Bond Vigilantes Are Back and Beating Obama's Fed

from Bloomberg:

By Liz Capo McCormick and Daniel Kruger

May 29 (Bloomberg) -- They’re back.

For the first time since another Democrat occupied the White House, investors from Beijing to Zurich are challenging a president’s attempts to revive the economy with record deficit spending. Fifteen years after forcing Bill Clinton to abandon his own stimulus plans, the so-called bond vigilantes are punishing Barack Obama for quadrupling the budget shortfall to $1.85 trillion. By driving up yields on U.S. debt, they are also threatening to derail Federal Reserve Chairman Ben S. Bernanke’s efforts to cut borrowing costs for businesses and consumers.

The 1.4-percentage-point rise in 10-year Treasury yields this year pushed interest rates on 30-year fixed mortgages to above 5 percent for the first time since before Bernanke announced on March 18 that the central bank would start printing money to buy financial assets. Treasuries have lost 5.1 percent in their worst annual start since Merrill Lynch & Co. began its Treasury Master Index in 1977.

“The bond-market vigilantes are up in arms over the outlook for the federal deficit,” said Edward Yardeni, who coined the term in 1984 to describe investors who protest monetary or fiscal policies they consider inflationary by selling bonds. He now heads Yardeni Research Inc. in Great Neck, New York. “Ten trillion dollars over the next 10 years is just an indication that Washington is really out of control and that there is no fiscal discipline whatsoever.”

Investor Dread

What bond investors dread is accelerating inflation after the government and Fed agreed to lend, spend or commit $12.8 trillion to thaw frozen credit markets and snap the longest U.S. economic slump since the 1930s. The central bank also pledged to buy as much as $300 billion of Treasuries and $1.25 trillion of bonds backed by home loans.

For the moment, at least, inflation isn’t a cause for concern. During the past 12 months, consumer prices fell 0.7 percent, the biggest decline since 1955. Excluding food and energy, prices climbed 1.9 percent from April 2008, according to the Labor Department.

Bill Gross, the co-chief investment officer of Newport Beach, California-based Pacific Investment Management Co. and manager of the world’s largest bond fund, said all the cash flooding into the economy means inflation may accelerate to 3 percent to 4 percent in three years. The Fed’s preferred range is 1.7 percent to 2 percent.

“There’s becoming an embedded inflationary premium in the bond market that wasn’t there six months ago,” Gross said yesterday in an interview at a conference in Chicago.

Shrinking Economy

Bonds usually rally when the economy is in recession and inflation is subdued. Gross domestic product dropped at a 5.7 percent annual pace in the first quarter, after contracting at a 6.3 percent rate in the last three months of 2008, according to the Commerce Department.

This time it’s different because the Congressional Budget Office projects Obama’s spending plan will expand the deficit this year to about four times the previous record, and cause a $1.38 trillion shortfall in fiscal 2010. The U.S. will need to raise $3.25 trillion this year to finance its objectives, up from less than $1 trillion in 2008, according to Goldman Sachs Group Inc., one of 16 primary dealers of U.S. government securities that are obligated to bid at Treasury auctions.

“The deficit and funding the deficit has become front and center,” said Jim Bianco, president of Bianco Research LLC in Chicago. “The Fed is going to have to walk a fine line here and has to continue with a policy of printing money to buy Treasuries while at the same time convince the market that this isn’t going to end in tears with fits of inflation.”

‘Potential Benefits’

Ten-year note yields, which help determine rates on everything from mortgages to corporate bonds, rose as much as 1.71 percentage points from a record low of 2.035 percent on Dec. 18. That was two days after the Fed said it was “evaluating the potential benefits of purchasing longer-term Treasury securities” as a way to keep consumer borrowing costs from rising.

The yield on the 10-year note rose one basis point, or 0.01 percentage point, to 3.47 percent this week, according to BGCantor Market Data. The price of the 3.125 percent security maturing in May 2019 fell 3/32, or 94 cents per $1,000 face amount, to 97 4/32. The yield touched 3.748 percent yesterday, the highest since November.

The dollar has also begun to weaken against the majority of the world’s most actively traded currencies on concern about the value of U.S. assets. The dollar touched $1.4169 per euro today, the weakest level this year.

Bond Intimidation

Ten-year yields climbed from 5.2 percent in October 1993, about a year after Clinton was elected, to just over 8 percent in November 1994. Clinton then adopted policies to reduce the deficit, resulting in sustained economic growth that generated surpluses from his last four budgets and helped push the 10-year yield down to about 4 percent by November 1998.

Clinton political adviser James Carville said at the time that “I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.”

The surpluses of the Clinton administration turned into record deficits as George W. Bush ramped up spending, including financing of the wars in Iraq and Afghanistan.

The bond vigilantes are being led by international investors, who own about 51 percent of the $6.36 trillion in marketable Treasuries outstanding, up from 35 percent in 2000, according to data compiled by the Treasury.

New Group

“The vigilante group is different this time around,” said Mark MacQueen, a partner and money manager at Austin, Texas- based Sage Advisory Services Ltd., which oversees $7.5 billion. “It’s major foreign creditors. This whole idea that we need to spend our way out of our problems is being questioned.”

MacQueen, who started in the bond business in 1981 at Merrill Lynch, has been selling Treasuries and moving into corporate and inflation-protected debt for the last few months.

Chinese Premier Wen Jiabao said in March that China was “worried” about its $767.9 billion investment and was looking for government assurances that the value of its holdings would be protected.

The nation bought $5.6 billion in bills and sold $964 million in U.S. notes and bonds in February, according to Treasury data released April 15. It was the first time since November that China purchased more securities due in a year or less than longer-maturity debt.

Obama’s Confidence

Treasury Secretary Timothy Geithner, who will travel to Beijing next week, will encourage China to boost domestic demand and maintain flexible markets, a Treasury spokesman said yesterday.

Obama spokesman Robert Gibbs said the president is confident that his budget and economic plans will cut the deficit and bring down the nation’s debt.

“The president feels very comfortable with the steps that the administration is taking to get our fiscal house in order and understands how important it is for our long-term growth,” Gibbs said.

Investors are also selling Treasuries as the economy shows signs of bottoming and credit and stock markets rebound, lessening the need for the relative safety of government debt. And while yields are rising, they are still below the average of 6.49 percent over the past 25 years.

‘Renewed Appreciation’

The world’s largest economy will begin to expand next quarter, according to 74 percent of economists in a National Association for Business Economics survey released this week. The Standard & Poor’s 500 has risen 36 percent since bottoming on March 9, while the London interbank offered rate, or Libor, that banks say they charge each other for three-month loans, fell to 0.66 percent today from 4.819 percent in October, according to the British Bankers’ Association.

Three-month Treasury bill rates have climbed to 0.13 percent after falling to minus 0.04 percent Dec. 4. That flight to safety helped U.S. debt rally 14 percent in 2008, the best year since gaining 18.5 percent in 1995, Merrill indexes show.

“Yes there’s been a big move, and you can argue the big move is driven by the renewed appreciation of the risks associated with holding long-term Treasury bonds,” said Brad Setser, a fellow for geoeconomics at the Council on Foreign Relations in New York.

Fed officials see several possible explanations for the rise in yields beyond investor concern about inflation. Among them: The supply of Treasuries for sale exceeds the Fed’s $300 billion purchase program, the economic outlook is improving and investors are selling government debt used as a hedge against mortgage securities.

