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August 01, 2008

The Uppers
by Doug Noland

For the week, the Dow dipped 0.4% (down 14.6% y-t-d), while the S&P500 added 0.2% (down 14.2%). The Morgan Stanley Cyclicals jumped 1.6% (down 14.5%), and the Morgan Stanley Consumer index added 0.7% (down 9.2%). The Transports slipped 0.2% (up 8.3%), and the Utilities declined 2.1% (down 13.3%). The broader market rally continued. The small cap Russell 2000 gained 0.8% (down 6.5%), and the S&P400 Mid-Cap index rose 0.7% (down 6.7%). The NASDAQ100 declined 1.1% (down 12.4%), while the Morgan Stanley High Tech index gained 0.7% (down 11%). The Semiconductors recovered 0.2% (down 17.1%). The Street.com Internet Index dipped 0.4% (down 11.1%), and the NASDAQ Telecommunications index slipped 0.2% (down 6.6%). The Biotechs rose 1.9%, boosting 2008 gains to 8.0%. The financial stocks rallied sharply. The Broker/Dealers gained 4.9% (down 26.8%), and the Banks rallied 6.4% (down 24.1%). With Bullion sinking $20, the HUI Gold index dropped 4.6% (down 4.7% y-t-d).

One-month Treasury bill rates sank 19 bps this week to 1.51%, and 3-month yields fell 9 bps to 1.66%. Two-year government yields dropped 22 bps to 2.49%. Five-year T-note yields declined 21 bps to 3.21%, and 10-year yields fell 17 bps to 3.93%. Long-bond yields dropped 13 bps to 4.56%. The 2yr/10yr spread widened 5 to 144 bps. The implied yield on 3-month December '09 Eurodollars sank 31 bps to 3.795%. Benchmark Fannie MBS yields declined 14 bps to 5.94%. The spread between benchmark MBS and 10-year Treasuries widened 3 to a notable 200 bps. The spread on Fannie's 5% 2017 note widened 10 bps to 71 bps, and the spread on Freddie's 5% 2017 note widened 10 bps to 72 bps. The 10-year dollar swap spread increased 2.75 to 72.25. Corporate bond spreads were mostly wider. An index of investment grade bond spreads narrowed 2 to 140 bps, while an index of junk bond spreads widened 4 to 563 bps.

Investment grade issuance this week included Berkshire Hathaway $1.0bn, Autozone $750 million, General Mills $700 million, and Coca-Cola Enterprises $300 million.

Junk issuers included Commercial Metals $500 million, Roper Industries $500 million, and Ferrellgas $200 million.

Convert issuers this week included XM Satellite $550 million, Affiliated Managers $400 million, and PSS World Medical $200 million.

International dollar bond issuance included Rogers Communications $1.75bn and Lebanon $500 million.

German 10-year bund yields sank 25 bps to 4.35%. The German DAX equities index dipped 0.6% (down 20.7% y-t-d). Japanese 10-year "JGB" yields declined 6 bps to 1.51%. The Nikkei 225 fell 1.8% (down 14.5% y-t-d and 22.4% y-o-y). Emerging markets were mixed. Brazil's benchmark dollar bond yields declined 3 bps to 5.88%. Brazil's Bovespa equities index rallied 0.8% (down 9.8% y-t-d). The Mexican Bolsa declined 0.5% (down 8.7% y-t-d). Mexico's 10-year $ yields fell 10 bps to 5.47%. Russia's RTS equities index declined 0.5% (down 15.2% y-t-d). India's Sensex equities index rose 2.7%, narrowing y-t-d losses to 27.8%. China's Shanghai Exchange index fell 2.2%, boosting 2008 losses to 46.7%.

Freddie Mac 30-year fixed mortgage rates dropped 9 bps to 6.52% (down 16bps y-o-y). Fifteen-year fixed rates fell 11 bps to 6.07% (down 25bps y-o-y), and one-year ARMs declined 22 bps to 5.27% (down 32bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates at 7.56%, a 3-week increase of 36 bps and up 98 bps from a year earlier.

Bank Credit dropped $13.8bn to $9.403 TN (week of 7/23). Bank Credit has expanded $190bn y-t-d, or 3.6% annualized. Bank Credit posted a 52-week rise of $762bn, or 8.8%. For the week, Securities Credit sank $26.9bn. Loans & Leases increased $13.1bn to $6.923 TN (52-wk gain of $594bn, or 9.4%). C&I loans declined $2.4bn, with y-t-d growth slowing to 8.0%. Real Estate loans jumped $11.8bn (up 1.5% y-t-d). Consumer loans declined $1.4bn, while Securities loans jumped $20.1bn. Other loans fell $14.9bn.

