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Saturday, November 15, 2008


bund auction failure

yves smith of naked capitalism pens a comprehensive missive regarding the failures of western government responses to triage and delever their financial sectors -- in an attempt to avert growth contraction -- preferring instead to attempt to transfer balance sheet risk without contraction onto government balance sheets.

the result has been rising creditworthiness concerns regarding western governments. willem buiter:

To be solvent, the face value of the government’s net financial obligations has to be no larger than the present discounted value of current and future primary government surpluses (government surpluses excluding net interest and other investment income)....

With the true net public debt to GDP ratio probably already well above 100 percent of GDP and rising, and with massive public sector deficits, partly cyclical and partly structural, about to materialise, the markets will question the fiscal-financial sustainability of the government’s programme with increasing vehemence. The CDS spreads on UK public debt will start rising. The notion that, except for currency, there may not be a safe sterling-denominated asset may come as a shock. But the same is true in the US. In 2009, the US government will have to sell (gross) at least $ 2 trillion worth of government debt (the sum of the Federal deficit plus asset purchases plus refinancing of maturing debt). The largest such figure ever in the past was $550 billion. In the US too, the markets will have to learn to do without a US dollar financial instrument that is free of default risk.

what's more, this is not an issue for the distant future. via yves, the financial times.

A German 10-year bond auction failed – something more or less unheard of until this year – as cash-strapped banks and investors snubbed the government offering.

It is a clear sign of straitened times when a benchmark bond in one of the most liquid markets in the world cannot attract enough bids to reach its target amount.

Crucially, it raises serious doubts about whether governments can raise the vast amounts of debt needed to fund fiscal stimulus packages and bank recapitalisations in the current tough market conditions.

Any sign of waning demand may force up bond yields – putting further pressure on public finances when they are already under strain.

... Germany – in spite of its fourth 10-year Bund failure this year – and the US are likely to be more successful in attracting investors and depressing yields, should the difficult conditions persist, than other countries as they have the most liquid markets and are seen as safe havens...

Another problem for the governments is the competition from banks and financial institutions, which have sovereign guarantees yet offer much higher yields.

For example, this week the UK’s Nationwide priced a three-year deal at close to 100 basis points over gilts.

“The simplistic question is, why buy government paper when you can buy government-backed paper such as this for a much greater return?,” says Sean Shepley, fixed income strategist at Credit Suisse.

the implications for the united states?

Nowhere is the issue more pressing than in the US.

Tony Crescenzi, strategist at Miller Tabak, says: “In a world with finite capital and where sovereign nations everywhere are in need of capital to finance their financial and economic stabilisation efforts, the substantial increase in Treasury supply could become manifested in higher long-term interest rates.”

yesterday john jansen monitored the 30-year auction. as he later noted, "the Treasury held a 30 year bond auction and nobody showed up for the party."

with the potential for rising "risk-free" yields at the first sign of equity market stabilization, we could be entering what will perhaps be the most damaging phase of the crisis of western economies.

it's long been held as orthodoxy that the the primary "policy error" of the great depression was the unwillingness of governments to assume sufficient responsibility in shouldering the burdens of private overindebtedness.

and yet, some would characterize the actions of the governments of the early 1930s as building a firewall between government and the private sector -- assuring that there would in the aftermath that there would be a government to pick up the pieces and start again.

the current cast of characters -- faced with a level of systemic indebtedness which dwarfs all precedent -- have thusfar chosen specifically to risk what their forebears did not see fit to. and what a wager it is, with the health and welfare of the leading national governments and currencies that represent the west in the balance -- and the example of failure looming in the shadows.

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