In These New Times

Default Risk Too High for World’s Taste

August 23, 2009

Seeking Alpha

It was another Ponzifest on Wall Street Friday as better than expected home sales took stocks to new highs.

There was also a negative side in this report: Home inventories failed to shrink as more condos were dumped onto the market. This part of the news, of course, was ignored as Wall Street’s bubble making machine rolled on.

I find it amazing how the Street can tune out all of the bad news and take stocks higher based on one meaningless data point. What the bubble boys need to realize is the housing crisis will continue as long as inventories are bloated.

This home sales bump should have been expected as many buyers took advantage of the $8000 first time home buyer tax credit.

I spoke to a mortgage analyst today who explained to me that this is where the big jump in sales is. Basically, this boost is nothing but first time home buyers buying low end 1-300k houses.

I fail to see why the Street is so giddy about this bump in sales.

Anyone stuck in a bubble loan at 600k and up is still basically screwed because most buyers are no longer able qualify for the types of mortgages that are required buy these homes.

The lending products that were used to purchase homes at such high prices are basically no longer available. This is why inventories at the high end still stand at around 20 months or so.

The analyst I noted above also shared with me that he is extremely concerned about what happens to the housing market after October 1st when this tax credit expires.

The thought of the tax credit disappearing at a time when real estate seasonally slows down must sends chills down the spines of the realtors. I can hear the crickets now!

I understand the government’s premise behind stimulus deals such as the home tax credits and “cash for clunkers”. The problem with such programs is you are stealing future growth away from the economy.

I can’t wait to see the car and home sales after these programs vanish. The only thing these programs have done is further burdened our consumers with more debt. This is what got us into this nightmare in the first place!

Is the world running away from our debt?
I don’t normally post much from the gold bugs, but I thought this chart was extremely interesting:

My take
Some of this article seemed a bit “tinny” to me but the data above is both interesting and frightening.

Other than Treasuries, the world is basically pulling a “Forrest Gump” and sprinting away from our various types of corporate and agency debt.

This is happening because the world isn’t stupid. They realize that our market is filled with fraud in the form of asset prices that are nowhere near marked to market.

Banks in this country are allowed to carry loans at “fantasy” prices without any penalty. Our previous accounting standards have been thrown out the window as the fraud on Wall Street rolls on.

This reckless behaviour makes the risk of default too high for the rest of the world’s taste. As a result it’s “Run, Forrest, Run!”.

You need to begin to wonder if the Fed might start monetizing the debt if they run out of customers.

The Fed has claimed that they would never do such a thing. However, based on the graph above, they may not have a choice unless they decide to pull the plug on liquidity which will then trigger a 1930s style collapse. I wouldn’t want to be Ben right now: Rock, meet hard place!

It’s going to be very interesting to see how long the world continues to have an appetite for our Treasuries. The Fed announced another $200 billion in Treasury auctions this week. We just recently finished up a $250 billion auction week. At this ridiculous pace, we will be selling $5 trillion of Treasuries per year! Can you say unsustainable?

The bottom line
At some point, the world is going to say “no mas” as we continue to build trillion dollar deficits. In my opinion, the Fed continues to arrogantly march this country right into default.

The yields on the 10 year were up sharply Friday as the bond market nervously awaited the results of the next round of massive auctions. You need to be careful in the short term if you are shorting Treasuries right now.

A credit trader explained to me that these rises in yield prior to auctions is an “old school” bond game from the ’70s. The bond market sells off Treasuries heading into the auctions so that the PDs(primary dealers) can buy up what’s left of the auctions the following week at a cheaper price.

Once the auctions get completed, Treasuries rise and the PDs turn around and sell the bonds and make a nice profit on the spread.

The bond market is currently extremely profitable for the PDs as long as the appetite for Treasuries remains high. However, if yields begin to steadily march higher then they are all going to be in a world of hurt. So far, the auctions have ran fairly smoothly except for a blip or two.

This has made bonds extremely profitable for the PDs of Wall Street.

Remember folks: Never underestimate Wall Street’s ability to find a game that can make them billions. This is a classic game that’s right out of the old playbook.

Long term, this action in bonds is not sustainable as the world prepares to pull a Forrest Gump and runs for the hills.