TED spread closed at highest gap since the GFC last night 51.68

http://www.bloomberg.com/quote/!TEDSP:IND/chart

Credit stress remains elevated and the difficulty in getting term funding deals away at a respectable price is practically impossible at the moment. A spread above 50 is something of a klaxon call to me - unlike the last brief flirt with the 50bpts with the debt crisis in June 2010, this rise has been gradual yet consistent. One to watch, especially if we start to see spike

Across Wiener Feinbäcker’s 350-strong chain of bakeries, the posters are everywhere. This typical German midsized company is promoting a bond alongside its Brötchen.

The unusual offer, which promises a 7 per cent coupon for five years, is an eloquent sign of the times. When a thriving business with profits growing at 30 per cent a year resorts to this kind of financing, it is a pretty sure sign that banks are not fulfilling their traditional role.

But if times are changing in Germany, the plight of companies in the peripheral nations of Europe is even tougher. “The credit market is not functioning right now,” says Guillermo Amann at Ormazabal, a Spanish maker of electrical components. “There is no money. The situation is becoming worse and worse.”

It is a complaint that is being made across Europe and, increasingly, in the rest of the world. Sir Mervyn King, governor of the Bank of England, warned this week of “early signs of a credit crunch, with concerns that it will get worse”. Kiyohiko Nishimura, deputy governor of the Bank of Japan, said he feared a “widespread credit crunch”. ANZ, one of Australia’s biggest banks, observed that the “credit crunch in Europe is spreading to Asia and it will spread here too”. The Organisation for Economic Co-operation and Development and the World Bank have likewise each uttered the C-words.

The victims of the squeeze have two big questions: why is this happening and how can we escape it? “We are looking out of the window and see what happens outside and it scares us,” says Flavio Radice, chief executive of Pietro Carnaghi, a successful Italian toolmaker. “What is incredible to see is that banks created the entire problem but they are now imposing it on the real economy.”

Banks are the traditional suppliers of credit – to governments whose debt they hoover up; to rivals through interbank lending; to companies, from sole traders to corporate behemoths; and to individuals. Banks provide the oil needed to run the economic machine; without that lubrication the machine seizes up. But to carry out that role, the banks themselves need money. And that is where the whole model is breaking down.

For a start, banks – traditionally among the biggest investors in government bonds – have been weakened by the eurozone’s worsening sovereign debt crisis. As they hoard capital in response, credit is rapidly becoming both scarcer and more expensive. And if banks can no longer fund the demand for loans in the world, the threatened recession in the eurozone is likely to be deeper, longer and more liable to spread around the globe.

By Wednesday, five of the world’s most powerful central banks, in the US, Canada, Britain, the eurozone and Switzerland, announced emergency action to ease banks’ access to funds. It was the second liquidity intervention of its kind in as many months.

As fears over the integrity of the eurozone have deepened, European banks have found it expensive, difficult or in some cases impossible to raise funding in the bond markets. So far they have covered barely two-thirds of the amount of outstanding funding that falls due in 2011. For most banks, the bond markets have been closed for months.

Supplies in the form of deposits from customers are also scarce. Banks in the peripheral nations of the eurozone are frantically competing for the funds of stretched savers – in Spain, they are typically paying 4 per cent interest rates to attract deposits, compared with the ultra-low 1.25 per cent European Central Bank base rate.

The few banks that have plenty of money are holding on to it, or depositing it with super-safe institutions such as the US Federal Reserve or the ECB. That means the third key mechanism for bank funding – interbank lending – is also drying up. According to data compiled by the Bank for International Settlements, which monitors global finance, interbank lending fell in the three months to June for the first time since the 2008-09 crisis. Bankers expect the three months to September to show a far sharper fall. HSBC, one of the world’s biggest suppliers of excess funding to rivals, shrank its interbank lending to financial institutions in the eurozone periphery by 40 per cent over the third quarter. Another jitter indicator – the so-called Euribor-OIS spread, showing how much Europe’s banks have to pay to borrow from rivals – has soared by one-third this year, heading back towards 2008 highs.

