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Jim Rickards: Political intervention destroying price discovery and markets
Fannie and Freddie's Bond Market Upheaval
By James Rickards
Financial Times, London
Thursday, August 12, 2010
http://www.ft.com/cms/s/0/3e726a68-a640-11df-8767-00144feabdc0.html
A strange fog has enveloped the bond market. Once the strength of a bond was based on the reputation of its issuer. But a change began in 2008, as Fannie Mae and Freddie Mac verged on bankruptcy, and legislation was rushed through the US Congress to restructure them. The political importance of these institutions created a new world, one in which a bond’s performance is determined by the reputation of its holders.
Next week the US Treasury hosts a major conference to discuss Fannie and Freddie's future. But to understand how they changed the rules, we must return to the circumstances of their restructure. Such things are normally straightforward. Equity is wiped out, assets are revalued, and the gap in the balance sheet is uncovered. Bondholders take a "haircut" -- meaning a lower than expected return -- or a principal reduction. Some principal converts to equity, management is replaced; voila, life goes on.
... Dispatch continues below ...
Prophecy to Become Coal Producer This Year
with 1.5 Billion Tonnes of Resource
Prophecy Resource Corp. (TSX.V: PCY) announced on May 11 that it has entered into a mine services agreement with Leighton Asia Ltd. to begin coal production this year. Production will begin with a 250,000-tonne starter pit as planned in August, with production advancing to 2 million tonnes per year in 2011. Prophecy is fully funded to production and its management team includes John Morganti, Arnold Armstrong, and Rob McEwen.
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But for Fannie and Freddie none of that happened. Both institutions were bankrupt. Today their stock trades at a steep discount, but it still trades. Those who held their debt took no haircut at all. Their assets were never fairly revalued and the balance sheet was replenished with taxpayer funds. Why the different treatment?
One reason is that Russia and China were among the largest holders of Fannie and Freddie bonds. Recall in 2008 that Russian tanks were rolling into Georgia, while the US was utterly dependent on China to purchase its debt. In Moscow a haircut on Fannie or Freddie debt would have been seen as financial warfare. China's dismay at losing money might have had even more daunting results, given its power to alter the structure of US interest rates at the touch of a keyboard. So, unusually, the identity of the holders, not the condition of the issuer, determined the bond's fate.
From there the trend continued. In 2009, during the Chrysler bailout, hedge funds holding Chrysler debt wanted a normal bankruptcy but were brushed aside by the Obama administration in its rush to accommodate trade union allies. One could have imagined a completely different outcome, if the company in distress had been non-union or if Chrysler's bonds had been more heavily owned by union pension funds instead of hedge funds. But the pattern remained, namely that it is the holder’s identity that mattered.
Much the same pattern was seen in Greece, where a rescue came because the debt holders were vulnerable European banks. More typical sovereign debt restructures, as seen in Brazil and Mexico in the 1980s, followed different rules. And while these are just the best-known cases, further examples are not hard to find. Take real estate debt, which is treated differently depending on whether it is owned by a bank or a private fund -- largely because banks can raise capital cheaply, courtesy of the Federal Reserve's close-to-zero interest rates.
This new trend is defended as good policy. We should not, the thinking goes, offend the Russians or the Chinese. Jobs at Chrysler are worth preserving. European banks must be saved from the threat of a Greek sovereign default. Maybe, but maybe not. For there will be a big price to pay for this kind of outcome by diktat.
Moral hazard is only the most obvious threat. More insidious is what economists call "regime uncertainty." This ungainly phrase refers not to a political regime, but to laws that allow all players in a market to follow the same rules. Price discovery is difficult in normal markets. But when geopolitics, expediency, and short-term concerns overlay them, it is little wonder that equity inflows are drying up, corporations are hoarding cash, and mergers and acquisitions have ground to a halt.
Here lies the crux. Policy, whether it be printing money, guarantees, or deficit spending, can prop up asset values for a while. This may even be useful in a liquidity crisis. But a solvency crisis is another thing. The longer policy distorts markets by ignoring fundamentals, the longer those reliant on market signals will sit on their hands. The Fed's recent decision to continue asset purchases shows there is no exit once this path is chosen. As we approach the second anniversary of the Fannie and Freddie bailouts, are we better off? Values cannot recover until they first hit bottom. In short, our economies would be growing more robustly today if we had taken our medicine in 2009.
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The writer is a writer, economist, lawyer, and investment adviser.
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Sona Resources Expects Positive Cash Flow from Blackdome,
Plans Aggressive Exploration of Elizabeth Gold Property
On May 18, 2010, Sona Resources Corp. (TSXV: SYS, Frankfurt: QS7) announced the release of a preliminary economic assessment for gold production at its flagship Blackdome and Elizabeth properties in British Columbia.
Sona Executive Chairman Nick Ferris says: "We view this as a baseline scenario for gold production. The project is highly sensitive to the price of gold. A conservative valuation of gold at $1,093 per ounce would result in a pre-tax cash flow of $54 million. The assessment indicates that underground mining at the two sites would recover 183,600 ounces of gold and 62,500 ounces of silver. Permitting and infrastructure are already in place for processing ore at the Blackdome mill, with a 200-tonne per day throughput over an eight-year mine life. Our near-term goal is to continue aggressive exploration at Elizabeth and develop a million-plus-ounce gold resource, commencing production in 2013."
For complete information on Sona Resources Corp. please visit: www.SonaResources.com
