Wednesday, November 12, 2008

CNBC Europe: USA May Lose its AAA Rating

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I have to tell you the past half year I've spent a lot of time watching CNBC Europe since I'm waking up at all hours watching history play out [Sep 15: Historic Times] - many of the guests they have there are so far superior than what they show on US TV. Or maybe I think that because many agree with me. Or it could just be a superiority complex that we hold as Americans thinking "this can't happen to us". Even as I analyze my own performance and how it could of been improved, I remember connecting most of these dots in 2007 but not believing it could truly get as bad as my brain thought it could - so I was operating to some degree under that same mantra of "can THAT really happen here?" Well it is happening. And apparently only folks in Europe are allowed to say it.

Back in April [Apr 15: Could the US Lost its AAA Rating?] we posted a piece about how the US could lose its AAA rating - this was after Bear Stearns but before the trillions of bailouts we've done since - the thesis at the time had a lot more to do with our unfunded long term liabilities [Jul 28: US Budget Deficit to Half a Trillion] [Mar 26: Annual Spring Entitlement Warning Falls on Deaf Ears] that as a nation we refuse to address and just kick the can down the road to another generation.

Now, however, we are adding untold amounts of new liabilities on top of our already scary long term obligations- just as with AIG where the cost to us grows by the week, Fannie and Freddie was sold to us as "at most $200 Billion" in cost [Sep 7: Bailout Nation Continues - Fannie/Freddie Now Owned by You] - you now seem the blueprint with AIG on how this will work. You are sold the product at one price, and the real price will be far greater and without transparency. Just yesterday Fannie said its liabilities are set to pass the value of its assets - which means its government spending time.
  • Fannie Mae's net worth -- the value of its assets minus the value of its liabilities -- fell to $9.4 billion at the end of September from $44.1 billion at the end of last year. If that number turns negative, Fannie Mae said it would be required to obtain funding from the Treasury Department.
  • The ultimate bill for taxpayers may depend on whether the government, under President-elect Barack Obama, uses Fannie Mae and its sibling company Freddie Mac as a way to alleviate the foreclosure crisis by aggressively modifying or refinancing loans. (yes we can! and we will)
  • "They're no longer being run for profit," said Fox-Pitt Kelton analyst Howard Shapiro.
Trust me, $200B for Fannie/Freddie is going to be peanuts before it's all said and done - we will celebrate if that's all it costs us. These entities are going to be used to bailout the homeowners in 2009/2010 - to the tune of untold liabilities to the federal balance sheet. These are historic times and the road ahead is as tough as I could imagine if my thoughts for the year or two ahead are anywhere near as accurate to how I thought things would turn out last year around this time [Dec 07: Predictions for the Coming 6 Months] Much of what I see ahead seems improbable but that said, so much of what we've seen in the past year has redefined what is possible.

[Jul 30: Federal Reserve Continues its Historic Actions]
[Jul 11: More Historic Actions (Potentially) by the Fed]
[May 4: Moral Hazard Run Amuck]
[Mar 22: A Historic 9 Days for the Federal Reserve]
[Mar 16: Fed Races to Rescue Bear Stearns]

So referring to the US credit rating of "AAA" I don't appear to be the only one questioning how long this can last. Remember, we are effectively bankrupt the moment out creditors (China, Japan, UK et al) stop bankrolling us. So we'll see how it plays out over the long run - the debt load of the US is becoming alarming even for our standards...

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The United States may be on course to lose its 'AAA' rating due to the large amount of debt it has accumulated, according to Martin Hennecke, senior manager of private clients at Tyche.

"The U.S. might really have to look at a default on the bankruptcy reorganization of the present financial system" and the bankruptcy of the government is not out of the realm of possibility, Hennecke said.

"In the United States there is already a funding crisis, and they will have to sell a lot more bonds next year to fund the bailout packages that have already been signed off," Hennecke told CNBC.

In order to solve or stem the economic slowdown, Hennecke suggested the US would have to radically reduce spending across all sectors and recall all its troops from around the world.

As for a stimulus package, there is not much of an industry left to stimulate back into life, Hennecke said. (and that folks, is truly the sad part of it all - how do you stimulate "shopping" as an industry)

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Meanwhile, Moody's assures us the US is in "fine fine" shape - of course the same Moody's who was rating all this toxic junk AAA and gets PAID by the people who create the debt instruments (no conflict of interest there)

  • Moody’s Investors Service said recent financial turmoil has not hurt the U.S.’s AAA credit ratings because the country retains “economic and financial resilience, flexible and competent policy-making, and a high level of balance-sheet flexibility.”
  • The firm said the power to tax is the most important element to credit ratings and increasing government debt is less of a risk than actions that hurt the economy and the tax base.
Last but not least Barron's is more on my side...
  • WHAT ONCE WAS UNTHINKABLE has come to pass this year: massive bailouts by the Treasury and the Federal Reserve, with the extension of billions of the taxpayers' and the central bank's credit in so many new and untested schemes that you can't tell your acronyms or abbreviations without a scorecard. Even more unbelievable is that some of the recipients of staggering sums are coming back for a second round. Or that the queue of petitioners grows by the day.
  • But what happens if the requests begin to strain the credit line of the world's most creditworthy borrower, the U.S. government itself? Unthinkable?
  • The Treasury is set to borrow $550 billion in the current quarter alone and $368 billion in the first quarter of 2009. "Near-term pressures on Treasury finances are much more intense than we had thought," Goldman Sachs economists commented when the government announced its borrowing projections last week. 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.
  • 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.
  • Scott Minerd, the chief investment officer for fixed income at Guggenheim Partners, a Los Angeles money manager, estimates that total Treasury borrowing for fiscal 2009 will total $1.5 trillion-$2 trillion. That was based on $700 billion for TARP, a $500 billion-$750 billion "cyclical deficit," an additional $500 billion stimulus program and some uncertain amount for the Federal Deposit Insurance Corp. Minerd doubts that private savings in the U.S. and foreign purchases of Treasury debt will be sufficient to meet those government cash requirements. That leaves the Fed to take up the slack; that is, monetization of the debt. (in English this means when there is no buyer for US Treasuries we will create the buyer in house: the Federal Reserve. So the left hand will be buying from the right hand i.e. desperation... banana republic style)
  • Both the yield spread and the cost of insuring debt moved up sharply together starting in September. Cutting through the technical jargon, the yield curve and the credit-default swaps market both indicate the markets are exacting a greater cost to lend to Uncle Sam. And it's not because of anticipated recovery, which would reduce, not increase, the cost of insuring Treasury debt against default. All of which suggests America's credit line has its limits.
Nothing seems impossible anymore.

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