M2 (narrow) "money" supply surged $48.7bn to a record $7.747 TN (week of 7/21). Narrow "money" has expanded $284bn y-t-d, or 6.8% annualized, with a y-o-y rise of $468bn, or 6.4%. For the week, Currency increased $2.4bn, and Demand & Checkable Deposits jumped $16.1bn. Savings Deposits rose $11.8bn, and Small Denominated Deposits added $3.2bn. Retail Money Funds jumped $15.2bn.

Total Money Market Fund assets (from Invest Co Inst) declined $5.2bn to $3.502 TN, with a y-t-d increase of $389bn, or 21.7% annualized. Money Fund assets have posted a one-year increase of $895bn (34.3%).

Asset-Backed Securities (ABS) issuance increased somewhat to $3.5bn. Year-to-date total US ABS issuance of $117bn (tallied by JPMorgan's Christopher Flanagan) is running at 26% of comparable 2007. Home Equity ABS issuance of $303 million compares with 2007's $211bn. Year-to-date CDO issuance of $16bn compares to the year ago $257bn.

Total Commercial Paper outstanding dropped $16bn this week to $1.728 TN, with a y-t-d decline of $57.3bn (5.4% annualized). Asset-backed CP declined $6.1bn last week to $744bn, boosting 2008's decline to $28.9bn (6.3% annualized). Over the past year, total CP has contracted $485bn, or 21.9%, with ABCP down $449bn, or 37.6%.

Fed Foreign Holdings of Treasury, Agency Debt last week (ended 7/30) rose $14.2bn to a record $2.368 TN. "Custody holdings" were up $311bn y-t-d, or 25.4% annualized, and $358bn y-o-y (17.8%). Federal Reserve Credit expanded $9.8bn to $892.8bn. Fed Credit has expanded $19.3bn y-t-d (3.7% annualized) and $35.2bn y-o-y (4.1%).

International reserve assets (excluding gold) - as accumulated by Bloomberg's Alex Tanzi - were up $1.336 TN y-o-y, or 23.6%, to a record $6.994 TN.

Global Credit Market Dislocation Watch:

July 29 - Wall Street Journal (Jonathan House): "The International Monetary Fund said it sees increased danger of economic fallout from the continuing financial crisis and urged the U.S. government to review the business model of housing-finance giants Fannie Mae and Freddie Mac. 'As economies slow, credit deterioration is widening and deepening, and as banks deleverage and rebuild capital, lending is beginning to be squeezed, restricting household spending and clouding the outlook for the real economy,' according to Jaime Caruana, director of the IMF's monetary and capital markets division. ...Mr. Caruana said banks have successfully raised equity to cover around three-quarters of $400 billion in write-downs of bad debt. He added, however, that U.S. credit problems are moving beyond the subprime-mortgage market... 'With delinquencies and foreclosures rising sharply and house prices continuing to fall, a bottom for the housing market is not yet visible, and the credit deterioration is spreading to even prime-mortgage loans.'"

July 29 - Dow Jones (Andrew Dowell and Andrew Morse): "In a major fire sale of toxic assets by a struggling investment bank, Merrill Lynch said... it has agreed to unload $30.6 billion in securities to private equity firm Lone Star at 22 cents on the dollar. In addition, Merrill Lynch said it will sell $8.5 billion in new shares to beef up its capital - less than two weeks after Chief Executive John Thain indicated such a move wouldn't be necessary... Merrill will book $10.6 billion in write-downs and additional expenses in the third quarter stemming from the moves."

July 28 - Bloomberg (Christine Harper): "Bondholders are demanding the highest interest rates for Wall Street debt since 2000, threatening the industry's business model of acquiring assets with borrowed money. Lehman Brothers... has seen borrowing costs for its five-year bonds rise to 7.7%, up from 5.2% six months ago... The yield offered on Lehman's $1.5 billion of bonds maturing in January 2012 is 4.3 percentage points more than the yield for five-year U.S. Treasury notes, a premium almost double what it was in late January."

August 1 - Bloomberg (Bryan Keogh): "Sales of U.S. corporate bonds in July fell to the lowest since 2003 as borrowing costs reached the highest in six years... Near-record-high corporate bond spreads pushed borrowing costs to the highest since April 2002..."

July 29 - Dow Jones (Jason Womack): "Small oil producers across the southern Plains states are getting pinched by the collapse of SemGroup L.P., a major buyer of crude from across the region. SemGroup filed for bankruptcy protection last week after losing $2.4 billion on trading in the oil futures market... Many producers haven't been paid for oil that was delivered to SemGroup in June or July, leaving some of them strapped for cash."

