Interest Rate Roundup

Friday, September 26, 2008

Everybody's working all this weekend (in Washington, anyway)

I've been quiet on the posting front because I don't know what else to say at this point. I believe it's highly likely there will be some form of bailout plan released over the weekend. The real question is whether it will "work" -- in terms of curing the credit market and the economy. I'm somewhat skeptical on those fronts, though I'll reserve my judgment until I see what actually comes out of Washington.

Why am I skeptical?

First, this bailout may help some banks avoid some additional losses, but it won't help all banks do so. Depending on what the government pays for these crummy assets going forward, the plan could actually cause even MORE losses. And let's say the government does agree to pay above-market prices for assets. Market players aren't stupid. They know the "real" prices are likely lower. So confidence in the balance sheets of the very banks the plan is supposed to support could become a real issue.

Plus, the sheer magnitude of bad debt out there is enormous. Even if the government buys some bad paper, plenty more loans will still sour, plenty more banks will see earnings tank, and more banks will likely fail.

Second, the bailout package won't magically make lenders take on huge risks again. After all, they've been burned badly in the past year. I don't think we'll see the ridiculously easy residential mortgage, commercial mortgage, auto loan, credit card, and leveraged buyout lending that we saw from 2002 through 2007 for a long, long time. I'm talking years, not months or quarters.

Third, the cost of this bailout could be gigantic. Even before this latest proposal, the U.S. had committed up to hundreds of billions of dollars to various rescues. That includes more than $25 billion to bail out Bear Stearns, $100 billion each for Fannie and Freddie, and $85 billion for AIG. Treasury has also floated the idea of spending billions more to backstop money market funds (the ultimate cost is unknown). Not to be left out, the auto industry looks like it's getting its own $25-billion bailout in the form of government-supported low interest loans.

And of course, the latest package has an initial price tag of up to $700 billion. All told, we're looking at more than $1 TRILLION in bailouts — and it's not like we have all that money sitting in a bank somewhere. We're a nation that spends much more than it earns, and borrows the rest.

The White House was ALREADY projecting that the 2009 federal deficit would be $482 billion. Now, with the additional bailouts announced and proposed, we could be looking at tacking another $1 trillion — or more — onto that number. This would push the budget deficit so far into the red, we'll all be swimming in crimson ink.

To fund those deficits, we're going to have to borrow a huge amount of money. The Treasury just held a record $34 billion sale of 2-year Treasury Notes. That was followed by a $24 billion sale of 5-year Notes, the biggest such sale in more than five years. Those numbers will only go higher with time. This is why Congress is talking about raising the federal debt ceiling to $11.3 TRILLION.

All the additional bond supply will likely drive bond prices lower and interest rates higher. Indeed, 10-year Treasury Note yields have already climbed from a low of 3.39% to 3.85%. That will blunt the impact of the bailout by driving financing costs higher on all loans whose rates are benchmarked to Treasuries.

Lastly, this crisis long ago stopped being just a financial one. This bailout bill won't prevent the "real" economy from sliding into recession. Witness the poor news on the durable goods and employment front this week. With all the money we're spending on the bailout bill, what funding does that leave for other potentially helpful government efforts, like stimulus packages?

Anyway, it will be an interesting weekend and fascinating Monday. Rest up!


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