Bond Yields can stay low - for decades?

[craigr]

My question is: How well would the PP have performed if we repeated that 89% stock market drop in the 1930's?   It doesn't take being under a gold standard to have a Great Deflation.

Hard to say. Nominally the allocation is 25% to stocks. So whatever -89% of 25% would be in theory (assuming no other assets went up to offset the losses - or maybe dropped as well).

But a deflation like that would make the bonds skyrocket and cash buy more. So in terms of real purchasing power the impact to the portfolio could be likely negated to a large degree.

[stone]

Machine Ghost:

My question is: How well would the PP have performed if we repeated that 89% stock market drop in the 1930's?  It doesn't take being under a gold standard to have a Great Deflation.

Surely there isn't a snow ball's chance in hell that the put options that Hussman relies on would have been honoured had things gone all 1930s. It would be a fat lot of good having a bunch of put options that supposidly were worth 100x what you paid for them EXCEPT that the counter-parties are all long bankcrupt and so  those put options are in fact entirely worthless.
Hussman quite rightly in my opinion says that it was wrong for the government to have bailed out the bank bond holders. However his strategy is entirely reliant on the "too big to fail philosophy" when it comes to financial derivative counter-parties.
IMO the PP assets seem much better placed to weather an utter collapse of the banking system. I think Clive once posted something showing that rebalancing into the midst of that 1930s 89% stock market drop would not have been as calamitous as might be supposed. It was punctuated by a stockmarket doubling and so a PP would have rebalanced into stocks, then out of them, then back in.

[dualstow]

I think the Hussman approach is that he is correct and the market is wrong  .

haha. Sounds like Rick Ferri on gold.

[Ad Orientem]

I think the Hussman approach is that he is correct and the market is wrong  .

haha. Sounds like Rick Ferri on gold.

LOL

[Pointedstick]

Bond yields staying low for decades seems like it's on the horizon what with the Fed's announcement to keep interest rates down for another few years. As crazy as it seems to be piling into bonds when the yields are this low, I think the writing is on the wall.

[Reub]

What does it mean that the fed will be purchasing mortgage backed securities instead of treasuries with QE3?

[moda0306]

What does it mean that the fed will be purchasing mortgage backed securities instead of treasuries with QE3?

According to my super-computer quantum-analysis... banks get richer.

[Ad Orientem]

What does it mean that the fed will be purchasing mortgage backed securities instead of treasuries with QE3?

According to my super-computer quantum-analysis... banks get richer.

I think that is a major part of this. The FED seems to be trying to do a few things all at once...

1. Strengthen the banks who are still dangerously exposed to MBS which are heavily overvalued.
2. Bypass the government bottleneck by injecting the newly printed money directly into the financial system without going through the Treasury first.
3. Taking a monetary sledgehammer to unemployment.

Will it work? I don't have a clue. If they want to play with economic nuclear weapons go for it. I feel reasonably safe in the PP.

[stone]

I've not understood how buying MBS is "Taking a monetary sledgehammer to unemployment."
On the face of it, it looks to me to be more a way to ensure that banks don't suffer from people being unemployed and not paying their mortgages (despite the banks having caused the mess). Basically the banks bid up house prices pre-2008 by granting unrealistically high mortgages. That meant that wages got spent on mortgage interest rather than on goods and services and the economy could not compete with other places where the debt servicing burden was lower. When the consequential collapse threatens the value of the mortgage debt, the Feb rides in to rescue the banks.

[murphy_p_t]

I've not understood how buying MBS is "Taking a monetary sledgehammer to unemployment."
On the face of it, it looks to me to be more a way to ensure that banks don't suffer from people being unemployed and not paying their mortgages (despite the banks having caused the mess). Basically the banks bid up house prices pre-2008 by granting unrealistically high mortgages. That meant that wages got spent on mortgage interest rather than on goods and services and the economy could not compete with other places where the debt servicing burden was lower. When the consequential collapse threatens the value of the mortgage debt, the Feb rides in to rescue the banks.

+1

exactly.

Job of the FED is to protect the interests of BANKERS. Period. Full stop.

FED = Banking Cartel / price fixing

[MachineGhost]

What does it mean that the fed will be purchasing mortgage backed securities instead of treasuries with QE3?

It means the banks will offload their low hanging fruit to the Fed to improve their balance sheets.  If the Fed just buys from Freddie Mae or Fannie Mac, then nothing will change.

We had a balance sheet recession in the early 90's due to the S&L crisis.  The problem is I think it was a bank balance sheet recession, not consumer.

So in the end, nothing really changes other than the extended predictability of short term interest rates not rising until 2015.  This is great for the Freddie/Fanne mortgage arbitrage REIT's.

Bernanke is anti-austerity, but he cannot turn the economy around.  Only Congress can with spending or getting the hell out of the way!

[MachineGhost]

2. Bypass the government bottleneck by injecting the newly printed money directly into the financial system without going through the Treasury first.

Its just a swap of MBS for bank reserves or currency.  Its not newly printed money.  But to the extent the action frees up capital and leverage ratios on the FIRE side, there could be more speculation leeway via the "wealth effect".  Compared to other QE's, this one has occured at a relative high rather than a relative bottom, so there may be no buyers left soon.

