Did Bernanke Really Lose $151B???

I read Bernanke’s bond losses: $151 billion plus over at money.com with great interest. It has a sensational title, but ultimately comes clean with a solid conclusion…these are just paper losses. It’s a good article…just make sure you read it all the way through:)

So…for a primer, here is how it all works. First, the Fed, using it’s magic wand, creates new/fake money. Then, they go out into the market, and use that money to purchase bonds… $1.9T of treasuries and $1.1T of mortgage bonds according to the article. This is more or less “quantitative easing”

So say I’m a saver, and I just purchased a shiny new $100 30 year treasury bond with a 2% yield. I paid $100, and am really looking forward to getting my $1 check in the mail every six months. Then I get a call from Uncle Ben (Bernanke). “Say….if you want to sell me that bond…I’d be happy to buy it for $101”. So I say ok….take my $1 gain, and replace it with another newly issued bond…this time at 1.99%. Rinse Repeat a few million times. Now…of course Ben’s not really going to call me up with a $1 treat….but his banking buddies…you bet!!

So now Ben has managed to take his imaginary money and push it into the real economy…lowering rates, making his banking buddies rich…maybe even creating a job or two for the Bugatti plant.

Every six months, Treasury cuts him a check for $1…he pays his staff, and sends the rest right back to the federal coffers….where they book it as revenue under “Federal Reserve Earnings”

Got that? Federal reserve creates imaginary money and uses it to finance the federal government (after running it through a third party),. Then, the federal government sends the Fed their interest due….and the Fed turns right around and sends it back as revenue. Hooray for government accounting!!

So, lets just cut through the crap….what is really happening is the Fed is printing money and using it to finance the deficit and lower the interest rates paid by the government. The end.

Moving on….What has happened recently is that interest rates have risen on the fear that the Fed will not only stop the money printing, but also start selling the $1.9T they have accumulated. The problem, of course, is…who has $1.9T to lend to Uncle Sam?? Not me…not for that deadbeat, and surely not at 2%!!

So now Ben has my old $100 30 year bond paying $2 per year. but nobody is willing to pay him the $101 he paid, or even $100, or $98 because I can buy a brand new one paying say $3 of interest per year….for $100. In order to get the same 3% yield I could get with a new bond….all I am willing to pay for the old bond is $67….good for a $34 loss if Ben wants to sell it back to me. Obviously, I more or less made up the numbers for simplicity and to make a point, but these mechanics are how the authors of the story came up with the $151B paper loss. I’m sure their math is right, but as the article mentions, these are paper only losses, and the Fed doesn’t have to actually recognize them until they sell their $101 bond for $67. They could hold them all to maturity and never book a loss. Now, I have a lot of problems with this entire program, but not with this.

Say I agree to loan a friend $100 at 5%. A week later, interest rates have doubled to 10%. While one could argue that had I waited a week I would have got a better rate and made more money….I shouldn’t have to write down the value of an asset just because I  kinda sorta maybe missed out on a higher rate. If rates drop, I shouldn’t write up the value either. I understand the arguments for….just the very idea of constantly marking assets up and down based on market whims kinda grinds at my accounting core….which yearns for stability. If my company purchases a work truck for 40k….and a shortage of trucks creates a surge in the market value of trucks….doubling it to $80k….I don’t write the value up and recognize a $40k gain….I recognize the gain or loss only if I actually sell the vehicle.

Moving on again…I know this is getting long. How does all this affect the deficit. First, QE enables the deficit…making the money available in the first place, at a lower  (manipulated)interest rate, and even lower rate still once you net out the interest paid to the fed and remitted back….and that’s the part I want to finish on. Looking Back to 2007, the fed was contributing about $30B per year to federal coffers. This spiked all the way to an $87B per year rate by mid 2011, but has since slid down a bit to about $78B… as revenue, this is a direct reduction in the deficit…if it went away tomorrow, our annual deficit over the next 12 months would be $78B higher.

This, it seems to me, is the risk to the cash deficit. First…If these losses are recognized…even if over many years, one would think that this would result in a further decrease to these payments. Say they dropped $50B….that’s a new $50B hole….in perpetuity. Second…even if there were no losses…should the Fed ever start selling these and winding down their $3T portfolio…that would slow the payments anyway…probably back down to the $30B or so we saw back in 2007….and that is ignoring any losses they incurred along the way.