Liquidity

Central bankers want to avoid appearing to react solely to market swings. Bernanke hasn’t formally asked policy makers to consider whether to increase Treasury purchases and may not do so before the Federal Open Market Committee’s next scheduled meeting June 23-24. Officials are confident they can mop up liquidity without gaining additional tools from Congress, such as the ability for the Fed to issue its own debt.

The Fed declined to comment for the story. Bernanke has an opportunity to discuss his views when he testifies June 3 before the House Budget Committee in Washington.

“We have daily reminders from bond vigilantes like Bill Gross about the prospect of losing our AAA rating,” Federal Reserve Bank of Dallas President Richard Fisher said in Washington yesterday. “This cannot be allowed to happen.”

Repair the Damage

The government and Fed are trying to repair the damage from the collapse of the subprime mortgage market in 2007, which caused credit markets to freeze, led to the collapse of Lehman Brothers Holdings Inc. in September and was responsible for $1.47 trillion of writedowns and losses at the world’s largest financial institutions, according to data compiled by Bloomberg.

The initial progress Bernanke made toward reducing the relative cost of credit is in jeopardy of being unwound by the work of the bond vigilantes.

The average rate on a typical 30-year fixed mortgage rose to 5.08 percent this week from 4.85 percent in April, according to North Palm Beach, Florida-based Bankrate.com. Credit card rates average 10.5 percentage points more than 1-month Libor, up from 7.19 percentage points in October.

“Longer term the danger is that the rise in yields disrupts the recovery or the rise in inflation expectations dislodges the Fed’s current complacency on inflation,” Credit Suisse Group AG interest-rate strategists Dominic Konstam, Carl Lantz and Michael Chang wrote in a May 22 report.

‘It’s Over’

Inflation expectations may best be reflected in the yield curve, or the difference between short- and long-term Treasury rates. The gap widened this week to 2.76 percentage points, surpassing the previous record of 2.74 percentage points set on Aug. 13, 2003. Investors typically demand higher yields on longer-maturity debt when inflation, which erodes the value of fixed-income payments, accelerates.

“The yield spreads opening up imply that inflation premiums are rising,” said former Fed Chairman Alan Greenspan in a telephone interview from Washington on May 22. “If we try to do too much, too soon, we will end up with higher real long- term interest rates which will thwart the economic recovery.”

Other economists are more pointed. After falling from 16 percent in the early 1980s, 10-year yields have nowhere to go but up, according to Richard Hoey, the New York-based chief economist at Bank of New York Mellon Corp.

“The secular bull market in Treasury bonds is over,” Hoey said in a Bloomberg Television interview. “It ran a good 28 years. They’re never going lower. That’s it. It’s over.”

Russians: America Has Become "Marxist"

Who would know better than the Russians what marxism looks like? From Pravda:

American capitalism gone with a whimper

27.04.2009

Source: Pravda.Ru

URL: http://english.pravda.ru/opinion/columnists/107459-american_capitalism-0

It must be said, that like the breaking of a great dam, the American decent into Marxism is happening with breath taking speed, against the back drop of a passive, hapless sheeple, excuse me dear reader, I meant people.

True, the situation has been well prepared on and off for the past century, especially the past twenty years. The initial testing grounds was conducted upon our Holy Russia and a bloody test it was. But we Russians would not just roll over and give up our freedoms and our souls, no matter how much money Wall Street poured into the fists of the Marxists.

Those lessons were taken and used to properly prepare the American populace for the surrender of their freedoms and souls, to the whims of their elites and betters.

First, the population was dumbed down through a politicized and substandard education system based on pop culture, rather then the classics. Americans know more about their favorite TV dramas then the drama in DC that directly affects their lives. They care more for their "right" to choke down a McDonalds burger or a BurgerKing burger than for their constitutional rights. Then they turn around and lecture us about our rights and about our "democracy". Pride blind the foolish.

Then their faith in God was destroyed, until their churches, all tens of thousands of different "branches and denominations" were for the most part little more then Sunday circuses and their televangelists and top protestant mega preachers were more then happy to sell out their souls and flocks to be on the "winning" side of one pseudo Marxist politician or another. Their flocks may complain, but when explained that they would be on the "winning" side, their flocks were ever so quick to reject Christ in hopes for earthly power. Even our Holy Orthodox churches are scandalously liberalized in America.

The final collapse has come with the election of Barack Obama. His speed in the past three months has been truly impressive. His spending and money printing has been a record setting, not just in America's short history but in the world. If this keeps up for more then another year, and there is no sign that it will not, America at best will resemble the Wiemar Republic and at worst Zimbabwe.

These past two weeks have been the most breath taking of all. First came the announcement of a planned redesign of the American Byzantine tax system, by the very thieves who used it to bankroll their thefts, loses and swindles of hundreds of billions of dollars. These make our Russian oligarchs look little more then ordinary street thugs, in comparison. Yes, the Americans have beat our own thieves in the shear volumes. Should we congratulate them?

These men, of course, are not an elected panel but made up of appointees picked from the very financial oligarchs and their henchmen who are now gorging themselves on trillions of American dollars, in one bailout after another. They are also usurping the rights, duties and powers of the American congress (parliament). Again, congress has put up little more then a whimper to their masters.

Then came Barack Obama's command that GM's (General Motor) president step down from leadership of his company. That is correct, dear reader, in the land of "pure" free markets, the American president now has the power, the self given power, to fire CEOs and we can assume other employees of private companies, at will. Come hither, go dither, the centurion commands his minions.

So it should be no surprise, that the American president has followed this up with a "bold" move of declaring that he and another group of unelected, chosen stooges will now redesign the entire automotive industry and will even be the guarantee of automobile policies. I am sure that if given the chance, they would happily try and redesign it for the whole of the world, too. Prime Minister Putin, less then two months ago, warned Obama and UK's Blair, not to follow the path to Marxism, it only leads to disaster. Apparently, even though we suffered 70 years of this Western sponsored horror show, we know nothing, as foolish, drunken Russians, so let our "wise" Anglo-Saxon fools find out the folly of their own pride.

Again, the American public has taken this with barely a whimper...but a "freeman" whimper.

So, should it be any surprise to discover that the Democratically controlled Congress of America is working on passing a new regulation that would give the American Treasury department the power to set "fair" maximum salaries, evaluate performance and control how private companies give out pay raises and bonuses? Senator Barney Franks, a social pervert basking in his homosexuality (of course, amongst the modern, enlightened American societal norm, as well as that of the general West, homosexuality is not only not a looked down upon life choice, but is often praised as a virtue) and his Marxist enlightenment, has led this effort. He stresses that this only affects companies that receive government monies, but it is retroactive and taken to a logical extreme, this would include any company or industry that has ever received a tax break or incentive.

The Russian owners of American companies and industries should look thoughtfully at this and the option of closing their facilities down and fleeing the land of the Red as fast as possible. In other words, divest while there is still value left.

The proud American will go down into his slavery with out a fight, beating his chest and proclaiming to the world, how free he really is. The world will only snicker.

