, brokers and home buyers benefit.

To tell you the truth, I need a tissue…

Read Part II of this look at the Housing Bailout.

Susanne Trimbath, Ph.D. is CEO and Chief Economist of STP Advisory Services. Her training in finance and economics began with editing briefing documents for the Economic Research Department of the Federal Reserve Bank of San Francisco. She worked in operations at depository trust and clearing corporations in San Francisco and New York, including Depository Trust Company, a subsidiary of DTCC; formerly, she was a Senior Research Economist studying capital markets at the Milken Institute. Her PhD in economics is from New York University. In addition to teaching economics and finance at New York University and University of Southern California (Marshall School of Business), Trimbath is co-author of Beyond Junk Bonds: Expanding High Yield Markets.

February 21, 2009

Fool Me Once, Geithner, Shame on You, Fool Me Twice…

Treasury Secretary Timothy Geithner revealed the new “Financial Stability Plan” on February 10, 2009. It’s thick with “why we need it” and thin on “exactly what it is.” He told Congress that he would open a website to disclose where all the bailout money was going. When asked if he would reveal where the first $350 billion went, he was a little vague on the details.

Senator Grassley (R-IA) asked him at the confirmation hearings about the Maiden Lane LLCs and the money he passed out to private, non-regulated companies. His written response then was “Confidentiality around the specific characteristics and performance of individual loans in the portfolio is maintained in order to allow the asset manager the flexibility to manage the assets in a way that maximizes the value of portfolio and mitigates risk of loss to the taxpayer.” In other words, he wouldn’t say. When asked “What specific additional disclosure would you support?” Tim’s response was “If confirmed, I look forward to working with you and with Chairman Bernanke on ways to respond to your suggestions and concerns.” Variations on the “If confirmed, I look forward to working on it” answer was cut and pasted into his 102 page written responses 104 times, or more than once per page.

Back in 2008 when the big bailout bucks were being passed around, we (and Congress) were led to believe that this was all being done to fix problems in housing and mortgage markets. Speaker of the House Nancy Pelosi (D-CA) said this in her speech on the floor before the vote: “We’re putting up $700 billion; we want the American people to get some of the upside. …[we] insisted that we would have forbearance on foreclosure. If we’re now going to own that [mortgage-backed securities] paper, that we would then have forbearance to help responsible homeowners stay in their home.” Three million homes went into foreclosure last year.

Speaker Pelosi went on to tell us that the bill would include “an end to the golden parachutes and a review and reform of the compensation for CEOs.” Excuse my cynicism but Tim Geithner took a $500,000 walk-away bonus when he left the Federal Reserve Bank of New York, the maximum earnings allowed under President Obama’s suggested compensation cap; but that was on top of his $400,000 salary which would put him over the limit. Obama appointee Deputy Secretary of State Jacob Lew took home just under $1.1 million last year as a managing director at Citi Alternative Investments, a unit of Citigroup, which so far took $45 billion in bailout money.

So, let’s add this up. Tim hides $330 billion from us while he’s at the Fed, refuses to tell Congress who it went to, refuses to tell Congress who Paulson gave the money to, and takes more than his share of compensation.

Now he wants us to believe that Treasury can “require all Financial Stability Plan recipients to participate in foreclosure mitigation plans.” Fool me once, shame on you. Fool me twice, shame on me. I, personally, don’t believe a word of it. And neither should you. It’s all baloney, bogus, phantom. They are paying lip service to the American taxpayers so you won’t send those faxes to Congress or throw shoes at the new President. They are passing the money to the same Democratic big wigs that paid for their election campaigns – just as they did in the past to the Republicans. Tim is shoveling more money to the same private companies that he previously sent freshly-printed Federal Reserve notes. Now he can also pass out Congressionally-approved money. While Congress struggled with spending $800 billion to directly stimulate economic activity in the US, Tim thumbed his nose at them by presenting a plan to spread around more than $2.5 trillion that won’t require their approval. That’s the way it is and I think it would be a very bad idea to stop him.

Yes, you read that right. I said it would be a bad idea to stop. I’m a fan of NASCAR racing. When a driver begins to lose control of the car and is sailing head first into a concrete wall at 190 miles per hour there is only one way to save it – stand on the gas. Your every instinct is to hit the brakes, to stop the car before you slam into the wall. But if you hit the brakes you’ll lose traction and control. By pressing down on the gas, you put power to the wheels which (hopefully) are still in contact with the track – with traction comes control and you can steer away from the wall. Oh, but it isn’t easy! Every cell in your monkey-cousin brain will scream: “Slam on the brakes!”

So, it’s like the economy is heading for the wall. And Tim has decided to hit the gas – another $100 billion for the banks, $1 trillion for private capital to put in junk bonds, $1 trillion for private investors to spend on junk loans, $600 billion for Fannie and Freddie’s debt – yet only $50 billion to reduce mortgage payments for “middle class homes” in foreclosure.

But even if we avoid hitting the wall, that doesn’t mean we don’t need to change the course. For years I have argued we need to fix the race track and improve the aerodynamics of the cars so they won’t head into the wall in the first place. I would insist that broker dealers have to deliver what they sell. I would prohibit the sale of derivatives in excess of the underlying assets. But that’s technical stuff, like requiring roof flaps in NASCAR (little flaps that come up when the car spins backwards to keep it from going airborne). It would prevent the really bad wrecks, but then no one would tune in on Sunday if there weren’t any wrecks, right?

