Author: Daniel Indiviglio

Google will be holding a news conference today where the company is expected to unveil its new smartphone. Tech blogs have been buzzing for quite some time with speculation that such a phone existed. Today, we’ll get some details. Will the Google phone revolutionize the smartphones? I doubt it, but that doesn’t mean its presence in the market isn’t significant.

Since the phone hasn’t been publicly released, details are still sketchy, but I actually happened to see the Google phone a few weeks ago. I was having drinks with a friend of mine who works for Google, and she was one of many employees beta testing the device. Although I didn’t get a full picture of the phone or its capabilities, from what I did observe, it appeared to be just another nice smartphone. When I asked her if she liked it, she said yes, but didn’t geek out on me about how great it was — like virtually every iPhone owner I’ve ever met.

I found that a little worrying for Google. If one of its own employees isn’t extremely impressed with the phone, what will a public with far less allegiance to Google think?

They will also like it, but also aren’t doing cartwheels. An ABC news clip included with an article about the device from Silicon Valley’s MercuryNews.com speaks to this point. In that clip, a few people who have no association to Google, but have used the phone, give their reactions. First, an editor from AllThingsD who has gotten to play with the phone reports that it’s a good smartphone. She likes the screen, camera, mapping and integration with Google services. But she still prefers her iPhone. Another technology columnist is also not that impressed. He expected a revolutionary device, but instead he thinks it’s “just a nice phone.”

What’s also troubling is the pricing. The article says:

Google is expected to offer consumers two options for buying the Nexus One, according to reports. They can pay $180 for it if they sign up for a two-year T-Mobile contract. Or they can pay $530 without a contract.

With a contract, that’s almost as much as the iPhone 3GS ($199). You can get the iPhone 3G for just $99. And without a contract, well, that’s just an awful lot of money for consumers to spend on a mobile device. Sure, they can use it with any service provider*, but I don’t believe many people will find that worth such an overwhelming price tag.

So is the Google phone doomed? Of course not. It’s a really good phone. There’s little doubt that a lot of people will buy one. But what I’m a little skeptical about is whether it has the chops to dethrone the iPhone as the premiere smartphone. I don’t see that happening.

But maybe Google doesn’t either. We should keep in mind that Google has some expectation for its smartphone, and that expectation is probably realistic. It’s a software company, so it would be ludicrous to think that its foray into hardware could be so incredibly triumphant to overtake the market and dwarf revolutionary devices like the iPhone, Blackberry and Droid. So I find it a little hard to believe that Google would have such outlandish expectations.

Instead, I suspect the company just wants to be a participant in the extremely important smartphone market. It probably wants a respectable market share, but isn’t looking to create any sort of earth-shaking paradigm change in mobile devices. Since the phone is a good device, it will appeal to some consumers, so that will be accomplished. And by providing access to all of its services, like Google Voice, other smartphone makers that aren’t as eager to allow integration of all-things-Google will feel more pressure to do so. So even if the Google phone doesn’t trump all others, it might not have to for the company to view the product as a success.

* As a few commenters have pointed out, this isn’t precisely true. What I mean by this is that an unlocked phone does provide more service provider flexibility than, say, the iPhone which is locked to AT&T.

That was the question that Tyler Cowen posed to Moodys’ chief economist Mark Zandi in an interview posted last week for the Big Think’s “What Went Wrong” series. If you follow my writing, then you know that I would love to see investors rid themselves of their dependence on the rating agencies. Since Zandi works for Moodys, I was very interested to hear his response. I don’t entirely agree.

First, let me say that I really like Zandi. I’ve talked to him a few times for articles, and he’s good at what he does, a nice guy and quite smart. He’s also one of those rare people who prefers to get things right, rather than bend himself into pretzels to fit into some political ideology. So I don’t think he’s just speaking the company line here, but expect that he really believes what he’s saying. Still, I disagree. He replies:

I think there’s a function for rating agencies because in a sense, there is a lot of despaired information and bringing it altogether is very costly and doing good analysis is difficult and you need scale to do it. Some bond houses are gaining that scale and doing that on their own. There’s the PIMCO’s of the world and other big bond houses that have the skill necessary to put together the staff to do the kind of analysis that needs to get done. But many other investors don’t have that scale and the rating agencies, in a sense, provide that for them. And so, there are scale economies in that kind of analysis and in a sense the rating agencies provide that.

