Jessie: In 2009 the US Will Be Forced to Selectively Default and Devalue Its Debt

"It should be obvious to anyone that we are approaching the apogee of the Treasury bubble, with the credit bubble having broken already."

The lead quote is taken from Jesse’s Café Américain and a recent post there that we are taking the liberty of reproducing below in its entirety. Doomers will appreciate Jesse’s further thoughts on the divergence of our chart’s yellow and red lines.

In 2009 the US Will Be Forced to Selectively Default and Devalue Its Debt

Jessie

We have seen estimates that next year the US will have to finance a $2 Trillion annual deficit. They may be able to push it further into the next Administration than that by the forbearance of the world, but not by much. We’d expect a significant drop in Treasuries by 2011 at the latest.

It should be obvious to anyone that we are approaching the apogee of the Treasury bubble, with the credit bubble having broken already.

When the Treasury says they are facing unprecedented challenges in financing the US public debt next year that is an understatement.

Once the deleveraging of the markets subsides, the dollar and Treasuries will drop, perhaps with some momentum, as the rest of the world realizes that the US has no choice but to default. This can be resolved in several ways, including continued subsidies from foreign sources in the form of virtual debt forgiveness, devaluation of the dollar, raising of taxes, and higher interest rates on debt.

The problem now is that the US has breached the point where it can service its debt out of real cash flows, and turning this around will require a severe devaluation of the US dollar.

Devaluation and selective default are the only foreseeable systemic alternatives. There are other exogenous paths of a more political nature such as consolidation and war that may color the default a slightly different color, but a selective default it remains.

This is the fundamental situation. Everything else is speculation and commentary.

Bloomberg
Ryan Says Treasury Faces `Unprecedented’ Financing Needs in ’09
By Rebecca Christie

Oct. 28 (Bloomberg) — The U.S. Treasury faces historic demands to fund a growing budget deficit and raise money for a $700 billion Wall Street rescue program the department’s top domestic finance official said today.

“This year’s financing needs will be unprecedented,” said Anthony Ryan, the Treasury’s acting undersecretary for domestic finance, at a Securities Industry and Financial Markets Association conference in New York, where he was a last-minute substitution for Treasury Secretary Henry Paulson.

To raise the necessary funding, the Treasury is looking at selling more long-term debt and possibly bringing back three- year note sales at the Nov. 5 refunding, Ryan said. The Treasury also is raising money to address “many different policy objectives” and reduce bond market disruptions and will try to keep its borrowing patterns as regular as possible, he said.

“We firmly believe that investors value greatly and pay a premium for Treasury’s predictable actions,” Ryan said. “To the very best of our ability, we intend to stay the course.”

Ryan also said the U.S. government now “effectively guarantees” debt issued by mortgage companies Fannie Mae and Freddie Mac, the government-sponsored enterprises placed into government conservatorship on Sept. 7. The preferred stock agreement included in the government takeover means the U.S. now backs “both existing and to be issued” GSE debt.

“The U.S. government stands behind these enterprises, their debt and the mortgage-backed securities they guarantee,” Ryan said. The GSEs have almost $6 trillion in outstanding debt and mortgage securities.

U.S. equity and credit markets remain under “considerable strain” and face ongoing challenges, he said. That said, Federal Reserve efforts to backstop commercial paper are “helping” to stabilize markets, he said.

To contact the reporter on this story: Rebecca Christie in Washington at Rchristie4@bloomberg.net;

Last Updated: October 28, 2008 10:47 EDT

10 Comments for this entry

John M. says:

October 29, 2008 at 10:25 AM

Jim Vogel’s on WaPo Page D01 today. Hands up Doomers who suspect the first part of the following quote has something to do with the second part

“Loan Giants’ Takeover Hasn’t Paid Off”, by Zachary A. Goldfarb, Washington Post, October 29, 2008.

To increase their portfolios, the companies borrow money. The problem is that they have been able to borrow only at higher rates because of investor anxieties over the credit markets generally and the fate of the companies specifically. This in turn has constrained their ability to borrow. The companies will issue $16.3 billion in debt this month, compared with $32.7 billion last month, according to Jim Vogel, an analyst at FTN Financial Capital Markets. That’s the lowest level in at least eight years.

With borrowing costs so high, Vogel said, the companies may no longer be earning enough from mortgage investments to cover their costs. That means Fannie Mae and Freddie Mac may find it more difficult to fund themselves.

“The market doesn’t want to buy the debt of a gigantic financial institution that’s funding its assets at a loss, regardless of how the U.S. government may or may not be standing behind them,” he said.
…

One of the government’s primary concerns before the takeover was that investors — particularly in Asia, traditionally among the biggest buyers of U.S. mortgages — were shedding the bonds out of fear that market demand for them would dry up.

But in the past two months, foreign investors have continued to dump the bonds. Foreign central banks’ holdings of regular Fannie Mae and Freddie Mac debt and mortgage bonds have declined by about $60 billion, to $923.4 billion, as of last week, according to the Federal Reserve.
Chuck Ponzi says:

October 29, 2008 at 10:43 AM

Jeebus, it’s like nobody ever heard of debt monetization.

We can keep this train running through the night.