Enjoy the show as Tim tries to keep from crashing into the wall. But don’t be fooled that he is fixing anything. Even if he pulls the economy out this time, the track is still broken and the cars are still not aerodynamically sound. They’ll wreck it again – as they did in 1981 (inflation so high that Treasury bonds paid 19%), in 1987 (October stock market crash of 23% was worst of all time), in 1991 (junk bond collapse and credit crunch) and in 2000 (the dot.com bust).

This will keep happening until we take the time to understand the real causes and put in real solutions. The solution is not now and has never been to throw money at it. This is the “junkie cousin” approach that Amy Poehler (Saturday Night Live) compared to the Original Bailout package: “It’s like you lend $100 to your junkie cousin to pay his rent. And when you run into him at the racetrack next week, you lend him another $50.”

At what point do you “get it” that your cousin is gambling away the money you lent him for the rent, that this is not really helping your cousin to kick junk? The solution is not throwing money around but accounting for all the money already out there (including the stocks, bonds and derivatives). It’s not more regulation, it’s enforcing rules that are already on the books. Real solutions take real work. I’m not hopeful that the US government and markets are willing to do the work. So, I’ll make sure I’m wearing a helmet with my seat-belt buckled for the next crash, say just around 2017.

Susanne Trimbath, Ph.D. is CEO and Chief Economist of STP Advisory Services. Her training in finance and economics began with editing briefing documents for the Economic Research Department of the Federal Reserve Bank of San Francisco. She worked in operations at depository trust and clearing corporations in San Francisco and New York, including Depository Trust Company, a subsidiary of DTCC; formerly, she was a Senior Research Economist studying capital markets at the Milken Institute. Her PhD in economics is from New York University. In addition to teaching economics and finance at New York University and University of Southern California (Marshall School of Business), Trimbath is co-author of Beyond Junk Bonds: Expanding High Yield Markets.

February 12, 2009
The Pleasure of Their Company
Executives from banks including Goldman Sachs, JP Morgan Chase, and Bank of America (who bought Merrill Lynch) have been called to Capitol Hill to explain what they did with their shares of the $750 billion bailout. (You can watch it live or read transcripts here.)

Here’s a good question to put to those executives: how much did you spend on whores?

According to a story by 20/20 aired on ABC on February 6, 2009, Wall Street executives and bankers used company credit cards to pay for prostitutes. When the head of the prostitution ring was arrested, her list of clients included bank executives who used company credit cards and disguised the charges as “computer consulting, construction expenses” and “roof repair on a warehouse”.

This raises their behavior to the level of a felony: committing fraud to hide a crime. Soliciting prostitutes is still a crime – even if it is rarely enforced. Disguising whoring as a tax-deductible business expense certainly qualifies as fraud. Making it even worse, if the ABC story is true, several of the bankers paid for their pleasure with our money. Included in the roster are:
- an investment banker at Goldman Sachs who spent $27,000
- an investment banker at JP Morgan Securities who spent $41,600
- a managing director from Merrill Lynch
Anyone who has spent time on Wall Street, as I did during the 1980s and 1990s, knows that paying prostitutes as entertainment goes on all the time. They fool themselves into thinking that they deserve it, or that everyone does it so it must be ok, or that no one is getting hurt.

Yet this is a pattern that goes well beyond buying women. I taught business ethics at New York University and the Stern School of Business for many years; ethics and economics is one of the field specializations in my Ph.D. Many people who paid for prostitutes with what amounts to the public’s money already rationalized other unethical decisions, like, for example, misleading a client on a stock because it will inflate your bonus. Or giving a AAA rating to a mortgage-backed security that looks dodgy but will earn a big fee.

So, if you have already taken the plunge in other areas, when you have a choice to spend $41,000 of the company’s money on a prostitute, you don’t consider the ethics. You already have made that decision before; you may have done it a thousand times before.

This is the kind of lapse that allows someone like John Thain to spend $1 million to redecorate his office while taking public funds. Or for a supposed public icon like Robert Rubin to defend his role in the Citicorp destruction by saying he could have made even more money working somewhere else.

And believe or not, it’s still going on. Another bailout baby, J.P. Morgan Chase is still completing a renovation of its New York headquarters at a reported cost of $250 million. They started their project in June 2007. Citigroup started their renovation of the executive offices in New York in September 2008, just as Congress was approving the first bailout package.

The good news is not everyone gives into the temptation. I know guys who walked away; guys who refused to take part in it even when their Wall Street boss offered to pass along the prostitute who was giving everyone in the office oral sex that afternoon. These guys wanted to wake up the next morning and look into their daughter’s eyes without remorse. Guys who decided to create a business environment in which they would want those daughters to live and work.

These are the guys who would take responsibility for their misjudgments in business and say no to a bonus in a year when their clients have been devastated. Sadly, many of those guys left Wall Street a long time ago. They probably are not the guys who are lined up for bailout money. This is not the kind of problem you stick around to fight to change. The problem with winning a gutter fight is that you are still in the gutter. Sometimes it’s better to just walk away.

