The Big Picture - Macro Perspective on the Capital Markets, Economy, Technology, and Digital Media

via RealtyTrak

With U.S. Treasury issuance skyrocketing over the past couple years, yields at new all-time lows and talk of a bond bubble rife, we are often asked, “Who is buying all this Treasury debt?” Below are a series of charts that attempt to answer this question.

Foreign Buyers

When asked who is buying Treasury debt, people usually instinctively think of foreigners.

At face value, the next two charts look impressive. The first shows all foreign buyers of Treasury notes and bonds on both on a monthly (top panel) and a rolling 12-month sum basis (bottom panel). This data comes from the Treasury International Capital(TIC) Report.

As the bottom panel shows, foreign net purchases of Treasuries totaled just over $500 billion in the past year.

When viewed in the light of surging issuance, foreign purchases are actually falling as a percentage of bonds auctioned.

The next chart compares foreign net purchases of Treasuries to the amount of bonds issued every quarter in blue. The red line compares Chinese net purchases of Treasuries to the amount of bonds issued every quarter.

From 2004 to 2008 all foreigners regularly bought more Treasury securities than were issued. This is shown as a ratio above 100%. To be clear, the ratio below shows all Treasury securities bought by foreigners (whether at auction or in the secondary market) relative to all securities issued by the Treasury department for the quarter.

Since mid-2008 foreign purchases of Treasury securities have been under 50% of securities auctioned, and the Chinese have bought less than 10% of the amount auctioned. Even though foreigners have almost doubled their buying of Treasuries in the last few years, they have not kept pace with growing Treasury issuance over the same period. As a result, foreign purchases now account for less than half of what has been issued since mid-2008. Domestic purchasers of Treasuries are now buying more than half of the amount auctioned.

Who are these domestic purchasers of Treasuries?

Domestic Investors – The Federal Reserve

When thinking about potential domestic purchasers of Treasury securities, the Federal Reserve quickly comes to mind. The two charts below show the Federal Reserve’s holdings of Treasuries and their quarterly net purchases. This data comes from the flow-of-funds report.

When the Federal Reserve first created the Term Auction Facility, or TAF, in late 2007, they initially “sterilized” any loans by selling Treasuries in an amount equal to those loans. This is evident in the large quarterly net sales in early 2008 in the second chart below. Since foreigners were buying more Treasuries than were being issued during this period (greater than 100% in the chart above), these sales were not a problem.

The Federal Reserve’s holdings of government securities quickly rose in light of QE1 and QE2.  Even though foreign demand for Treasuries was still present during this time, the Federal Reserve’s purchases far outpaced foreign purchases.

Domestic Investors – Mutual Funds

The next big domestic buyer that comes to mind is the mutual fund community with more than $12.1 trillion in assets ($9.5 trillion in long-term funds — stocks, bonds and hybrid funds — and $2.6 trillion in money market mutual funds). The two charts below show the net purchases of Treasuries for money market mutual funds and long-term mutual funds. This data also comes from the Federal Reserve’s flow-of-funds report.

As the first chart shows, money market mutual funds were net sellers of Treasuries seven quarters in a row before returning with net purchases in Q4 2010 and Q1 2011.

The second chart shows long-term mutual funds are net buyers of Treasuries, but in small quantities. In Q1 2011 their net purchases only totaled $3.07 billion. Clearly neither the long-term mutual funds nor the money market funds are large players in the Treasury market when compared to foreigner or the Federal Reserve.

Domestic Investors – Banks

Are banks’ holdings of Treasuries closer in scale to those of the Federal Reserve or foreigners?

The first chart below shows U.S. chartered bank holdings of Treasuries have declined from $294 billion in Q1 1994 to just $37 billion in Q1 2011. The second chart shows a long-term look at the percentage of banks’ assets invested in Treasuries. Back in the 1950s it was near 40%. Today it is less than 0.5%. Simply put, banks do not buy Treasuries.

Domestic Investors – Households

The two charts below are also from the Federal Reserve’s flow-of-funds report. Households’ holdings of Treasuries have grown more than threefold since December 2008 despite net sales of $155 billion in Q1 2011. But who are households?

