Google+

Tags: Bonds

Detroit Defaults



Text  



The City of Detroit has defaulted on a portion of its bonds, specifically on payments to unsecured creditors. Those who invested in bonds with dedicated revenue streams attached have been spared, for the moment, but the reorganization plan drawn up by emergency manager Kevyn Orr envisions a great deal of “shared sacrifice,” which apparently is what they’re calling it these days.

Typically, bondholders in the past have lost interest due them, but not their principals. That is not going to be the case in Detroit. Specifically, Detroit is expecting its creditors to take less than 10 cents on the dollar for having been foolish enough to lend money to the collection of misfits, miscreants, and criminals who govern that poor city. That’s step one. Step two is . . . borrowing more money, in order to pay for a program meant to rebuild the city’s institutions, reinvigorate its economy, and improve basic services. Who, I wonder, would be foolish enough to lend Detroit money hot on the heels of a default? The answer is likely to include the unwilling taxpayers of Michigan and those of the United States.

Detroit’s tax revenues are declining, and the city already is at or near the legal limit for the various taxes it imposes. It has a city income tax, but that will not do it a tremendous amount of good: In 2000, Detroit had 353,813 employed persons; today it has only 279,960. In 2000, it had an unemployment rate of 7.3 percent; today, it has an unemployment rate of 18.6 percent. It is a blighted and crime-ridden city — now the second-most-dangerous city in the country, according to the FBI, with nearby Flint leading the pack — which in addition to being a broader social problem is specifically a tax problem: Property values, and hence property-tax collections, are declining. 

Kevyn Orr has also made it clear that reductions in pensions and health-care benefits for city retirees are a necessary part of any long-term solution for Detroit, which of course they must be: The city currently spends 40 percent of its revenue on so-called legacy costs, mostly retiree benefits.

That 40 percent number jumped out at me: Under current Congressional Budget Office projections, the federal government’s spending on its legacy costs (Social Security, Medicare, and interest on the debt) will be more than 50 percent of revenue in ten years. And, though the total impact will be small, you probably can add to those federal totals a little bit to account for the fact that Detroit plans to get out from under its health-care costs in part by dumping its liabilities onto Medicare and Obamacare. Thanks, Detroit!

As has been discussed at some length here, it is not entirely clear that Detroit, to say nothing of fiscally moribund states such as California or Illinois, legally can reduce its pensions and retiree benefits. In Michigan as in most states, those payments are protected by statute and/or constitutional provision. Orr is making it clear that he believes Detroit can reduce those payments — it simply does not have the money to make them and cannot raise sufficient funds through taxes. There are federal bankruptcy protections available to cities, though Detroit apparently plans to try to reorganize without a formal bankruptcy — Orr says there is a 50/50 chance that the city will not enter formal bankruptcy. But there are no such bankruptcy protections for states, and, unless the public-sector unions agree to a haircut for retirees (stop laughing) the pension mess probably is headed for the Supreme Court.

Detroit already is looking for federal assistance. For example, it is planning on spinning off the city water authority as a quasi-autonomous entity in the hopes that it will generate a nice revenue stream. It will be looking for federal loans to help make that happen. It will be looking for more federal funds to address its blight problems, to fix up the Coleman A. Young airport, to help fund services through grants, etc. It will be looking for money from the state of Michigan, too.

The problem is that the same political leadership that brought Detroit to this sorry pass remains in power. There probably is not much that can be done about that, and very little, short of mass seppuku in front of the Spirit of Detroit statue, that would convince me that they have mended their ways. Detroit cannot be trusted with its own money, it cannot be trusted with its creditors’ money, and it certainly cannot be trusted with federal taxpayers’ money.

— Kevin D. Williamson is a roving correspondent for National Review and author of the newly published The End Is Near and It’s Going to Be Awesome.

 

 

Tags: Bankruptcy , Bonds , General Shenanigans

Of German Bonds and American Prosperity



Text  



The question I am asked most often is: What will it take to get the government to stop running up the debt? A Republican president? A Republican president with a Republican House and a Republican Senate? A Republican president named Ron Paul?

