It has been almost a year since we last mentioned the TED Spread.

This is an indicator worth watching because it gives you an insight into the amount of risk the biggest money players see in the system. The last couple data points are pointing ominously upwards. Here is the link to Bloomberg.

Can precious metals and U.S. Treasury bonds fall together? You bet.
April 8, 2010

By Editorial Staff

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Gold, Silver and T-bonds
(Robert Prechter, February 2009)

This section will offer a novel viewpoint. Can you imagine a scenario under which precious metal and Treasury bond prices would fall together? Most people would think such an event would be impossible. After all, as we showed in our study of March 2008, bonds do well during deflationary recessions, and gold goes up during inflationary booms. Shouldnt they be contra-cyclical?

Look at Figure 3 and realize that gold and T-bonds have been going up together for an entire decade.

This is completely normal behavior according to our liquidity theory of market movement at the end of credit bubbles and their aftermath, as proposed in Conquer the Crash back in 2002. If gold and T-bonds can go up together for ten years, they certainly can go down together as well.

[Here is a scenario that] is likely to occur later, but since it could happen now, let’s review it. …U.S. Treasuries cannot hold up forever, particularly given the drunken-sailor approach to fiscal management that Congress has practiced over the past century and which has accelerated madly in the past eight years and even more outrageously since last September. At some point, Uncle Sam’s credit rating will begin to slip. According to the price of credit-default swaps on U.S. Treasury debt, it is already slipping.

When the monopoly issuing agent of dollar-denominated debt — the Federal government — begins to lose credibility as a debtor, the U.S.’s great experiment in fiat money will end. Read it here first: The U.S. government is the borrower of last resort. When it can’t borrow any more, the game will be up, because the government’s T-bonds are the basis of our "monetary" "system."

What will happen when creditors begin to smell default? They will demand more interest. At first, it might not be much: 4%, 6%. But as the depression spreads, spending accelerates, deficits climb and tax receipts fall, the rate that creditors demand might soar to 10, 20, 40 or even 80%. In 1998, annual bond yields in Russia reached over 200% before the government finally threw in the towel and defaulted.

Prices of outstanding bonds, of course, collapse when yields surge. As rates rise, many people will sell other investments to lend at these "attractive" rates. In such a situation, T-bonds would be the primary engine of falling prices, as they suck value from other investments. So, this is another way that gold and bond prices can go down at the same time. …

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Everybody “knows” that Gold and other precious metals go up in inflationary cycles and that US Treasury Bonds go up in deflationary recessions. Shouldn’t Gold and T-Bonds be contra-cyclical?

In this 118 page Free Investor eBook, Bob Prechter lays out the most probable scenarios for T-Bonds and Gold in today’s current and likely future economic environment. Well worth the read especially if you thought that Gold and T-Bonds could not possible go in the same direction for years on end. Prechter also reveals what he believes will be, hands down, the very best investment at the end of the depression – if it still exists.

Dec. 9 (Bloomberg) — Treasuries rose, pushing rates on the three-month bill negative for the first time, as investors gravitate toward the safety of U.S. government debt amid the worst financial crisis since the Great Depression.

The Treasury sold $27 billion of three-month bills yesterday at a discount rate of 0.005 percent, the lowest since it starting auctioning the securities in 1929. The U.S. also sold $30 billion of four-week bills today at zero percent for the first time since it began selling the debt in 2001.

What should we take from this?

One thing, certainly, is the obvious – an 80 year low in any major financial indicator is self-evident proof that something BIG is underfoot.

The Bloomberg writers attribute this historical event to institutional purchasers’ collective desire to have “something of value” on their books for their year end balance sheets. There’s probably something to that. The individuals making the decision to buy zero interest securities are employees of major institutions who have to answer to somebody about the riskiness of their portfolios.

But even if we accept that explanation as the entire story we are still left with the ugly fact that in today’s environment “something of value” means getting your money back.

The folks at Elliott Wave International are saying that this auctions is screaming “Deflation.” It’s hard to argue against that.

The TED Spread appears to be settling into the high end of the recent range. Not exactly a reason to rejoice over an anticipated credit splurge but at least something close to normal. The connection between the TED Spread and the equity markets is not 1:1. Monday’s plunge in the DOW is proof of that. You can use the TED Spread to get a handle on the willingness of big bankers to lend to each other.

Worries about a severe global economic slump should cause investors to continue to unwind riskier holdings and park funds in generally safe assets such as U.S. Treasury debt, boosting the greenback, analysts said.