According to the Associated Press, nine out of ten senior executives still at the banks that took federal bailout money were there to play a role in creating the crisis. Far too few have been thrown out for incompetence. So far none has been thrown in prison for fraud or theft. Most probably will take their nice vacations, count their sick days accumulated, and keep that vital company credit card for entertaining. This is not the case, of course, for the 100,000 bank employees who lost their jobs between 2006 and 2008.

As the newest shareholders in these banks, the US taxpayers should have some say in all this. Shareholders should be able to oust the Board and the executives who led their firms, and the country, into this morass. We have bailed these miscreants out but without taking any control. So we end up paying for the pleasure of their company while they go out and use our money to pay for someone else’s. On Wall Street, or here in Omaha, that’s called getting screwed.

Susanne Trimbath, Ph.D. is CEO and Chief Economist of STP Advisory Services. Her training in finance and economics began with editing briefing documents for the Economic Research Department of the Federal Reserve Bank of San Francisco. She worked in operations at depository trust and clearing corporations in San Francisco and New York, including Depository Trust Company, a subsidiary of DTCC; formerly, she was a Senior Research Economist studying capital markets at the Milken Institute. Her PhD in economics is from New York University. In addition to teaching economics and finance at New York University and University of Southern California (Marshall School of Business), Trimbath is co-author of Beyond Junk Bonds: Expanding High Yield Markets.
February 11, 2009
This Perp Walk Needs Handcuffs

Do many of us truly understand the scale of one trillion dollars? The following executives have been called to Capitol Hill to explain what they did with their shares of the $750 billion bailout:

– Mr. Lloyd C. Blankfein, Chief Executive Officer and Chairman, Goldman Sachs & Co.
– Mr. James Dimon, Chief Executive Officer, JPMorgan Chase & Co.
– Mr. Robert P. Kelly, Chairman and Chief Executive Officer, Bank of New York Mellon
– Mr. Ken Lewis, Chairman and Chief Executive Officer, Bank of America
– Mr. Ronald E. Logue, Chairman and Chief Executive Officer, State Street Corporation
– Mr. John J. Mack, Chairman and Chief Executive Officer, Morgan Stanley
– Mr. Vikram Pandit, Chief Executive Officer, Citigroup
– Mr. John Stumpf, President and Chief Executive Officer, Wells Fargo & Co.

The panel was called in by the house Committee on Finance. (You can watch it live at house.gov on February 11, 2009, 10:00 a.m. Eastern.) The House events are more exciting than the Senate, whose members take decorum too seriously to ask direct questions and raise their voices when they don’t get answers.

These guys (no women) are being called in to answer questions about what they did with the $750 billion bailout. Most people don’t really understand what a billion dollars is, let alone a number of billions that equals three-quarters of a trillion dollars. Let me try to bring it home.

Most people know what a million dollars is – it’s been popularized in TV programs like “Who Wants to be a Millionaire?” and “Joe Millionaire”. Most state lotteries have minimum prizes of a few million dollars. Angelina Jolie and other very popular actors reportedly receive $20 million for making one movie. Blockbuster movies can have more than $100 million in ticket sales on a good opening weekend. There are about 130 million housing units (homes, condos, trailers, etc.) in the U.S. The population of the US is a little over 300 million. We’re working our way up to $1 billion if we think of $3 or $4 per person. $1 billion is about equal to the annual income of 16,555 Americans. The entire population of Nebraska earns about $120 billion in a year. The population of California would earn about $150 billion in a month.

The U.S. Treasury and Federal Reserve paid $150 billion for an 80-percent stake in American International Group (AIG) in a bailout announced on September 16, 2008. On September 22, just days after receiving this bailout, AIG spent $443,000 on a spa outing at the luxurious St. Regis Resort in Monarch Beach, California, including $23,000 in spa treatments. AIG visited the Hill on October 7, 2008 where its CEO defended the spending as “necessary to maintain business.”

When they left the Hill, they threw a second party for themselves at another luxury hotel, this time $86,000 at a New England hunting retreat. They canceled 160 events after Congress and the press complained, but they still went on to spend $343,000 on a three-day event at Arizona’s Pointe Hilton Squaw Peak Resort in November. This time they made sure there were no AIG signs on the premises – three months later I still can’t figure out why no one is in jail for fraud.

Treasury, so far, has refused to tell us where much of the money went, beyond paying for pricey canapés and comfy beds. Not surprisingly, Fox Business Network ran a half-page ad in USA Today on February 3 to announce that they “sued the Treasury and the Federal Reserve” to find out where the TARP and FRB-NY money went. The Senate is considering subpoenas to get Treasury to tell them where it all went. Talk about imperial government!

Let’s keep going, because the numbers get bigger. The Treasury passed out $750 billion in their bailout. Treasury Secretary Henry Paulson and Fed Chief Ben Bernanke said that “The initiative is aimed at removing the devalued mortgage-linked assets at the root of the worst credit crisis since the Great Depression.” (Bloomberg, September 19, 2008.) There were about 3,000,000 homes in foreclosure at the end of 2008.

But who was really being bailed out? For $750 billion you could buy all of them outright and still have more than $100 billion left over to make car loans, student loans, small business loans – or pay bonuses to all the Wall Street and Bank executives in 2008. California had the most foreclosure of any state in 2008 – 523,624. $750 billion would have saved all of them – three times over.

