Reply #21: In an Undercollateralized World [View All]

[Demeter]

http://dailyreckoning.com/in-an-undercollateralized-world/

The world is undercollateralized. This is the single most important feature of the 2011 economy. Sixty years ago, if assets were worth less than loans, it was possible to work our way into the black. In 1950, 59% of US corporate profits were from manufacturing; 9% were from finance. The roles of manufacturing and finance have reversed. Thus, we witness the desperate attempts to forestall what cannot be prevented. Yet, the world must deleverage. Banks must write off loans. Loans to bankrupt developers and companies must be called. Living standards must fall. The authorities are doing all they can to prevent the necessary deleveraging. That is the context in which Michael A.J. Farrell, CEO of Annaly Capital Management (NYSE:NLY), spoke to investors during his company’s first quarter 2011 conference call:

“The change that is happening in the financial markets is a chaotic mess. I believe the simultaneous execution of radical monetary policy, fiscal policy, and financial regulatory reform is introducing rather than reducing systemic risk in the global financial system by ignoring the simplest lesson of the scientific method. Rather than change one variable in a complex system and test the outcome, regulators and policymakers are changing virtually all of them at the same time: QRM , risk retention, the Volcker Rule, Basel III capital rules, derivatives clearing and related margin requirements. GSE reform. FAS 166 and 167. Zero-bound fed funds policy and QE2. Deficit financing, structural budgetary imbalances, and debt limit debate.”

We are overleveraged, undercollateralized, and accentuating these unsustainable imbalances. Lewitt notes, “the Federal Reserve has accounted for 101 percent of the net Treasury bond issuance during the first four months of 2011.” He goes on: “The US government has been the largest purchaser of Treasuries, promulgating a Ponzi scheme of unprecedented scale.”

The US Treasury issues debt and QE2 buys it. Lewitt notes that 10-year Treasury yields have fallen from 3.59% on April, 11 2011, to 3.15% on May 6, 2011. Since the Fed is the sole net buyer, the 10-year-yield is not a real interest rate. This is also true of the zero-percent short-term yield, one of the trial balloons listed by Michael Farrell. Interest rates are integral to the pricing of assets. A country without an interest rate has a stock market with a price, but not a value. The future-focused investor should estimate the value of stocks, commodities, and bonds as if interest rates were 5% higher. That day will come to pass: when assets seek the price of their true collateral...

Read more: In an Undercollateralized World http://dailyreckoning.com/in-an-undercollateralized-world/#ixzz1MwJj80eD