Notes From Underground: Policy Should Set Stock Prices. Imagine That

The ideas CNBC is spreading about the FISCAL CLIFF is just absurd. The addiction to higher stock prices has meant that a failure to get the equity market to rally due to falling off the “CLIFF” prevents quality policy from being attained. Going over the “CLIFF” will at least put spending front and center for we are all sure that taxes are going higher so the discussion must get to a genuine discussion about spending, and yes, that means serious cuts in the bloated defense sector. The FED‘s policy means that monetary policy will support the economy into the medium term and alleviate some of the pain from government spending cuts. It’s not drastic austerity but a realistic plan for dealing with rampant profligacy.

Many pundits and saltwater economists claim the global financial system is not worried about U.S. fiscal policy because the 10-year note yield continues to hover around 1.7%. This argument is preposterous because the price of U.S. debt is meaningless as long as the FED‘s continued QE and large-scale asset purchases (LSAP) continues to badly distort the market. The FED is now purchasing $85 billion a month in Treasury and MBS debt. When you couple that with the continued needs of insurance companies and pension funds, the pricing mechanism for DEBT is badly broken. To exemplify the issue, Bloomberg ran an article yesterday about bond ratings cuts by Moody’s and S&P advancing at their fastest pace since 2009. Yet in the face of rising credit downgrades, firms worldwide are issuing more debt to take advantage of CENTRAL BANK manipulated prices.

In the quest for yield in a zero interest rate environment, investors are taking on credit risk for very low risk premiums. This cannot end well. The proverbial bond vigilantes have been knocked to the sidelines for as JM KEYNES reminds us, “markets can remain irrational far longer than you and I can remain solvent.” The FED has created a negative real yield financial arena and for some analysts to maintain that low BOND YIELDS reflect the world’s confidence in the U.S. as a credit-worthy borrower is pure fantasy. Going over the “fiscal cliff” cannot be any more reckless than buying U.S. debt with negative real yields. Move over, I’m driving.

***Adding to the DEBT MORASS is a piece in the Financial Times today: “U.S. Buyout Groups Increase Their Use of Debt.” This reminds me of CSNY: Deja VU, “if I have ever been here before.” When the debt-inspired housing bubble exploded in 2007, a large part of the debt overhang was the LBO and CDO that the banks were holding as the private equity firms went wild in borrowing to finance acquisition deals. As the global debt markets are screaming for paper, “More buyout firms have borrowed against a company to pay themselves a special dividend this year than at any time since 2007…” This is exactly the type of activity that caused the banks so many headaches during the credit crisis. The FED‘s policies have ancillary effects and the collapse in risk premiums is causing the bond markets to behave imprudently.

The article goes on to state: “Strong demand for paper in the U.S. has pushed average yields on non-investment grade corporate debt down 3 percentage points this year to an all-time low of 6.5 per cent …” The fiscal crisis needs to be resolved to prevent a crisis in the global credit markets for when the FED‘s policy begins to lose its influence the huge amount of badly priced risk is going to cause pain in the credit markets. The growth in corporate debt is one of the reasons why banks have huge amounts of deposits relative to the amount of loans they are making.

In comparing the amount of investment grade debt issued during the last two years, Bloomberg statistics shows that underwriters issued approximately $880 billion in 2011, while this year a $1.1 TRILLION was underwritten. The debt markets are screaming for investable product and the ease in which bonds are sold renders bank loans very expensive. The FED‘s ability to power the PORTFOLIO BALANCE CHANNEL is leading to the mispricing of risk assets. The FISCAL CLIFF MAY TURN OUT TO BE  A PALLIATIVE FOR A FAR GREATER DISEASE.

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5 Responses to “Notes From Underground: Policy Should Set Stock Prices. Imagine That”

  1. Joe Says:

    “Move over, I’m driving.” You need another cold one? Pfist.

  2. kevinwaspi Says:

    Once again, models are everything, logic, common sense (not so common anymore) and basic economics suffer. “This Time Is Different” has become the nation’s motto, but I still know the sound that follows screeching tires as two cars aproach head-on at a high rate of speed! To go “over the cliff” would be a nice start to the New Year, and probably much less devestation than what we are eventually building toward.
    Oh well, have a happy New Year and enjoy these pictures of a young Ben Bernanke, learning his craft at an early age!

  3. arthur Says:

    It is time we stopped tossing around big defense budget saving numbers like chips in a poker game, or pretending that magical reforms in how the Pentagon does business can quickly yield huge savings painlessly, and instead linked possible savings to changes in military capability and associated impact on our national security.

    Happy New Year!

  4. yra harris Says:

    Arthur–I this one I disagree.I believe cuts can be made without impacting operational capability in defense.More importantly what Ohanlon fails to mention that in a serious efffort to contain spending,once cuts to defense are made then all other sacred cows are able to be gored.The liberal establishment which desires defense cuts almost as much as their coexist bumper stickers will begin to realize that defense cuts will lead to massive cuts in many programs that they view as important.The imperial nature of the defense establishment has made the social welfare system the siamese twin of budget policy—-serious spending cuts means the end of all sacred cows—that has been the point of many of my blogs.The brookings piece is lacking in comrehending the collateral damage from initiating defense cuts—that is one type of daisy cutter I am in favor of

  5. arthur Says:

    OK! I really appreciate your taking the time to share your thoughts on this. Best

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