For $750 billion you could buy 3,507,951 single-family homes in the US. That’s equivalent to every home built in the US in 2006 and 2007. You could buy about 3% of all the homes standing today in the US.

$750 billion would buy you 1,524,390 single-family homes in LA County, or 83% of the total. With $750 billion you could buy all the land in private hands in Los Angeles County (but not the buildings on it) and still have enough left over ($185 billion) to buy all the buildings and structures in Los Angeles city.

Now, Congress is working on a stimulus package that is approaching $1 trillion. Not to rush you through the math, but if you got this far, then you are already three-quarters of the way there. Apparently, Los Angeles is $1 trillion: That’s about the value of all the residential, commercial and industrial property in LA County. (Actually, $1.109 trillion, but what’s a hundred billion among friends?)

A stimulus package of $819 billion should give $6,306 to every household. It won’t, of course. But it should.

So what’s my conclusion? This bailout plan has little to do with addressing the root problems of the housing crisis, or helping hard-pressed Americans. It’s about bailing out the big banks and financial institutions from the consequences of their own miscalculations.

NOTE: calculations use median home prices and median incomes. Unless specified as “single-family homes” the housing numbers refer to all units which include condominiums, manufactured housing, apartments, etc.

Susanne Trimbath, Ph.D. is CEO and Chief Economist of STP Advisory Services. Her training in finance and economics began with editing briefing documents for the Economic Research Department of the Federal Reserve Bank of San Francisco. She worked in operations at depository trust and clearing corporations in San Francisco and New York, including Depository Trust Company, a subsidiary of DTCC; formerly, she was a Senior Research Economist studying capital markets at the Milken Institute. Her PhD in economics is from New York University. In addition to teaching economics and finance at New York University and University of Southern California (Marshall School of Business), Trimbath is co-author of Beyond Junk Bonds: Expanding High Yield Markets.

February 9, 2009

Should We Bailout Geithner Too?

This morning the Senate Finance Committee approved the nomination for treasury secretary of Timothy F. Geithner, head of the Federal Reserve Bank of New York. Geithner is a Wall Street darling, but taxpayers may have a different take. Senator Jim Bunning (R-KY) reminded us at the Senate confirmation Hearing January 20 that Geithner was part of every bailout and every failed policy put forth by the current Treasury secretary. After you read this, you should begin to see why I’m so opposed to Geithner’s appointment – I don’t want the fox any closer to the hen house than he already is.

For starters, look at what the Fed has admittedly been up to – this is from a recent speech by the President of the San Francisco Fed, Janet Yelin. The Federal Reserve Act authorizes the Fed to lend to “individuals, partnerships, or corporations” in extraordinary times. For the first time since the Great Depression, the Fed is invoking this authority to make direct loans to subprime borrowers – that is, those who can’t get credit from a bank.

Basically, the New York Fed, under Geithner’s direction, created a couple of special companies so they could print money to get around restrictions on what the Fed can do directly. Now, be perfectly clear on this first point – this is not Treasury or TARP or Congress that’s spending this money. It’s the Federal Reserve. They don’t have to ask Congress for money, they just print it. The Fed is providing “credit to a broad range of private borrowers.” And by-and-large, they don’t have to tell you who they give the money to, either. Here’s how Yelin put it:

“It is worth noting that, as the nation’s central bank, the Fed can issue as much currency and bank reserves as required to finance these asset purchases and restore functioning to these markets. Indeed, the Federal Reserve’s balance sheet has already ballooned from about $900 billion at the beginning of 2008 to more than $2.2 trillion currently—and is rising.”

Notice how easy it is to double our money – they just keep the printing presses running. In fact, the recent expansion is extraordinary. Since 2003 the Fed’s balance sheet averaged only $838 billion. So this doubling has all taken place in the past year. In the last recession, around 2002, the Fed’s balance sheet increased by only 13%. If the current recession started in 2007, and if the Fed’s balance sheet is any gauge, then we’re in for much worse.

Average Federal Reserve balance sheet

Year	Reserves	% change
2000	$625,822,500,000
2001	$653,774,500,000	4.5%
2002	$740,502,000,000	13.3%
2003	$762,853,509,434	3.0%
2004	$803,004,846,154	5.3%
2005	$843,397,519,231	5.0%
2006	$877,922,692,308	4.1%
2007	$907,023,653,846	3.3%
2008	$1,228,848,679,245	35.5%
2009	$2,175,364,000,000	77.0%

2000-2002 are for last 2 weeks only; 2009 is for first 2 weeks only. Data available from http://www.federalreserve.gov/releases/h41/hist/

Where are they spending all this cash? You probably didn’t hear that the Fed started buying commercial paper through these “private-sector vehicle[s]” created to sidestep an act of Congress. (Commercial paper is the short term debt of corporations.) Another thing you aren’t hearing about is that back in November 2008, the Fed bought $600 billion of mortgage-backed securities from AIG. This action, if taken without subterfuge, would not be legal. The Federal Reserve Act limits the Fed to buying securities that were issued or guaranteed by the U.S. Treasury or U.S. agencies. In order for the Executive Branch to get around a limit placed by the Legislative Branch, the Fed got help from the Treasury.