The nervousness surrounding many European banks is rooted in fears about losses they face, particularly on their sovereign debt holdings. Bankers recognise the concerns but complain that the effect is being compounded by regulators’ insistence that the banks should meet tough new capital ratios. The European Banking Authority, which oversees bank regulators across the continent, has identified a total €106bn ($143bn) gap at 70 banks that it stress-tested for their exposure to eurozone sovereign debt. Rather than raise fresh capital in turbulent equity markets to bridge that gap, many are opting instead to shrink their balance sheets and comply with the capital ratios that way.
. . .
It gets grimmer. As expectations of recession cloud profit forecasts, a further route to capital accumulation for businesses – holding on to earnings instead of paying big dividends – looks less likely, warns Simon Samuels of Barclays Capital. Banks could end up shrinking their balance sheets by as much as €3,000bn, or 10 per cent, he says, in order to hit those capital targets.
“The EBA are idiots,” splutters the chairman of one big European bank. “They are causing the credit crunch.”

Certain areas of banking are being shrunk more aggressively than others – businesses that consume a lot of capital but are relatively low in profit are the obvious candidates. So lenders from Royal Bank of Scotland in the UK to France’s BNP and Société Générale to the troubled German Landesbanken are currently hawking books of aircraft, shipping and infrastructure finance. This form of “deleveraging”, some believe, should be of little concern. “Deleveraging doesn’t have to mean a disastrous contract of the credit supply,” says one UK bank boss. “Japanese and Chinese banks are bidding enthusiastically for some assets, particularly aircraft leasing.” In other words, the business will still be done, just by a different lender.

Trade finance is another area that some banks, notably the French, are retreating from – much to the concern of economists fearful that global business flows could be horribly disrupted. “Trade finance is the shortest exposure in any book of business. It’s always the business that banks have the most flexibility to pull back on,” says Karen Fawcett of Standard Chartered. But here, too, better capitalised groups, such as StanChart, HSBC and Citigroup are keen to fill the gap.

Other areas of credit provision, however, do appear to be in unstoppable decline – most noticeably funding of small and medium-sized enterprises, which demands high regulatory capital levels and can be risky, especially in a recession. At the other extreme, large-scale transactions in leveraged or acquisition finance are finding few willing backers. In some markets, consumer and mortgage finance is also in short supply.
. . .
Worst of all is the risk of global contagion. “To assume this [crisis] is confined to Europe would be a mistake,” says Paul Casson at Henderson Global Investors.

Regionally, the greatest concern is over eastern Europe. The reason is simple. Banking there is highly reliant on western European financial groups – most countries have only one significant independent bank left. Nearly three-quarters of lending depends on parent entities in Austria, Italy, France, Portugal, Spain and Greece – many stretched by the crisis. “You’re facing a credit crunch [almost] across the region,” says Magdalena Stoklosa of Morgan Stanley.

Latin America is also at risk. As the woes of Spain’s banks deepen, analysts question their ability to fuel growth at their Latin outposts. Already Santander, which controls swaths of that region’s banking system, has signalled its intention to free up capital by floating off a chunk of its Chilean subsidiary. Asian banks, too, are conscious of the dangers. China, Hong Kong, Singapore, Indonesia – the biggest financial economies of Asia – are all braced for a repeat of 2008, when the collapse of Lehman Brothers in New York pushed much of their own region towards recession.

The US, too, is showing increased concern about the feedback loop from the eurozone. A drying up of the liquidity flow from US money market funds to French banks prompted both BNP and SocGen to signal a pullback from US exposures – the kind of move that in turn lay behind this week’s central bank dollar intervention, say bankers, as Fed officials grew nervous about the impact of hasty deleveraging on the American economy.

Globally, however, some such as Bill O’Neill at Merrill Lynch Wealth Management believe the broad picture for corporate funding is nowhere near as bleak as it might be. Many companies have substantial buffers of funding accumulated over recent years and others have no desire to borrow amid the bleak outlook, he notes. Or as David Haines, chief executive of Grohe, the German tap maker, puts it: “The best way of financing yourself is through excellent cash management.”

For those that do need finance, there is a clear differentiation based on both size and location. Large companies find it easier to bypass banks and get their financing from the corporate bond markets. But issuance from top-rated companies has been lacklustre. The situation is trickiest for companies in the troubled eurozone periphery because high interest rates for governments feed through to corporate funding costs – either via bank borrowing or corporate bond costs. Barclays Capital estimates that for every 1 percentage point rise in the cost of borrowing for a sovereign, corporate bond costs rise by 0.6 point.
The problem is most acute for smaller companies, which in Europe are almost totally dependent on banks for funding. So concerned is the UK government that it launched this week a £20bn initiative to guarantee bank bonds issued to finance SME lending, aping German and French schemes.