Also, there’s a lot more esoteric kinds of bonds and securities that are issued and it always will makes sense to have, I think, something like a rating agency providing an opinion as to the quality of that particular bond or that security. So, I think there’s an economic reason for rating agencies, so I think they will always be around, obviously the role is going to change as a result of events, but I think there will always be a role for them.

I see things differently for two reasons.

First, how about the stock market? There’s plenty of information to analyze when evaluating a stock, but investors do that without an over-reliance on rating agencies. For that matter, banks and investment houses could develop fixed income research teams for bonds that serve a purpose similar to the equity research groups that exist today to look at stocks. That would provide a diverse spectrum of ideas, rather than a government-sponsored oligopoly of agencies charged with this task.

Second, maybe it’s good that full analyses of complex bonds are costly. I don’t know about you, but I think that there were entirely too many mortgage-backed securities in the market during the housing boom. Maybe if investors had to bear the cost involved with doing the analysis themselves, they would have been a little less eager to scoop up those bonds. Maybe then, demand for MBS would have been more restrained. Consequently, there would have been far fewer mortgage originations. The housing bubble might not have been nearly as severe, and we would have saved ourselves from a lot of trouble.

The point is that complex securities should be costly. When a market has a staggering demand for complexity, then there’s probably a market failure lurking in the shadows, particularly when investors aren’t doing the work. By having a few rating agencies that claim to understand these puzzling products, and the market accepting their declarations as gospel, investors will fail to assign the right cost to abstruse bonds. I think the market would ultimately benefit from a complexity premium.

Last week I debated the Federal Reserve’s 2010 monetary policy philosophy on CNBC’s Kudlow Report with host Larry Kudlow and UC-Irvine business professor Peter Navarro. Since it was one of those segments where you never have enough time to fully address all of the points made, and since I have had a little additional time to reflect on some of what was said, I thought it might be good to provide a more detailed response to a challenge put forth by Kudlow. He says that the bond market is signaling a boom by pushing up interest rates, and that the Fed should follow suit. I disagree and want to better explain why.

First, here’s the clip, in case you’re dying to see me in action:

Kudlow is one of the most cheery optimists for 2010 I’ve heard from. Earlier in the show, I believe he said that he expected something like 5% to 6% GDP growth in 2010. I think we’ll be lucky if it’s half that. He believes that the bond market is signaling this recovery. In the course of the discussion he asks me:

As we come to the end of the year, the whole Treasury interest rate structure has increased by 50, 60 basis points or more. To me that is a signal the Fed should heed. The market is trying to pull the Fed up and the Fed may not be listening, Daniel, what’s your take? There are two-year rates, there are five-year rates, and the 10- and 30-year rates. They’re all going up. Is that not signaling a boom? Is that not telling the Fed they should follow and start raising their own rate and withdraw and shrink their balance sheet, Daniel?

I don’t believe that this is signaling a boom, but would blame a few other factors on why bond yields are increasing.

First, as I noted a week ago, Treasury yields are taking a hit from, both, supply and demand. First, the government is going to flood the market with debt in 2010 to fund all of its spending. With all that supply investors are going to require a better return to soak it all up. Second, they’re also going to demand a higher risk premium, as many believe that the U.S. debt levels are getting riskier.

There are other factors driving up rates as well. Inflation expectations are growing, which should also increase the nominal rate for longer-term bonds. The U.S. is pondering historically unprecedented financial regulation, which thrusts a great deal of political uncertainty into the financial markets. That also amounts to a higher risk premium on bonds. Finally, many bond yields were too low prior to the financial crisis, as they didn’t properly reflect the risk present in these securities. Investors likely recognize that this must change once Wall Street goes back to business as usual.

So no, I don’t think the bond market is simply betting on a huge economic recovery in 2010. And if it is, then, well, I think it’s wrong. As I say in the clip, if we’ve learned anything from the financial crisis, it’s that investors aren’t as smart as they think and can get things very, embarrassingly wrong. This could be yet another case of irrational exuberance in a sort of mini-bubble.

That’s why I don’t believe the Fed should follow suit and take drastic action to reduce its balance sheet. I actually worry that ending some of its programs in the first quarter is already a little bit too aggressive. As I’ve mentioned, I don’t see the mortgage-backed securities market comfortably walking on its own two feet in 2010, so mortgage rates could consequently skyrocket, hampering the housing recovery. Consumer credit could also suffer by ending the Fed’s Term Asset-Backed Securities Loan Facility, harming spending and GDP growth.