My guess is that none of these is sufficient. The government will continue to borrow money for as long as the market remains willing to lend it money. Which is why Germany’s failed bond auction is of interest. From the Financial Times:

Germany saw one of its poorest debt sales on Wednesday in what was seen as a failed auction by many market participants amid fears the eurozone’s debt crisis is spreading all the way to Berlin.

Marc Ostwald, at Monument, said “I cannot recall a worse auction … If Germany can only manage this sort of participation, what hope for the rest. Yields are at completely the wrong level.”

Germany is suffering because of pan-European problems, not because of specifically German problems. But when Europe’s most solid economy is having a hard time raising money in the marketplace, that should be a wakeup call.

When governments take bonds to market and the market doesn’t want them, governments have two options: One, stop borrowing money. Two, raise interest rates in order to make bonds a more attractive investment. The ability to borrow money is the thing that makes being in politics fun and rewarding, so No. 2 is the go-to option.

In the United States, we have historically low interest rates right now. We’re also monetizing a great deal of debt, which is an invitation to inflation, and governments also raise interest rates to fight inflation. So there is good reason to suspect that interest rates will go up in the future. (No, I’m not guessing when or by how much. If I could forecast that with any accuracy, I’d have Lloyd Blankfein skimming the bubbles off my Moët-filled swimming pool.) But we do have some historical precedents to consider. As recently as June of 1984, interest rates on 30-year Treasury bonds went to 13.44 percent. To do a little thought experiment: What would happen if it suddenly cost Washington 13.44 percent to finance our deficit spending?

At an interest rate of 13.44 percent, it would cost just a little over $2 trillion a year to finance our current $15 trillion or so in debt — not counting future borrowing. Total federal revenue in 2010 was also just over $2 trillion. Which is to say that if financing costs should return to what they have been within recent memory — hardly a historically unprecedented level — then the cost of financing our debt could equal or exceed all federal revenues combined. If you’re in a position necessitating that you borrow money just to pay interest on your current debts, you’re in a pretty weak credit position, and so there will be pressure for interest rates to go even higher. A government isn’t a household, but to use the household comparison: If your income is $5,000 a month and the minimum on your credit cards is $5,500 a month, you’re going to have a hard time getting new loans.

In that situation, we could cut all federal spending beyond debt service to $0.00 and still not be able to pay our bills. No turkey on our national table that Thanksgiving.

There are two ways of looking at American prosperity. One way is say: Wow, Americans are only 5 percent of the world’s population, but they get to divvy up nearly 25 percent of the world’s economic output — lucky Americans! The other way is to say: Wow, Americans are only 5 percent of the world’s population, but they produce nearly 25 percent of the world’s economic output — lucky world! Thanks, Americans!

Both are valid. But however you look at it, it is absurd that a country with 5 percent of the world’s population and a quarter of its economic output cannot responsibly manage its public finances. As we count our blessings this week — and our national cup truly runneth over — it is worth keeping in mind that American prosperity is neither random nor accidental, nor is it a fixed state of affairs. This didn’t just fall out of the sky: We are prosperous in no small part because we had good ancestors — and we should work to be better ancestors ourselves, that future Americans may continue to count the prudence of their forefathers among their many blessings.

—  Kevin D. Williamson is a deputy managing editor of National Review and author of The Politically Incorrect Guide to Socialism, published by Regnery. You can buy an autographed copy through National Review Online here.

Tags: Bonds , Debt , Deficits , Europeans , Fiscal Armageddon

A Default in My Backyard?



Text  



I’m no titan of industry, but I do wonder: How the hell do you lose your shirt renting parking spaces in New York City — at Yankee Stadium, no less? (Via Megan McArdle.)

 

(This will be the closest thing to sports reportage you get from me.)

Tags: Bonds

First PIMCO, Then OPEC, Then . . . ?



Text  



This remind you of anything?

March 14 (Bloomberg) — Oil exporting countries are cutting holdings of U.S. government debt as energy prices rise, helping depress the dollar, the worst performing major currency of the past six months.

Treasuries owned by oil producers and institutions such as U.K. banks that are proxies for Middle East nations fell 9 percent in the second half of 2010 to $654.6 billion, the first decline in the final six months of a year since the Treasury Department began compiling the data in 2006. The sales may continue, if history is any guide, because Barclays Plc says Middle East petroleum exporting nations have traditionally placed only 25 percent of their savings in dollar-based assets.