In my own forecast, I have this revenue continuing indefinitely, growing at a 3% pace. from 2014 on. I have it there because I do not believe at this time that the fed can ever unwind it’s $3T portfolio of imaginary money without blowing up the entire economy….in fact it will probably continue to grow, since there is nobody else with the ability to absorb the $12T or so of additional debt the US will need to issue over the next 10 years (assuming we make it that far). So…while I acknowledge the “revenue” associated with these cash payments from the Fed now appear to be in Jeopardy, I am not quite convinced the Fed can or will ever actually start unloading it’s $3T portfolio. That said…I’ll keep watching because you never know when something crazy might happen.

Social Security Analysis 6-2013

Yesterday I did a brief analysis of interest payments, which make up about 5% of our annual outlays. My conclusion was that rising interest rates will ultimately blow this category sky high, but for the time being…at least a couple years or so, I don’t expect this to be a huge problem because rates are incredibly low, and more or less locked in for long enough to blunt any sudden move in rates.

Today, I want to take a similar look at Social Security, which is a problem now, and will continue to be. So…looking back at 2007 for some scale…in January, Social Security EFT were $38B, $469B for the whole year. Fast forward to May-2013…the monthly outlays were $61B, and the TTM was $700B….18% of all cash outlays over the past 12 months.

One quick note. On the DTS…only payments made by electronic transfer are captured…paper checks, though a small %…fall through to “other”. In the past, I have seen estimates that in the past 90%-95% of social security payments were electronic transfers. Obviously, this population would not stay constant. I think it would be a safe assumption that the paper checks go to the older recipients at a higher rate than younger (relatively 🙂 ) recipients. So…as the older recipients with paper checks pass away, and are replaced by younger recipients who prefer direct deposit…the$ of SS EFT’s would grow…even if SS total payments were constant…somewhat skewing our analysis. Early this year, they actually made a push to eliminate paper checks…not sure how successful that was, but there were some notable upward blips in the data consistant with this, so it is probably safe to say that there are only a few % left. All together, I think the population of paper checks, and the rate of change associated with it are small enough to more or less ignore…I just wanted to put it out there for full disclosure.


So let’s start with the charts:

The monthly:

06-25-2013 Social Security Monthly

and the TTM:

06-25-2013 Social Security TTM

So the first question you probably have…what are those huge saw-tooth looking swings? Most of these are caused by timing…where the first social security payment due the third of the month is pulled into the prior month due to weekends/holiday ect… This causes a spike, then dip that is very prominent in the monthly, and even apparent on the TTM. This isn’t common, but it does happen every year or so. There is one additional spike in May-2009 related to stimulus…I believe about $13B of extra payments were made in an effort to buy votes stimulate the economy.

The charts are clear…Social security is huge, is growing, and that growth is expected to accelerate over the next 10 years. I’m no actuary, but I recently looked at some age tables a while back and the next 10 years should see a accelerating growth as we get into the meat of the Boomer generation. For example…per the data I have… about 2.7M people will turn 65 in 2013.  next year spikes up to 3.7M…trending up to around 4.5M per year by 2025.

Note…the SS population is in constant flux…people retire every day, and people pass away every day. Right now…we seem to be adding about 125k people per month to the program(consolidated…retirement and disability ect…), with a year over year growth of about $60B per year and headed higher. So in the context of the entire budget…just to stay even each year…you have to come up with an additional $60B+ per year of cuts or new revenue…in perpetuity just to stay even. A year or two…we can probably cough up…but after 10 years…you are talking about a huge hole that appears to be too massive to fix.

This is the ticking time bomb I expect to blow the budget apart in the long run. From $700B per year now….in just five years…June 2018 assuming 6-7% annual growth, we will cross the $1T per year threshold. Who thinks we will elect someone in 2016 on a “cut social security” platform?? Didn’t think so. Over 57M people currently get checks each month….with 60M or so Boomers in line for their cheese…..The math suggests a very unhappy ending for all.

Interest Rates Rising – What Does It Mean For The Deficit??

At $221B over the last 12 months, cash interest paid on the public portion of the debt isn’t huge…it’s about 5% of all outlays, but it holds an incredibly important role in the future of the debt/deficits. To fully understand why…let’s go back about 6 years to the beginning of 2007. Public debt outstanding was at $3.8T, and annual cash outlays for interest were at $152B. Fast forward to the end of May-2013…where public debt outstanding was $11.9T with the aforementioned $221B of cash interest payments. Does that sound a bit off to anyone?

06-24-2013 TTM Cash Interest 2007-2013

It should…Over the same time period that publicly held debt outstanding has more than tripled, cash debt payments has only increased 45%. It’s a really sweet deal….if you can get it…and by actively manipulating the market (screwing over savers in the process) that is exactly what the government has accomplished. The key, of course, is lower rates…declining from an estimated 3.2% in 2007 to about 1.9% as of the end of May. I say estimated…I take the TTM cash payments, and divide it by the average public debt outstanding over the prior 12 months. No…it’s not perfect, but applied consistently I think it tells right story with an acceptable margin of error.