Finally, wish I had posed a question to Kudlow and Navarro: what’s worse — a little bit of inflation, or unemployment increasing to 15% in 2010? I’d prefer the former, but if the Fed drastically reduces its balance sheet — and we aren’t out of the woods — then the latter could result. I think that the Fed would be taking a huge risk by acting too aggressively to shrink its balance sheet too soon. That could cause the Great Recession to become another Great Depression. I also don’t believe that inflation can manifest itself too significantly until the economy has fully recovered. Thus, the risk posed by shrinking monetary supply in 2010 appears far greater than the benefit.

In responding to a lengthy review (.pdf), the Internal Revenue Service has decided that it needs stricter oversight of firms that prepare tax returns. It wants these parties to register, prove competency, perform continuing education and follow ethics guidelines. While these new rules seem sensible at first glance, I think they miss the point.

Here’s a key statistic from the report:

For 2007 and 2008, over 80 percent of all federal individual income tax returns were prepared by paid tax return preparers or by taxpayers using consumer tax preparation software.

80% is a lot! So the logic goes, since so many people use prepares, the IRS better make sure that these parties are doing things right. Given the current convoluted and overly-complex tax system, this probably makes sense. The IRS is one of those government agencies with too small a staff to possibly ensure that everyone is paying their taxes properly.

Even though the press release talks a lot about protecting consumers, I can’t help but believe that this is really being done mostly to ensure that Uncle Sam gets his taxes. That’s one way to increase tax revenue.

As an honest taxpayer, I’m okay with that. Whenever I hear someone talk about their “tax guy” who saved them thousands of dollars this year, I always squirm. While there are plenty of legitimate reasons out there to claim deductions, I have little doubt that there are quite a few shady tax preparers who stretch the truth a little too far and ignore the intended purpose for many tax deductions.

Despite the fact that this regulation might seem sensible, I would have responded differently to the statistic I quoted above. If over 80% of people hire others to help prepare their taxes, my immediate reaction isn’t to demand more regulation of those preparers — it’s to demand a simpler tax code. If we had a clearer, less-complex tax system, then we wouldn’t have to waste money hiring people to help us with our taxes. Heck, I used to work in finance and have a degree in physics, but I still use tax software to avoid wasting countless hours to fully understand the tax code. As we all know, Treasury Secretary Timothy Geithner, who is now technically the head of the IRS, has also used such software in the past — and made mistakes!

So yes, in the current framework, regulate tax preparers. But a much better solution would be to construct a new tax system where we don’t need tax preparers. Maybe I’m crazy, but I think more simplicity is a far better alternative to more regulation.

There’s a lot of talk this morning about a speech yesterday by Federal Reserve Chairman Ben Bernanke. At the annual meeting of the American Economic Association in Atlanta, he provided some concrete views on what caused the housing bubble. Several articles I’ve read about the speech imply that Bernanke is shoving off blame, since he says the Fed keeping interest rates extremely low shouldn’t be faulted. But what he says did cause the mess should still keep the Fed in the hot seat. Yet, he’s using it to ask for even more responsibility.

First, I’m not trying to agree that the Fed keeping rates so low had nothing to do with the housing bubble. I actually believe that played a role, but certainly shouldn’t take on close to all of the blame. The more major cause according to Bernanke: not enough regulation. After a lengthy argument that rates weren’t the problem, he says:

What policy implications should we draw? I noted earlier that the most important source of lower initial monthly payments, which allowed more people to enter the housing market and bid for properties, was not the general level of short-term interest rates, but the increasing use of more exotic types of mortgages and the associated decline of underwriting standards. That conclusion suggests that the best response to the housing bubble would have been regulatory, not monetary. Stronger regulation and supervision aimed at problems with underwriting practices and lenders’ risk management would have been a more effective and surgical approach to constraining the housing bubble than a general increase in interest rates. Moreover, regulators, supervisors, and the private sector could have more effectively addressed building risk concentrations and inadequate risk-management practices without necessarily having had to make a judgment about the sustainability of house price increases.

My first observation is that this hardly deflects criticism. The Fed doesn’t only wear a rate-setting hat; it’s also a regulator. It could have stepped in and created rules for subprime mortgages, adjustable-rate mortgages, underwriting standards, etc. It didn’t do so in time. So even if its rates setting policies didn’t fail, its regulatory oversight certainly did.