July 29 - Bloomberg (Pierre Paulden and Jonathan Keehner): "MGM Mirage and Dubai World are late in raising as much as $3.5 billion for their $11.2 billion CityCenter project in Las Vegas because banks saddled with debt to casinos and hotels are wary of making new loans. Deutsche Bank AG and Credit Suisse Group... are among the holdouts... Funding was supposed to be completed by the end of June... President James Murren said... Deutsche Bank has been part of every MGM loan since 1998. 'No company in America is having an easy time doing bank deals right now,' Murren said... 'There will be some banks that can't commit because they have a lot of exposure in the area or don't like the pricing.'"

July 29 - Wall Street Journal (David Enrich): "It isn't just souring loans that are giving banks fits. A number of small lenders also gambled too heavily on bank stocks. The 45% swoon by bank stocks from their October highs is hurting the investment portfolios of many small U.S. banks, which usually are much more heavily concentrated in financial stocks than the portfolios of the largest banks. Write-downs to reflect the fallen stock prices essentially erased second-quarter profits at some banks, deepening the misery caused by bad loans. 'It's almost like doubling down,' said Gerard Cassidy, a bank analyst at RBC Capital Markets. 'At times like this, you're getting hit twice as hard.'"

Financial Times - July 29 - (Paul J Davies and Joanna Chung): "Banks have been given a one-year reprieve by US accounting standard-setters from having to take up to $5,000bn of debt assets on to their balance sheets, easing fears that they would be forced to raise large amounts of new capital quickly. The Financial Accounting Standards Board voted to delay until January 2010 the introduction of rules that will force banks to consolidate more off-balance-sheet vehicles directly in their accounts. However, Robert Herz, FASB chairman, said that the move was made reluctantly after a staff recommendation for a delay because there might not be enough time for all companies to adjust to the up-heaval. 'It does pain me to allow something that has been abused by certain folks, to let that go on for another year,' he said."

July 29 - Bloomberg (Michael B. Marois): "States including Florida and Connecticut are conducting a coordinated investigation into bid-rigging of financial products sold to U.S. local governments, following similar federal probes, XL Capital Ltd. said in a regulatory filing... The state probes mirror those under way for more than a year by U.S. prosecutors and the Securities and Exchange Commission looking for evidence of anticompetitive practices and price fixing by banks in the $2.66 trillion municipal bond market. They have focused on contracts to invest bond-sale proceeds, known as guaranteed investment contracts, and derivatives, such as interest-rate swaps tied to bonds."

July 29 - Reuters (Kevin Krolicki): "GMAC and Ford Motor Credit disclosed steps on Tuesday to cut back on auto leases in a move that leaves automakers facing the risk of even more pressure on auto sales already at decade lows. The steps by GMAC and Ford Motor Credit stopped short of Chrysler Financial's wholesale abandonment of lease financing that shocked the struggling carmaker's dealers on Friday. Analysts said the steps could protect the balance sheets of the auto finance companies, but cautioned the new financial constraints could make a tough market even harder for the Detroit-based automakers. 'The pullback could provide another negative for U.S. auto sales this year,' Deutsche Bank said... GMAC confirmed it would no longer offer leasing incentives on vehicles sold in Canada."

July 30 - Globe & Mail (Lori McLeod): "The global credit crisis has claimed another victim in the Canadian mortgage industry as General Electric Co. winds up its mortgage operations here. After three years in the business, GE Money Canada said it will stop taking new mortgage applications tomorrow. It's the latest in a string of alternative lenders that have decided to scale back operations or close shop amid the credit crunch. Lenders who relied on bundling and selling loans to fund new mortgages have run into trouble as the securitization market went dry."

July 29 - Bloomberg (Reed V. Landberg): "The U.K. Treasury should rule out creating a government-backed agency like Fannie Mae of the U.S. to bolster mortgage funding, a study for Chancellor of the Exchequer Alistair Darling showed today. Former HBOS Plc Chief Executive James Crosby, who was asked by Darling in April to consider improvements to the home-loan market, said it would take too long to create such an agency."

July 28 - Bloomberg (John Glover): "Companies in eastern Europe had more credit rating downgrades than upgrades for the first time in a year last quarter as damage from the financial crisis triggered by U.S. mortgages spread worldwide, Moody's... said."