From the name, one could conclude that households are “mom and pop.” But this category is more than this. As we explained last year:

To answer this question we must first lay out the definition of households from the flow of funds report (page 12):

For most categories of financial assets and liabilities, the values for the household sector are calculated as residuals. That is, amounts held or owed by the other sectors are subtracted from known totals, and the remainders are assumed to be the amounts held or owed by the household sector. For example, the amounts of Treasury securities held by all other sectors, obtained from asset data reported by the companies or institutions themselves, are subtracted from total Treasury securities outstanding, obtained from the Monthly Treasury Statement of Receipts and Outlays of the United States Government, and the balance is assigned to the household sector.

To be clear, the “household sector” is misnamed. It is the residual account with a fancy name. So given this, what does it mean when the residual account soars? We would suggest that it means there is a measurement problem. In this case, the Federal Reserve cannot “find” the buyers of Treasuries thanks to the exploding deficit. They correctly assume that the buyer exists (otherwise the market would not exist) and therefore place the “missing” buying in the residual account. Since this account is called the “household sector”, we all assume that “mom and pop” bought this sum.

If “mom and pop” were really the end buyers we would expect to see similarly booming numbers from the mutual fund industry. However, as we detailed above, mutual fund purchases are a somewhat insignificant portion of domestic buying.

Our guess is the domestic buyer is a leveraged carry trader, a mutual fund, a brokerage subsidiary or other group that does not have a category and gets “dumped” into the default category of “households.”

Conclusion

We have shown that the deficit has exploded higher to the point that issuance is outrunning foreign purchases.  Clearly a large portion of this issuance has been bought by the Federal Reserve in the form of QE1 and QE2.  Households sold a record $155 of Treasuries during Q1 2011, a trend that bears watching.

With QE2 now a relic of the past, the Federal Reserve would have to initiate a new round of QE to continue soaking up Treasury issuance.  Perhaps the decline in interest from both foreigners and “households” was one factor in prompting the Federal Reserve to guarantee low rates for a period of two years.  For the time being, the drop in rates seems to indicate that leveraged traders are taking full advantage of this opportunity.  Only time will tell if this is reflected by increased demand from “households.”

Source:
Who Is Buying U.S. Treasuries?
Bianco Research, 23 August, 2011

Make no mistake about this: Warren Buffett just saved Bank of America’s bacon.

A few items leap out this announcement:

1) BoA needed both capital and a reputation reboot. Buffett provided a little bit of both.

2) This gives lie to the claim that BofA needed no money

Counter argument — this was about the stock slide, not the capital structure, which remains opaque.

3) The fine print will be revealing of the specifics of the terms, but I am curious as to how this compares to the deal cut with Goldman Sachs (GS) and GE.

4) Buffett met with Obama a few days ago; I wonder what was discussed in THAT meeting.

5) Investors are cautioned that unless you are buying on the same terms as the billionaire, you are making a very different bet than he is.

More to follow later today.

>

Related:

• Buffett Invests $5 Billion in BofA (WSJ)

• Bank of America Says Buffett’s Berkshire Will Invest $5 Billion (Bloomberg)

“Federal Reserve Chairman Ben Bernanke is unlikely to use his speech Friday at the central bank’s annual Jackson Hole, Wy, conclave to unveil new efforts to bolster the US economy, despite financial markets’ lingering hopes that he will,” said the WSJ today. While no specific sources were cited, it’s likely no coincidence that this was written the day before Bernanke’s speech. Jackson Hole is not the new forum for an FOMC meeting. Last year was an outlier and as I’ve stated already, the Aug 9th FOMC meeting was the ’11 version of ’10 Jackson Hole and they won’t add to it just 2 1/2 weeks later. European bank stocks are rallying after Credit Agricole reported better than expected earnings and the iTraxx European financial index CDS is falling 10 bps to 245 bps, a 3 day low. One comment on gold to put the amazing move we’ve seen since 1999 into perspective. The rally to $1900 a few days ago from the 1999 low of $253 is a rise of 7.5 times. The 1970′s bull market sent gold from $35 to $850, a gain of 24 times. Gold of late was well overdue for a sharp drop after its recent parabolic move but this 11 year bull market is not over and understand that gold is not in a bubble, global paper money creation is.