Yelin laid it out unabashedly: “Cooperation with the Treasury is necessary because the program entails some risk of loss and, under the Federal Reserve Act, all Fed lending must be appropriately secured. The Treasury has committed $20 billion of TARP funds to protect the Fed against losses on the Fed’s lending commitment of up to $200 billion.” Don’t kid yourself: this is a credit default swap on a national level.

On June 26, 2008, the Fed used this scheme to buy the assets of Bear Stearns. That money went to JP Morgan. On November 25, 2008, Geithner’s New York Fed bought out the underlying assets for which American International Group had written credit default swaps, saving AIG from having to pay off the swaps when the assets failed. On December 12, 2008, they bought more residential mortgage-backed securities from AIG. Those two bailout packages currently stand at about $73 billion. The big ones are those where the recipients are not being named. On October 27, 2008, they bought commercial paper from “eligible issuers.” On November 24, 2008, they bought “certificates of deposit, bank notes, and commercial paper from eligible issuers.”

In an odd twist of democracy, you can read all about Geithner’s personal income tax problem but you won’t find anywhere information on who is benefiting from this particular bailout money which Geithner is in charge of passing out. The commercial paper bailout from the Fed (this doesn’t include anything that Treasury is doing or that Congress has authorized) stands at $333 billion.

They aren’t done, either. According to Yelin, there are plans in place to substantially expand this spree of lending, buying, and guaranteeing to include more kinds of assets issued by more kinds of institutions, like commercial loans and non-agency mortgage-backed securities.

Senator Chuck Grassley (R-IA) referred to this as Geithner’s participation in “a monstrous act of government intervention and ownership over our financial markets.” While TARP has a Special Inspector General and various congressional oversight duties, similar transparency and oversight does not exist for the bailouts conducted by Geithner in New York. Geithner may be, as Grassley asked him, “the general, drawing on your financial sector expertise, who will marshal the financial troops and assets of the Treasury Department.” But he can’t “lead our nation to prosperity.”

He couldn’t, in six years, stop the primary dealers in US Treasuries from selling more bonds than Treasury issued. The only way this could go on to the extent that it did, with an average of $2.1 trillion of Treasuries sold but undelivered for seven weeks from September 24 to November 5, is because Geithner did not have the support of the “financial troops” to stop it. In fact, I will suggest to you that this level of abuse, in what amounts to massive naked short selling of US Treasury securities, could only be done with complicity.

Finally, it is a simple matter to compare Geithner’s activities at the Fed to those of Ken Lay at Enron. Remember all those “partnerships” with cool names derived from Star Wars movies? Geithner’s New York Fed created Delaware Limited Liability Companies with the name “Maiden Lane” which is the Fed’s street address in New York. They are using unregulated companies to make loans and to buy and sell assets completely outside the view of the public. The Senate Finance Committee approved Geithner’s nomination on January 22, 2009 in an Open Executive Session. Geithner has proven he can hide the ball; let’s not let this scheme move to Treasury.

January 22, 2009

Solving the Financial Crisis: Looking Beyond Simple Solutions

When presented with complex ideas about complicated events, the human tendency is to think in terms of Jungian archetypes: good guys and bad guys, heroes and villains. The more complicated the events, the more the human mind seeks to limit the number of variables it considers in unison in order to make sense of what it sees. The result is a tendency to describe events in the simplest black and white terms, ignoring the spectrum of colors in between.

This principle can be seen in the current explanation of the financial crisis. University of West Virginia Professor of Sociology Lawrence Nichols has developed what he calls the “landmark narrative” shaping how the public reacts to dramatic swings in financial cycles.

As Professor Nichols explains, the narrative described by the landmarks can be a contrived and even inaccurate version of history. By its nature, the shorthand narrative is often unable to describe the detailed reality of an occurrence. Much like an interstate highway, the landmark narrative takes the valley pass, avoiding the mountaintops from which the full view of history can be seen and understood. If we move away from the landmark narrative – beyond the highway for a view from the hilltop – we’ll see more of the landscape: enough to make sense of the complicated events that make up our financial environment.

There is real danger in limiting our view of events to what can be described by the landmark narrative. It’s like describing New Jersey from the I-95 Turnpike: funny enough for late night television but not particularly useful for problem solving. Basing our view of events on the landmark narrative can, and very well might, lead to “solutions” that could prove as dangerous – or worse – than doing nothing.

Specifically, reactions to the current financial crisis are making their way into popular consciousness, potentially becoming imbedded in unpredictable and usually indelible ways. In a democracy, our elected officials are bound to respond to these shifts in popular consciousness. The constant repetition of contrived and inaccurate versions of events eventually leads us to suffer what Nobel Laureate Merton Miller called “the unintended consequences [of] regulatory interventions.” Austrian Economist Ludwig von Mises, in fact, warned decades earlier that market data could be “falsified by the interference of the government,” with misleading results for businesses and consumers.

As Americans, we have repeatedly failed to learn this lesson. Throughout our history, Americans have had an irrational fear of finance. Deemed to be too complicated, the field of finance lends itself easily to description by landmark narrative. Quite possibly to our detriment, the rise of the financial sector has been tied to economic expansion throughout our modern business history. The more robust the flow of finance in capital markets, the more robust is economic activity. Our economy, our livelihood and our well-being are inextricably related to finance at home and around the world.