Global Inflation Turmoil Watch:

July 28 - Bloomberg (Shamim Adam): "Asian governments from India to Malaysia, clinging to budget-busting fuel subsidies, may end up paying an even higher price: saddling their economies with an extended period of stagflation. 'Subsidies will come increasingly in the way of future growth,' says Kalpana Kochhar, a senior adviser for the IMF's Asia-Pacific Department... 'Not passing prices through and keeping artificial price and wage controls never works.' Governments are being forced to choose between two unattractive alternatives: run up bigger deficits by continuing to shield citizens from soaring energy prices, or start to withdraw subsidies, fueling inflation and political backlash. Inflation has already reached decade highs throughout the continent and played a role in destabilizing politics."

July 29 - Bloomberg (Khalid Qayum and Farhan Sharif): "Pakistan's central bank increased its benchmark interest rate for a third time this year to tame inflation running at the fastest pace in three decades. The State Bank of Pakistan raised the discount rate at which it lends to commercial banks to 13%... Governor Shamshad Akhtar told reporters... 'Inflationary pressures are more alarming than ever before... Global crude and commodity prices have induced recessionary trends in global economies. Pakistan is no exception.'"

July 29 - Reuters (C. Bryson Hull): "At a forgotten edge of Kenya's economy, remoteness has been no protection from the global pain of rising prices for the mountain town of Moyale. It perches at the Ethiopian border, far north of the capital Nairobi across mountains that descend to a forbidding desert of black volcanic stones, sand and armed bandits before rising again into the frontier town's green scrub hills. Few trucks reach Moyale, at the end of a tire-chewing (310 mile) rock road... But its distance and the lack of a good road has only magnified the impact of world fuel and food price rises..."

Currency Watch:

The dollar index gained 0.8% to 73.42. For the week on the upside, the South African rand increased 4.4%, the Mexican peso 1.2%, and the Brazilian real 1.0%. On the downside, the Australian dollar declined 2.9%, the New Zealand dollar 2.3%, the Swiss franc 1.4%, the Swedish krona 1.2%, the Euro 1.1%, the Danish krone 1.1%, the Taiwanese dollar 1.0%, and the British pound 1.0%.

Commodities Watch:

Financial Times - July 30 - (Javier Blas): "After years of strong growth, liquidity in commodities futures markets, particularly crude oil, is falling abruptly as the credit crunch finally hits leveraging in the sector and contributes to a sharp increase in price volatility. The number of outstanding contracts - known as open interest in industry jargon - in key US commodities markets has fallen 5.5% since March and is now at its lowest level since January, according to Barclays... In oil, open interest has fallen to its lowest in more than a year and a half. Analysts and traders say the reduction in liquidity has been brought about by financial institutions deleveraging - particularly among cash-squeezed Wall Street banks..."

Financial Times - July 30 - (Hal Weitzman): "Profits at Tyson, one of the US's biggest meat producers, were almost wiped out in the past quarter by the high cost of animal feed and unprofitable cattle price-hedging bets. The company warned that it is bracing itself to be hit even harder in the coming three months as consumer price rises lag behind increases in feed costs."

Financial Times - July 29 - (Elizabeth Rigby): "Kraft Foods raised its full year earnings and sales forecast on Monday as the largest food maker in the US reported a rise in profits for the quarter after price increases helped it offset big rises in the price of commodities like wheat."

Gold dropped 1.6% to $910, while Silver added 0.7% to $17.50. September Crude recovered $1.94 to $125.20. September Gasoline gained 1.5% (up 24.6% y-t-d), and September Natural Gas rose 2.9% (up 25.5% y-t-d). September Copper slipped 0.7%. September Wheat declined 2.1%, and August Corn fell 2.1%. The CRB index gained 0.9% (up 16% y-t-d). The Goldman Sachs Commodities Index (GSCI) added 0.5% (up 25% y-t-d and 51.5% y-o-y).

China Watch:

July 29 - Bloomberg (Wang Ying): "China, the world's second-biggest energy consumer, is facing a deepening summer power crisis that may persist into the winter months, the nation's dominant electricity distributor said. State Grid Corp. of China, which more than 1 billion people rely on for power, said electricity shortages have worsened because of inadequate coal supplies. Forty-six percent of the power stations connected to the distributor's grid have coal stockpiles below the 'caution line,' or seven days of consumption... China, facing its sixth year of electricity shortages..."

July 28 - People's Daily: "The per-capita salary for employees at urban state-owned enterprises was 13,800 yuan, up 17%, and that for workers at private entities, 12,610 yuan, up 19.2%... The per-capita disposable income of urbanites rose 14.4%... Farmers' per-capita cash income stood at 2,528 yuan in first half, up 19.8%, or 10.3% adjusted for inflation."