PIMCO, OPEC: not buying what we’re selling.

And does anybody think that the No. 3 U.S. government debt buyer, Japan, is going to be in the market for a while?

Here’s a little piece of knowledge:

“I moved my clients out of any mutual funds that held Treasuries 12 to 18 months ago, including the Pimco Total Return Fund,” said Steven Tibbitts, owner of Tibbitts Financial Consulting, a $50 million advisory firm.

In place of Treasuries, he has moved clients into floating-rate-bank-loan funds and international bonds, including emerging-markets debt.

“It’s not a matter of whether rates rise, because they will, and when they do, it will be negative for longer-term bonds, especially longer-term government bonds,” Mr. Tibbitts said.

Question: Who thinks the U.S. government will still have a AAA rating in five years? Answer in the comments and tell me why/why not.

—  Kevin D. Williamson is a deputy managing editor of National Review and author of The Politically Incorrect Guide to Socialism, just published by Regnery. You can buy an autographed copy through National Review Online here.

Tags: Anemic Fiat Dollars , Bonds , Debt , Deficits , Despair

How Do You Say “Subprime” in French?



Text  



The French, God bless them, are picky about what foreign words get adopted into their language. But I was not surprised to see that one hated Anglo-Saxon term has made it into the Francophone world unmodified: subprime.

France is on the verge of losing its AAA sovereign credit rating. Other European nations surely will follow.

This is a good news / bad news thing for the United States, I think. Short term, we will continue to benefit from the flight to the dollar and U.S. Treasury bonds — so long as the world does not offer much of an attractive alternative, our debased currency and our flimsy government securities will continue to look good, and so we’ll enjoy a meaningful subsidy. But it’s the subsidy that comes from being at the end of the domino line rather than at the beginning. The longer Washington enjoys artificially cheap borrowing and a propped-up dollar, the worse it is going to be when it comes down. The problem is the boom, not the bust. Even if the boom hasn’t felt like much of a boom.

Wildcard: Chinese inflation. If inflation continues to run high in China, those relatively low-yield investments in Treasuries and other sovereign debt are going to start looking a lot less attractive, no? The portion of our publicly held debt owned by the Chinese government and Chinese institutions under government control is often exaggerated, but it is still a big chunk. China is still a very poor country — one where food prices are going up at an uncomfortable rate. Beijing might very well decide to buy fewer bonds and more rice, or decide to hold fewer U.S. dollars and more oil.

Question: When does the United States lose its AAA rating? Give me your predictions in the comments section.

Tags: Bonds , Debt , Deficit , Despair , Fiscal Armageddon , Public Finance

Bernie Madoff, Keynes, St. Augustine, and Cassanova



Text  



A stinging observation from John Cochrane:

If you really believe Keynesian Stimulus, you think Bernie Medoff is a hero. Seriously. He took money from people who were saving it, and gave it to people who were going to consume it. In return he gave the savers worthless promises that look a lot like government debt.

Brutal. And this:

The current policy attempt, consisting of  stimulus now, but strong promises to address the deficit in the future, can have no effect whatsoever. If you think stimulus works by fooling people to ignore future tax hikes or spending cuts, then loudly announcing such tax hikes and spending cuts must undermine stimulus!  Augustinian policy, “give me chastity, but not yet,” will not work. Casanova is needed.

Cochrane’s essay, “Fiscal Stimulus, R.I.P.,” is well worth a read.

Tags: Bonds , Debt , Deficit , Despair , Fiscal Armageddon , General Shenanigans , Stimulus

The Bond Market vs. Obamacare



Text  



So, it turns out the people who handle federal debt for a living do not believe the persistently repeated claim that Obamacare actually would reduce the national debt:

Treasuries rose, pushing 10-year note yields down from a six-month high, as a federal judge ruled against the U.S. health-care overhaul, easing concern that the government will struggle to contain record deficits.

Bonds also advanced as less U.S. debt was submitted to the Federal Reserve in its buyback today. Treasuries dropped earlier on speculation Congress will support economic growth by passing President Barack Obama’s agreement to extend tax cuts.