So what are the assumptions about finance we see today? It turns out many of the assumptions are often erroneous and usually dangerous. The problems on Wall Street, for example, did not stem from too few laws; rather, it resulted from not enforcing the laws we already have. When I talk to regulators and industry participants about problems with fails-to-deliver in bond and equity markets, they often respond that there is no rule against it. Indeed, there is no specific law that says that the seller of stock cannot fail to deliver the shares on the settlement date (usually 3 days after the trade); there is no specific punishment in place. Yet it seems clear that if someone takes your money and doesn’t give you what they promised, this is stealing and there are laws against it. Look at it this way: there is no specific law that says “it is a crime to hit a person on the head with a hammer.” Yet I assure you that if I hit you on the head with a hammer the police will arrest me for a crime. It will have some other name (like “assault with a deadly weapon”) instead of “the crime of hitting a person on the head with a hammer.” But I will be just as arrested. And it is just as much a crime.

So the real problem here is not a lack of laws, but a lack of enforcement of what already exists on the books. Our reluctance to act on this reality has serious consequences. First, we don’t focus on punishing the perpetrators. Our government says they don’t have time for “finger pointing” because they are too busy rushing rapidly to fix the problem – a problem they have yet to define. So we pour money into institutions, allow huge bonuses to be paid with public money, lavish retreats on insurance company executives – and then insist what we need is massive regulatory reform.

This has reached the level of absurdity. The House Financial Services Committee held hearings on January 5 to assess the alleged $50 billion investment fraud engineered by Mr. Bernard L. Madoff. The assumption is that somehow we don’t have the laws on the books to prevent Ponzi schemes; in fact those laws have been there for decades. A rash of new laws to prevent such occurrences is not necessary; we simply need to enforce what already exists.

Yet rewrite we will, and with what may well be reckless abandon. Opening the session, Congressman Paul E. Kanjorski (D-PA), the Chairman of the Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises, called for Congress to “rebuild” the regulatory system and commence with “the most substantial rewrite of the laws governing the U.S. financial markets since the Great Depression.”

But this is the wrong approach. The real question isn’t new laws – although that may make good headlines for vote-seeking congressmen. The more basic question should be: where has the lawman been?

Hearings like this are an integral part of the “landmark narrative.” Unless we’ve learned our lesson, we will be in for a rash of new rules, regulations and legislation paving the path for a future round of financial turmoil while allowing the perpetrators who created the crisis to avoid prosecution. Remember Sarbanes-Oxley, the measure supposed to prevent ill-doing by Wall Street. Passed in 2002, it didn’t seem to do anything except keep accountants and lawyers busy. In fact, it had the unintended consequence of discouraging small businesses from going public because of the extra cost for the reporting it required. Need more examples? Here’s a speech by an SEC economist that explains how regulations designed “to reduce executive compensation could actually increase expected compensation.” I’ve written in the past about “regulatory chokeholds” that make the failures of financial institutions almost inevitable.

In 2009, we are presented with a new opportunity to display our capacity to evolve beyond the same old pattern of reaction and spurious law-writing. When dealing with violations of the law by respectable and powerful groups (like bankers), we need to consider using the laws already there; it’s simply time to find someone to enforce them.

Susanne Trimbath, Ph.D. is CEO and Chief Economist of STP Advisory Services. Her training in finance and economics began with editing briefing documents for the Economic Research Department of the Federal Reserve Bank of San Francisco. She worked in operations at depository trust and clearing corporations in San Francisco and New York, including Depository Trust Company, a subsidiary of DTCC; formerly, she was a Senior Research Economist studying capital markets at the Milken Institute. Her PhD in economics is from New York University. In addition to teaching economics and finance at New York University and University of Southern California (Marshall School of Business), Trimbath is co-author of Beyond Junk Bonds: Expanding High Yield Markets.

January 17, 2009

A Housing Boom, but for Whom?

By Susanne Trimbath and Juan Montoya

We just passed an era when the “American Dream” of home ownership was diminished as the growth of home prices outpaced income. From 2001 through 2006, home prices grew at an annual average of 6.85%, more than three times the growth rate for income.

This divergence between income and housing costs has turned out to be a disaster, particularly for buyers at the lower end of the spectrum. In contrast, affluent buyers – those making over $120,000 – the bubble may still have been a boom, even if not quite as large as many had hoped for.

For middle and working class people, the pressure on affordability was offset by historically low mortgage interest rates which fell from over 11 percent around the time of the 1987 Stock Market Crash to 6 percent in 2002. Yet if stable interest rates were beneficial to overall affordability, the artificially low interest rates promoted by the Federal Reserve may have created instability. By allowing people to increase their purchasing power to an extraordinary level, low mortgage interest rates fueled a rapid escalation in housing prices.

Now that prices are falling quicker than incomes, there should be a surge in new buyers. Since 1975, whenever the ratio of mortgage payments to income falls, home sales usually rise. The correlation coefficient indicates that for every 1% improvement in affordability there is a 2% increase in home sales. But now, something is wrong. In 2007, for every 1% improvement in affordability, home sales fell by 2%.

Part of the problem is that prices still are simply too high. Even as recently as August 2008, the median home price was still historically high in comparison to median income – about 4 times. It takes lower rates than in the past for a family with the median income to afford the median priced house. This means that homes are less affordable today than they were 6 years ago.