India Watch:

July 28 - Wall Street Journal (Jackie Range): "India's slowing economy is beginning to show another big crack: A growing government deficit that could hurt much-needed investment in India's ramshackle infrastructure, boost inflation and undermine growth. A hefty list of expenditures is at the root of India's fiscal woes, especially a once-a-decade salary increase that S&P's estimates could mean pay increases of as much as 40% for 2.9 million central government employees. Were the government to approve the full amount, the ratings agency figures it could cost as much as the equivalent of 2.4% of gross domestic product. State governments are likely to follow suit... Overall, Morgan Stanley predicts, India's fiscal deficit -- including central, state and so-called 'off-budget' items -- will rise to 11.4% of GDP in the fiscal year ending March 31, up from an estimated 7.7% in the previous year."

August 1 - Bloomberg (Anil Varma): "Money supply in India grew 20% in the two weeks ended July 18 from a year earlier, compared with 20.5% in the prior two weeks..."

July 31 - Bloomberg (Subramaniam Sharma): "India's inflation was below 12% in the week ended July 19, the Business Standard newspaper reported..."

July 29 - Bloomberg (Cherian Thomas): "India's central bank increased its benchmark interest rate by a half point... and forecast slowing economic growth as inflation at a 13-year high erodes spending by consumers and companies. The Reserve Bank of India raised its repurchase rate to 9%... the third increase in two months..."

Asia Bubble Watch:

August 1 - Bloomberg (William Sim): "South Korea's inflation accelerated faster than expected in July to the highest in almost 10 years... Consumer prices jumped 5.9% from a year earlier..."

August 1 - Bloomberg (Suttinee Yuvejwattana): "Thailand's inflation accelerated to the fastest pace in a decade in July... Consumer prices gained 9.2% from a year earlier..."

August 1 - Bloomberg (Naila Firdausi and Arijit Ghosh): "Indonesia's inflation accelerated more than estimated to a 22-month high in July... Consumer prices jumped 11.9% from a year earlier..."

Latin America Watch:

July 29 - Bloomberg (Joshua Goodman): "Brazil's Planning and Budget Minister Paulo Bernardo said the country's inflation rate should end the year 'around' 6.5%. 'Brazil is one of the few countries in the world that still has a chance of reaching this level... Many countries have already exceeded their target and also their margin of error. Here in Brazil, things aren't as bad as they are elsewhere.'"

August 1 - Dow Jones: "Bank lending to Mexico's private sector increased 15% year-on-year at the end of June, led by commercial lending, according to the Bank of Mexico."

August 1 - Bloomberg (Matthew Walter and Daniel Cancel): "Venezuelan President Hugo Chavez is set to tighten his government's grip on the economy by taking over his first bank, the local unit of Spain's Banco Santander SA. Plans to nationalize the country's third-largest bank... will give the state access to Banco de Venezuela SA Grupo Universal's 285 offices and $9.46 billion in deposits."

Unbalanced Global Economy Watch:

July 30 - Dow Jones (Natasha Brereton): "U.K. net mortgage lending could drop by almost half in 2008 as falling house prices and the lower availability of credit stem consumer demand, a senior official at the British Bankers' Association says."

July 29 - Bloomberg (Jennifer Ryan): "U.K. mortgage approvals fell to the lowest since at least 1999 in June as financial institutions curbed lending, deepening the housing slump."

July 31 - Bloomberg (Brian Swint and Svenja O'Donnell): "U.K. house prices declined the most in almost two decades in July and consumer confidence fell to a record low as the economy edged closer to a recession. The average value of a home dropped 8.1% from a year earlier, the biggest decline since at least 1991..."

July 29 - Bloomberg (Brian Swint): "An index of U.K. retail sales dropped in July to the lowest level in a quarter-century as record oil costs forced shoppers to curb spending, the Confederation of British Industry said."

August 1 - Bloomberg (Svenja O'Donnell): "U.K. manufacturing contracted by the most in a decade in July and inflation in the industry was the strongest since at least 1999, sharpening the Bank of England's dilemma as it tries to steer Britain clear of a recession."

July 31 - Bloomberg (Ian Guider): "Ireland's economy will grow at the slowest pace in more than two decades this year as a 17% slump in construction pushes up unemployment, the country's central bank said..."

July 31 - Bloomberg (Fergal O'Brien): "Inflation in Europe accelerated to the fastest pace in more than 16 years in July... The inflation rate for the 15-nation euro region rose to 4.1% from 4% in June..."

July 30 - Bloomberg (Fergal O'Brien): "Europeans' confidence in the outlook for the economy dropped the most since the Sept. 11 terrorist attacks as soaring energy costs and the euro's advance against the dollar rattled consumers and executives."

July 29 - Bloomberg (Simone Meier): "The inflation rate in Germany, Europe's largest economy, held at a 12-year high in July... Consumer prices rose 3.4% from a year earlier..."