Stanislav Mishin

The article has been reprinted with the kind permission from the author and originally appears on his blog, Mat Rodina

Fitch Downgrades California Bond Rating -- And It May Get Worse!

from Marketwatch:
Fitch Ratings said late Friday it lowered its ratings outlook on the State of California to negative from stable. Fitch has an A long-term general obligation bond rating on the state. "The revision of the outlook to negative reflects growing concerns with the state's widening budget and cash flow deficits," Fitch said in a statement. "While there appears to be consensus for quick action by the legislature, should it be delayed or fail to materialize, further rating actions may occur."

Relationship Between Dollar and Commodities

This chart shows the direct inverse relationship between the Dollar and the price of commodities. The Dollar is the green one, and the Rogers Commodity Index is shown in blue. The relationship is strikingly correlative!

How Do I Handle the Mood Swings?

from Dr. Brett--
A reader asks the question:

"How do I avoid the inevitable mood swing when a couple of trades go bad? For a few days in March I was afraid to get back on the horse and had to tell myself to jump back on/trade as the only way to get over it."

My response is that you'll *always* have situations in which "a couple of trades go bad". If you average 55% winning trades, you'll have two consecutive losers about 20% of the time. For the active trader, that means that "a couple of trades go bad" occurs every week, if not daily.

Mood swings when trades go bad are *not* inevitable. The professional trader *plans* to be wrong and manages positions accordingly. That trader knows that you can trade well and still have a couple of trades go bad. Embracing risk and uncertainty, the successful trader limits losses by controlling position sizes and establishing loss limits (per trade, per day).

The good trade gone bad often provides a trader with valuable information--if the trader is open to the message. Today I worked with a trader who tried to buy the market in the afternoon, only to get stopped out. Shortly after, he noticed weakness in the 10-year Treasury notes and reversed his position. By day's end, he was profitable by a healthy six figure sum. The "bad trade" offered opportunity, not threat.

If you do experience mood swings around losing trades, it's probably because you are evaluating yourself by the criterion of being right--not by the criterion of trading well. It isn't the losing trade making you feel bad; it's the perfectionistic expectation that you should always be right. By embracing uncertainty and staying open to learning from it, the threat of losing can turn into the opportunity of rethinking market assumptions.

$546, 668 Per Household in Debt

USA Today indicated today that the federal debt amounts to $546,668 per household in America. Here's the article:

Taxpayers are on the hook for an extra $55,000 a household to cover rising federal commitments made just in the past year for retirement benefits, the national debt and other government promises, a USA TODAY analysis shows.

The 12% rise in red ink in 2008 stems from an explosion of federal borrowing during the recession, plus an aging population driving up the costs of Medicare and Social Security.

That's the biggest leap in the long-term burden on taxpayers since a Medicare prescription drug benefit was added in 2003.

The latest increase raises federal obligations to a record $546,668 per household in 2008, according to the USA TODAY analysis. That's quadruple what the average U.S. household owes for all mortgages, car loans, credit cards and other debt combined.

"We have a huge implicit mortgage on every household in America — except, unlike a real mortgage, it's not backed up by a house," says David Walker, former U.S. comptroller general, the government's top auditor.

USA TODAY used federal data to compute all government liabilities, from Treasury bonds to Medicare to military pensions.

Bottom line: The government took on $6.8 trillion in new obligations in 2008, pushing the total owed to a record $63.8 trillion.

The numbers measure what's needed today — set aside in a lump sum, earning interest — to pay benefits that won't be covered by future taxes.

Congress can reduce or increase the burden by changing laws that determine taxes and benefits for programs such as Medicare and Social Security.

Rep. Jim Cooper, D-Tenn., says exploding debt has focused attention on the government's financial challenges. "More and more, people are worried about our fiscal future," he says.

Key federal obligations:

• Social Security. It will grow by 1 million to 2 million beneficiaries a year from 2008 through 2032, up from 500,000 a year in the 1990s, its actuaries say. Average benefit: $12,089 in 2008.

• Medicare. More than 1 million a year will enroll starting in 2011 when the first Baby Boomer turns 65. Average 2008 benefit: $11,018.

•Retirement programs. Congress has not set aside money to pay military and civil servant pensions or health care for retirees. These unfunded obligations have increased an average of $300 billion a year since 2003 and now stand at $5.3 trillion.

Is the Bubble About to Burst?

from Atlantic Business:
It's extremely easy to get very deep in the weeds very quickly when talking about what's happening in the market for government bonds. "Steepening yield curve," is one of those signal phrases that informs 99% of the population that what follows will be intelligible or uninteresting, or both. But recent moves in the market for government debt have exercised insiders. Across the Curve's John Jansen got the blogosphere's attention, for instance, by writing:

Maybe the final climactic event is upon us. Maybe the final bubble to burst is the US Treasury market and maybe we are on the verge of a financial Krakatoa which will realign financial markets.

Whatever the case it feels like the calm before the storm and we are about to embark on another interesting expedition.

Ok, then. Best to try and figure out what's going on.

Very basically, the government is having a much easier time selling short duration debt than it is long duration debt. Both central banks and private investors are piling into shorter maturity bills and notes. The question is why. Potential explanations include waning interest from buyers who were seeking safety but who now feel comfortable buying things other than government debt, and investors nervous about repayment prospects. The main factor is related to both of these explanations -- investors are anticipating a recovery, and are anticipating that recovery will bring inflation.

Those expectations mean that interest in longer maturity bonds will decline until rates on those bonds rise; investors need to be compensated for the expected deterioration in the value of the dollar over the life of the instrument. The downside here is that the Fed has tried very hard to keep long-term interest rates low in order to increase investment and juice the economy, and the rise in long-term rates is pushing up the cost of things like 30-year mortgages. On the other hand, a little inflation and dollar depreciation would be healthy for the economy, provided that it didn't lead to a damaging spike in commodity prices.

But the real silver lining to the steepening yield curve is the effect on the banking industry. It certainly looks like we're committed to propping troubled banks up while they attempt to earn their way out of this mess, and a steep yield curve is good for bank earnings. So, you know, bright side!

Yield Curve Steepening

from Mish's Global Economic Analysis:
Bernanke cannot have his cake and eat it too. If the economy is recovering the yield curve should steepen. And steepen it has. The Yield Curve Is Steepest On Record.

The difference in yields between Treasury two and 10-year notes widened to a record on concern surging sales of U.S. debt will overwhelm the Federal Reserve’s efforts to keep borrowing costs low.

The so-called yield curve steepened to 2.75 percentage points, surpassing the previous record of 2.74 percentage points set on Aug. 13, 2003.

Ten-year notes have lost 10.3 percent this year, according to Merrill Lynch & Co. indexes, while 30-year bonds have lost 27.5 percent. Two-year notes have gained 0.2 percent...

If the economy is recovering, the Fed should welcome this steepening. However, what if the yield curve is simply reacting at the thought of Bernanke monetizing Obama's massive deficits and the various stimulus plans?

I doubt the economy is recovering but it is may be getting worse at a lesser rate. Moreover, if the curve flattens, it sure will not be because of intervention, it will be because the so-called recovery has stalled. Heaven help Bernanke if the economy worsens and the yield curve continues to steepen.

Regardless why the yield curve is steepening, Bernanke's belief that he can control both the long and short end of the curve is seriously misguided. The fact is he cannot really control either, at least for long.

Business Gets Worse, Says ISM Survey

from Bloomberg:
U.S. business activity contracted at a faster pace than forecast this month as orders and employment dropped.

