Bond Plunge Sign of Systemic Economic Crisis
by John Hoefle
Aug. 5 (EIRNS)Trying to walk the line between inflation and deflation, Federal Reserve chairman Sir Alan Greenspan finds himself in a no-win situation: If he lowers interest rates further, the system will explode in a hyperinflationary supernova; and if he raises rates, the system will implode into a deflationary black hole. Any way he turns, he loses.
Greenspan finds himself at the tail end of a series of bailouts of the system, each one of which bought the system some time, at the expense of creating an even bigger problem down the road. The result is a crushing level of government, corporate, and household debt, a shrinking income stream, a collapsing physical-productive sector, and a decaying infrastructurealong with very few options.
To save the system, Greenspan must find a way to roll over the debt yet again, but the system can't absorb the increased debt service the larger debt levels will require. Whatever he does, somebodyand then everybodygets burned. - Bloody Bonds -
The May-June-July period was the worst three months for the Treasury bond markets since at least 1927, with the 10-year notes losing 10% of their value and 30-year bonds losing 15%, according to Blanco Research. Since its June 13 peak, yieldswhich rise as bond prices falljumped from a 45-year low of 3.11% to 4.42% on the 10-year Treasury, and from 4.17% to 5.33% on the 30-year.
This drop "ranks among the most rapid bond sell-offs ever," and marks the end of a two-decade bull run in the bond markets, according to the Wall Street Journal, which reported the figures. Australia's Sydney Morning Herald was less restrained, running a story under the headline "Bloodbath in bonds terrifies traders."
According to market accounts, what precipitated this bloodbath was the perceived shift in policy by the Fed, with Greenspan first suggesting that the Fed would continue to cut interest rates and perhaps even buy Treasury bonds in order to inject liquidity into the system to fight deflation, and then suggesting that deflation was under control. Believing that lower interest rates were locked in, speculators placed large, highly leveraged bets in the bond and interest-rate derivatives markets, bets which would be lucrative if the assumptions behind them were correct, but disastrous if they were wrong. And wrong they were.
In late June, when the Fed cut rates only a quarter-point instead of the expected half-point, many speculators started bailing out, sending Treasury bond values plunging, and yields soaring. The problem quickly spread to the mortgage-backed securities market, where the rise of long-term interest rates caused a sharp decline in mortgage refinancings, which in turn triggered a sell-off of long-term securities by Fannie Mae, Freddie Mac, and other big mortgage holders, as they rebalanced their interest-rate hedges. That, in turn, drove bond values even lower, and yields even higher, in a vicious circle. - Insanity -
Bond-market players have expressed their rage and dismay at Greenspan's actions, but that only exposes their own diminished psychological state. The idea that the system could be saved by the Fed buying Treasury debt is ludicrous, and shows how far removed from reality these speculators have become. That the bond market could go into a tailspin over a quarter of a point in interest rates, is a sign that the financial markets are dangerously unstable and over-leveraged, dependent upon the wildest of monetary manipulations to keep the edifice from crumbling.
Despite the criticism, Greenspan has done nothing to sully his reputation as the chairman of the bubble, and perhaps the worst central banker of all time. In the testimony before Congress which sent the bond markets into a tizzy, he indicated that he was prepared to cut interest rates to zero if necessary, and said that the Fed was studying ways to add incentives after that. He also said the collapse of the U.S. manufacturing base was "economically irrelevant," as it made no difference whether the nation made its own goods or imported them. - Pensions Plunge -
The three-year decline in global stock markets has wrought havoc on both public and private pension plans. During the run-up of the stock market in the late 1990s, companies used the rise in the values of the stocks in their pension funds as an excuse to lower, or even stop, their contributions to those funds. At the height of the stock market, many of these plans were considered overfunded, but these pension surpluses evaporated along with the stocks.
The Pension Benefit Guaranty Corp. estimates that U.S. corporate pension plans are underfunded by some $300 billion, and a study by the actuarial consultant firm Watson Wyatt shows that the percentage of employers with fully funded plans fell from 84% in 1998, to only 37% in 2002.
Government plans are also in trouble. The U.S. has some 2,200 state, county, and city pension plans covering 17 million public workers and 6 million retirees. These plans have about $2 trillion in assets, but are still underfunded by hundreds of billions of dollars; $65 billion was contributed to public pension plans in 2001, but $101 billion was withdrawn.
These pension shortfall projections, as grave as they are, are actually based upon rather rosy assumptions about future economic growth. When the stock market enters its next downturn phase, the pensions will take another big hit, and the shortfalls will grow even larger.
Reprinted from the Aug. 11 New Federalist.
|