You want to survive this crash and the next one? Then follow Downtown Josh Brown’s Rules for Surviving a Crash:

1. Acknowledge that its a crash. Once we’re past down 10% in the Dow Jones Industrial Average from wherever the peak was (yes, the Dow is a way better crash gauge than the S&P 500), you can stop saying correction and start saying crash. Better to be wrong in hindsight on the nomenclature.

2. Pencils Down! Whatever trendlines or individual stock research you were working on needs to be shelved for the moment. Your drawings and calculations will not work here. If you happen to buy a stock and it rips higher, it will not be because of your research, it will be because the market went up. Correlations always get jiggy in crashes, stocks become commoditized like bushels of wheat that must be liquidated regardless of the underlying businesses.

3. Don’t listen to “stockpickers” or sell-side equity analysts. They are only looking out from within their own little bubble and they cannot comprehend the other little bubbles around them let alone the whole bathtub. Anyone covering specific stocks needs to know when the macro gyrations trump whatever earnings they’ve estimated or the conference calls they’ve listened to. There’ll be a time to “know your stocks” but this ain’t it.

4. Ignore the asset-gatherers and the brokerage firm strategists, their job is to calm markets and soothe investors. Let’s say Morgan Stanley runs $1 trillion in stock market wealth for investors. And then let’s say they felt there was serious trouble ahead. Do you really think they would ever make the sell call? Can Morgan Stanley really say “Sell 20% of your equities”? No. Because that would be $200 billion in supply hitting the stock market at once – they would crash it all by themselves! Too Big To Keep It Real has always been the problem with the wirehouse advice model.

5. Make sacrifices by reducing stock exposure by beta and volatility. This is my iron-clad rule. The moment you recognize the crash, kick the small caps, biotechs, emerging markets etc. You must separate your feelings for a particular asset class, sector or individual stock and recognize that the higher the volatility, the worse they’re gonna act in the short-term. I have a prenuptial agreement with every position I put on and we get divorced cleanly in a crash situation if need be.

5a. Also, margin balances must get cleaned up immediately, take the losses, I don’t care. Because broker-dealers and clearing firms can and will raise equity requirements right at the moment of maximum pain and force you to sell out later – and lower. I could tell you war stories you would not believe, kids.

6. Make two lists. The first list everyone knows about and talks about – the “if they get cheap enough I’ll buy it at that price” shopping list. Fine, but don’t forget the “things I will sell on the next bounce list”. Even the worst markets have short-term bounces in the midst of the chaos, use these bounces to get rid of the things that make you ill on the red days, even if you’re taking a loss. The stocks you bought on a flyer one day or the companies that have been disappointing or where the story has changed – sell ‘em on the rips.

7. Watch sentiment more closely than technicals or fundamentals. Pay attention to the squishier things in a crash moreso than you would normally. Are people screaming in pain? Or are they still looking for a bottom? Or have they given up entirely? There is no math to this, a lot of it is “feel”.

8. Abandon any hope or intention of catching the bottom. You won’t and it is unnecessary. No one will carry you out on their shoulders if you manage to do it but you will definitely get carried out on a stretcher if you get it really wrong with your own capital. Keep in mind that time becomes more important than price…not where will it end but when?

9. Suspend disbelief. “Bank of America could NEVER be a $5 stock!” “How could Bear Stearns possibly go out of business, its a hundred-year-old firm!” “No way this stock should trade at 5 times earnings, it’s a Dow component!” “How could the market go down 5% four days in a row?” Guys, anything can happen in a crash, there are machines making the trades and they have no respect for the prestige or standing of a particular company. This is both gut-wrenching to behold and great for the level-headed who eventually got to buy Wells Fargo in the teens or Apple in the $100s once the bottom was in.

10. Stop being a know-it-all and shut up. If you are telling people a price or a support line where the selling will end, you are only kidding yourself. Have a guess based on your discipline and research, but don’t act like you’re talking facts. Fair Value is fine, but call it a guideline. Support is also fine, but call it a historical estimate of where buyers have come in before. The deal with crashes is that extremes are the norm, not the exception. Things tend to overshoot through reversion to the mean trendlines or fair value estimates on their way back to stasis.

Source:
Downtown’s Rules for Surviving a Crash,
The Reformed Broker, August 19, 2011

It’s Official: Human Activity Can Cause Earthquakes

Human Activity Is Officially Acknowledged to Cause Earthquakes

The United States Geological Survey is America’s official expert on earthquakes. It’s the Federal agency charged with monitoring, reporting on, researching and stressing preparedness for earthquakes.