But bankers still hope a proper alternative can be found. “Maybe some good can come out of the eurozone crisis,” says Michel Pébereau, former chairman of BNP Paribas. “Maybe European companies, even small ones, can become more like their American counterparts.” There, 80 per cent of companies finance themselves via the capital markets rather than the old-fashioned bank borrowing used by 80 per cent of European companies.

The bakers at Wiener Feinbäcker – one-third of their way towards their target of raising €12m from the customer bond issue – might just be showing European companies one way out of the credit crunch.

Gov'ts are looking at it's super or pension funds as a source of cheap revenue, had to happen.

Sovereign Man
Notes from the Field

Date: December 5, 2011
Reporting From: Santiago, Chile

Say what you want about him, but Bernie Madoff was a guy who knew how to keep the party going. For years, he ran one of the largest private-sector Ponzi schemes in history and always heeded the golden rule of financial scams: make sure your inflows are greater than your outflows.

He was finally done in when redemptions exceeded new investments. He didn't have enough cash to pay out investors, and he wasn't able to scam more people into paying in to the scheme. As a result, Madoff finally had to admit that the whole thing was a total fraud.

Governments around the world are in similar situations right now with their own public sector Ponzi schemes. Faced with failed auctions, declining demand, and rising yields, politicians are having to resort to desperate measures.

Like any good scam artist, they're appealing to the masses first; all over Europe, governments are sponsoring new marketing campaigns suggesting that it's people's patriotic duty to buy government debt.

In Spain, they're actually issuing instruments called 'Bonos Patrioticos,' or 'patriotic bonds.' Ad campaigns say that the bonds are "good for you, good for the future."

In Ireland, they've issued "Prize Bonds" which carry a 0% interest rate; instead of receiving interest, bondholders are entered into a weekly lottery contest. Naturally, lottery winnings are only possible as long as people keep buying the bonds... pretty much the definition of a Ponzi scheme!

In Italy, they're rolling out the country's sports celebrities to encourage everyone to buy Italian sovereign debt.

What's ironic is that Italy's dismal balance sheet is almost universally acknowledged. It's as if everyone knows the country has almost no chance of making good on its obligations, but they still feel the need to willingly throw away their hard earned savings for the greater good of political incompetence.

Thing is, it's not the millionaire sports stars, wealthy business leaders, or political elite who are buying these bonds... at least, not in anything beyond a token, symbolic amount. It's the average guy on the street who really stands to get hurt when the government finally capitulates.

This is a truly despicable act and amounts to theft, plain and simple.

The United Kingdom, which is rapidly reaching this banana republic sovereign debt status itself, has unveiled a plan to issue roughly $50 billion in infrastructure bonds. This would be the equivalent of issuing $300 billion in the US-- not exactly chump change.

Given Britain's already colossal debt level, private investors aren't exact diving in head first to loan the government even more money.

Undeterred, British Chancellor George Osborne plans to 'highly encourage' UK pension funds to mop up about 60% of the total amount. "We have got to make sure that British savings in things like pension funds are employed here and British taxpayers' money is well used," he said.

In other words, 'we are going to make sure that British people buy our junk, one way or another.'

The last year has seen numerous pension funds around the world, from the United States to Argentina to Hungary, be raided for the sake of keeping these Ponzi scheme going. The UK is already lining up to be the next.

It's one of the last acts of a truly desperate government to begin directing public and private savings into their Ponzi schemes.

Fast-forward a few downgrades and you can plan on seeing the exact same thing in the United States-- appealing to people's patriotism to loan their hard-earned savings (if they even have any) to the Federal government at a rate of interest that fails to keep up with inflation.

It's nothing more than a very clever (and subtle) form of theft.


Until tomorrow,

Simon Black
Senior Editor, SovereignMan.com

Govts in trouble have rarely been able to resist the honeypot that accummulated private pension funds represents - Argentina and Hungry are two recent examples that come to mind.... future candidates that quickly come to mind include many of the European nations as well as Japan.

There is only one way in which I can express this. Fools. Totally greedy, stupid fools. Completely lacking in anything remotely resembling a moral compass.