Second, Felix Salmon makes an observation that I agree with regarding a paragraph following the one I quoted where Bernanke goes on:

The lesson I take from this experience is not that financial regulation and supervision are ineffective for controlling emerging risks, but that their execution must be better and smarter. The Federal Reserve is working not only to improve our ability to identify and correct problems in financial institutions, but also to move from an institution-by-institution supervisory approach to one that is attentive to the stability of the financial system as a whole. Toward that end, we are supplementing reviews of individual firms with comparative evaluations across firms and with analyses of the interactions among firms and markets. We have further strengthened our commitment to consumer protection. And we have strongly advocated financial regulatory reforms, such as the creation of a systemic risk council, that will reorient the country’s overall regulatory structure toward a more systemic approach. The crisis has shown us that indicators such as leverage and liquidity must be evaluated from a systemwide perspective as well as at the level of individual firms.

Salmon says that he sees a power grab. Presumably, he thinks Bernanke really means something like, “Gee, look: if we could regulate more, then we could have avoided this whole mess.” Salmon is probably right. Bernanke doesn’t appear to so much be looking for absolution for messing up as he does to try to argue that the Fed should be able to do even more regulation.

I think that’s nuts. The Fed already had sufficient power to regulate mortgage banking, yet it failed to do so. If it’s given even more regulatory authority, such as systemic risk regulation, why do I have any reason to believe that it will do better next time? To me, this amounts to someone dropping a dozen eggs and saying that he will do better if he has to carry two dozen next time instead.

I’ve argued before, as the central bank the Fed has too many a conflicts-of-interest to be trusted to spearhead financial regulation. One of its major priorities is to protect banks. The moment that mission conflicts with sensible regulatory restraint, I worry that the Fed will defer to the banking industry’s stance. You could even imagine back in 2004 that the Fed might have liked the housing boom and worried that full employment could suffer if the mortgage industry had more regulation. Which priority should it put first — regulation or full employment?

While the Fed is talking loudly now about new regulation while we’re in the recessionary trough with 20/20 hindsight, let’s see if it will be as quick to create and enforce new regulations when happy times are here again. I remain highly skeptical.

In case you’re a regular Business Channel reader that doesn’t always check out the other Atlantic Voices, I wanted to highlight a good post by Clive Crook today that you may have missed. He addresses a recent article in the New York Times about Pay Czar Kenneth Feinberg’s efforts to rein in banker pay during the bank bailout. He also considers some criticism of Feinberg from Felix Salmon. Check it out!

In case you weren’t following the news over the holidays, an interesting media story was gaining momentum with Time Warner threatening to drop Fox Broadcast networks from its service. When I saw that headline, it registered a quick snort with the thought, “Yeah, like that would ever happen.” Indeed, it appears a deal has been struck to keep Fox a part of Time Warner subscribers’ lives — shocker! But the New York Times has a good article today breaking down the fight, and explaining what it means in the broader context for cable subscribers: higher bills.

The reason why Time Warner threatened to drop Fox was because its parent company, News Corporation, was demanding subscriber fees for the Fox Broadcasting network. Traditionally, the non-cable networks, like Fox, ABC, CBS and NBC had relied entirely on advertising for their revenue since anyone could view their local affiliates with an antenna. While most cable networks also got some advertising money, they also relied on fees paid by subscribers from companies like Time Warner and Comcast who bring their channels to their customers.

According to the Times, CBS started asking for fees a few years ago. Obviously Fox demands them now too. It says the others are likely to follow.

As you can probably guess, cable companies are hardly going to let these new fees hit their bottom line: they’ll just charge consumers more. Indeed, Time Warner has already announced a rate increase likely related to the Fox deal. Expect those fees to increase as ABC and NBC eventually cash in.

Is it OK that the networks are forcing viewers to pay for content? That depends on your view of the world.

On one hand, if cable channels are profiting from, both, advertising and subscriber fees, why can’t the traditionally non-cable networks? In this day and age, fewer and fewer people are relying on antennas anyway. The distinction between cable and non-cable channels seems so. . . 20th century.

On the other hand, these companies appeared to be doing pretty well based on advertising revenue alone for decades. Why the sudden need to milk cable customers out of additional money to pad network executives’ pockets? As a consumer, I’m certainly not pleased that my bill may be going up by a few dollars.

Of course, this all boils down to the important contemporary question of whether media should charge for its content, rely purely on advertising or do both. That’s the question that Internet news sources are struggling with. But with cable the quandary develops a different dimension. You can decide whether or not to subscribe to the Wall Street Journal online, but if you don’t like MSNBC, you’re probably out of luck. Few people have the ability to decide which cable networks they get on an “à la cart” pricing basis.