Longer-dated U.S. Treasury yields fell to five-decade lows this week as extreme risk aversion fueled a frantic rush to safety. The monthly capital flows data released earlier this week showed overseas investors were big buyers of U.S. securities in September.

“The yen and the dollar will remain the only two safe-haven currencies in this global recession,” said Stephen Jen, global head of currency research at Morgan Stanley in London. “Risky assets will likely remain under pressure, as long as the end of the global recession is not in sight.”

The world’s leading economies will likely be in recession for around a year, with the UK hit particularly hard, a Reuters poll of around 250 economists across the Group of Seven nations showed this week. (Side note: On the same day that a committee of 250 economists is right about anything we will also be seeing pigs in mink coats flying down Main Street.)

Source: Reuters

A well written and insightful article that explains how the social engineering projects of the Democrats have wrecked the US credit markets. Worth the read just to know the background when you see Barney Frank mugging the camera and proclaiming himself the savior. An excerpt:

“However, the strategy announced in 1999 was to spur the banks to make more loans to people with poor credit rating, and especially to blacks and Hispanics. This was done by offering mortgages at 1 per cent above the standard variable rate. Home ownership rates among these groups had in fact been growing rapidly during the period 1993-98, 87 per cent for Hispanics and 72 per cent for blacks, but this was considered insufficient to close the gap between these and other groups. As early as 1998, Fannie Mae was already making 44 per cent of its purchases from loans to these groups.

Not everyone was convinced this was a good idea. Peter Wallison of the American Enterprise Institute warned: “If they fail, the government will have to step up and bail them out.” The US Senate finance committee in 2005 considered a bill to increase scrutiny of Fannie Mae and its accountancy mechanisms. In 2003 it had been revealed that Freddie Mac’s accounting practices contained $4.5 billion worth of errors brought about by the removal of three of the company’s top executives. By this time, combined debt at Freddie Mac and Fannie Mae was equal to 46 per cent of then national debt. The then US Federal Reserve chairman, Alan Greenspan, warned of forthcoming financial collapse if Fannie Mae’s activities were not reined in.

The bill was opposed by the Democrats, and lost.”

Source: The Australian

WASHINGTON (Reuters) – U.S. securities regulators on Tuesday gave the financial industry a reprieve from marking hard-to-value assets down to fire sale prices, throwing a lifeline to an industry beset by strained credit markets and the latest round of bank failures.

In the new guidance, first reported by Reuters, the U.S. Securities and Exchange Commission reminded financial services firms that they don’t need to use fire sale prices when evaluating their hard to price assets.

“This is a significant first step and adds stability, confidence, and liquidity within the capital markets,” said Steve Bartlett, president and chief executive of The Financial Services Roundtable. “By clarifying how to treat assets in an uncertain market, the SEC is continuing to provide transparency to investors and helping institutions to provide credit in periods of market stress.”

————-

Mark-to-market is a useful accounting concept when there actually is a market for the securities being valued, and a stupid bureaucratic nightmare when there is not.

There is a simple explanation for the “credit crunch.” Banks can loan at about a 10-1 ratio to assets. If a bank has $10 billion in assets it can put about $100 billion into the economy, creating $90 billion in new money or liquidity.

If the bank’s assets are suddenly devalued not only is the banks’ ability to create new money reduced or eliminated but the very existence of the bank can be placed in jeopardy. If the asset write-off is severe enough to jump the loan-to-asset ration to 15:1 or 20:1 then the bank is declared insolvent and bankrupted by the regulators.

The bank is failed and removed from the economy even though its cash flow and ability to operate are not changed by the asset devaluation. Stockholders lose everything and bank directors lose their jobs, pensions and bonuses. About 3,000 banks and savings and loans were failed in the 80s when real estate development portfolios were marked down.

Since bank directors are not of the class prone to commit personal financial suicide, whenever there is a whiff of danger to their asset valuation in the air they stop lending money to everybody and anybody.

Glad to see that the SEC and other regulators are finally getting around to scheduling a meeting to talk about the “problem.” It’s not like anybody with a finger in the bond market wouldn’t have known years ago that mortgage backed securities would be difficult if not impossible to value on a mark-to-market basis. If you ever get the chance read a prospectus on some mortgage backed derivative security and you’ll see what I mean. There couldn’t be 6 people in the entire world who could understand or explain exactly what was being sold in those offerings.