Another crack in a rotten system
December 17, 2011

It's the season for gongs, those cheesy "best and worst of the year that was" wrap-ups. Worse even than gongs, a rash of the dreary "what the year ahead holds" stories is upon us.

Never fear, let us save you the effort. Here is what the pundits will say: challenges lie ahead, we are cautiously optimistic, we forecast equities to rise by 10 per cent in 2012. Bank it.

Top down, bottom up, name your methodology, they'll get there. Year in, year out, any big-city economist, strategist, or anything "ist", will tell you: "up 10 per cent, difficult environment, cautiously optimistic".

You can bet on that, but unless you are too big to fail, you can't bet on the market without risk.

Take Jon Corzine. Corzine has just found out he is not quite big enough to elude failure. His broking firm MF Global took a hairy-chested $US6.3 billion punt on European bonds - a bet more than five times the book value of the firm - and blew up. Worse, MF had gambled $US1.2 billion of its clients' funds, funds that were supposed to be in segregated accounts, sacrosanct.

And so it was that markets were perturbed again this week, and not just by the usual boondoggling in Europe. Yes, there was the spectre of deflation anew, which hurt asset prices. Speculators even took the long-handle to gold. But there was also Jon Corzine and the latest bogey-word - "re-hypothecation" - which shook the confidence of the trading cognoscenti.

Hypothecation is when borrower pledges capital. Re-hypothecation happens when a broker or a bank redeploys assets pledged as collateral by customers for its own borrowing. The risk is that somebody else controls those assets in the event of default.

So markets were spooked. Why didn't you tell me about this loophole in international brokerage borrowing rules? Are my funds safe? How about my counterparty's counterparties? What if I have been re-re-hypothecated? If they can pledge the money in my account to somebody else in cross-border mega-punt … get me out!

Corzine, a former chairman of Goldman Sachs and Democrat Senator, was ducking and weaving last night as Republicans went for his jugular for staying at the Ritz Carlton in Washington despite the vanishing of his clients' funds.

It was just another show trial on Capitol Hill. For all the corruption and the trillions of dollars lost in the past four years there is yet to be a "perp-walk".

Same deal here. Babcock, Allco, MFS, ABC, Rubicon. Nary a bad word or a slap on the wrist.

At least they handcuff them from the front when they perp-walk them stateside. But there has been none of that. And MF Global looks unlikely to be the first. Corzine is, after all, a big Democrat donor. Besides, it only got its dealer's licence from the Federal Reserve earlier this year, one of 22 licences to deal Treasury bonds. And apparently, gearing up client money on the sly and punting it is legal.

Under the Fed's Regulation T and SEC Rule 15c3-3, a prime broker may re-hypothecate assets to the value of 140 per cent of the client's liability to the prime broker.

In Britain, there is no statutory limit on how much you can re-hypothecate. All one needs is an office in London and a brass plaque.

According to Thompson Reuters, thanks to this "asymmetry of rules", by 2007 re-hypothecation had "grown so large that it accounted for half of the activity of the shadow banking system''.

So when you hear that old chestnut from your broker - "there's a lot of cash sitting on the sidelines" - just be mindful of the daisy-chain of financiers who might stake a claim to that "cash".

The International Monetary Fund reckons collateral has been "re-hypothecated to a factor of four".

Nor are Australia's banks quarantined from this staggering leverage. Hyper-hypothecation highlights how little grip regulators have on the complexities of world finance. Be sure that when it comes to our banks, exposure to re-hypothecations will loom large among the host of toxic gremlins lurking off balance sheet. That's the problem, it's all off-balance sheet.

All we know for sure is that, whatever it is, we as taxpayers own it thanks to "too big to fail".

Not to worry, the world will muddle through. The next couple of months may be interesting though. Christmas is traditionally the time for a rally. It happens most years.

This year though, it may be tricky, what with band-aid solutions to the gaping wounds of Europe, marauding hedge funds and possibly the European Central Bank in holiday mode.

Just a thought, but sovereign bonds are vulnerable to attack. Holiday markets are illiquid. No doubt Jon Corzine's old firm, Goldman Sachs can do its bit.

It's latest corporate strategy is to "seed" a bevy of hedge funds with capital. Financed and schooled in the Goldman way - probably heavily re-hypothecated - these evil little mini-me Goldmans are being unleashed on the world, ready to hypothecate all over the place.