The last time that home sales fell as they became more affordable was in the 1990s at a time known as a “credit crunch.” At that time, the ratio of home prices to income was actually lower – 3.8 times in September 1990 compared to 4.3 in September 2008. The difference was that between 1990 and 1992 mortgage interest rates averaged a hefty 9.26%. In the last 3 years, the average was 6.14% and while the words “credit crisis” bled in headlines around the world, the regular mortgage interest rate barely budged.

What we are clearly witnessing is a fundamental slow-down in the gains towards homeownership. Of course, most of the gains in homeownership in the US were made in the 20 years after World War II: owner-occupied housing went from 43% in 1940 to 62% in 1960. In the 40 years that followed ownership crept up a bit, from 62% to 68%.

Boom, yes. But for Whom?

One disturbing aspect of this slow-down has been its effects by class. Overall, ownership has gained only among households making $120,000 or more; for all other groups the ratio of owners to renters is lower today than it was in 1999. (About 80% of American households have income less than $100,000 per year. For Hispanics and African Americans, the number is closer to 90%.)

There have been some exceptions, particularly among minorities targeted by national policy: expanding home ownership opportunities for minorities was a fundamental aim of President Bush’s housing policy. In the early years of this decade Hispanics enjoyed a net 2.6 percentage point gain in home ownership. In the next four years, while most Americans were seeing a decrease in home ownership, the Hispanic population continued to see gains. Although African Americans initially gained more than Whites in home ownership, they gave back more of those gains in the housing collapse

The great irony is that exactly those programs aimed at improving affordability may have been responsible for this recent decline. We first wrote about Housing Affordability in 2002. One of our concerns then proved to be true: buyers would focus on “can I afford this home” instead of “what is this home worth.” Although there were some gains in overall home ownership rates in the US during the early part of the boom, about 40 percent of that was given back during the last four years as home prices surged out of reach.

	Rate	Change in Rate
Location	2008 Q2	1999-2004	2004-2008	1999 – 2008
US	68.1	2.2	-0.9	1.3
Northeast	65.3	1.9	0.3	2.2
Midwest	71.7	2.1	-2.1	0.0
South	70.2	1.8	-0.7	1.1
West	63.0	3.3	-1.2	2.1
City	53.4	2.7	0.3	3.0
Suburb	75.5	2.1	-0.2	1.9
Non-metro*	74.9	0.9	-1.4	-0.5
White	75.2	2.8	-0.8	2.0
Black	48.4	3.0	-1.3	1.7
Other**	60.2	5.5	0.6	6.1
Multi	56.4	NA	-4.0	NA
Hispanic	49.6	2.6	1.5	4.1

Table based on historical data from US Housing Market Conditions, U.S. Department of Housing and Urban Development, Office of Policy Development and Research,
*Non-metro includes all areas outside metropolitan statistical areas (non-urban). Note from Census.gov: For Census 2000, the Census Bureau classifies as “urban” all territory, population, and housing units located within an urbanized area (UA) or an urban cluster (UC). It delineates UA and UC boundaries to encompass densely settled territory, which consists of: core census block groups or blocks that have a population density of at least 1,000 people per square mile and surrounding census blocks that have an overall density of at least 500 people per square mile.
**”Other” includes “Asian”, which reports household incomes about 20% to 30% higher than the Racial/Ethnic category “All” regardless of income level category.

The areas with the biggest losses in home ownership rates in the 2004-2008 period were outside the cities, particularly in the Midwest which encompasses Missouri, Iowa, Kansas, Nebraska, Minnesota and the Dakotas (west north central) plus Wisconsin, Illinois, Indiana, Michigan and Ohio (east north central). Of the geographic segments, non-metropolitan Americans gained the least in home ownership in the 1999-2004 housing boom; and only the Midwest geographic segment gave back more.

What about the future? The Obama-Biden Agenda Plan on Urban Policy mentions housing nine times, including a headline on “Housing” with plans for making the mortgage interest tax deduction available to all homeowners (it currently requires itemization) and an increase in the supply of affordable housing throughout Metropolitan Regions. The former should help middle-class households; the latter will help lower-income households. This is not a continuation of the Bush Administration policy which relied on stimulating the demand for housing by providing mechanisms to bring households into the market. The data shows that low income households barely kept even on ownership (versus renting) under this policy, middle-class households suffered tremendous losses and only the wealthy, those making more than $120,000 in income, had a gain in home ownership.

The last President ignored our advice in 2002: “A more balanced effort to stimulate supply would equilibrate the potential adverse affect on prices” from over stimulating demand. Let’s hope this new President gets the balance right.

Dr. Trimbath is a former manager of depository trust and clearing corporations in San Francisco and New York. She is co-author of Beyond Junk Bonds: Expanding High Yield Markets (Oxford University Press, 2003), a review of the post-Drexel world of non-investment grade bond markets. Dr. Trimbath is also co-editor of and a contributor to The Savings and Loan Crisis: Lessons from a Regulatory Failure (Kluwer Academic Press, 2004)

Mr. Montoya obtained his MBA from Babson College (Wellesley, MA) and is a former research analyst at the Milken Institute (Santa Monica, CA) where he coauthored Housing Affordability in Three Dimensions with Dr. Trimbath. He currently works in the foodservice industry.

