An interesting take on U.S. treasuries as an investment. (HT zerohedge). Chris Pavese over at Zero Hedge provides a contrarian view to the common wisdom that the government printing presses will spawn massive inflation. Chris argues that with our increasingly large debt burden, relatively small increases in yields will substantially increase the cost of servicing our massive debt which will off expansion and keep a lid on inflation.
Chris points out that recent asset bubbles have been burst by successively lower rises in interest rates. Short treasuries is a crowded trade with everyone and their mother calling for massive inflation; that day may very well come, but in the near to mid-term, the risk of inflation may be grossly overstated.
Personally, I believe that with the dual impact of the economic stimulus package rolling off in the second half of 2010 and the massive shadow inventory of foreclosed homes waiting to hit the market, we are on our way to the second leg down.
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Update on the Fed’s $123 billion in emergency lending to AIG.
For those intrigued by my credit default swap post, there is a good article in yesterday’s New York Times. The article asks, “where are the funds being lent to AIG by the Fed going within the company”
The American International Group is rapidly running through $123 billion in emergency lending provided by the Federal Reserve, raising questions about how a company claiming to be solvent in September could have developed such a big hole by October. Some analysts say at least part of the shortfall must have been there all along, hidden by irregular accounting.
The article goes on to describe that accounting for its derivatives trades, largely the selling of credit default swap protection, had been severely lacking oversight. As more attention was drawn to the activities of AIG’s Financial Products group, an alarming picture began to emerge.
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Credit Default Swaps – A Primer
A credit default swap is a type of credit derivative. Credit derivatives “derive” their value from an underlying credit instrument; generally the bonds of sovereign nations or the bonds of a corporate entity. In recent years, credit derivatives have been created that are based obligations rather than entities; one common reference obligation are asset backed securities based on home equity loans.
A credit default swap is a contract that allows one to take or reduce credit exposure. The contract is between the two parties and does not directly involve the underlying reference entity. A credit default swap is essentially an insurance policy where one entity pays a premium to a second entity to take on the risk of a loss.
Let’s look at a fictitious example.