Trillion with a T

The national debt is increasing at a rate of over $3 billion per day. From the lows of December 18th, the 10-year and 30-year Treasury bills have risen substantially. December was a panic flight to quality that pushed the 30-year yield to 2.55%. It rose to 3.80% as the panic subsided and investors realized the supply of Treasuries in the next several years will be enormous. The Fed stepped in saying it would buy longer term treasuries which brought yields down sharply. This steep fall in yields was not sustained in the next few days. I believe that much of this is due to concern about the future rate of inflation. If the Fed sustains it's buying for too long, it will fuel inflation. China is talking about scaling back its purchases of US Treasuries. I am sure others will not be far behind.

AIG Bonuses

With the handing out of $165 million worth of bonuses to AIG executives, some are upset. In large part the reaction to this is on pure emotion and the remedy disregards respect for due process. The anger directed at Edward Liddy, the CEO of AIG, is downright absurd. He joined AIG after the disaster in the credit default market, taking a salary of $1 and compensation in equity. If there's no value left in the company, Liddy will not profit.

Only a part of AIG was part of the mess that resulted in a government bailout. AIG lost huge sums of money on credit default swaps that they wrote. Many of AIG's business units are profitable, and there is no reason why the executives that lead those businesses shouldn't receive bonuses. Since AIG is planning to sell some of its business units, it would be very unwise to push their leaders out and sell a business that is in shambles. Such a policy punishes those that had nothing to do with AIG's failures. If we still believe AIG is an investment for the government, this policy destroys the value of the investment.

The bonuses as a percentage of the bailout money received are a very small part of the total. The bonuses in question are $165 million compared to the bailout of at least $90 billion, perhaps more by now. The federal government is running a deficit of $1.7 trillion. Even if the bonuses are completely undeserved, this is no reason to invalidate contracts and throw out the rule of law.

The bill passed by the House to tax the AIG bonuses at 90% is a clear violation of the spirit of the Constitution. I am not a Constitutional scholar by any means, but this is a clear example of a bill of attainder. The text of the bill does not explicitly single out AIG or this group of executives, but the intent is clear from the words that Congressmen use.

"Our message is clear: If you won't give the bonuses back, we will tax them back," Rep. Steve Israel, D-N.Y., said at a Wednesday press conference to announce the legislation.

Taxing these bonuses at 90% reduces us to mob rule.(Should we not consider this confiscation just because they get to keep 10%). The intent of this bill is to:

1. Punish by taxing at a 90% rate
   
2. Single out a specific group of individuals
3. Impair private contract

My guess is that many of the same people that oppose Guantanamo Bay are in favor of this bill of attainder. Where is the ACLU on this one?

The Biggest Borrower in the History of the Universe

I suppose it should be no surprise that yields on the treasury bonds are rising again, particularly on the long end of the curve. In the later part of 2008, we saw a panic in every other part of the market and a bubble in Treasuries that seemed to contradict the fundamentals. The US government was the running large deficits over the last few years, and all indications are that they will get even larger. With this massive supply of Treasuries, sooner or later the prices would have to fall as there is not limitless demand for US government's promises to pay.

While a technical default is not conceivable in my mind over the term of the long bond, investors realize that the probability of increasing inflation and the spectre of unfunded social security and healthcare obligations is very real. Even the Chinese might think that there has to be other places to put their dollars.

Banks to Return TARP Funds

Not all of the banks needed a bailout, and some right now are quite insistent upon returning the TARP funds they received over the last several months. Larger banks like US Bank and Northern Trust as well as smaller ones like Iberia Bank are applying to return TARP funds. It's not just Rick Santelli that is railing against bailout. The more responsible bankers in the world do not want to foot the bill for their less responsible colleagues.

TCF Financial Corp., the Wayzata, Minnesota-based bank that never made a subprime loan and hasn’t lost money since 1995, is asking why it should help clean up the mess made by Wall Street.

“I’m kind of bitter,” said William Cooper, chief executive officer of the 448-branch bank, adding that over the years TCF has invested about $1 billion in the Federal Deposit Insurance Corp.’s fund that guarantees bank deposits. “We pay for the excesses of our competitor over and over again.”

-- Bloomberg

Some of these banks will be able to pay bank the government soon and they can run their business as they see fit in the best interest of the shareholders. After all this crisis is over, it will be very interesting to see what the new banks look like in the services they offer and their underwriting practices.

If the well-managed banks are treated in the same way as the banks with lax standards, what incentive does that leave in the future?

"Mr. President, they'll see everything, they'll see the big board!"

I use Google Analytics to acquire some aggregate information on my site. I have seen an increase in page views over the last couple weeks, which is certainly encouraging. However, the bounce rates are very high suggesting that people don't actually read my site much. The more optimistic assumption would be that they are promptly adding it to their RSS reader, which would not be tracked properly by Google Analytics. Thank you for reading my site. I will have more content posted this weekend.

Markets at Work

In some cases, the principal on loans is already being reduced by players in the market without government assistance or encouragement. For sure, there are many scams out there claiming to reduce payments and principal, but there are some legitimate negotiations taking place. Hedge funds have bought speculative mortgages and they have approached borrowers in order to make a deal.

This recent article in Bloomberg gives an example of a hedge fund that purchased a mortgage for 60 cents on the market and renegotiated the terms of the loan. The hedge funds have worked proactively to protect their investments.

"Greenberg says she warmed to NAD’s proposal after Hussion explained that the value of the house had fallen well below the amount of the loan, and that it was in the company’s interest to head off a default by reworking mortgages like hers."

A relatively small percentage of "under water" mortgages have been renegotiated so far by the free market. The Obama administration has pledged support for changes in bankruptcy law that would allow judges to "cramdown" and force changes in the terms of mortgages. This idea raises a few questions in my mind

1. Are there in fact too few reductions of principal taking places in the market? In some cases it might be most efficient to foreclose and sell the house to another investor.
   
2. What will the long-term effects of changing bankruptcy law to allow "cramdowns" on mortgages? I suspect higher interest rates and worse terms for home buyers in the future.
3. What changes in regulation could make the market-based renegotiation of mortages more efficient?