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“I do not want Fannie and Freddie to be just another bank… I do not want the same kind of focus on safety and soundness.”

-Barney Frank (September 25, 2003)

In his recently released “The End of Wall Street”, Roger Lowenstein kicks off a chapter titled, “To The Crossroads” with that quote from the House of American Perceived Wisdoms. As we try to figure out where the US stock market goes after a +76.9% rally, we should always remember that Congress helped create a massive hole in America’s balance sheet that the Chinese will never forget.

When President Obama asked China’s President Hu Jintao for a “more market oriented rate” yesterday in Washington, one has to wonder if that smile on Hu’s face was kindly asking the President of the United States ‘are you kidding me?’

In the face of the US Government marking the rate of return on Fed funds at ZERO percent, telling the Chinese to mark-to-market is the height of hypocrisy. Sure, the Chinese have their own accounting issues, but so do we, and it’s about time our President recognizes this as fact. This has nothing to do with China’s LGFV’s (Local Government Financing Vehicles). This has everything to do with America marking US government deficits and liabilities to model.

Now that Congress is back in session, if you want to see Barney Frank, Tim Geithner, and Ben Bernanke do the collective squirm, have your local Congressman ask any of them if GSE debt (Fannie and Freddie) is sovereign debt? Simple question; simple answer. Not unlike a low quality company that tries to keep their sordid secrets off-balance sheet, this is exactly what America has signed off on letting our politicians of the Bubble in American Politics do – it’s called marked-to-model.

GSE debt is backed by the US government and is, therefore, sovereign debt. You don’t have to take my word for it. Ask our largest creditor what they think. If it quacks and swims in a circle, it’s a one-legged duck.

Some “free marketers” of the Reagan revival will quickly come to the rescue of the US Treasury market and pronounce their proclamation of faith that Treasuries trade in a liquid market and are therefore trading marked-to-market. That’s all good, fine (and theoretical) and, to a degree I might actually agree with part of that argument if you push me out long enough on the curve. But reality is that the Fed Funds Rate is keeping the short end of the curve artificially depressed (or marked-to-model).

So my simpleton suggestion this morning is that we take a good hard long look in the mirror before we start trumpeting our once vaunted system of American Capitalism and see this for what it has become. Greece getting a short term bailout by European government officials who decided to mark Greek debt 200 basis points under the marked-to-market rate is simply a roadmap to our very own perdition.

Funding long term debt obligations by borrowing short on a conflicted and compromised government rate is the opposite of what we should have learned from the last 24 months of this mess. These American and Western European politicians aren’t doing anything different right now with sovereign debts than what Bernanke and Paulson attempted to have Wall Street bankers do in the early stages of 2008. It’s pathetic.

We can’t do this for much longer or the Chinese and Japanese are going to start doing exactly what we taught them to do, which is get out when something smells like it’s going down the path of a debt spiral. While hope is not an investment process, I can only pray that they don’t start doing this aggressively any time soon.

China has been a net seller of Treasuries for the past 3 months. This doesn’t include the March data, and in the month of March we saw a ton of Treasury selling on the short end of curve (2-year yields went from 0.8% at the beginning of March to 1.1% in a straight line = +37.5%). Can you imagine where interest rates would be if President Obama heeded his own advice and marked the Fed Funds rate at a “more market oriented rate”?

 

The Piggy Banker Spread is 10 basis points (0.10%) off its record wide levels in America. Again, the government’s choice has been to bailout financiers who need to borrow short to attempt to invest long, and that is what it is. Who underwrites this spread? You do. You don’t get the savings rates of return that Chinese, Australian and Brazilian citizens do because the ideology of the Greenspan and Bernanke Feds continues to be marking your savings rate to model, below the level of inflation.

Below the level of inflation? Yes. Expected inflation is one of the main drivers the long end of the Treasury curve in the last month. You see, the further you push out on the curve, the further away you get from the Fed’s marks. That’s why the yield spread (Piggy Banker Spread) between 10-year and 2-year rates is +282 basis points wide this morning.

Both the long end of the Treasury market and the US Dollar are marked-to-market more appropriately than the short end – Bernanke has politicized that just like Greenspan did. Meanwhile, both Mr. Currency and Mr. Bond Market see the inflation that will be reported here in the USA tomorrow, however compromised and conflicted that government calculation may be.

My immediate term support and resistance levels for the SP500 are now 1184 and 1201, respectively. If this note read as angry, it should have. Re-reading Lowenstein’s account of what caused this mess has reminded me of my greatest fear. With the stock market back up, we may have learned nothing.

Best of luck out there today,

KM

Marked-To-Model - OBAMA