The Institute for Supply Management-Chicago Inc. said today its business barometer decreased to 34.9 from 40.1 in April. Readings below 50 signal a contraction.

The report ran counter to others this month that indicated manufacturing was starting to improve this quarter, perhaps signaling that Chicago’s proximity to the auto slump in neighboring Detroit may be affecting the entire Midwest. Still, private economists have scaled back forecasts for economic growth in the second half of the year.

Here Come Commercial Mortgage Downgrades

from FT:

Fears among credit investors have risen that threatened ratings downgrades of commercial property debt might thwart US government efforts to revive the markets that help fund office blocks, shopping centres and other commercial real estate.

Standard & Poor’s warned this week that it was likely to downgrade tens of billions of dollars in triple A securities backed by recent real estate loans – with 90 per cent of the securities backed by 2007 mortgages likely to face rating cuts.

Q1 GDP Revised UP to -5.7%

from FT:

The US economy continued to contract in the first quarter of this year, but at a slower pace than previously thought, as the pain of the recession spread from consumers to businesses in the face of eroding global demand.

Revised commerce department figures showed on Friday that US gross domestic product declined by an annualised rate of 5.7 per cent in the first three months of the year, compared with last month’s estimate of 6.1 per cent. The decline was less severe than original projections due to slower liquidation of inventories and the narrowing trade gap.

Crude Oil Surpasses $66/Barrel

from Bloomberg:

COMMODITIES HEAD FOR BIGGEST MONTHLY GAIN SINCE JULY 1974

Commodities headed for the biggest monthly rally in 34 years, led by energy, as the slumping dollar boosted demand for raw materials as a hedge against inflation.

In May, the Reuters/Jefferies CRB Index of 19 energy, metal and agricultural prices has gained 14 percent, the most since July 1974. The dollar was poised for the biggest monthly drop since August against a basket of six major currencies.

Signs of a recovery in the global economy have spurred demand for fuel, industrial metals and crops. Crude oil was set for the biggest monthly gain in a decade. Gasoline has soared more than 30 percent in May. Gold copper surged, while corn and soybeans reached the highest since September.

Devaluation of the Dollar

Compare the charts of the Dollar with the other currencies below. Why is the United States government devaluing its currency and intentionally stoking the fires of inflation?

US DollarEuroBritish PoundAustralian DollarCanadian Dollar

Groaning Greenback = Climbing Commodities = Inflation

There is a nearly perfect inverse relationship between the devaluation of the Dollar and the climbing prices of commodities, as shown here with the price of crude oil, gold, and the declining value of the Dollar! This is no coincidence! It is correlation!

Crude OilGoldDollar

The Psychology of Behavioral Premises

from Dr. Brett-

I'm going to try to explain an important psychological concept and why it's of paramount importance to trading. The concept is something I call "behavioral premises". A behavioral premise is a rationale for our actions; it's the set of assumptions that drive our choices and responses in various situations. The network of our behavioral premises represents our belief system about ourselves, others, and the world around us. These beliefs may not be enunciated, but they are the filters through which we perceive the world, thus coloring how we respond.

An important principle is that our behavioral premises tend to evoke responses from other people that, in turn, reinforce those premises. That is, people's responses toward us will be shaped, in part, by how we approach them--and the beliefs that underlie our approach. Here are a few examples:

* A person has been hurt in past relationships and doesn't want to face rejection again. Her behavioral premises are that relationships are dangerous and that others don't really care about her after all. As a result, she maintains a guarded stance with people who might otherwise want to get to know her. Seeing that she is not approachable, others keep their distance from her and make no effort to open up themselves. This reinforces her premise that people are uncaring and unavailable, convincing her that she must stay all the more guarded.

* A job applicant believes that he has no chance to land a desirable position. His behavioral premise is that he lacks the charm and personality to come across well in an interview. As a result, he is nervous throughout his visit to the firm and comes across as unsure of himself. Sensing this, the interviewer concludes that he won't be an effective representative of the company and turns him down. This confirms the man's belief that he is not cut out to be hired for a good job, and he approaches the next interview with even less confidence.

* A businessman is convinced that others are out to cheat him. His behavioral premise is that he needs to be on guard at all times, because his employees can't be trusted. He establishes strict rules and maintains stifling oversight of his employees, even after their training phase has been completed. The employees, feeling untrusted and not valued, leave the business one by one to find a more suitable work environment. This convinces the businessman that he's right; that employees will just take his training, use him, and move on. As a result, he trusts the new group of employees even less.

Notice that each of these scenarios is one in which there is a vicious cycle. The behavioral premise leads to actions that bring outcomes that reinforce the premise. This is one major reason people stay stuck in self-defeating patterns.

The same dynamics occur in trading. Imagine that, feeling like a defeated trader (per the recent post), you act on the behavioral premise, "I just can't make money in the market." You follow your rules, enter a trade, and it moves a few ticks against you. This only reinforces your negative belief and you quickly exit the position before the loss becomes too great. Meanwhile, the market chops around a bit before eventually moving in the direction you had anticipated. All you can do is shake your head: your premise has proven true once again.

So how do people escape from these vicious cycles? Most people can't talk themselves out of their premises; they need direct, powerful emotional experiences to show them that their beliefs are wrong. This is one reason I emphasize solution patterns with the traders I work with. We spend extra time examining trades that have worked out and isolating what the trader did right on those trades. By creating a model for good trading out of these successful trades, we increase success and disconfirm negative behavioral premises.

One of my favorite exercises is to look at what happened in the market after exiting a trade. Very often the basic trade idea was right all along; it was the timing that was off. This also disconfirms negative premises. The message is that it's not that you can't read the market; it's just that you need to refine your execution: when you enter, how large you enter, and where you stop yourself out. I've often seen big results from such seemingly small refinements. Why? Because the process of making those refinements challenges the behavioral premises that led to the "stuck" patterns to begin with.

We will always live up to our most deeply held behavioral premises--for better or for worse.

RELATED POSTS:

Solution Focused Trading

The Question to Ask When You're in a Slump

Treasuries Demand Strong in Today's Auction

from NYT:
Stocks turned higher Thursday after solid demand at a Treasury auction eased fears that demand for United States debt would dry up and force the government to pay higher interest rates to entice buyers. Higher rates could choke the economy’s recovery by making loans on everything from homes to cars more expensive.

"Bad Bank" Program May Be Put On Hold

from WSJ:
A government program designed to rid banks of bad loans, part of a broader effort once viewed as central to tackling the financial crisis, is stalling and may soon be put on hold, according to people familiar with the matter.

The Legacy Loans Program, being crafted by the Federal Deposit Insurance Corp., is part of the $1 trillion Public Private Investment Program the Obama administration announced in March as a way to encourage banks to sell securities and loans weighing on their balance sheets to willing investors.

Treasuries Stabilizing?

from Bloomberg:
Treasuries rose for the first time in a week on speculation the U.S. economy won’t recover soon enough to keep yields at the highest level in six months.

Ten-year notes gained after falling the most since January yesterday, narrowing the difference between two- and 10-year yields to 2.73 percentage points from 2.76 percentage points. The gap widened to a record yesterday on speculation surging sales of U.S. debt will overwhelm the Federal Reserve’s efforts to keep borrowing costs low.

