National Debt Gets More Expensive

This post first appeared on Minyanville.

The national debt is getting more expensive.

Over the past 15 months, Federal Reserve Chairman Ben Bernanke and Treasury Secretary Hank Paulson have unleashed a litany of programs aimed at averting wide-scale collapse of the American -- and indeed the global -- financial system. They go by the acronyms we've all come to know and love: TARP, CPFF, TAF, PDCF, TSFL, etc.

For all their nuances and complexities, the aim of each is to pump more cash into the American economy. Many of these programs are financed with Treasury debt, which is sold on the open market to domestic and international investors alike.

Bloomberg reports that, despite aggressive interest-rate cuts, the cost of US debt is rising - and will likely continue to do so.

Recently, as markets swooned, investors flocked to Treasuries as a safe haven. Yields -- which move in inverse relation to prices -- became almost non-existent as protecting capital trumped earning returns. Now, as credit markets slowly heal and the appetite for risk cautiously returns, many doubt existing demand will be enough to sop up the massive supply of American debt set to be issued in coming months.

Bureaucrats and regulators have pledged billions in support for our struggling economy: The money has to come from somewhere.

Foreign investors -- particularly Japan and China -- are the largest holders of our government-backed debt, and, as their economies stumble, federal budgets will become strained. Lower tax receipts and mounting costs means these countries will demand a higher return on their investments abroad.

This dynamic, coupled with increasing supply, is likely to push up yields on US Treasury debt. That means American taxpayers, gazing down the double barrel of the $700 billion bailout package and a likely second round of stimulus checks, will see their debt costs rise.

Credit costs throughout the economy are similarly moving north. Credit card companies like American Express (AXP) and Capital One (COF) are slashing lines and hiking up interest rates. Mortgage rates stubbornly continue to move higher, and corporate borrowing is as expensive as it’s ever been. That’s all after more than 400 basis points in Federal Reserve easing in less than a year-and-a-half.

Meanwhile, taxpayers wait eagerly to see if this increasingly expensive debt will be put to good use. In the past week, both Bank of America (BAC) and JPMorgan (JPM) have announced plans to step efforts to modify troubled mortgages. This is encouraging - but with 1800 banks lined up at the government trough, that $700 billion isn’t likely to last long.

For a group that would implore their fellow Americans to get out of debt and live within their means, Congress and their regulatory counterparts certainly don’t set a very good example.

Bank of England Takes on Mortgage Debt

The following post first appeared on Minyanville.

Mimicking recent moves by the Federal Reserve, the Bank of England announced today a plan to trade $100 billion in government Treasury bills for mortgage-backed securities.

The Wall Street Journal reports the lending facility will allow British banks to swap AAA-rated assets backed by U.K. and European mortgages for government bonds. Although it will also accept highly rated credit card debt, the central bank said specifically it won't take securities backed by U.S. mortgages.

Similar to the Fed's Term Auction Facility and Term Securities Lending Facility, the Bank of England claims the asset swaps won't result in increased credit exposure for the central bank itself. If securities are downgraded, banks must replace them with new AAA-rated assets. Unlike the Fed's swap arrangements -- which last only 28 days at a time -- the new British facility will last one year and is renewable for up to three.

Banks in the U.K. have been slower to write down asset values than U.S. financial institutions, partly because British borrowers have kept up on mortgage payments better than their American counterparts.

Although the move may alleviate concerns of big bank insolvency, it's unlikely to jumpstart credit markets. The Bank of England will learn what the Fed has learned: Handing banks like Citibank (C), Bank of America (BAC), and Merrill Lynch (MER) taxpayer money in exchange for questionable mortgage debt doesn't mean they'll turn around and lend it out.

The capital markets operate on trust, a characteristic noticeably missing from today's environment. Whether they're lending to a grocery store, homeowner or another bank, financial institutions don't offer loans without the expectation of being repaid - unless of course they're able to offload the risk to another party. That ability, so prevalent during the credit boom, is now gone.

Faced with the choice of providing loans to borrowers increasingly struggling under the weight of inflation and an uncertain employment outlook, financial firms are keeping capital close to home. Recent fears about data integrity in the bank-to-bank lending markets evidence just how little trust currently exists in the system.

Market turmoil resolves itself as a function of either time or price. Central banks are hoping to resolve the credit crisis by removing the price side of that equation. Unfortunately for them, the market was a long time in creating this problem. It will be a long time fixing it as well.

Reprinted by Permission copy write 2008 Minyanville Publishing and Multimedia