For its part, Goldman had hypothecated $US18 billion in capital as of September 2011. It was modest by Wall Street standards, as JP Morgan sold or re-pledged $US410 billion of collateral received under margin loans, derivative transactions, securities borrowed and reverse repurchase agreements.

Read: http://www.smh.com.au/business/another- ... z1gjy3hZ6L

Read another of M.West's articles this morning:

http://www.smh.com.au/business/no-joy-i ... 1p719.html

One line or exercise in connecting the dots that left me somewhat concerned, especially if true:

"Macquarie Group, Australia's biggest investment bank, may be considering the sale of its retail lending business to concentrate on investment banking," said the report, which was met with the requisite "we don't comment on speculation".

"The banking unit, also known as BFS, is one of six key divisions at Macquarie, and accounted for the equivalent of 45 per cent of total profit in the six months ended September 30 and generated about one-third of the group's total funding," the report said.

It was their banking licence that saved them. Under the sovereign guarantees scheme - the detail of which you won't find any more as it has been purged from public data-bases - Macquarie raised nearly $17 billion in wholesale funding.

That cool $17 billion bought breathing space. Macquarie went for long duration funds - five-year paper that is. The three-year paper starts to roll soon. That means the bank has to refinance, likely at a higher rate. It's tough enough on global bond markets for the Big Four.

But how, pray tell, did they splash that $17 billion?

A recent leak to a friendly source gives us a hint: "Macquarie Group has moved to take advantage of deleveraging by competitors in Europe, snapping up a parcel of loans offloaded by the beleaguered Societe Generale."

That last line is perhaps the scariest rumour I have read in any paper for a long while - MFGlobal anyone?

If true it is one scary countercyclical bet, that if it fails, will have profound implications for the Australian economy. With the TED currently hovering near 60pips and the term funding market all but closed for the past 3months, it will only take one slip from one institution to have profound effects on the ability of all remaining Australian institutions to raise offshore term funding. I'm afraid we'll all be tarred with the same brush if the mighty silver donut falls over.

MacBank could well be the canary in the coal mine for the Aust Banks and the Australian housing market - I hope they're merry band of bankers continue chirping for sometime yet - for all our sakes.

David Malone has a 'sort of interesting' blog at http://www.golemxiv.co.uk including the following one on re-hypothecation: (following on from Judd's 17 Dec post in this thread)

http://www.golemxiv.co.uk/2011/12/rumou ... thecation/

for someone who is a documentary film maker he reads OK () - maybe an intermediary for some insider

Interesting article on Demographics

The number of people older than 65 in Brazil, Russia, India and China will rise 46 percent to 295 million by 2020 and to 412 million by 2030, according to United Nations projections. The pool of 15 to 24-year-olds, the mainstay for factories like Liu’s that drove China’s boom for three decades, will fall by 61 million by 2030, about the population of Italy.

As the BRICs slow down, global growth probably will peak at about 4.3 percent this decade and fall to 3.9 percent in the 2020s, according a Dec. 7 report by Goldman analysts. That’s prompting fund managers including Mark Mobius to invest in so- called frontier markets such as Nigeria, Vietnam and Argentina, where average annual growth is set to rise to 5.1 percent this decade, from about 4.3 percent in the previous 10 years.

One of his holdings, Nigeria’s Zenith Bank Plc (ZENITHBA), has risen 11.9 percent in the past two years, while the MSCI Emerging- Markets Index (MXEF) is down 7.4 percent.

Top Ten

Goldman Sachs Asset Management Chairman Jim O’Neill, who coined the BRICs acronym a decade ago, said other emerging economies may now be better investments -- especially Indonesia, Turkey, Egypt and Mexico.

“These four countries could be in the top 10 contributors to global GDP this decade, adding well over $2 trillion,” London-based O’Neill said in an e-mailed response to questions on Dec. 29. “With large young populations, these countries could become powerful growth stories.”....

...more...

http://www.bloomberg.com/news/2012-01-0 ... ation.html

After peaking at close to 60 (thankfullly didn't quite get above that point) the TED spread dropped back below 50pts today - closed at 48.12

http://www.bloomberg.com/quote/!TEDSP:IND

Hopefully if it continues to fall we may see the bond market start to reopen/operate in a more normal fashion, as opposed to the rather extreme examples that we've seen recently in regards to the few issuances that have managed to get away eg the CBA covered bond issuance at 190pts over (or there abouts from memory).