“I don’t think this level is reasonable” for Treasury yields, said Yasutoshi Nagai, chief economist in Tokyo at Daiwa Securities SMBC Co., part of Japan’s second-largest brokerage. “The main economic data continue to deteriorate.”

The yield on the benchmark 10-year note fell two basis points to 3.72 percent as of 9:32 a.m. in Tokyo, according to data compiled by Bloomberg. The price of the 3.125 percent security due in May 2019 rose 5/32, or $1.56 per $1,000 face amount, to 95 3/32.

Yields increased 19 basis points yesterday, the most since Jan. 19. A basis point is 0.01 percentage point.

Treasuries tumbled yesterday on concern record supply will overwhelm investor demand as the U.S. economy begins to show signs of stability.

The U.S. will likely sell $3.25 trillion of Treasuries in the fiscal year ending Sept. 30 to fund bank bailouts, stimulus spending and a record budget deficit, according to Goldman Sachs Group Inc., one of the 16 primary dealers required to bid at government debt sales.

The State of the Banks

from Bonddad blog:
Over the last few days the FDIC has released the quarterly banking profile. I'm going to tackle this in two parts. In the first I'll look at the report. In the second we'll look at the graphs:

Sharply higher trading revenues at large banks helped FDIC-insured institutions post an aggregate net profit of $7.6 billion in the first quarter of 2009. Realized gains on securities and other assets at a few large institutions also contributed to the quarter’s profits. First quarter earnings were $11.7 billion (60.8 percent) lower than in the first quarter of 2008 but represented a significant recovery from the $36.9 billion net loss the industry reported in the fourth quarter of 2008.1 Provisions for loan and lease losses were lower than in the fourth quarter of 2008 but continued to rise on a year-over-year basis. The increase in loss provisions, higher charges for goodwill impairment, and reduced income from securitization activity were the primary causes of the year-over-year decline in industry net income. Evidence of earnings weakness was widespread in the first quarter; more than one out of every five institutions (21.6 percent) reported a net loss, and almost three out of every five (59.3 percent) reported lower net income than in the first quarter of 2008.

The first part of this overview indicates we've got a statistical blip. "Realized gains at a few large institutions" were the primary reason for the overall jump. The last sentence indicates there are still problems out in the financial sector. 21.6% of all institutions reported a net loss and 59.3% lower year over year results. Those that the figures that should cause us concern.

Insured institutions set aside $60.9 billion in loan loss provisions in the first quarter, an increase of $23.7 billion (63.6 percent) from the first quarter of 2008. Almost two out of every three insured institutions (65.4 percent) increased their loss provisions. Goodwill impairment charges and other intangible asset expenses rose to $7.2 billion from $2.8 billion a year earlier. Against these negative factors, total noninterest income contributed $68.3 billion to pretax earnings, a $7.8-billion (12.8 percent) improvement over the first quarter of 2008. Net interest income was $4.4 billion (4.7 percent) higher, and realized gains on securities and other assets were up by $1.9 billion (152.6 percent). The rebound in noninterest income stemmed primarily from higher trading revenue at a few large banks, but gains on loan sales and increased servicing fees also provided a boost to noninterest revenues. Trading revenues were $7.6 billion higher than a year earlier, servicing fees were up by $2.4 billion, and realized gains on securities and other assets were $1.9 billion higher. Nevertheless, these positive developments were outweighed by the higher expenses for bad loans and goodwill impairment. The average return on assets (ROA) was 0.22 percent, less than half the 0.58 percent registered in the first quarter of 2008 and less than one-fifth the 1.20 percent ROA the industry enjoyed in the first quarter of 2007.

The bottom line: there was some good news. But the bad news outweighed the good news. Loan loss provisions and goodwill impairments are increasing. These factors outweighed the increased revenue from servicing and trading.

For the sixth consecutive quarter, falling interest rates caused declines in both average funding costs and average asset yields. The industry’s average funding cost fell by more than its average asset yield in the quarter, and the quarterly net interest margin (NIM) improved from fourth quarter 2008 and first quarter 2008 levels. The average NIM in the first quarter was 3.39 percent, compared to 3.34 percent in the fourth quarter of 2008 and 3.33 percent in the first quarter of 2008. This is the highest level for the industry NIM since the second quarter of 2006. However, most of the improvement was concentrated among larger institutions; more than half of all institutions (55.4 percent) reported lower NIMs compared to a year earlier, and almost two-thirds (66.0 percent) had lower NIMs than in the fourth quarter of 2008. The average NIM at institutions with less than $1 billion in assets fell from 3.66 percent in the fourth quarter to 3.56 percent, a 21-year low.

The increased net interest margin was better for the bigger banks. Period.

First-quarter net charge-offs of $37.8 billion were slightly lower than the $38.5 billion the industry charged-off in the fourth quarter of 2008, but they were almost twice as high as the $19.6 billion total in the first quarter of 2008. The year-over-year rise in charge-offs was led by loans to commercial and industrial (C&I) borrowers, where charge-offs increased by $4.2 billion (170 percent); by credit cards (up $3.4 billion, or 68.9 percent); by real estate construction loans (up $2.9 billion, or 161.7 percent); and by closed-end 1-4 family residential real estate loans (up $2.7 billion, or 64.9 percent). Net charge-offs in all major categories were higher than a year ago. The annualized net charge-off rate on total loans and leases was 1.94 percent, slightly below the 1.95 percent rate in the fourth quarter of 2008 that is the highest quarterly net charge-off rate in the 25 years that insured institutions have reported these data. Well over half of all insured institutions (58.3 percent) reported year-over-year increases in quarterly charge-offs.

Here is the key takeaway: The annualized net charge-off rate on total loans and leases was 1.94 percent, slightly below the 1.95 percent rate in the fourth quarter of 2008 that is the highest quarterly net charge-off rate in the 25 years that insured institutions have reported these data.

The high level of charge-offs did not stem the growth in noncurrent loans in the first quarter. On the contrary, noncurrent loans and leases increased by $59.2 billion (25.5 percent), the largest quarterly increase in the three years that noncurrent loans have been rising. The percentage of loans and leases that were noncurrent rose from 2.95 percent to 3.76 percent during the quarter; the noncurrent rate is now at the highest level since the second quarter of 1991. The rise in noncurrent loans was led by real estate loans, which accounted for 84 percent of the overall increase. Noncurrent closed-end 1–4 family residential mortgage loans increased by $26.7 billion (28.1 percent), while noncurrent real estate construction loans were up by $10.5 billion (20.3 percent), and noncurrent loans secured by nonfarm nonresidential real estate properties rose by $6.9 billion (40 percent). All major loan categories experienced rising levels of noncurrent loans, and 58 percent of insured institutions reported increases in their noncurrent loans during the quarter.

First loans become non-current, then banks charge them off. In other words wven though banks are charging off a ton of loans, there are more defaults in the pipeline. That is terrible news. In addition, the rate of increase appears to be accelerating. None of this is good.

Housing Could Get Worse

from Accrued Interest Blog:

It was shades of 2002, only in reverse today. Mortgage servicers sold intermediate/long rates, which drove rates higher, which brought out more mortgage hedge sellers. Now we are set with some very basic problems.

The Fed can't keep mortgage rates at or below 5% with the Treasury market where it is. Can't happen.

In addition to this, we need to keep in mind that starting in 2010, mortgage resets will begin to rise again, and will continue to rise to a peak in 2011.