But of course it won't do anything to the real economy.  The problem is the consumer balance sheet.  Until that is repaired, banks cannot lend.  No lending, no economic growth.  We are pushing on a string just as Japan has for over two decades.  Only Congress can get us out of this mess rather than letting time and inflation devalue the debt.  I wouldn't hold my breath.

[MachineGhost]

Surely there isn't a snow ball's chance in hell that the put options that Hussman relies on would have been honoured had things gone all 1930s. It would be a fat lot of good having a bunch of put options that supposidly were worth 100x what you paid for them EXCEPT that the counter-parties are all long bankcrupt and so  those put options are in fact entirely worthless.

I don't think that is a risk or under a fiat exchange system.  I don't know about the UK but over here we have what is called the Options Clearing Corporation (OCC) that nets out the option buyers or sellers so theres no counterparty risk.  See: http://www.optionsclearing.com/about/co ... is-occ.jsp

There's never been an insolvency incident, even after Black Monday in 1987 when naive put writers got their own personal SHTF scenario.

[stone]

Surely there isn't a snow ball's chance in hell that the put options that Hussman relies on would have been honoured had things gone all 1930s. It would be a fat lot of good having a bunch of put options that supposidly were worth 100x what you paid for them EXCEPT that the counter-parties are all long bankcrupt and so  those put options are in fact entirely worthless.

I don't think that is a risk or under a fiat exchange system.  I don't know about the UK but over here we have what is called the Options Clearing Corporation (OCC) that nets out the option buyers or sellers so theres no counterparty risk.  See: http://www.optionsclearing.com/about/co ... is-occ.jsp
There's never been an insolvency incident, even after Black Monday in 1987 when naive put writers got their own personal SHTF scenario.

Machine Ghost, I'm ignorant about options. I don't understand how there could be no counterparty risk unless whenever someone sells a put option promising to say buy a share at $100, they also hand over $100 and that is kept in a safe until the option expires. Is that what is done?
Afterall, 1987 was  a mere blip in the "Great Moderation". We're talking here about a rerun of the 1930s. Looking at that link  suggest to me that the options clearing people rely on a system of margin calls etc to raise funds in the event of a default. That doesn't sound riskless to me:

Open Positions. Generally speaking, OCC will close out open positions of the suspended clearing member in the most orderly manner practicable, which may include a private auction. Open long positions, short positions and covered short options positions and open long and short positions in futures may be closed-out as provided in Rule 1106, including close-out by offset (netting) and by other permitted transactions or means. Open positions in stock loan (borrow) transactions may be closed out as provided in the Stock Loan/Hedge Program and Market Loan Program rules. However, OCC may defer effecting such close-out transactions (including liquidating margin and other deposits of the suspended clearing member) as well as may elect to implement protective (hedging) transactions in respect of positions or deposits of the suspended clearing member, subject to the reporting requirements, as applicable, in the rules. In addition and subject to applicable rule, law and/or regulation, OCC may effect certain position and/or asset transfers to other non-suspended clearing members. The close-out of cross-margining accounts maintained with a Participating CCO will be effected in accordance with the terms of the applicable rules and cross-margining agreement, which generally require coordinated action between OCC and the Participating CCO. See generally Rule 1106, Rule 707, Rule 2210, Rule 2211, Rule 2210A and 2211A.

The procedure seems to be that a margin call would be made on whoever wrote the put options so as to try and buy back enough of those put options from the market to close the position. The assets of whoever sold the put options would get sold off to try and raise the funds. Such firesales of assets would further depress asset prices and make the put options harder to buy etc etc.

[moda0306]

I have to disagree with Murphy's judgement on the fed, but there is something about the fed buying financial products of the private sector that seems fundamentally screwed up.  The fed buying treasuries is one thing, but when the fed starts buying private sector assets, it's actually picking winners and losers.

I wish the fed would buy my underwater home from me .

However, ironically, I feel this is one of the strongest moves they could have made towards recovery.  The fed buying "nontraditional" assets is more than simply pushing on a string.  In a balance-sheet recession, that's a huge distinction.

Notice how LTT's are actually going up significantly in yield... it seems that the fact that they're buying non-treasury assets to do the job, as well as stronger recovery hopes that go with buying those kinds of assets, is actually having a different affect on the long end of the treasury yield curve, which makes sense.

[stone]

Will it allow households to refinance their mortgages to being lower interest mortgages? Perhaps the idea is that if the Fed owns the MBS, then the banks will be happy for the Fed to take the loss from that

[dualstow]

Picked up some new TLT this morning in a kind of mini-rebalance. I think treasury yields can go lower.

[moda0306]

stone,

Problem is, it's not interest rates, but balance sheets, not allowing people to refinance.  I think it's great for people to be able to get even lower rates, but if someone's 10% underwater, their main constraint is their lack of equity, not current interest rates.

Combine this with a program to allow people to take tax/penalty-free distributions from their retirement accounts (of a limited amount) to refinance if they bought between 2004 and 2008 (or something like that), and I think we'd have a fixer.  