Risk on?

Jonothan Pain's Report is always of interest: Excerpted, on an issue that keeps 'bubbling away'-

...Over the last several months there has been a notable escalation in tension in the Persian Gulf with the European Union announcing on January 23 that it would ban oil imports from Iran, starting July 1, because of concerns the country is developing nuclear weapons. This follows the International Atomic Energy Agency (IAEA) declaration last November that Iran had carried out tests “relevant to the development of a nuclear explosive device.”

So what happens next?
I believe it is now fair to say that the chances of a military conflict, involving Iran in 2012, are no longer possible but probable. As time goes by, the geo-political jigsaw puzzle of potential conflict becomes ever clearer and the latest E.U oil embargo will serve to accelerate the timetable. Unfortunately, the E.U's actions will strengthen, rather than weaken, Ahmadinejad's political base. Students of Iranian history know only too well that Iran has been a victim of international meddling for a very long time and none of us should forget that Iran's only truly democratically elected government, led by Mossadegh, was overthrown by the American and British secret services in 1953. If you throw in Israel, any attack led by an American and British coalition will lead to unimaginable consequences across the region. We also know that Saudi Arabia has been itching for a fight with its arch Shia enemy for some time. Following the Saudi intervention in Bahrain in March 2011, the Saudi- Iranian relationship is at its worst in memory, with the Wahhabi clerical establishment fuelling the anti-Shia flames.

To further complicate an already highly volatile scenario is the reality that Ahmidinejad believes that he is on a mission to facilitate the return of the hidden Imam, following a major showdown between the forces of good and evil. (I urge you to conduct your own research on this subject)

I think it is fair, if not completely obvious, to say that America, Britain and France are doing everything they can to keep Israel out of a potential conflict with Iran. In contrast, Iran is doing everything it can to make this a battle between them and Israel. Everyone knows that Israel claims the right to strike pre-emptively against Iran and will not wait for the arri-val of a nuclear warhead. In recent days Israel's defence minister Ehud Barak, whilst speaking at the World Economic Forum in Davos, has given clear voice to this position: “It seems to us to be urgent, because the Iranians are deliber-ately drifting into what we call an immunity zone where prac-tically no surgical operation could block them.”

The belief, in Israel, that Iran will soon enter what they describe as an "immunity zone‟ suggests that they have a time-table to strike Iran. Clearly Washington, London and Paris are well aware of this and it is the reason, in my view, why the E.U imposed the oil embargo.

Enter the Straits of Hormuz.
In response to the announced oil embargo, Mohammad Kowsari, deputy head of Iran‟s committee on national security, said the Straits “would definitely be closed if the sale of Iranian oil is violated in any way.”

An article in the New York Times, from January 12, tells us what the American response to a closure of the Straits would be. “The Obama administration is relying on a secret channel of communication to warn Iran‟s supreme leader, Ayatollah Ali Khamenei, that closing the Strait of Hormuz is a "red line" that would provoke an American response, according to United States government officials.”

The following extract from the same article provides us with some insight as to what might happen next. “The tight squeeze of the strait, which is less than 35 miles wide at its narrowest point, offers little manoeuvring room for warships. "It would be a knife fight in a phone booth,‟ said a senior Navy officer. The strait's shipping lanes are even narrower: both the inbound and outbound lanes are two miles wide, with only a two-mile wide stretch separating them.” The article continues, “In 2002, a classified, $250 million Defense Department war game concluded that small, agile speedboats swarming a naval convoy could inflict devastat-ing damage on more powerful warships. In that game, the Blue Team navy, representing the United States, lost 16 major warships- an aircraft carrier, cruisers and amphibious vessels- when they were sunk to the bottom of the Persian Gulf in an attack that included swarming tactics by enemy speedboats... the whole thing was over in 5, maybe 10 minutes.”...

I read a very interesting article by PIMCO's Bill Gross over the weekend, but an unfortunate run in with a Norovirus has left me too laid up to consider responding, and coming into work today I've found the article still up on my screen (yes - being a timid bank worker fearful of a job cut I was in at work on Sat trying to curry good favour with the powers that be.... or maybe I was just catching up from work I should have done instead of skiving off to read SG?)