FDIC List of Problem Banks Continues to Grow

from WSJ:

The Federal Deposit Insurance Corp. put out its quarterly profile of the banking industry on Wednesday.

Among its highlights:

• The number of “problem” banks rose from 252 at the end of the fourth quarter to 305 at the end of the first quarter.
• The 21 bank failures in the first quarter is the most since the fourth quarter of 1992 (15 have already failed in the second quarter).
• The average size of problem banks grew as well, up from an average of $631 million in assets to $721 million in assets per bank.
• The deposit insurance fund fell from $19 billion to $13 billion in the quarter, and it is expected to continue falling through 2009. The fund backstops roughly $4.8 trillion in deposits.
• Higher trading revenue at large banks pushed the industry to an aggregate profit of $7.6 billion in the first quarter.
• Banks charged off $37.8 billion in the first quarter, slightly less than the $38.5 billion charged off in the fourth quarter.
• Noncurrent loans and leases grew by $59.2 billion (or 25.5%), and the percent of loans that were bad rose from 2.95% to 3.76% during the quarter.
• FDIC officials said they did not believe losses to commercial real estate and construction and development loans had peaked yet.

Hidden Risk in Accounting Gimmicks

from Econompic blog:
Off balance sheet only frees up capital because it hides risks. This is absolutely mind boggling. Not the fact that they are asking, but how is this even a remote possibility?

Treasury Tumble

Treasuries continue to fall rapidly, with rising interest rates.

Crude $65

Crude oil has reached $64.99, just one penny shy of the $65 handle!

GM to File Bankruptcy

from Bloomberg:

General Motors to File for Bankruptcy Protection June 1
General Motors Corp. plans to file for Chapter 11 bankruptcy protection June 1 and seek a sale of most of its assets to a newly formed company, people familiar with the plan told Bloomberg News. The automaker, which celebrated its 100th anniversary last year, will get U.S. Treasury financing while seeking the asset sale.

Durable Goods: Good or Bad, Depending on Who Spins It!

I've noticed that the media spins the durable goods numbers this morning in different ways. Interesting! From what I've read, it was about as expected, but hovering near record lows! The spin-meisters are suggesting that this is good news because it was "as expected", but the fact that durable goods remains at terrible levels suggests that things are still very bad! I've learned to be a skeptic of all news reporting!

Bloomberg usually has a relatively even-handed approach to the numbers:

Durable-goods orders hovered near a 13-year low and the number of Americans collecting unemployment insurance reached a 17th straight record, offering no sign of an imminent rebound from the worst U.S. recession in half a century.

Orders rose 1.9 percent in April after a 2.1 percent drop in March that was more than twice as large as previously estimated, the Commerce Department said in Washington. Meanwhile, the Labor Department said 6.79 million people are collecting jobless benefits, and another report showed new-home sales were lower than forecast in April.

$64 Crude Oil

Mortgage Defaults: One in Eight Homes

from Bloomberg:
Mortgage delinquencies and foreclosures rose to records in the first quarter and home-loan rates jumped to the highest since March as the government’s effort to revive the housing market lost momentum.

The U.S. delinquency rate climbed to a seasonally adjusted 9.12 percent and the share of loans entering foreclosure rose to 1.37 percent, the Mortgage Bankers Association said today. Both figures are the highest in records going back to 1972. Fixed rates rose to 4.91 percent, Freddie Mac said. New home sales fell 34 percent from April 2008, the Commerce Department said.

The three-year housing slump is proving resistant to efforts by the Federal Reserve and the Obama administration to lower rates and keep homeowners from failing on their mortgages. One in every eight Americans is now late on a payment or already in foreclosure as mounting job losses cause more homeowners to fall behind on loans, the MBA said.

“If people don’t have a paycheck they can’t support a mortgage,” Jay Brinkmann, the MBA’s chief economist, said in an interview. “The longer the recession lasts the more people run through their savings reserves, leading to higher delinquencies and higher foreclosures.”

Even Commodities Struggle to Stay Above Water

Mortgage Rates Soar

from Bloomberg:
Yields on Fannie Mae and Freddie Mac mortgage bonds rose for a fourth day, after yesterday for the first time exceeding where they stood before the Federal Reserve announced it would expand purchases to drive down loan rates.

Yields on Washington-based Fannie Mae’s current-coupon 30- year fixed-rate mortgage bonds climbed to 4.3 percent as of 10:25 a.m. in New York, the highest since March 10 and up from 3.94 percent on May 20, data compiled by Bloomberg show.

The Fed, seeking to use lower home-loans rates to stem the housing slump and bolster consumers, said March 18 it would increase its planned purchases of so-called agency mortgage bonds by $750 billion, to as much as $1.25 trillion, and start buying government notes. Rising mortgage-bond yields, driven higher in part by climbing Treasury rates, means the Fed now “faces a challenge to its ability to sustain low mortgage rates,” according to Jeffrey Rosenberg at Bank of America Corp.

“Market participants may be asking themselves the same question as Scorpio in ‘Dirty Harry’: ‘Do I feel lucky?’ ” Rosenberg, the bank’s head of credit strategy research in New York, wrote in a report yesterday, referring to a character in the 1971 Clint Eastwood film who may be shot.

Bloomberg Headlines Tell the Story

Too much debt! Even mortgages are rising despite Fed's efforts to push rates down!

Stocks Plunge Too!

Treasuries Plunge Off A Cliff

The treasury auction must have been a disaster today!

National Sales Tax Being Considered

from the Washington Post:

Note that the headline says it was "once considered unthinkable"!

With budget deficits soaring and President Obama pushing a trillion-dollar-plus expansion of health coverage, some Washington policymakers are taking a fresh look at a money-making idea long considered politically taboo: a national sales tax.

Common around the world, including in Europe, such a tax -- called a value-added tax, or VAT -- has not been seriously considered in the United States. But advocates say few other options can generate the kind of money the nation will need to avert fiscal calamity.

Deficit to Balloon -- IRS Revenue Plunges 34%

from USA Today:

Federal tax revenue plunged $138 billion, or 34%, in April vs. a year ago — the biggest April drop since 1981, a study released Tuesday by the American Institute for Economic Research says.

When the economy slumps, so does tax revenue, and this recession has been no different, says Kerry Lynch, senior fellow at the AIER and author of the study. "It illustrates how severe the recession has been."

For example, 6 million people lost jobs in the 12 months ended in April — and that means far fewer dollars from income taxes. Income tax revenue dropped 44% from a year ago.

"These are staggering numbers," Lynch says.

Big revenue losses mean that the U.S. budget deficit may be larger than predicted this year and in future years.

Soybeans Sell Off After Open

The Dollar is stronger today, but stocks are still neutral. Arlan Suderman says that "Soybean stocks run on empty with three months left in the year." This sounds very bullish to me!

$12 Soybeans

This feel overbought to me. Funds just keep buying more and more soybeans! This will inevitably bring scrutiny, and with a Democrat-dominated Congress, it will likely lead to more regulation that will damage the futures markets. No one, it seems, has learned anything from past mistakes. More overleveraging, more debt, more excessive driving of the commodity futures. George Santayana said that those who fail to learn the lessons of history are doomed to repeat them.

Stock Static

Looks just like radio static!