06-24-2013 Interest Rates 2007-2013

So some quick math…just say we can assume 2007’s 3.2% was a “normal” number….something we could plug into a 50 year forecast. I’m not sure it is, but let’s go with it. At that rate…we would be spending $380B per year on external interest payments…$160B over the current run rate. Over the 10 year timeframe our congress critters seem to prefer….It would be a lot more than $1.6T due to the magic destruction of compound interest. This in an era where we can’t even agree on simple cuts that will only save a few billions a year.

It has long been my theory that this is the true primary reason behind low interest rates. Not stimulating lending, or the economy, or making housing affordable…those are all just cover stories for this….manipulating interest rates down to near zero is the only way in hell the government can afford to finance the budget without the whole thing blowing sky high. That is why my thesis is that they simply cannot allow rates to go higher at all, and so when they invariably do go higher…it indicates that the Fed has lost control, and things could get very ugly very fast.

This is why I believe this is one of the most important charts I track each month. Once that curve starts to head up and crosses 3%…the long term deficit is going to take off, exposing what has been obvious for quite a while anyway…the US government will default on on and off balance sheet debt sooner or later….the only question is when, and who gets screwed the most (Seniors, veterans, government employees…all of the above?).

So…if you’ve been to a finance site recently…you’ve probably heard that rates are headed up across the board. Is this the end?? Well…let’s look at some data. It looks like…from yahoo finance, that the 6 month bond has increased 50% from .06% to .09%. That’s an incredibly low rate….so bumping it up 50% is more or less inconsequential for now. Say $1T of the $11.9T debt is 6 months or less….assuming I have my decimals in the right place…that’s only $1.2B per year at .06%…or $1.8B at .09%….rounding errors really.

Obviously, the 6 month is only a small piece of the market, but I think the illustration works for the entire spectrum…extremely low rates have increased a bit in the last few weeks, but are still extremely low. Furthermore….the $11.9T of debt is fixed for terms of  days, up to 30 years…. so while bondholders are immediately affected by rate swings, treasury more or less only has to worry about the debt it is rolling, about $600B per month(primarily short term), plus any new deficits that need financing…say $75B per month. To further complicate things, we are using the cash interest payments, which are going to lag issuance by up to 6 months.

So…for now, while it’s not a good sign, I don’t see the action in rates over the last month creating an immediate crisis, but perhaps sowing the seeds for an inevitable crisis down the road. It will be months before these rather small (in the big picture….maybe not so much if you were betting with leverage the other way) increases in rates flow through to cash, and even then they probably won’t be noticeable. Still….very interesting stuff to keep your eyes on. I’ll probably start sounding the alarm when the rate creeps back up past 2.25% and looks like it is trending up. Given the vast size of the market…this isn’t going to happen overnight. Even if the seeds have indeed been sown in the last few weeks… I think it could be a year or two before enough debt is rolled at higher rates to start seeing a materially higher cash interest expense.  I guess when it comes down to it, we all know how this parade ends….it’s the timing that we aren’t sure about.

Kroger Fuel Rewards…4X points deal is back!!

I haven’t seen it advertised, but when I swung my local Kroger yesterday, I noticed their 4X  fuel points on gift cards deal was back….making it a great time to stock up on any gift cards you may need.

About a month ago, I did a write up on how to use the program to save a ton of money on gas. Quick recap….purchasing $250 of gift cards will get you 1000 fuel points, which you can use to save $1 per gallon for 35 gallons of gas….a $35 saving if you do it right…