I don't think it's in anyone's interests to have a bunch of bank-owned homes on our city blocks.  Foreclosed homes (in my area) are extremely poorly taken care of.  Having banks own homes in mass is a disaster.  Beyond a stable, healthy degree, banks taking ownership of personal or business property is simply not in their skill set.  It's a last resort.  For that reason, I think making both banks and individual home owners have an incentive to coming back to the table together is a really good thing.


dualstow,

Same here.  Especially with another congressional fiasco approaching (which we all know will probably, and ironically, lower rates, not raise them... especially with the deflationary time-bomb approaching of slashing spending and hiking taxes if congress can't agree on a compromise).  CPI-U has tracked negative for the last few months or so...  Peopl's balance-sheets are only moderately repaired... 3.1% for 30 years is a good deal IMO.

[stone]

I wonder whether all that this Fed action will do is create a mini commodity bubble that pushes up costs for manufacturers and actually hurts the real economy?

[dualstow]

dualstow,

Same here.  Especially with another congressional fiasco approaching (which we all know will probably, and ironically, lower rates, not raise them... especially with the deflationary time-bomb approaching of slashing spending and hiking taxes if congress can't agree on a compromise).  CPI-U has tracked negative for the last few months or so...  Peopl's balance-sheets are only moderately repaired... 3.1% for 30 years is a good deal IMO.

You and I are either very wise or very foolhardy. Or perhaps we're just disciplined.

[Pointedstick]

dualstow,

Same here.  Especially with another congressional fiasco approaching (which we all know will probably, and ironically, lower rates, not raise them... especially with the deflationary time-bomb approaching of slashing spending and hiking taxes if congress can't agree on a compromise).  CPI-U has tracked negative for the last few months or so...  Peopl's balance-sheets are only moderately repaired... 3.1% for 30 years is a good deal IMO.

You and I are either very wise or very foolhardy. Or perhaps we're just disciplined.

I did it too. So we'll all float or sink together...

The PP is a strange beast. I awoke to find my EDV position down 4% and I was overjoyed. What the heck is wrong with me??

[buddtholomew]

dualstow,

Same here.  Especially with another congressional fiasco approaching (which we all know will probably, and ironically, lower rates, not raise them... especially with the deflationary time-bomb approaching of slashing spending and hiking taxes if congress can't agree on a compromise).  CPI-U has tracked negative for the last few months or so...  Peopl's balance-sheets are only moderately repaired... 3.1% for 30 years is a good deal IMO.

You and I are either very wise or very foolhardy. Or perhaps we're just disciplined.

I did it too. So we'll all float or sink together...

The PP is a strange beast. I awoke to find my EDV position down 4% and I was overjoyed. What the heck is wrong with me??

I, for one, was not too amused by the drop in LTT's today. Am I missing something? Are we predicting lower yields given the approaching "congressional fiasco". It appears as though the market expects higher inflation and yields are rising to compensate.

[murphy_p_t]

great question...considering that I just topped off my bonds w/ EDV 2 days ago...I had previously sold them down to 15% of PP

[MachineGhost]

Machine Ghost, I'm ignorant about options. I don't understand how there could be no counterparty risk unless whenever someone sells a put option promising to say buy a share at $100, they also hand over $100 and that is kept in a safe until the option expires. Is that what is done?

When someone writes an option, the seller has to put up a margin deposit as a fraction of the underlying value.  I think that is set by the Federal Reserve's Regulation T and is 20% of the underlying, i.e. 5:1 leverage.  Brokerages enforce different levels of option strategy clearance on accountholders with naked, uncovered sales being the most riskiest and stringent.  For instance, retirement accounts cannot write naked options, they have to do what is called "cash secured puts" where 100% of the underlying value is in the account in case a written put gets exercised and "put" to you.  This is allegedly for safety reasons of the accountholder, not counterparty risk.

So I guess if a brokerage doesn't do their due diligence properly and allows stupid idiots to write options for more than they have in the account for margin or an accountholder gets a margin call when the market drops dramatically who lied about his liquidable assets and net worth, there would be counterparty risk, but that is where the OCC would step in. 

In 1987, you had writers simply wiped out who wrote naked options deep out of the money under the stock market.  They had to liquidate their own personal assets to clear with the OCC.  And this was all back before electronically-enforced margin rules and electronically-enforced due diligence, etc..  Truly a different era and we survived just fine.

The OCC system surely isn't foolproof but its not like the subprime debacle with off exchange transactions in illiquid customizable contracts written by investment banking firms "ripping the faces off muppets".  The former is prudent regulation to protect everyone involved, the latter was just blase gaming of the system.

A similar clearing system to OCC exist for stocks, futures, etc..  Its all epheremal B.S. at the end of the day.  Hence, the need to hold physical gold.

[MachineGhost]

The procedure seems to be that a margin call would be made on whoever wrote the put options so as to try and buy back enough of those put options from the market to close the position. The assets of whoever sold the put options would get sold off to try and raise the funds. Such firesales of assets would further depress asset prices and make the put options harder to buy etc etc.

Don't forget there are market-makers involved in options too.  They have to ensure an orderly market, but that too failed in 1987.