Anyhow the gist of Bill's point in his article was:

zero-bound interest rates do not always and necessarily force investors to take more risk by purchasing stocks or real estate, to cite the classic central bank thesis. 

Essentially as best as I can paraphrase his argument, when short term interest rates are very low, say 0.25% and the rest of the yield curve is particularily flat, eg US10Yrs at 2% (thanks to operation "Twist") and intersting problem develops. Basically rational investors will chose to simply park their money and prefer to earn ST interest at 0.25% and be guarranteed to get their money back, than risk investing in the LT, with at best the possibility of a couple more points of upside, all the while being exposed to massive amounts of downside duration risk, if interest rates merely move from 2% back to a more normal level for 10yrs of around 3.5 - 5%. Consequently the effect of zero interest rates is to suck forward investment funds, in terms of where people choose to place they funds, ie what would have otherwise been invested LT into the ST.

Why is this a problem? Banks are basically the transmission mechanism from the monetary policies of the central banks into the real economy, so just as investors become reluctant to invest in LT govt bonds, they suddenly become much more reluctant to invest in LT bank bonds (while text books classically defined banks as serving an intermidiatary role, of borrowing short and lending long, the outcome of the GFC has revealed the reality much more complex, banks have a combination of borrowing horizons, ranging from overnight, out to a 5 or 7 year bond, and heaven help any bank too reliant upon ST funding).

Basically the implication of Bill's viewpoint is that zero bound interest rates, are unlikely to cure credit crisis, infact they may accentuate the problem by making the risk reward pay off for investors choosing to invest LT less desireable, and then transmit that through to the banks, who are unable to source LT funding (or pay a much higher price for it) and then ultimately restrict LT credit to the wider economy, despite the appearance of massive amounts of liquidity being pumped into the system by central banks.... explaining the cunundrum of why all the central bank funds ultimately get parked back at the central bank earning 0.25% instead of being onlent into the wider economy.

Anyhow, the more interesting part of Bill's article is attached below:

When all yields approach the zero-bound, however, as in Japan for the past 10 years, and now in the US and selected “clean dirty shirt” sovereigns, then the dynamics may change. Money can become less liquid and frozen by “price” in addition to the classic liquidity trap explained by “risk.”
 
Even if nodding in agreement, an observer might immediately comment that today’s yield curve is anything butflat and that might be true. Most short to intermediate Treasury yields, however, are dangerously close to the zero-bound which imply little if any room to fall: no margin, no air underneath those bond yields and therefore limited, if any, price appreciation. What incentive does a bank have to buy two-year Treasuries at 20 basis points when they can park overnight reserves with the Fed at 25? What incentives do investment managers or even individual investors have to take price risk with a five-, 10- or 30-year Treasury when there are multiples of downside price risk compared to appreciation? At 75 basis points, a five-year Treasury can only rationally appreciate by two more points, but theoretically can go down by an unlimited amount. Duration risk and flatness at the zero-bound, to make the simple point, can freeze and trap liquidity by convincing investors to hold cash as opposed to extend credit. 

Where else can one go, however? We can’t put $100 trillion of credit in a system-wide mattress, can we? Of course not, but we can move in that direction by delevering and refusing to extend maturities and duration. Recent central bank behaviour, including that of the US Fed, provides assurances that short and intermediate yields will not change, and therefore bond prices are not likely threatened on the downside. Still, zero-bound money may kill as opposed to create credit. Developed economies where these low yields reside may suffer accordingly. It may as well, induce inflationary distortions that give a rise to commodities and gold as store of value alternatives when there is little value left in paper. 

Where does credit go when it dies? It goes back to where it came from. It delevers, it slows and inhibits economic growth, and it turns economic theory upside down, ultimately challenging the wisdom of policymakers. We’ll all be making this up as we go along for what may seem like an eternity. A 30-50 year virtuous cycle of credit expansion which has produced outsize paranormal returns for financial assets – bonds, stocks, real estate and commodities alike – is now delevering because of excessive “risk” and the “price” of money at the zero-bound. We are witnessing the death of abundance and the borning of austerity, for what may be a long, long time.

http://www.businessspectator.com.au/bs. ... commentary

Hi Guys,

New to the forum and finding the posts really useful. I just came across an article stating insider selling has been at its highest in recent times. Sometime in future market may pull back 4-6%.

http://www.marketwatch.com/story/the-in ... 2012-02-09