Some thoughts about the eventual bill we’ll have to pay…..
by Tom on November 28, 2008
in Market Musings, banks
I found this article at Jesse’s Cafe. I need to let you know that article was written on November 11. That’s 18 days ago. What has happened in the last 18 days?
Oh, approximately $1,100,000,000,000 worth of additional spending on bailing out the financial sector. Let’s review:
Citibank got $29 Billion in cash and the agreeement that the government will absorb up to $306,000,000,000 of Citibank’s losses on the assets that they own (assets being loans and other investments that they have).
Fannie and Freddie got notice that the Treasury is going to buy $100,000,000 of mortgages that Fannie and Freddie own and another $500,000,000 of mortgages that they have guaranteed.
The Treasury is also buying $200,000,000 worth of securitized (bundled) car loans, credit cards and student loans in an effort to get banks to start writing more loans.
So, everything that is said in the article that I’m basing this on is from 2 weeks before all of these bailout numbers…..
Now, here’s part of the article:
It may finally be catching up with Uncle Sam. That’s what the yield curve may be whispering. But some economists are too deaf, or dumb, to get it.
The yield curve simply is the graph of Treasury yields of increasing maturities, starting from one-month bills to 30-year bonds. The slope of the line typically is ascending — positive in math terms — because investors would want more to tie up their money for longer periods, all else being equal. Which it never is.
If they expect yields to rise in the future, they’ll want a bigger premium to commit to longer maturities. Otherwise, they’d rather stay short and wait for more generous yields later on. Conversely, if they think rates will fall, investors will want to lock in today’s yields for a longer period.
The Treasury yield curve — from two to 10 years, which is how the bond market tracks it — has rarely been steeper. The spread is up to 250 basis points (2.5 percentage points, a level matched only in the past quarter century in 2002 and 1992, at the trough of economic cycles.
Based on a simplistic reading of that history and the Cliff Notes version of theory, one economist whose main area of expertise is to get quoted by reporters even less knowledgeable than he, asserts such a steep yield curve typically reflects investors’ anticipation of economic recovery. (LOL, nicely phrased – Jesse)
Never mind that the yield curve has steepened as the economy has worsened and prospects for recovery have diminished. Like the Bourbons, the French royal family up to the Revolution, he learns nothing and forgets nothing.
As with so much other things, something else is happening this year.
The steepening of the Treasury yield curve has been accompanied by an increase in the cost of insuring against default by the U.S. Treasury. It may come as a shock, but there are credit default swaps on the U.S. government and they have become more expensive — in tandem with an increase in the spread between two- and 10-year notes.
Okay, Tom here. What is it that they are talking about?
Let me try to explain it to you in simple terms:
1. The reason that long term Treasuries are higher than short term Treasuries is not because we are heading into an economic recovery (as the normal “steep” yield curve would show) but because the risk of something bad happening to US debt is increasing.
2. What’s the “something bad?” A couple of scenarios are bouncing around:
- The foreign investors stop buying US Treasuries – that would send rates on Treasuries skyrocketing.
- Devaluation of the value of the dollar – that would create all sorts of nasty consequences, things that we can’t take enough time for here…..
So what does that mean?
Essentially this, it means that like all of the rest of us, the United States has a limited credit line and we (collectively) need to be careful how much we spend and what we spend it on.
The way we recover from this mess is for the federal government to increase the revenue it recieves from taxes, which tranlates to highter productivity or higher taxes. And of course for Congress to stop spending money like they have a printing press. Oh, I guess they do have a printing press.
Larry,
Good point. I’d like to hear if you have any specific ideas on the concept of increasing taxes not by increasing tax rates, but by increasing productivity. Are there things that the government can or should do in place of throwing money at banks to increase productivity and generate more jobs?
That’s where I think we need to be heading…..
Tom