Oil Passes $63

Soak-the-Rich Policies Lead to Lower Tax Revenues

from the WSJ:

Here's a two-minute drill in soak-the-rich economics:

Maryland couldn't balance its budget last year, so the state tried to close the shortfall by fleecing the wealthy. Politicians in Annapolis created a millionaire tax bracket, raising the top marginal income-tax rate to 6.25%. And because cities such as Baltimore and Bethesda also impose income taxes, the state-local tax rate can go as high as 9.45%. Governor Martin O'Malley, a dedicated class warrior, declared that these richest 0.3% of filers were "willing and able to pay their fair share." The Baltimore Sun predicted the rich would "grin and bear it."

One year later, nobody's grinning. One-third of the millionaires have disappeared from Maryland tax rolls. In 2008 roughly 3,000 million-dollar income tax returns were filed by the end of April. This year there were 2,000, which the state comptroller's office concedes is a "substantial decline." On those missing returns, the government collects 6.25% of nothing. Instead of the state coffers gaining the extra $106 million the politicians predicted, millionaires paid $100 million less in taxes than they did last year -- even at higher rates.

No doubt the majority of that loss in millionaire filings results from the recession. However, this is one reason that depending on the rich to finance government is so ill-advised: Progressive tax rates create mountains of cash during good times that vanish during recessions. For evidence, consult California, New York and New Jersey..

Government Motors -- Government to Own 70% of Post-Bankruptcy GM

NY Times is citing sources that indicate that the U.S. government will own 70% of GM when its restructuring plan is complete. It will also inject $50 billion more into the company. I'll never buy a car from a government-run, union-run company. Never!

Interest Rates Continue Strong Rise on Treasury Liquidations

Now the Euro Credit Rating Is In Jeopardy

from Bloomberg:
The euro fell for the first time in seven days against the dollar after Moody’s Investors Service downgraded its rating outlook for two Bulgarian banks, reviving concern over the health of the European financial system.

The 16-nation currency also dropped versus the yen after the Telegraph newspaper reported an official at Germany’s financial regulator saying the debt of the country’s banks will blow up “like a grenade” unless they participate in the government’s bad bank plan. South Korea’s won declined for a second day versus the dollar on concern North Korea will conduct more nuclear tests after the communist state said yesterday it successfully carried out an underground explosion.

“The credit-rating issue will continue to dominate the market and currencies or countries which are targets of speculation may come under pressure,” said Yuichiro Harada, senior vice president of the foreign-exchange division in Tokyo at Mizuho Corporate Bank Ltd., a unit of Japan’s second-largest banking group. “No country across the globe will be able to maintain a AAA rating.”

The euro declined to $1.3977 as of 1:43 p.m. in Tokyo, from $1.4017 yesterday in New York. It climbed as high as $1.4051 on May 22, the strongest since Jan. 2. The single currency weakened to 132.32 yen from 132.92 yen. The dollar traded at 94.68 yen from 94.83 yen.

The euro dropped for the first time in four days versus the yen after Moody’s said it placed the financial-strength ratings of Bulgaria’s DSK Bank AD and First Investment Bank Ltd. on review for possible downgrade. Moody’s cited “the likely deterioration of the Bulgarian operating environment,” as the reason for its decision. DSK Bank is rated D+ and First Investment is ranked at D.

German banks have 200 billion euros ($280 billion) of bad debts, Jochen Sanio, president of Germany’s regulator BaFin said last week, according to the Telegraph. Write-offs may reach 816 billion euros, twice the total reserves of the country’s financial institutions, the newspaper reported, citing an internal memo from the regulator’s office. Germany is “more than able” to cope with the 200 billion euros of toxic assets that its banks still hold, Sanio said in an interview with Bloomberg News last week.

“That report over the German debt situation isn’t helping sentiment toward the euro,” said Adam Carr, a senior economist in Sydney at ICAP Australia Ltd., a part of the world’s largest interbank broker.

Gains by the dollar may be tempered on speculation bond sales this week will renew concerns that a record supply of Treasuries will jeopardize the U.S.’s AAA credit rating.

Ten-year Treasuries fell the most since June 2008 last week as the U.S. prepared to resume debt sales after a two-week pause. The Treasury plans to sell $40 billion in two-year notes today, $35 billion in five-year notes May 27 and $26 billion in seven- year notes May 28. It will sell $61 billion in three-month and six-month bills in a weekly auction today.

The U.S. will increase debt sales to $3.25 trillion in the fiscal year ending Sept. 30, according to Goldman Sachs Group Inc., as President Barack Obama borrows record amounts to try to snap the deepest recession in at least 50 years. S&P lowered its outlook on the U.K.’s AAA credit rating May 21 to “negative” from “stable,” raising concern that the same may happen to the world’s biggest economy.

“Given growing concerns about U.S. creditworthiness, capital outflows from the dollar-denominated assets may gain further momentum,” said Kengo Suzuki, manager of the foreign bond trading department in Tokyo at Mizuho Securities Co., a unit of Japan’s second-largest banking group.

Energy Shortages Coming in 3-5 Years Without More Development

from Bloomberg:
Reduced spending on energy would slow the economic rebound, trigger a surge in prices and hurt future prosperity, the Group of Eight industrialized nations said at the close of their meeting in Rome.

“The current financial and economic crisis must not delay investments and programmed energy projects which are essential to economic recovery and sustainable prosperity,” ministers from the G8 and 15 other countries including Saudi Arabia, China and India said in their concluding statement yesterday after a three-day meeting.

The global economic slowdown has restricted credit for new energy projects and eroded demand for fuels, leading to a 58 percent slump in crude prices from their high of $147.27 a barrel in July. Oil companies’ spending this year dropped almost $100 billion, or 21 percent, according to a report this month from International Energy Agency.

Oil prices may jump in four to five years because energy companies, fighting the worst recession in more than six decades, are cutting investment in new projects, IEA Chief Economist Fatih Birol said in the report.

Dallas Fed President Begs "Don't Monetize the Debt"

from WSJ:

From his perch high atop the palatial Dallas Federal Reserve Bank, overlooking what he calls "the most modern, efficient city in America," Richard Fisher says he is always on the lookout for rising prices. But that's not what's worrying the bank's president right now.

His bigger concern these days would seem to be what he calls "the perception of risk" that has been created by the Fed's purchases of Treasury bonds, mortgage-backed securities and Fannie Mae paper.

Mr. Fisher acknowledges that events in the financial markets last year required some unusual Fed action in the commercial lending market. But he says the longer-term debt, particularly the Treasurys, is making investors nervous. The looming challenge, he says, is to reassure markets that the Fed is not going to be "the handmaiden" to fiscal profligacy. "I think the trick here is to assist the functioning of the private markets without signaling in any way, shape or form that the Federal Reserve will be party to monetizing fiscal largess, deficits or the stimulus program."

The very fact that a Fed regional bank president has to raise this issue is not very comforting. It conjures up images of Argentina. And as Mr. Fisher explains, he's not the only one worrying about it. He has just returned from a trip to China, where "senior officials of the Chinese government grill[ed] me about whether or not we are going to monetize the actions of our legislature." He adds, "I must have been asked about that a hundred times in China."