December 28, 2008

Phantom Bonds Update: The New Treasury Bond Owner’s Manual

Shortly after my piece on Phantom Bonds, Blame Wall Street’s Phantom Bonds For The Credit Crisis, posted here on NewGeography.com in November, a friend called from New York to ask if I’d seen the latest news. Bloomberg News reported on December 10 that “…The three-year note auction drew a yield of 1.245 percent, the lowest on record… The three-month bill rate [fell] to minus 0.01 percent yesterday.” The US Treasury is seeing interest rates on its notes that are “the lowest since it started auctioning them in 1929.”

My friend is an intelligent person, a lawyer who managed to accumulate more than $1 million working a 9-to-5 job in a not-for-profit firm and retire in her 50s. Some of her portfolio is in Treasury bonds, so she had a lot of questions. In the course of our conversation, it became clear that I wasn’t going to be able to explain all she needed to know on the phone, despite her background. I decided to write this short owner’s manual.

Here’s how it works, and how it ties back to the problem of phantom bonds. When the US government needs to raise money it authorizes its agent, the Federal Reserve Bank (FRB), to sell securities. The different names for these securities are associated with how long they will remain outstanding, like the term of a loan: bills are up to 1 year, notes are up to 7 years, and anything longer than that is a bond. We’ll just call them bonds to make it easy.

The FRB has relationships with several primary dealers like Citigroup, Goldman Sachs, JP Morgan, and Morgan Stanley. When notifications are sent out that some bonds will be sold, these primary dealers submit bids in the form of prices. If a financial institution bids $99 for a $100 bond, then that bond will essentially pay – or ‘yield’— roughly 1% from the US Treasury (UST) to its holder. If the investor bids $101 for the $100 bond, then it will pay 1% for the privilege of lending money to the UST; the bond’s ‘yield’ would then be minus 1%. That’s a very good thing if you happen to be the UST, which of course we all are because it’s all taxpayer money.

So— as the prices of bonds rise, the yields fall, and these yields translate into the interest rate that the UST pays to the bondholders in order to borrow the money it needs to fund the budget deficit (and to refinance the existing national debt).

This is all roughly speaking, of course. But the idea is that the interest rates are set based on the prices that are bid in something that’s like a blind auction. The bidders don’t see the other bids, but because there are more bids than there are bonds available, financial institutions will bid the highest prices they can to avoid being shut out altogether. (FRB usually gets bids for 2 to 3 times as many bonds as they have available to sell.) This is good for UST, with a heavy emphasis on the “us”! High bond prices translate into low interest rate loans for UST.

Bonds are funny that way: when a bond’s price goes up, its interest rate goes down, and interest is the cost of borrowing money. So we should like to see Treasury bonds selling at very high prices, and with very low costs to the UST. Unfortunately, all those fails-to-deliver — those phantom bonds — especially over the past few months, had the effect of pushing down the price of bonds by (artificially) increasing the supply. That was keeping the interest rate paid by UST higher than it needed to be over the last year or so.

When bond prices are high — or inching up, as they are now — we all benefit. UST sold $32 billion in 30-day Treasury bills on December 9th at a yield of 0%, meaning that investors are lending UST money for nothing except the promise to return their money without losing any of it. Investors bid for four times as many of these particular Treasury bills as were available for sale. This is as it should be.

As the primary brokers rush to cover their phantoms — those failed to deliver Treasuries of the past — in order to settle their transactions, we’re seeing a surge in the price of treasury securities. The prices of bonds are rising, the yield is falling; the UST is paying lower rates on the money it borrows from investors.

An increase in the price of the new bonds can also mean that the price of existing bonds – those already outstanding – will also increase. The increase in the prices of outstanding bonds will help my friend in New York. A good part of her $1 million retirement portfolio is invested in Treasuries. Treasury bond funds, like Merrill Lynch and Vanguard, are earning 11 to 12 percent for their investors.

These high rates of return in Treasury bond funds won’t last forever, of course. The number of fails-to-deliver in Treasuries is falling quickly, now that the spotlight is on. When settlement is final and on time, then the usual rules of supply and demand will apply. Prices of new bonds and those bonds in the funds (the outstanding bonds) will even out. But the demand for UST bonds will likely stay strong as long as there is global financial turmoil. And that demand turns out to be good for the US (lower interest rates) and good for us (higher prices for the bonds in funds).

People like my friend in New York ask me if Treasury bonds are safe. I tell them: if the US Treasury fails to pay you back, you’ll have bigger problems than a decrease in the value of your portfolio.

Susanne Trimbath, Ph.D. is CEO and Chief Economist of STP Advisory Services. Her training in finance and economics began with editing briefing documents for the Economic Research Department of the Federal Reserve Bank of San Francisco. She worked in operations at depository trust and clearing corporations in San Francisco and New York, including Depository Trust Company, a subsidiary of DTCC; formerly, she was a Senior Research Economist studying capital markets at the Milken Institute. Her PhD in economics is from New York University. In addition to teaching economics and finance at New York University and University of Southern California (Marshall School of Business), Trimbath is co-author of Beyond Junk Bonds: Expanding High Yield Markets.

December 24, 2008