Benson's Economic
& Market Trends
The Fed
Loves Power and Creating Profits for Finance Companies
Richard Benson
March 15, 2004
Last month
when the Federal Reserve's Monetary Policy Report to the Congress
was presented by the Fed Chairman, Alan Greenspan, in my view
he made the goals of his legacy crystal clear: For the core business
of Wall Street, investment banking and banking (the "carry
trade"), he wants to be remembered in the Hall of Fame for
having made the finance business the greatest profits in the
history of our nation.
The carry trade, for those who are not Wall Street insiders,
is the business of borrowing short and lending long. This business
is executed by institutions that have access to borrowing directly
at the Fed funds rate, or the ability to borrow by using security
Repurchase Agreements ("REPO"), most commonly using
U.S. Treasury, mortgage-backed, asset-backed, and GSE securities.
The carry trade has created the United States finance economy,
and about 30% of all profits for S&P companies come from
financing activities.
The business of borrowing short and lending long has allowed
the unprecedented increase in mortgage and consumer borrowing.
This has been used by the Fed Chairman to pump up housing prices
45% in the past 4 years so that they can claim household net
worth, at $44 Trillion, is the greatest it has ever been.
What has the Chairman actually said and exactly what is it that
he wants to accomplish? First, in his speech to the New York
Economic Association, he stated that at some point interest rates
in the United States will rise. Certainly, Wall Street firms
and bank hedge funds engaged in the carry trade care more about
a rise in long-term interest rates, than a rise in short-term
interest rates. A rise in long-term interest rates can quickly
wipe out not only a year's worth of carry profit, but it can
wipe out a financial institution's capital (the carry trade offers
leverage of over 20 to 1). Currently, Fed funds are locked at
1 percent, and the 10-year Treasury note is locked around 3.7
- 4 percent, which offers about a 3 percent carry profit. If
short-term rates only went up one-half percent, or 50 basis points,
the carry profit would still look okay, unless long-term interest
rates rose.
Last year the Fed was talking about fighting deflation by pegging
long-term interest rates. Talk was turned into action by cutting
deals with the central banks in Japan and China to do just this.
Japan and China currently "peg" the 10-year note yield
by buying incredible volumes of United States Treasuries. (Japan,
China, and other Asian central banks are flooding their markets
with new money. This holds the value of their currencies down
while these Asian central banks finance the U.S. budget and trade
deficits. In return, Asia gets the new factories and new jobs.)
This financing of our trade and budget deficits by foreign central
banks is the only reason the U.S. carry trade has not collapsed.
The Bush Administration is getting nervous that unless Japan
and China revalue their currencies up, we will have virtually
no growth before the November Presidential election. For President
Bush, this is very bad. However, Greenspan has just said that
while Japanese intervention at some point will be problematic,
that time is not now. Moreover, Greenspan has also indicated
that it would be unwise for China to revalue now because money
might flee China. While neither statement on face value is credible,
what is obvious is that the only reason the carry trade has not
"blown up" is because of Japan and China "pegging
the 10-year Treasury" and if they were forced to revalue,
they would stop buying U.S. Treasuries. Since our country has
no savings and a $550 billion government deficit to finance,
when Asia stops buying, our mortgage market will no longer be
able to finance equity extraction from homes. Moreover, since
wages and salaries are growing at less than the inflation rate,
home equity extraction is the only source of unending cash to
the U.S. consumer. If the consumer stops spending, not only would
it mean that George Bush might not be elected President in November,
but the whole world might enter recession. America is the buyer
of last resort.
In short, while a devaluation of the dollar against Japan and
China sounds good, when that event comes it will bring a spike
in long-term interest rates. A sharp rise in long-term interest
rates will destroy the financial firms in the carry trade who
have not yet sold their Treasuries and Agency securities to the
Asian central banks. When the carry trade shuts down, our mortgage
market will shut down, and we, as consumers, will have to cut
our spending. This event will certainly be called a recession!
To keep our economy rolling, Alan Greenspan now has only one
hope - he must bring the U.S. housing price bubble to even more
ridiculous heights with more free money from the mortgage market.
(Why else would his friends at the Japanese central bank drive
the 10-year Treasury note yield to 3.7% in the past few weeks?)
In order to serve this "greater good" and help
the current President earn a second term, the Fed Chairman has
extraordinary advice for the homeowner; to run (not walk) and
get a variable-rate mortgage today because it offers a lower
monthly payment. A lower monthly payment will, of course,
mean the consumer will: 1) have more after tax money to spend;
2) be able to afford a more expensive house; and 3) take more
money out of their home. What a guy! On one hand, Greenspan is
warning financial institutions in the carry trade that interest
rates will go up, and on the other hand he is telling consumers
they will pay less interest if they get a variable rate mortgage!
At present, 25% of home mortgages have variable rates. If interest
rates rise, those with variable rates will obviously pay higher
interest while the remaining 75%, with fixed rate mortgages,
won't suffer at all (you may recall when fixed-rate mortgages
virtually wiped out the thrift industry when the previous Fed
Chairman was fighting inflation).
The banking industry, and other players in the carry trade, would
love it if all mortgages were a variable rate. If the lenders
get to "borrow short and lend short" they can lock
in a profitable interest rate spread without any interest rate
risk. The lender doesn't lose if interest rates go up because
he still earns his spread or "carry". Indeed, since
Alan Greenspan's real constituency are the banks, hedge funds
and Wall Street investment banks, it's understandable that he
would want all homeowners to have a variable interest rate mortgage
because they help the banks make money when interest rates are
low, and high!
The Fed's problem, as it brings inflation and rising interest
rates back, is the homeowner with a fixed rate mortgage. When
interest rates go up, that homeowner may not curtail his spending
on other things. Worse yet, when inflation picks up, that same
homeowner will receive a big windfall because his low monthly
payment of fixed rate debt will be virtually forgiven. Meanwhile,
the banks and pension funds owning those low coupon FNMA securities
will be pulverized. Naturally, this state of affairs will make
even a 78-year old central banker enraged. If only fixed rate
mortgages were outlawed!
If I were a major player in the carry trade, I would be using
the central bank buying by Japan and China to get out of all
positions by the end of the summer. When China and Japan float,
you can kiss the carry trade good-bye.
As a consumer, I would listen to the Fed Chairman urging me to
get a variable rate mortgage. I would then turn around and run
the other way and immediately lock in the lowest long-term interest
rate we have seen in 46 years (and may never see again in our
lifetime)! Remember, this is a Fed Chairman dedicated to giving
savers an interest rate below the rate of inflation and looking
for ways to encourage consumers to borrow and become debt slaves
to the banks and Wall Street. The best investment for the average
American remains paying off debt, not taking on new debt!
Richard Benson
President
Specialty
Finance Group, LLC
Member NASD/SIPC
2505 S. Ocean Boulevard
- Suite 212
Palm Beach, Florida 33480
1 800-860-2907
eMail: rbenson@sfgroup.org
______________
321gold Inc
|