Chuck Ponzi
LVrenter211 says:

October 29, 2008 at 12:25 PM

Nonsense. The debt is being used to buy securities that pay the govt much more in interest than the govt pays on its debt.
MikeC says:

October 29, 2008 at 4:03 PM

Okay, so EVERY fiat currency in history has failed (except for those around today, which haven’t been around so long in the grand scheme of things). And okay, so perhaps recent events show that we are no more “special” today than we ever have been in the past….

Well now, let’s look at the silver lining of once.

If the worst were to happen and hyper-inflation were to set in, perhaps our money will be useful for heating our homes?

http://en.wikipedia.org/wiki/Image:Inflation-1923.jpg
John M. says:

October 29, 2008 at 6:23 PM

This WSJ story was just re-posted in Australia (i.e. near East Asia). The news about the GSEs’ new effective guarantee is starting to spread, and buyers (i.e. sellers) of Agency Debt are having a hard time getting a handle on what it all means.

“Fannie, Freddie borrowing costs rising”, by James R. Hagerty, Wall Street Journal / Australian, October 30, 2008.

One problem now is that investors remain uncertain to what degree the government will stand behind their debt in the long term. The Treasury has agreed to provide each of them with as much as $US100 billion in capital if needed to cover losses on surging mortgage defaults. James Lockhart, director of the regulatory agency, says that is “equivalent” to a government guarantee of their debt. Mr Lockhart told Congress last week that there was an “explicit” guarantee on the debt, but he later issued a clarification, saying it was an “effective” guarantee.

Foreign investors, particularly those in Asia who have long been among the biggest buyers of Fannie and Freddie debt, are confused by the rapid-fire policy changes and statements, according to bankers who talk to those investors. “They want clarification” on the long-run government plan for Fannie and Freddie, something that probably will come only from the next administration, says Arthur Frank, head of mortgage-securities research at Deutsche Bank in New York.

Partly because clarity is lacking, Fannie and Freddie are finding that long-term debt has become much more costly for them. The yield on Fannie’s five-year notes has risen to about 1.5 percentage points above comparable Treasury bonds from one percentage point in early September.
…

Using short-term borrowings to finance mortgage securities, which typically have maturities of five years or more, is a risky strategy, requiring the companies to use more derivative contracts to hedge against swings in interest rates.
MikeC says:

October 30, 2008 at 6:50 PM

Inteesting, John – I hadn’t realized that doubt confusion/doubt existed in the first placec. One would think that in an environment where every last investment dollar is needed the powers that be would be quick to clarify the issue as soon as they realized it existed… unless a clarification would carry the news that the investors didn’t want to hear?
John M. says:

October 30, 2008 at 7:22 PM

MikeC -

There are two constituencies here. An explicit guarantee that satisfies the bond-holders would totally freak out OMB, because they would have to admit America’s sovereign debt was about twice what they’ve been telling everyone it is.

Starting on 1938, FDR in effect provided government loan guarantees to American homeowners to fight the Great Depression. In 1968 LBJ pretended to end those guarantees by “selling” Fannie (the government agency running the program) to private shareholders.

The ambiguous nationalization of the GSEs, if completed, would place those (now monumentally magnified) loan guarantees onto Uncle Sam’s tab. That itself would be just like consolidating a ludicrously big QSPE back onto Congress’s balance sheet.

Retired St Louis Fed President Bill Poole has described managing the present crisis as being like making moves on a chess board. What I have just described has a name in chess — Zugzwang
MikeC says:

October 31, 2008 at 1:56 AM

John – thank you for the clear explanation. This is a terrifying corner to have to back out of, to say the least. Gold, anyone?

“Zugzwang”-now added to my vocabulary!
John M. says:

October 31, 2008 at 4:52 AM

MikeC -

Congratulations! You are now slightly ahead of Mark Zandi and The Globe.

“Very fixed rates”, by Steven Syre, Boston Globe, October 31, 2008.

Federal Reserve chairman Ben Bernanke has been cutting interest rates like a lumberjack for more than a year now. So why isn’t it a dime cheaper to borrow money to buy a home?
…

But there’s a twist in the typical story this time. The federal government, stepping in to take control at Fannie Mae and Freddie Mac, is clearly standing behind the mortgage securities they issue. Shouldn’t that help rates?

It should, and it might. But it hasn’t done much so far. Interest rates Fannie Mae and Freddie Mac pay to borrow the money they need to buy mortgages have actually gone up since the government got behind the big lenders. That doesn’t seem to make any sense.

One likely answer: Foreign investors are looking for very explicit assurances about the government’s backing of mortgage securities issued by Fannie and Freddie. James Lockhart, director of the agency that regulates the two big lenders, called the federal guarantee “explicit” last week. But later he clarified his comments and called it an “effective” guarantee. Lockhart was trying to assure investors, but only blurred the message.

“There’s been some discussion about just how rock solid those government guarantees have been,” says economist Mark Zandi of Moody’s Economy.com. “It’s kind of a silly debate, but it’s important to global investors.
…

Confusion about the government’s support of mortgage securities issued by Fannie Mae and Freddie Mac should be cleared up before too long. That would be a clear plus for home buyers.”
MikeC says:

November 1, 2008 at 4:48 AM

Wow…
This has been the scariest Halloween in many years…