So I was surprised to read the following statement by the USGS:

Earthquakes induced by human activity have been documented in a few locations in the United States, Japan, and Canada. The cause was injection of fluids into deep wells for waste disposal and secondary recovery of oil, and the use of reservoirs for water supplies. Most of these earthquakes were minor. The largest and most widely known resulted from fluid injection at the Rocky Mountain Arsenal near Denver, Colorado. In 1967, an earthquake of magnitude 5.5 followed a series of smaller earthquakes. Injection had been discontinued at the site in the previous year once the link between the fluid injection and the earlier series of earthquakes was established. (Nicholson, Craig and Wesson, R.L., 1990, Earthquake Hazard Associated with Deep Well Injection–A Report to the U.S. Environmental Protection Agency: U.S. Geological Survey Bulletin 1951, 74 p.)

Injection Wells Can Induce Earthquakes

The New York Times noted in February:

Researchers with the Arkansas Geological Survey say that while there is no discernible link between earthquakes and gas production, there is “strong temporal and spatial” evidence for a relationship between these quakes and the injection wells.

For decades, scientists have been researching induced seismicity, or how human activity can cause earthquakes. Such a link gained attention in the early 1960s, when hundreds of quakes were recorded in Colorado a few years after the Army began injecting fluid into a disposal well near the Rocky Mountain Arsenal.

Lawrence Berkeley Laboratory points out:

Induced seismicity [i.e. earthquakes] in oil and gas production has been observed ever since the 1930s, i.e., ever since large scale extraction of fluids occurred. The most famous early instance was in Wilmington, California, where the oil production triggered a series of damaging earthquakes. In this instance the cause of the seismicity was traced to subsidence due to rapid extraction of oil without replacement of fluids.

***

In the last decade a number of examples on earthquake activity related to oil and gas production as well as injection of liquids under high pressure have been observed, although not with as serious consequences as for Wilmington. Almost all induced seismicity associated with petroleum extraction can be traced to either fluid injection or extraction. In some recent cases injection of produced water (excess water extracted during oil and gas extraction) has produce significant seismic activity. Examples are in Colorado and Texas where gas and oil production yield large volumes of water that must be put back underground. In some cases the water cannot be put back exactly where it was produced and over pressurization of the water causes induced seismicity.

Lawrence Berkeley Lab provides details:

Fluid pressures play a key role in causing seismicity. Explained in simple terms, fluids can play a major role in controlling the pressures that are acting on the faults. The fluid pressure in the pores and fractures of the rocks is called the pore pressure.

***

Injecting fluids into the subsurface is one way of increasing the pore pressure and thus allowing the faults and fractures to “fail” more easily, thus inducing an earthquake.

***
That is why in many cases induced seismicity is caused by injecting fluid into the subsurface or by extracting fluids at a rate that causes subsidence and/or slippage along planes of weakness in the earth. Figure 2 is an example of induced seismicity being caused by water injection. Figure 2 is a cross section of the earth showing the location of the earthquakes (green dots), the locations of injection wells (thick blue lines) and production wells (thin lines, these wells extract fluid). Note the large number of events associated with the injection wells.

Figure 2. Example of injection related seismicity; note the close correlation between water injection wells and the location of the seismicity.

For additional scientific documentation, see this, this, this, this, this, this and this.

“Fracking” Can Cause Earthquakes

Lawrence Berkeley Lab also points out that hydrofracturing (or “fracking” for short) can cause earthquakes:

Another type of induced seismicity is that which is associated with “hydrofracturing”. Hydrofracturing is done by injecting fluid into the subsurface to create distinct fractures in order to link existing fractures together in order to create permeability in the subsurface. This is done to extract in situ fluids (such as oil and gas). Hydrofracturing is distinct from many types of shear induced seismicity because hydrofracturing is by definition only created when the forces applied create a type of fracture called a tensile fracture, creating a “driven” fracture. Shear failure has been observed associated with hydrofracturing operations, as the fluid leaks off into existing fractures, but due to the very high frequency nature of tensile failure ( seismic source at the crack tip only) only the associated shear failure is observed by microseismic monitoring . However, hydofracturing is such a small perturbation it is rarely, if ever, a hazard when it is used to enhance permeability in oil and gas or other types of fluid extraction activities. To our knowledge hydrofracturing to intentionally create permeability rarely creates unwanted induced seismicity large enough to be detected on the surface even with very sensitive sensors, let alone be a hazard or an annoyance. In fact the very small seismic shear events created from the shear failure associated with the hydrofracture process are used to map the location of the induced permeability and as management toll to optimize fluid production. If not for the very small shear events it would be much more difficult to understand the effect of hydrofracturing because the seismic energy created from the “main fract” is to low to be detected, even from he most sensitive instruments at the surface of the earth Figure 3 is an example of how seismicity is used to map these hydrofractures. Last but not least another reason that the seismic risk is so low associated with hydrofracture operations in that they are of relatively low volume and short durations ( hours or days at the very most) compared to month and years for other type of fluid injections described above.

Figure 3. Cross section through a stimulation well showing six different stages of hydrofracture stimulation and the associated seismicity (magnitude -1.0 to -2.5) during the entire hydrofracture (less than 24 hours) Warpinski et al 2005.

AP reported in February:

Scott Ausbrooks, geohazards supervisor for the Arkansas Geological Survey, said the quakes are part of what is now called the Guy earthquake swarm – a series of mild earthquakes that have been occurring [in Arkansas] periodically since 2009. A similar swarm occurred in the early 1980s when a series of quakes hit Enola, Ark.

Ausbrooks said geologists are still trying to discover the exact cause of the recent seismic activity but have identified two possibilities.

“It could just be a naturally occurring swarm like the Enola swarm, or it could be related to ongoing natural gas exploration in the area,” he said.

A major source of natural gas in Arkansas is the Fayetteville Shale, an organically-rich rock formation in north-central Arkansas. Drillers free up the gas by using hydraulic fracturing or “fracking” – injecting pressurized water to create fractures deep in the ground.

Ausbrooks said geologists don’t believe the production wells are the problem, but rather the injection wells that are used to dispose of “frack” water when it can no longer be re-used. The wastewater is pressurized and injected into the ground.

***

Ausbrooks said the earthquakes are occurring in the vicinity of several injection wells.

***

[Police Chief Dave Martini] the earthquakes started increasing in frequency over the past week and that the disposal well has seen an increase in use recently.

Websites Ask Whether Fracking Caused the Virgina Quake

Front-page articles at Daily Kos, OpEdNews, and RT ask whether the August 23rd Virginia earthquake was induced by fracking.

I have no idea whether or not this is true, and have been too busy to look at the supposed evidence of drilling near the epicenter of the earthquake.

But given that some human activity is officially acknowledged to be able to induce earthquakes, it’s worth asking these types of questions. 

Discuss

My afternoon reading material:

• Obama Goes All Out For Dirty Banker Deal (Rolling Stone)
• An important lesson from Jackson Hole 2010 (FT.com)
• Doug Kass: Kill the Quants Before They Kill Us (The Street)
• Food and Energy Price Shocks: What Other Prices Are Affected? (Fed of Cleveland)
• George and the giant investment problem (Deus Ex Macchiato)
• Imagining a Real Government Rescue for Banks (WSJ)
• WTF headline: Cheney Says He Had Secret Resignation Letter (Bloomberg)
• Yet another WTF headline:  Is the market forecasting war? (Market Watch)
• Me Media: Gold ETF gain signals equities are oversold (City Wire, Aug 23, 2011 at 14:53, GMT)
• Sprint to Get iPhone 5 (WSJ)

What are you reading?

>

Hey you XM Satellite Radio listeners!

I will be guest hosting for Pete Dominick today, and for the next Wednesdays, from 3-6PM ET on P.O.T.U.S. SiriusXM 124

3:05 Floyd Norris, NYT (phone) Financial news
3:35 Henry Blodgett, Business Insider (phone) Bank of America
4:05
4:35 Peter Boockvar, Miller Tabak (phone) economy/markets
5:05 Daniel Gross, Yahoo Finance (In studio) economy

Should be lots of fun!

~~~

Source:
Life in luxury
Jennifer Collins
Marketplace Morning Report, August 24, 2011
http://marketplace.publicradio.org/display/web/2011/08/24/am-life-in-luxury/