July 28 - Bloomberg (Christian Vits): "German consumer confidence dropped to the lowest in more than five years as soaring energy prices sapped purchasing power and the economic outlook deteriorated."

July 29 - Bloomberg (Helene Fouquet): "Consumer confidence in France fell to a record low in July as inflation accelerated to the fastest pace in 12 years, eroding households' purchasing power."

July 30 - Bloomberg (Tasneem Brogger): "Danish house prices fell an annual 3.9% in the three months through June, declining for a second consecutive quarter, as rising borrowing costs sapped demand."

July 31 - Bloomberg (Ben Sills): "Spanish inflation accelerated to the fastest pace since at least 1997 in July after oil prices surged. Consumer prices rose 5.3% from a year earlier after increasing 5.1% in June..."

July 28 - Bloomberg (Sharon Smyth): "Home sales in Spain plunged in May, confirming that the nation's property market is heading for a slump after a decade-long boom. The number of homes sold dropped 34.3% from a year earlier..."

July 29 - Bloomberg (Tasneem Brogger): "Norwegian banks continued to tighten lending conditions to non-financial corporations and households in the second quarter, the central bank said. Commercial banks reported a 'considerable' tightening of lending conditions to the real-estate industry compared with the first quarter, and said there was a 'marginal' tightening of lending conditions to households..."

July 31 - Bloomberg (Tasneem Brogger): "Norway's domestic credit growth slowed to 13.3% in June, indicating interest rates at a 5 1/2-year high are deterring consumers and corporations from taking on more debt."

July 31 - Bloomberg (Johan Carlstrom): "Swedish consumer confidence fell to its lowest level since 1995 in July on the back of rising unemployment, the fastest inflation in 15 years and the prospect of higher interest rates."

July 28 - Bloomberg (Kati Pohjanpalo and Juho Erkheikki): "Finnish consumer confidence fell to the lowest in seven years in July, while retail sales grew at the second-slowest pace in two years in June as inflation accelerated, interest rates rose and economic growth cooled."

July 30 - Bloomberg (Maria Levitov): "Russian inflation was 9.3% in the year through July 28..."

July 28 - Bloomberg (Mark Bentley and Ali Berat Meric): "Turkish central bank Governor Durmus Yilmaz increased his forecast for year-end inflation to 10.6%... Yilmaz... raised the forecast from 9.3% three months earlier."

July 29 - Bloomberg (Mark Bentley): "Turkish mortgage lending by banks fell about 20% in the first half of the year as compared with the same period in 2007, Dunya newspaper reported, citing Ismet Erdem, chief of Yapi & Kredi Bankasi..."

July 30 - Bloomberg (Mike Cohen): "South African inflation accelerated to 11.6% in June, the fastest pace in at least 10 years, adding to pressure on the central bank to raise interest rates next month."

July 31 - Bloomberg (Jacob Greber): "Australia may be headed for a housing recession similar to those roiling the U.S. and U.K. The cause is a combination of rising default rates, the biggest drop in home prices in five years, the highest borrowing costs in a decade and slowing economic growth. Prices in the property market... will fall 30% by 2010, according to Gerard Minack, senior economist at Morgan Stanley... Prices dropped in all of Australia's major cities last month for the first time since just before the Great Depression. 'I panicked' when the figures came in, said John Edwards, CEO of Residex Ltd., a Sydney company that tracks property prices. 'We've been doing this for 20 years and have data that goes as far back as 1865, and it's really abnormal.'"

July 31 - Bloomberg (Jacob Greber): "Australian retail sales fell by the most in six years, stoking speculation central bank Governor Glenn Stevens will be forced to cut 12-year high interest rates. Sales declined 1% from May, the biggest drop since June 2002..."

July 30 - Dow Jones (Shri Navaratnam): "New Zealand's string of finance sector credit woes spilled into other areas of the economy as fund manager Guardian Trust Co. Ltd. said it has suspended investor payments... Guardian Trust, a New Zealand based fund manager, said... it was suspending new investments and withdrawals from one of its funds... due to liquidity difficulties."

July 29 - Bloomberg (Tracy Withers): "New Zealand home-building approvals slumped to the lowest in almost 22 years in June... Approvals fell 20% from May to 1,337, the lowest since October 1986, Statistics New Zealand said..."

