Thursday, May 28, 2009

PPIP and the Ever-Steepening Yield Curve

Not two months after it was announced with much fanfare, the “Legacy Loan” portion of the PPIP looks DOA, due to lack of interest. The funny thing is that yesterday, an article appeared in the WSJ claiming that banks were jockeying to buy their own toxic assets to move them into off-balance sheet partnerships, complete with government supplied leverage. Sheila Bair wisely put the kibosh on that idea. For one thing, mysterious off-balance sheet partnerships were a big part of the problem (SIV’s anyone?) For another, merely shuffling assets around from one subsidiary to another was never the intention of the PPIP. The PPIP was supposed to provide transparency in pricing. It was supposed to tell us what all of this crap was really worth. How’s that going to happen if banks are buying the assets from themselves with the government just providing leverage to banks that have already received capital injections? In any event, after much furor in the blogosphere, Ms. Bair put her foot down with a resounding “That’s not gonna happen! Now if you’ll excuse me, I have some more loss-guarantees I must work out with some private equity funds.” Ms. Bair hinted that not enough interest, other than that from banks wanting to buy their own assets at inflated prices, was evident to go ahead with the legacy loan plan, which makes me fairly happy because I hated the idea to begin with.

Speaking of government plans gone awry, anyone notice the complete and utter bludgeoning of mortgages and treasuries yesterday? Poor Bernanke, this quantitative easing business is not quite as easy as he thought it would be. The problem with the idea of the Fed buying treasuries to drive down mortgage rates is one simply of supply versus demand. While it may seem like the Fed is buying a lot of treasuries, it is nothing compared to amount of treasuries that the Treasury has to issue to finance our ballooning deficits. So rates go higher. I mentioned earlier in the year that one of the big issues tugging at the market would be the question of deflation vs inflation. Is all of the fiscal and monetary stimulus being heaved at the economy going to cause run away inflation, or is the continuing deleveraging of the financial sector going to cause a deflationary spiral? My answer is that we get deflation first, and then inflation later, which is perhaps what bond investors are betting on right now, as the yield curve is very steep. Declining home prices, fabulous sales on consumer goods, and auctions of downsizer’s valuables are clear signs of deflation. But once the economy turns, which admittedly might not be for awhile, who knows if the Fed will be able to pull back the spigot fast enough to avoid an inflationary spiral?

1 comment:

Mr Wrightwood said...

Historically, a steep yield curve has very consistently portended economic growth, so we've got that going for us. Which is nice.