December 20, 2023 | Merry Christmas and a safe and happy New Year to all of our readers. Please note our holiday sale through 12/31/2023. We’ll be publishing an update on Citigroup (C) and some other developments later this week for subscribers to our Premium Service.
Below is a link to Jaquie Lawson greetings, one of our favorite vendors. As you enjoy the year-end holiday at home with your family and friends, ponder this: Are you the big dog or the little dog? Remember those who have the least.
The past year was challenging for many people in the world of finance and credit, but 2024 may be even more problematic. The tidal wave of irrational progressive politics seems to be ebbing in favor of a more realistic and informed view.
Could it be that the soaring number of bankruptcies may have something to do with this more sober perspective? Or perhaps still positive home price inflation? Poor results at the last several auctions of U.S. Treasury debt is another case in point.
Q: How many 10-year notes do you suppose Treasury Secretary Janet Yellen can sell at 4% yield come January 2024? Think about that all you risk managers. Below we juxtapose the assets of the FOMC vs the VIX index. Do you suppose the FOMC is selling VIX contracts?
VIX vs SOMA
There has been a lot of debate recently about the state of the REIT market, both commercial and residential. The residential sector is generally unremarkable, but resi REITs are trading at a discount to the managers. Given the havoc in the commercial real estate sector, we'd say that commercial REITs are camped out at ground zero for 2024. By no coincidence, Nom de Plumber wrote to us in a touching pre-Christmas note:
"When a private REIT redeems some investors at its “stated” NAV, any overmark within that NAV gets stuffed to the remaining investors. Magically, perhaps via Myth, the Blackstone and Starwood non-traded REITs have performed far better then publicly traded REITs, in terms of reported share prices, despite both REIT types owning comparable commercial real estate, especially office buildings."
Many participants in the equity markets are chewing on ski tips this holiday season, this after boldly predicting lower interest rates in Q1 of 2024. In the world of credit, however, risk professionals and allied counsel are preparing for battle. We look for more defaults in the world of nonbank finance in the New Year. If as we suspect the FOMC does not cut short-term interest rates until 2025, we think a couple of issuers in nonbank land may roll over.
Consider the big picture. The Powell Fed is imposing interest rate discipline on an economy that is heavily over-levered and sports a rate mismatch (aka "under water") of 5-6 points between average coupon rates and funding. The time of endless cash enjoyed is now replaced by an era of constraint, symbolized by the mounting public debt of the major industrial nations. Both Joe Biden and Xi Jinping lead nations up to their gills in debt and neither has a plan beyond more of the same.
As we noted in our last issue, the question is not how low inflation must go to satisfy the requirements of Fed Chairman Jerome Powell and the other members of the FOMC. In the near-term, the answer is at or below 2% for some period of time. The real question to us, though, is how high must inflation be over the longer-term to keep the US and other major industrial nations from defaulting on their debt.
Most of the debt issuance by the US and other industrial nations is merely to refinance existing IOUs for yesterday’s spending. This debt is a dead weight on future economic growth and will eventually be repudiated to some extent, mostly via inflation. That may sound pretty dire, but the US situation is manageable. And we'd rather have the US portfolio than China any day.
Professor Brad DeLong writes in The International Economy about the end of what he calls the Second Gilded Age:
“Some of us are more optimistic than others about the future. We optimists recognize that it is still possible to escape from the traps that America’s Second Gilded Age has laid. During a gilded age, productive capabilities are direct-led away from providing most people with necessities and conveniences, and toward exorbitant spending on status-seeking and other worthless activities... What is the case for optimism? For starters, it is worth remembering that the United States did eventually emerge from the original Gilded Age in the late nineteenth century, and it did so by embracing immigration, expertise, and shared interests—the basis of the American Century that followed.”
Of course there is constructive progressive reform and then there is destructive progressive socialism. A big part of the fiscal and economic problems facing the US comes from the plunge into debt fueled politics since the 2008 financial crisis. Progressive socialism, fueled by zero interest rate policies by the FOMC, encouraged a vast accumulation of public debt long before COVID. This debt is now a serious drag on the economy and private borrowers. Crowding out returns as a public policy issue.
At the same time, new layers of regulation have been added to the mix, slowing growth and stiffling market liquidity. We'll be posting our written comments on the Basel III Endgame proposal early in the New Year. Read our latest column in National Mortgage News on the appalling state of the mortgage market after three years of progressive chaos. Budget deficits have actually led the Biden Administration to propose cuts in funding for Ginnie Mae and the FHA.
Down the road not so far, the FOMC may eventually be forced to run the economy “hot” in terms of inflation – think mid-single digits – just to keep the swollen Treasury market liquid and asset prices stable. Double digit long bond yields anyone??
Imagine a political environment where unemployment is not a problem -- everyone must work -- but real wages are falling so rapidly that it becomes the most pressing domestic political issue. The heavily indebted progressive state is powerless to respond. Think Argentina, which is now at an effective exchange rate 1,000 pesos per $1.
Notice that the folks at FRED cannot keep up with the rate of depreciation of the peso since the election of President Javier Gerardo Milei, an academic economist who wants to dollarize Argentina’s economy. While he does not have the power to declare dollarization outright, Milei is going to talk the peso down until all of his citizens flee into dollars. Memo to Powell: Better schedule more pallets of dollars for the next flight to BA.
Let’s hope that the New Year brings a change in government in Washington and with it a more serious appreciation for some of the risks facing the US economy and the global financial system. Even if the FOMC were to drop short-term interest rates 100bp tomorrow, it would not have much impact on the direction of commercial credit losses in 2024. When you see that the FDIC's Receivership was only able to sell single-digit stakes in the rent controlled assets of the former Signature Bank, that tells you all you need to know about the state of money and credit in the final ridiculous year of the Biden Administration.
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