“The latest bump-up in Treasuries comes from the ruling about Obama’s health-care being unconstitutional,” said Larry Milstein, managing director of government and agency debt trading in New York at R.W. Pressprich & Co., a fixed-income broker and dealer for institutional investors. “If we are not going to be spending a trillion dollars over the next 10 years it’s a significant reduction in deficit spending, which means less debt being issued.”

But getting rid of the mandate does not get rid of Obamacare in toto, and, in fact, it makes the economics of it even worse: As things stand, insurance companies still will be required to cover those with pre-existing conditions, and now nobody has an incentive to buy insurance before he gets sick.

Two obvious options if the mandate stays thrown out: One is that Congress decides to keep all or most of the rest of Obamacare, replacing the individual mandate with gigantic subsidies to the insurance companies to offset costs associated with the pre-existing conditions rule. There are many insurance companies that probably would be happy with that arrangement, if the subsidies are fat enough. The other option is a more or less complete repeal –  which is the better option, and therefore the less likely to happen.

Tags: Bonds , Debt , Deficits , Despair , Obamacare

News Flash: Inflation Is on the Way



Text  



Uncle Stupid is dumping $109 billion in new debt on the bond market this week. This week alone, taxpaying chumps. And everybody has his eye on the new issue of inflation-protected bonds, which hit the market at 1 p.m. today. And what an interesting development it is:

The government bond market this week will also have to contend with $109 billion in new debt. Auctions kick off at 1 p.m. Monday with a $10 billion sale of five-year Treasury Inflation-Protected Securities. The notes are likely to be auctioned at a negative yield, the first ever negative yield for the issue. TIPS yields have declined as buyers have stepped into the market on the belief that more QE could stoke inflation down the road. TIPS return real yield plus inflation, and provide protection from rising prices.

Inflation fears are now sufficient that investors are prepared to take a less-than-zero yield on government bonds, calculating that the inflation bonus will be more profitable than the next-to-nothing yields everything else is paying in our present loosey-goosey cheap-money environment. Inflation is a cruel and rapacious tax on the people who make the economy go — savers, who provide the capital for real investment. With an economy in dire need of a lot of new saving and investment, Washington is getting ready to put the screws to the people best positioned to help turn us around. To what end? More dubious stimulus? Fiscal stimulus is not working and monetary-policy stimulus is not working, because the problem is not lack of consumer appetite. The problem is a broken banking system, a trillion dollars or more in dead or devalued capital, and a national commitment to sustaining the ragged remains of the real-estate bubble that helped to cause this mess.

That sound you hear? That is the sound of future generations cursing us for the tax we are levying on them today.

– Kevin D. Williamson is deputy managing editor of National Review and author of The Politically Incorrect Guide to Socialism, to be published in January.

Tags: Bonds , Debt , Deficits , Despair , Fiscal Armageddon , General Shenanigans , Inflation

No Inverted Yield Curve = No Double Dip?



Text  



Bloomberg seems to think that the lack of an inverted yield curve (meaning a bond market in which long-term bond yields fall below short-term yields) means there will be no double-dip to this recession: The inverted yield curve has been a prelude to almost every earlier recession.

But . . . short-term rates are basically zilch. How do you get a long-term rate under that? Slide it under the carpet? Stuff it in a gopher hole? At least one investment manager is thinking the same thing:

An inverted yield curve has twice failed to predict a recession — in late 1966 and late 1998. The bears say bonds may be sending another “false positive.” With the Fed’s target rate for overnight loans between banks at a record low of zero to 0.25 percent, it may be impossible for long-term yields to fall below short-term debt.

“As long as the Fed continues with ultra easy policy the yield curve’s relative importance as an economic signal is diminished,” said Christopher Sullivan, who oversees $1.6 billion as chief investment officer at United Nations Federal Credit Union in New York.

As for the politics of it, the optimists at the Cleveland Fed are predicting a sclerotic 1.14 percent growth over the next year — not exactly guns-blazing, unemployment-slashing stuff. 

Tags: Bonds , Double Dip , Economy , Fiscal Armageddon , Recession

Sign up for free NRO e-mails today:

Subscribe to National Review