CBO vs CBO Update

Back in March, I posted a piece I called Congressional Budget Office vs Citizens Budget office, or CBO vs. CBO. The premise was to compare the CBO’s 10 year forecast to my own rather primitive trend based forecast. In the end, I forecasted a 10 year deficit of $12.7T to the CBO’s $6.8T forecast, with the primary difference being revenues. To me, their revenue forecasts were wildly optimistic, predicting 11-12% YOY growth between 2013 and 2015, before tapering off to 5%-6% in the out years. I could buy 2013 at over 10% due to the tax hikes, but two more years of 10%?…not buying it.
While I didn’t post projections for specific years, after blowout revenues in April, and a rumored $59B “special” Fannie Mae payment in a few months….it is starting to look like round 1 (Year 1) is going to go to the experts at the CBO. At publication, I had pegged the FY 2013 deficit at $1006B vs the CBO’s forecast of $845B. While I haven’t done a full refresh of my forecast, I have tweaked it a bit, bumping up expected growth in withheld taxes to 12% from 10%, as well as made some downward adjustments to outlays to account for the sequester. With an additional 2 months of data in the bank, I now have the FY 2013 deficit forecasted at $866B….not including the rumored $59B from Fannie Mae. (regular payments from Fannie/Freddie are included) So if we back out the Fannie payment, $800B founds like a fairly reasonable preliminary forecast for FY 2013…..which would be a pretty decisive round one victory for the CBO.
Understanding my miss was pretty simple…I didn’t forecast the April Surge, I didn’t forecast the $59B Fannie Mae payment, and I was over a bit on outlays because I thought sequestration would be avoided or mitigated one way or another. Of course….there are still 5 months left..a lot of ball left to play, so who knows where we will end up.
As it turns out, the CBO has also revised their forecast…which is actually what prompted me to write this…I had planned on waiting until May actuals were in. Not content with coasting to a round one victory over their rival Citizens Budget Office….the CBO has actually revised down their deficit forecast even further from $845B to $642B. Do they know something I don’t? Well…let’s hope so, but I suspect it is actually something else.
The reduction is pretty evenly split…about $100B is increased revenue, and $100B is decreased outlays. The revenue I get…$59B from Fannie, plus an upward tweak to account for stronger than expected inflows for the remainder of the FY. Outlays however presents a different issue I suspect completely related to the impending debt limit fight.
First…some methodology review. My forecast of the deficit is strictly cash based….cash in, less cash out, adjusted for debt issuance and debt repayment. Changes in internal debt have no bearing on this calculation at all because as I have discussed at length, all it represents is cash taken from social security and other similar programs and already spent….pretending you owe yourself money does not affect cash.
Second, the cash deficit includes things almost certainly not included in the official deficit. the most prominent example is the post office. I’m not sure why, but all of the post office’s revenues and costs are run through treasury’s bank accounts, contributing about $88B in cash to the coffers in the last 12 months, about $7.3B per month. On the other side, we can see about $40B of outlays related to Postal Money Orders. So the post office ran a $48B surplus right??? Nope…employee costs, and probably other costs as well are lumped together with Federal Salaries, and elsewhere to (probably intentionally) muddy the water. More or less, it’s a wash, though with the PO, one would expect some cash deficit impact, nothing material to the Federal deficit. There are a handful of other smaller categories as well.
Still, despite the differences in methodology and accounting definitions, for FY 2012, the official deficit came in at $1089B compared to the cash deficit at $1092….suggesting that most of the items that affect cash, but are excluded from the official revenue and outlays are deficit neutral….cash inflows = cash outflows.
I am afraid that this correlation is about to get broken by the “extraordinary measures”…which may explain the desire of some to push the debt limit into early October…just into FY 2014. The effect will be to shift $100B of cost out of FY 2013…and into FY2014. Bottom line…it is more malarkey. Shifting $100B of cost from 2013 to 2014 and having Fannie Mae borrow $59B just to pay a large dividend based on phantom income very well may get the official deficit down to $642B in FY2013, but in all honesty it does absolutely nothing to the long term picture. That $100B will come right back at us in 2014, and Fannie, forced to issue $59B in debt, will contribute that much less to the treasury in the future those revenue streams will be diverted to interest and principal payments, or maybe even defaulted on.
Finally…just want to emphasize that this is exactly why I use the Daily Treasury Statement (DTS), and only the DTS in calculating the true (cash) deficit. Any other series provided by the government is at risk for accounting shenanigans….but the DTS absolutely has to tie out by every single business day at 3PM. Your beginning cash + cash in less cash out better equal your ending balance….and the changes in public debt better be pretty darn close to the debt to the penny…separately published every day (discounts and premiums on bonds cause small differences). Sure…shenanigans are theoretically possible, but they would have to be systematically accomplished in less than 24 hours….every single day in perpetuity. Anything is possible, but the risk of this series is materially less than any other government generated reports, as we are about to find out come the end of the FY when Obama trots out a bogus deficit of ~$650B..and proceeds to beat the Republicans with it.
**update** just a note that previous “extraordinary measures” were initiated and resolved in the same fiscal year….probably causing shifts between months, but not between FY. This time….though anything could happen, it seems like with the FY ending 9/30, putting off resolution until October would result in a ~$100B shift from FY 2013 to FY 2014. Of course, we don’t know when this will actually be resolved. it could be tomorrow, or it could drag on well into FY 2014 (but I doubt it)