A native of Los Angeles who grew up in Mexico, Mr. Fisher was educated at Harvard, Oxford and Stanford. He spent his earliest days in government at Jimmy Carter's Treasury. He says that taught him a life-long lesson about inflation. It was "inflation that destroyed that presidency," he says. He adds that he learned a lot from then Fed Chairman Paul Volcker, who had to "break [inflation's] back."

Mr. Fisher has led the Dallas Fed since 2005 and has developed a reputation as the Federal Open Market Committee's (FOMC) lead inflation worrywart. In September he told a New York audience that "rates held too low, for too long during the previous Fed regime were an accomplice to [the] reckless behavior" that brought about the economic troubles we are now living through. He also warned that the Treasury's $700 billion plan to buy toxic assets from financial institutions would be "one more straw on the back of the frightfully encumbered camel that is the federal government ledger."

In a speech at the Kennedy School of Government in February, he wrung his hands about "the very deep hole [our political leaders] have dug in incurring unfunded liabilities of retirement and health-care obligations" that "we at the Dallas Fed believe total over $99 trillion." In March, he is believed to have vociferously objected in closed-door FOMC meetings to the proposal to buy U.S. Treasury bonds. So with long-term Treasury yields moving up sharply despite Fed intentions to bring down mortgage rates, I've flown to Dallas to see what he's thinking now.

Regarding what caused the credit bubble, he repeats his assertion about the Fed's role: "It is human instinct when rates are low and the yield curve is flat to reach for greater risk and enhanced yield and returns." (Later, he adds that this is not to cast aspersions on former Fed Chairman Alan Greenspan and reminds me that these decisions are made by the FOMC.)

"The second thing is that the regulators didn't do their job, including the Federal Reserve." To this he adds what he calls unusual circumstances, including "the fruits and tailwinds of globalization, billions of people added to the labor supply, new factories and productivity coming from places it had never come from before." And finally, he says, there was the 'mathematization' of risk." Institutions were "building risk models" and relying heavily on "quant jocks" when "in the end there can be no substitute for good judgment."

What about another group of alleged culprits: the government-anointed rating agencies? Mr. Fisher doesn't mince words. "I served on corporate boards. The way rating agencies worked is that they were paid by the people they rated. I saw that from the inside." He says he also saw this "inherent conflict of interest" as a fund manager. "I never paid attention to the rating agencies. If you relied on them you got . . . you know," he says, sparing me the gory details. "You did your own analysis. What is clear is that rating agencies always change something after it is obvious to everyone else. That's why we never relied on them." That's a bit disconcerting since the Fed still uses these same agencies in managing its own portfolio.

I wonder whether the same bubble-producing Fed errors aren't being repeated now as Washington scrambles to avoid a sustained economic downturn.

He surprises me by siding with the deflation hawks. "I don't think that's the risk right now." Why? One factor influencing his view is the Dallas Fed's "trim mean calculation," which looks at price changes of more than 180 items and excludes the extremes. Dallas researchers have found that "the price increases are less and less. Ex-energy, ex-food, ex-tobacco you've got some mild deflation here and no inflation in the [broader] headline index."

Mr. Fisher says he also has a group of about 50 CEOs around the U.S. and the world that he calls on, all off the record, before almost every FOMC meeting. "I don't impart any information, I just listen carefully to what they are seeing through their own eyes. And that gives me a sense of what's happening on the ground, you might say on Main Street as opposed to Wall Street."

It's good to know that a guy so obsessed with price stability doesn't see inflation on the horizon. But inflation and bubble trouble almost always get going before they are recognized. Moreover, the Fed has to pay attention to the 1978 Full Employment and Balanced Growth Act -- a.k.a. Humphrey-Hawkins -- and employment is a lagging indicator of economic activity. This could create a Fed bias in favor of inflating. So I push him again.

"I want to make sure that your readers understand that I don't know a single person on the FOMC who is rooting for inflation or who is tolerant of inflation." The committee knows very well, he assures me, that "you cannot have sustainable employment growth without price stability. And by price stability I mean that we cannot tolerate deflation or the ravages of inflation."

Mr. Fisher defends the Fed's actions that were designed to "stabilize the financial system as it literally fell apart and prevent the economy from imploding." Yet he admits that there is unfinished work. Policy makers have to be "always mindful that whatever you put in, you are going to have to take out at some point. And also be mindful that there are these perceptions [about the possibility of monetizing the debt], which is why I have been sensitive about the issue of purchasing Treasurys."

He returns to events on his recent trip to Asia, which besides China included stops in Japan, Hong Kong, Singapore and Korea. "I wasn't asked once about mortgage-backed securities. But I was asked at every single meeting about our purchase of Treasurys. That seemed to be the principal preoccupation of those that were invested with their surpluses mostly in the United States. That seems to be the issue people are most worried about."

As I listen I am reminded that it's not just the Asians who have expressed concern. In his Kennedy School speech, Mr. Fisher himself fretted about the U.S. fiscal picture. He acknowledges that he has raised the issue "ad nauseam" and doesn't apologize. "Throughout history," he says, "what the political class has done is they have turned to the central bank to print their way out of an unfunded liability. We can't let that happen. That's when you open the floodgates. So I hope and I pray that our political leaders will just have to take this bull by the horns at some point. You can't run away from it."

Voices like Mr. Fisher's can be a problem for the politicians, which may be why recently there have been rumblings in Washington about revoking the automatic FOMC membership that comes with being a regional bank president. Does Mr. Fisher have any thoughts about that?

This is nothing new, he points out, briefly reviewing the history of the political struggle over monetary policy in the U.S. "The reason why the banks were put in the mix by [President Woodrow] Wilson in 1913, the reason it was structured the way it was structured, was so that you could offset the political power of Washington and the money center in New York with the regional banks. They represented Main Street.

"Now we have this great populist fervor and the banks are arguing for Main Street, largely. I have heard these arguments before and studied the history. I am not losing a lot of sleep over it," he says with a defiant Texas twang that I had not previously detected. "I don't think that it'd be the best signal to send to the market right now that you want to totally politicize the process."

Speaking of which, Texas bankers don't have much good to say about the Troubled Asset Relief Program (TARP), according to Mr. Fisher. "Its been complicated by the politics because you have a special investigator, special prosecutor, and all I can tell you is that in my district here most of the people who wanted in on the TARP no longer want in on the TARP."

At heart, Mr. Fisher says he is an advocate for letting markets clear on their own. "You know that I am a big believer in Schumpeter's creative destruction," he says referring to the term coined by the late Austrian economist. "The destructive part is always painful, politically messy, it hurts like hell but you hopefully will allow the adjustments to be made so that the creative part can take place." Texas went through that process in the 1980s, he says, and came back stronger.

This is doubtless why, with Washington taking on a larger role in the American economy every day, the worries linger. On the wall behind his desk is a 1907 gouache painting by Antonio De Simone of the American steam sailing vessel Varuna plowing through stormy seas. Just like most everything else on the walls, bookshelves and table tops around his office -- and even the dollar-sign cuff links he wears to work -- it represents something.

He says that he has had this painting behind his desk for the past 30 years as a reminder of the importance of purpose and duty in rough seas. "The ship," he explains, "has to maintain its integrity." What is more, "no mathematical model can steer you through the kind of seas in that picture there. In the end someone has the wheel." He adds: "On monetary policy it's the Federal Reserve."

Note to Mr. Fisher and the Fed: Actions speak louder than words! The Fed has no cred!