Trend: In February 2009, the US government will unleash some heavy financial artillery in the fight to stimulate the economy and reverse the downtrend.
In this post, we eavesdrop on Pimco's Paul McCulley (PMc) as he describes the remedies for the financial crisis to his pet rabbit Bun Bun (BB).
Link: PIMCO - GCB December 2008 McCulley All In.
PMc: The recently announced Term Asset-Backed Securities Loan Facility, known as the TALF, and scheduled to come on in February, is a perfect example of just such a joint venture, with the Treasury putting up $20 billion of equity and the Fed putting up $180 billion of loans senior to the Treasury.
The TALF will effectively step around the risk-adverse commercial banking system and provide warehouse financing directly for securitization of new consumer and business loans to Main Street. It’s a really cool innovation, which is likely to be expanded or replicated. And most important, it is likely to get reflationary traction.
The Fed also stands ready to print $600 billion of money to buy directly $500 billion of Agency MBS (Mortgage-backed Securities) and $100 billion of Agency debentures, so as to pull down and hold down long-term mortgage rates. The buying of the debentures is already under way, and the buying of MBS is likely to start in a matter of weeks.
And if necessary, the Fed is openly willing to print money to buy longer dated Treasuries, providing a further downward gravitational force for long-term interest rates....it is indeed a fact, a glorious fact, in my view, that the Fed does presently stand ready to print as much money as necessary to accommodate the financing of an all-in reflationary fiscal policy thrust, as promised by President-elect Obama. Through holes in the floor of heaven, Hyman Minsky weeps tears of joy.
Call it good, very good: the monetary and fiscal authorities, separately yet together, going all in. And call me cautiously optimistic that Reflation will get traction.
...With respect to the willingness of policy makers to do the right reflationary thing, we can drop the adverb cautiously. I’m flat out optimistic. But prudence demands that I at least acknowledge that even the best laid reflationary plans might go awry, at least in the short run.
The “right reflationary thing” is a macro concept, not necessarily a micro concept. It doesn’t mean extending the soothing socialist hand to every square inch of the capitalist landscape.
The right reflationary thing to do is to systemically save capitalism from its inherent debt-deflationary pathologies, not to eliminate capitalism. Recall, capitalism at its micro core is a process called creative destruction, churning resources from yesterday’s technologies and work methods to the more productive ones of tomorrow.
BB: Ok, that makes some sense. In my world, that’s called the survival of the fittest. Wouldn’t make sense for government to try to overrule that force of nature, I agree. But it would make sense for the government to put out a forest fire that threatened to consume all us creatures, right?
PMc: Nice way to put it, Princess. Very nice! It’s a delicate balance.
BB: Thank you. In your world of investing, it seems the analog would be to go long the forest, because the government is going to keep the flames of deflation from burning it down, while taking a selective approach to going long particular creatures. Is that about right?
PMc: Yea verily, I say unto thee again. But with just a slightly finer point on the matter: In order to save the capitalist economic forest, there are certain creatures that the government must necessarily also save. The right investment strategy is to go long both the forest and those creatures.
BB: Fair enough. Now name them!
PMc: We have been publicly naming them for months here at PIMCO, Bun Bun. Well maybe not always particular names, but rather the attributes of those names. The most important is explicit government support, which is most notably the case with the debt issued by banks that get to drink a triple-thick socialist shake: Equity injections from the Treasury, debt guarantees from the FDIC, and access to the munificent liquidity facilities of the Federal Reserve.
BB: But isn’t it time to get a little more daring than that? What would be wrong with starting to average into some funds in the major stock and bond indexes, as a play on your thesis that the American capitalist economy is a going concern? Yes, I know that means you would be indirectly going long some individual names that will be on the fatal end of the creative destruction process, but isn’t that always the case?
PMc: I can’t argue with you, Princess. Your suggested strategy is consistent with the all-in reflationary policy responses. Yet caution is still warranted. I’d tilt it toward corporate bonds over corporate stocks, however, as seemingly little known in the popular press, high grade corporate bonds have, on a risk- and volatility-adjusted basis, been beaten up even more than blue chips stocks this year.
via John Mauldin
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