But the Web will likely transform this debate for TV as well. Technology appears to be increasingly moving towards a sort of content-agnostic world, where the web will be where we access all forms of media, whether print, radio or TV. So while it’s fine for us to quibble over this latest trend for non-cable TV networks, I suspect it’s just one step in an evolution leading to a new world where all of our media consumption will be very, very different.

An enormous $24 billion lawsuit was filed yesterday against Credit Suisse accusing the bank of defrauding investors in a giant real estate scam. The loans involved were for properties in resort communities in Montana, Nevada, Idaho and the Bahamas. Although I can’t seem to get my hands on all of the details, from the articles I’ve read on the suit this morning, I’m a little skeptical.

I’ll be very interested to see the full allegations, and the facts of the case. But for now, here’s what Reuters reports:

In a lawsuit filed Sunday in federal court in Idaho, the plaintiffs said Credit Suisse colluded with real estate firm and co-defendant Cushman & Wakefield in a “loan to own” scheme to artificially inflate the value of resort projects.

It said this scheme was designed to burden resorts and purchasers of property in resorts with too much debt, while winning Credit Suisse “enormous fees” and letting the bank foreclose on or take control of resorts at well below market value.

Saddling property owners with too much debt so that the bank can foreclose on the real estate in question? Sounds vaguely familiar, doesn’t it? Oh yeah! That’s what pretty much every bank in the U.S. was accused of doing with the subprime mortgage bubble. I have to wonder if this case is really any different than the complaints of millions of homeowners who say that banks purposely gave them loans that they knew wouldn’t perform just to get fees from the borrowers and eventually force them into foreclosure.

And what’s more suspicious is that most of these purchasers should have been a lot savvier than your typical subprime borrower. These were luxury properties sold to millionaires and billionaires, according to Reuters. Ever hear of a little thing called “buyer beware”? Did these guys happen to do any third-party due diligence to verify the value of these properties? Did they manage to do any of their own budgetary analysis to see if they could afford the debt they were taking on, given the terms of the loans given?

Again, we’re not talking about some poor guy working two minimum wage jobs who doesn’t understand what an adjustable-rate is, but was coaxed into taking a subprime mortgage. These are very rich people who should know a thing or two about managing their finances — or at least have people working for them who do that kind of thing for them in a professional capacity.

I don’t mean to pass an early judgment without all of the facts: Credit Suisse may very well have broken some laws — I don’t know. But unless there was widespread fraud and conspiracy involving Credit Suisse, appraisers, third-party auditors, financial consultants, etc., then I can’t help but be cynical about these claims. Besides, it’s hardly smart business for Credit Suisse to knowingly take advantage of rich people for a one-time gain. They could make a lot more money off these individuals if they cultivated relationships with them through legitimate loans over the course of many years.

So could Credit Suisse be culpable here? Sure. But from what we know so far, I have my doubts. I also have trouble feeling much sympathy for those filing the suit. It sounds to me like a bunch of wealthy real estate investors who are annoyed that the housing market collapsed after they bought a piece of some very expensive property with loan terms that weren’t particularly generous.

In a word: ugly. That’s what economist Paul Krugman thinks about the past decade. He calls it “the big zero,” since there was no significant growth in any measure of the economy. Zero job creation, zero increase in median income, zero gain for home prices, zero gain for stocks. While I sort of agree with his assessment of how awful a decade it was in economics, I think there are a few reasons why it was such a disastrous decade that he misses: the wars in the Middle East and the U.S.’s reliance on its real estate market.

What does Krugman mostly blame on this lost decade for U.S. economic progress? Not enough regulation and not learning from our mistakes:

Even as the dot-com bubble deflated, credulous bankers and investors began inflating a new bubble in housing. Even after famous, admired companies like Enron and WorldCom were revealed to have been Potemkin corporations with facades built out of creative accounting, analysts and investors believed banks’ claims about their own financial strength and bought into the hype about investments they didn’t understand. Even after triggering a global economic collapse, and having to be rescued at taxpayers’ expense, bankers wasted no time going right back to the culture of giant bonuses and excessive leverage.

As I’ve mentioned before, bubbles are notoriously difficult to avoid. Although the Federal Reserve might have been able to take some action to make the real estate bubble less severe, I find it hard to believe that government intervention could have avoided it altogether — unless he means that the government should not have allowed Fannie and Freddie to grow so large. But somehow, I don’t think that’s the kind of government action he’s talking about.