Bursting Bubble Economy Watch:

July 29 - Financial Times (Francesco Guerrera and Saskia Scholtes): "The US financial crisis is spreading from subprime borrowers to wealthier consumers, with evidence mounting that more affluent people are failing to pay their mortgages and credit card balances. Growing concerns over the financial health of richer borrowers are prompting banks and card issuers to tighten lending practices in moves that could futher dampen consumer confidence and spending more. Banks such as JPMorgan Chase and credit card groups such as American Express have clamped down on lending to customers that have traditionally been regarded among the safest and most profitable borrowers. 'The crisis is just starting to spread beyond the middle class,' said Curtis Arnold, founder of CardRatings.com. 'Even folks with good credit-ratings scores are no longer immune from adverse actions from their card issuers.' Senior bankers say that after the subprime debacle, the worsening outlook of 'prime' portfolios shows the crisis is far from over and could inflict substantial losses on financial institutions... At American Express, which has traditionally focused on high-spending consumers... Kenneth Chenault, chairman and chief executive, said the company's most affluent card-holders were feeling the pinch."

July 28 - New York Times (Peter Goodman): "Banks struggling to recover from multibillion-dollar losses on real estate are curtailing loans to American businesses, depriving even healthy companies of money for expansion and hiring. Two vital forms of credit used by companies -- commercial and industrial loans from banks, and short-term 'commercial paper' not backed by collateral -- collectively dropped almost 3% over the last year, to $3.27 trillion from $3.36 trillion, according to [fed] data. That is the largest annual decline since the credit tightening that began with the last recession, in 2001. The scarcity of credit has intensified the strains on the economy by withholding capital from many companies, just as joblessness grows and consumers pull back from spending in the face of high gas prices, plummeting home values and mounting debt... Drew Greenblatt, president of Marlin Steel Wire Products, figured it would be easy to get a $300,000 bank loan to finance a new robot for his factory... His company, which makes parts for makers of home appliances, is growing and profitable, he said... But when Mr. Greenblatt called the local branch of Wachovia -- the same bank that had been aggressively marketing loans to him for years -- he was distressed by the response. 'The exact words were, 'We're saying no to almost everybody,' Mr. Greenblatt recalled."

July 30 - New York Times (Michael Grynbaum): "Several national restaurant chains were shuttered on Tuesday, possibly offering an early taste of what's in store this year for businesses that depend on free-spending consumers whose budgets are now being squeezed. The parent company of Bennigan's... with about 200 sites across the country, filed for bankruptcy, a move that will put hundreds of employees out of work and leave many landlords with empty retail space during a painful time in the real estate market. A sister brand, Steak & Ale, will also close... The restaurants are the latest casualties in the so-called casual dining sector, considered a cut above fast food. Soaring food costs and a surfeit of locations have hurt the companies' bottom lines just as Americans are choosing to take more meals at home..."

August 1 - Bloomberg (Mike Ramsey): "U.S. auto sales tumbled 13% in July, pushing the industry toward its worst year since 1993, as General Motors Corp., Ford Motor Co. and Toyota Motor Corp. posted declines on lower demand for fuel-thirsty trucks... The industry's annualized selling rate for July was 12.6 million vehicles, the lowest since April 1992, according to Autodata."

August 1 - Bloomberg (Jeff Plungis): "Leasing a car is about to get more expensive. Chrysler LLC, the money-losing automaker owned by Cerberus Capital Management LP, is closing its unprofitable leasing business today, and General Motors Corp. and Ford Motor Co. are scrapping leases for some models."

July 29 - Boston Globe (Beth Healy): "The Massachusetts Educational Financing Authority yesterday said it will not be able to provide student loans this fall for the first time in its 26-year history, leaving more than 40,000 families without an important source of tuition funds just weeks before college classes begin. The nonprofit lending authority, which last school year provided $510 million in loans, said it has been unable to secure funding to provide private student loans... 'As a result of our problems and the continued dislocation of the capital markets, we have been unable to raise funds for the coming academic year,' said Thomas M. Graf, the authority's executive director."

July 30 - New York Times: "Mervyn's and the parent company of Bennigan's both filed for bankruptcy protection yesterday, providing more evidence that the pace of corporate flame-outs is accelerating. Only half way through 2008, billion-dollar bankruptcies are at their highest level in five years, according to BankruptcyData.com... 'We seem to be in the midst of a 'perfect storm' leading to more bankruptcies: high levels of debt, high energy and raw materials costs and weakness in the U.S. economy," George Putnam III of New Generation Research, which publishes BankruptcyData.com, said..."