Isn’t it comforting to know that lawyers and accountants guided by the genius of people like Barney Frank will have the power to affect the US economy?

The Treasury bailout plan to recapitalize the U.S. banking system may help the U.S. avoid a deep and protracted recession. But even if the plan succeeds, it almost surely will not prevent a recession.

The major reason for this is that the credit markets have been under incredible stress for well over a year, and have recently taken a significant turn for the worse. During the last two weeks, the spread between Libor (the cost of borrowing between banks) and the rates on zero-risk Treasury bills exploded to more than 300 basis points, the widest gap since October 1987. This kind of stress reflects fear and a lack of trust among banks, which will be reflected in the real economy with a lag.

The commercial-paper market — which funds auto loans, credit cards, and short-term working capital for businesses — also is under incredible stress. Spreads on asset-backed commercial paper relative to comparable maturity Treasurys rose to more than 500 basis points in recent weeks. Not surprisingly, the commercial-paper market shrank by more than $100 billion in the last two weeks. It’s down by more than $520 billion since the summer of 2007, when the credit crisis began.

The Federal Reserve’s Senior Loan Officer’s Survey also shows record fractions of loan officers reporting tighter lending standards for the broad swath of business and household credit. Similar spikes in lending standards during 1990 and 2001 were marked by recession.

If a recession is unavoidable, the question is how deep and long it will be. While second quarter real GDP showed respectable 2.8% growth, trade was the only thing keeping the economy above water: Gross domestic purchases contracted during the second quarter. Gross domestic purchases also contracted during the fourth quarter of 2007, and only rose by 0.1% at an annual rate during the first quarter.

More bad news: Real retail sales growth has been negative on a year-to-year basis for nine consecutive months, the longest streak of declines since 1991. This data, and the tremendous spike in both jobless claims and the unemployment rate, are telltale signs of an economy that is in reverse gear.

The best we can hope for is that the downturn remains mild — and for a modest recovery to take shape in the second half of 2009. But the fiscal policies of the next administration will play a crucial role here. If tax rates on capital and labor are raised sharply, a hoped-for recovery may be jettisoned altogether.

Some have suggested we’re close to the housing price bottom. That’s hard to imagine, as new home sales just sunk to new cycle lows in August while inventories remain at elevated levels. New home sales bottomed three years before prices in the housing recovery of the early 1990s. Home prices also remain elevated relative to rents in a way they were not at the bottom of the home-price cycle in the early 1990s.

On the inflation front, the most recent bout of credit stress has a silver lining: Industrial commodity prices have declined sharply. At the same time, bond market inflation expectations recently receded to the lowest level in six years. Gold has risen aggressively off the lows of mid-September but remains below the March peak. The dollar is off the September highs, but is also well above the record lows seen in April. Collectively, these market-based signals suggest that headline inflation will ease from the 17-year highs seen in July.

The likely easing in inflation in the months ahead may not be permanent. In the past two weeks, the Fed’s balance sheet (the asset side of the monetary base) has exploded by nearly $300 billion. Yet this avalanche of liquidity has done little to relieve strains in credit markets. In other words, we cannot expect central-bank liquidity to be a substitute for financial-sector solvency.

The long-term outlook for price stability now depends on whether the Treasury pays for the bailout by selling U.S. debt to the public, or if the Fed finances it with printing-press money. If it is the latter, there will be an inflationary legacy that long outlasts the 2007-2008 credit crises.

Mr. Darda is the chief economist of MKM Partners.

Source: Wall Street Journal Opinion

“The Fed’s failure to expand the set of institutions it deals with reflects failure to adapt to the new world of financial intermediation. Previously, lending was dominated by banks, which meant the Fed could address liquidity shortages threatening the supply of credit by providing liquidity directly to banks. Today, lending is increasingly separated from banks. First, banks sell many of the loans they originate so that the ultimate lender is not a bank. Second, many originating lenders are non-bank firms. That means the credit supply is vulnerable to disruptions among these other lenders.” Preventing a Financial Crash

The columnists in the AsiaTimes are an unending source of analysis and most often criticism of the American financial system. Sometimes you can’t help get the impression that it’s a wonder our polity has managed to survive without the guidance of these ever so prescient journalists.

Hopefully, the Fed, and other Central Bankers when needed, will keep liquidity at the top of the priority list. Inflation and a battered dollar will no doubt result but those evils as bad as they can be are not fatal.