As for regulation, some definitely would have helped prevent the crisis. For example, higher capital requirements may have helped. Better disclosure, allowing investors to understand all of the hidden leverage within banks, would also have helped. If you had better limited banks’ leverage, or required more capital, then the purported bonus problem would have taken care of itself, as bankers’ earnings would have been necessarily lower.

I would add a few additional causes to Krugman’s list, however. One is the wars in the Middle East. The tab from Iraq and Afghanistan is approaching $1 trillion. That money is a pure economic lost. When you blow up a bomb, or fire a bullet, it’s like burning money. I guess you could argue that it’s an investment in U.S. security, if you believe that the nation is really all that much more secure as a result of the military action in the Middle East. Given the nearly successful terrorist attempt even just this past weekend, I’m not particularly convinced that was $1 trillion well-spent. Imagine if Americans had paid $1 trillion less in taxes, how much economic activity that might have spurred.

Additionally, I think anytime a nation gets too carried away with real estate, it’s a bad sign for long-term growth. Real estate investment doesn’t really create wealth in the same way that producing goods and services can. There’s no technological innovation involved; there’s no exporting of goods and services. All a domestic real estate market can really do is supply demand for houses as population increases and old homes need replacing. While some additional supply can be created through second homes for the wealthy, you would hardly want to establish an economy dependent on that.

A prime example of this is Florida. Other than tourism, over the past decade, the real estate market drove its economy. Once the housing bubble popped, it became clear that the state was in big trouble: it has no other major industry other than tourism to pick up the slack. If, instead of trying to develop such a strong real estate market, it focused its efforts on developing other industries like solar energy, high-tech manufacturing or even something like entertainment, it might not have such awful employment prospects in the years that follow. Last month, when virtually every state saw fewer jobless, the unemployed continued to increase significantly in Florida. Far too much of its population growth depended on real estate industry jobs. Now that the music has stopped, there are too many people and too few jobs.

And that’s a good analogy for the broader U.S. economy over the past decade. Unless it concentrates on industries that can actually drive sustainable growth, it will remain stagnant. Even when the tech bubble popped, not all was lost. Silicon Valley remains a hub for technological innovation. There was some sustainable growth there through technological advances and jobs that would endure. There will always be a real estate market, and a need for construction and housing. But it should never drive GDP, jobs, or U.S. growth. Other industries can do far better.

Earlier, I noted that the Federal Reserve’s decision to stop purchasing mortgage-backed securities (MBS) should cause an increase in mortgage rates. But that won’t be the only thing driving up long-term rates: the Treasury’s trouble going forward in selling debt will also contribute to higher mortgage rates, according to a Morgan Stanley economist. Here’s what he says, via Bloomberg:

Yields on benchmark 10-year notes will climb about 40 percent to 5.5 percent, the biggest annual increase since 1999, according to David Greenlaw, chief fixed-income economist at Morgan Stanley in New York. The surge will push interest rates on 30-year fixed mortgages to 7.5 percent to 8 percent, almost the highest in a decade, Greenlaw said.

Yikes! Those are some pretty high mortgage rates — and much higher than we’re used to seeing over the past several years. They should cut significantly into the demand for refinancing and even new home purchases. Rates like that could also worsen the foreclosures crisis, as many adjustable rate mortgages (ARMs) have benefited from historically low interest rates. Once they adjust to near, or over, double-digits, many more homeowners with ARMs will be force to fold.

The cause of this increase in mortgage rates comes from what this economist believes will be a higher yield demanded for government Treasury securities. Those are generally considered risk-free rates, so any mortgage bearing a similar long-term coupon will consist of its default risk premium added to that risk-free rate.

Bloomberg explains that the government debt will become more expensive because of both supply and demand:

The U.S. will face increased competition from other debt issuers, spurring investors to demand higher yields as the Federal Reserve ends a $1.6 trillion asset-purchase program, according to James Caron, head of U.S. interest-rate strategy in New York at Morgan Stanley. The central bank was the largest purchaser of Treasuries in 2009 through a $300 billion buyback of the securities completed in October.

The Treasury will sell a record $2.55 trillion of notes and bonds in 2010, an increase of about $700 billion, or 38 percent, from this year, Morgan Stanley estimates. Caron says total dollar-denominated debt issuance will rise by $2.2 trillion in the next 12 months as corporate and municipal debt sales climb.

So in addition to the pressure that I mentioned earlier stemming from the Fed’s departure from the MBS market, the broader investment community will likely drive rates higher on long-term debt as well. While bad news for the housing market, this is probably good news for sensible investing.