Re-leveraging to Counter De-leveraging

The US Financial Secretary's announcement on the 1trillion US saving plan has injected cocaine on the stock market. All major markets worldwide have experienced a rise by 3-5%.

Integrating with the previous re-purchasing of newly issued Treasuries by FED, the intention of the method of implementing Obama's pledge now is clearer. US government attempts to counter deleveraging by releveraging.

The re-leveraging is done by the 1trillion plan by initiating the participation of private equity. The ideas is simple: US government provides "storage fee/rent" and "insurance" against the "goods" while the private equity stores at no cost with the expected gain through sitting over till asset re-appreciation. Since US government can decide the amount of "dividends" to be minimial and supply half of the capital, private equity can have a leverage around, say, 80-95%. In other words, any 10% increase on the goods' prices can result in the 16-19% increase on private equity's revenue. The remaining 5-10% will be the risk premium for US government to replenish its own capital after a short period.

Another important mechanism is the submission of proposals to US government to apply for "trading licence" for the "goods". Through such mechanism US government can also limit the number of "bidders" to maximize the "potential gain/expected return amount". The rather incompetitive market can also be more convenient to be monitored (or even manipulated when necessary): the key point is to maintain the price of the "goods".

A risk is associated with the above measure: the potential USD depreciation due to the pumping of money on the asset with uncertain value. Nevertheless, the FED's action of re-purchasing the newly issued treasuries has minimized the adverse effect.

The purchase at a premium can provide supports to the Treasuries price and maintain its shelter status. As long as there are other countries/parties continuing their supports, the demand of USD is there, and hence the price will not subject to great depreciation.

Also, the purchase itself injects money to the US government which will soon need a stable and an ample supply of capital. By the above action FED has stablized and capitalized, and can continue to supply the capital for US government low cost.

What will the US government do with the capital? Recall the previous stimuli plan?

The current saving measures are only a part of the plan, and only kill the pain. The source of the problem is the alreaady collapsed property and asset market. Property, being the last most reliable collateral next to land, will serve great purpose on rebooting the overall market.

To reboot the overall property market, they need people who can afford the property, or at least the mortgage of it. While the previous money selling approach by FED can serve the purpose of re-liquidating the market bypassing banks, the real deal comes with government expenditure, especuially on infra-structures, medical reformation, and potential new inventions on high-tech. US government needs money to perform these tasks, and FED prints to them by buying the US treasuries.

Ideally, the expenditure can bring jobs and income to public to continue the housing payment. The expectations can relax the risk of bank. Given that the toxic most asset was no longer in the balance sheet, the bank can re-start lending money. Meanwhile, the stablized property price can also provide support and liquidation to the toxic assets at the private equity's hands. Those companies will earn the bigger part while the smaller portion of the pie will go back to the government that can repay FED's balance sheet.

But it exposes to two risks:
1. The zombie enterprises will be a heavy laden that continues to waste precious resources that can be used elsewhere - be it the capital for reformed medical care, educational funds, or even capital for secondary industries with better operational efficiencies. Nevertheless, the afraid of job cutting will simply weaken the above measures: after the improvement of production efficiency through facilites, the actual benefit will not be significant due to the over-paid labour.
2. Moral risk - re-leveraging by concept is to encourage the market to leverage as much as to the previous level. It encourages another bubble without value creation. How long can such bubble persist? What if the bubble bursts again? It is sure that by that time USD will eventually lose its status and the trust from its buyers. A real hyper-inflation of USD will result.

Now the entire measure bets on the timely restoration of economy by 1-2 year time. As shown from the yield curve, the turning point is on the 2-year T-note. It can be a prove that the government purchases this maturity t-note most. By 1-2 year's time, the expected stablization and recovery can at least allow the government takes back some revenues from the toxic asset and returns to the FED through maturity of the T-note.

If that is the case, plus the free-available money is still short, as shown on the 3 month TED remains at 102 basis points premium, 5-year AAA finance risk premium is at 523 basis points and 10-year AAA finance risk premium is at 556 basis points, a speculation on stocks and commodities will happen. However, the over-capacity, high cost of capital and the eventual shortage of continuous fund will dry up the momentum of the raw material related stocks. Gold may increase when bad news happen, so is bond. These 2, of course, may not go up and down at the same time. USD against other currencies will stablize as capital will flow into US market to speculate on its government spending related projects.

BUT, as the real problem is not solved, or at least not sure if can be solved, a long term call perspective is still in vain.