July 28 - UPI: "Los Angeles food bank operators say the troubled economy has produced the biggest demand for their help they've ever seen. The demand is spreading from poverty-stricken residents to those in the middle and upper classes, they told the Los Angeles Times. 'This is probably the most people we've ever seen use emergency food assistance," Darren Hoffman, communications director for the Los Angeles Regional Food Bank, told the newspaper. 'We're seeing people who were making $70,000 a year coming into a food bank for the first time.' Food bank operators say people who have spent their retirement savings to pay their mortgages are turning to the pantries to avoid going hungry. Some told the Times that major job losses in the banking and entertainment industries, coupled with the housing crisis, are hitting the San Fernando Valley area especially hard."

July 30 - Bloomberg (Meg Tirrell): "Profits at U.S. companies may have dropped the most in at least a decade last quarter after credit writedowns triggered a combined $7.43 billion loss at Merrill Lynch & Co. and Lehman Brothers Holdings Inc. Earnings of S&P 500 Index companies have tumbled 24% from a year earlier, according to data compiled by Bloomberg on the 291 companies that had reported quarterly results... As recently as July 3, analysts expected a drop of 11%. Financial industry profits... have plummeted 87%... The energy group of the S&P 500 has posted a 15% gain in profits so far."

July 30 - Bloomberg (Kevin Bell and Beth Jinks): "The Starbucks index is pointing down in Las Vegas. The Nevada city's gambling-driven growth in the 1990s proved irresistible to Starbucks Corp... Las Vegas, which had no Starbucks outlets before 1995, has about 155 now... Starbucks, stung by a slowdown in sales as strapped consumers shy away from $4 lattes, is staging the biggest retreat in its 37-year history, closing 600 of 11,168 U.S. company-owned and licensed stores. Las Vegas is taking the biggest hit, losing 16 of the once-trendy cafes, including in North Las Vegas, or 10% of its total. Los Angeles will lose just two of about 56 and New York City 10 of more than 200."

July 30 - Bloomberg (Mike Ramsey): "Bayerische Motoren Werke AG, the world's largest maker of luxury vehicles, is trying to reduce the 60% of its U.S. sales that come from leases as automakers balk at the contracts' rising costs."

Central Banker Watch:

July 28 - Wall Street Journal (Sudeep Reddy): "A year after credit markets seized up, the Federal Reserve is still struggling with the crisis and expanding key lending programs that were designed as temporary measures to nurse the financial system back to health. The central bank announced Wednesday that it is extending programs through January that allow investment banks to borrow from the Fed. The move is an effort to prevent a worsening in what the Fed described as 'continued fragile circumstances in financial markets.' Troubles in the financial world continue to take the Fed deeper into new territory in its effort to prevent a larger credit crunch."

MBS/ABS/CDO/CP/Money Funds and Derivatives Watch:'

July 29 - Bloomberg (Timothy R. Homan): "Home prices in 20 U.S. metropolitan areas fell at a faster pace in May, indicating the three-year housing slump has not stabilized, a private survey showed today. The S&P/Case-Shiller home-price index dropped 15.8% from a year earlier... The gauge has fallen every month since January 2007. Stricter loan rules, rising mortgage rates and an increase in foreclosures are making it more difficult for prospective buyers to get financing, hurting home sales."

Real Estate Bust Watch:

July 30 - Bloomberg (Sharon L. Lynch): "Home prices in the Hamptons, the summer haven of New York financiers and socialites, fell almost 12% in the second quarter from a year earlier as Wall Street firms cut jobs and the economy teetered near a recession. Sales dropped 26% and the median price slid to $970,000 in the resort towns on the East End of Long Island... broker Prudential Douglas Elliman Real Estate and appraiser Miller Samuel Inc. said... 'We used to think of the Hamptons as insulated and that's not the case,' said real estate developer Arthur Rauscher... It's not what it used to be.'"

July 30 - New York Times (Abha Bhattarai and Fred Bernstein): "A record number of hotels are opening this year, and the timing could not be worse. High gasoline prices and a slumping economy have put a damper on leisure and business travel. Airlines have been cutting service and raising fares. While new hotels open, occupancy rates are falling across much of the United States. 'We're really on the verge,' said Charles Snyder of Smith Travel Research... 'It hasn't turned into a hotel recession just yet, but we're certainly keeping an eye on the economy.' Until recently, the industry was in the midst of a major boom, and it was during those good times that the hotel companies made plans to build many of the new rooms. But the outlook has started to sour in the last couple of months."

GSE Watch:

July 30 - Bloomberg (Dawn Kopecki and Jody Shenn): "Fannie Mae, the largest U.S. mortgage-finance company, said its portfolio expanded at a 23% annualized rate in June, the fastest pace since 2003. The holdings rose by $12.7 billion to $749.6 billion... Freddie Mac last week said its investments swelled at a 33% annual rate to a record $792 billion."

Fannie and Freddie's combined Books of Business (retained portfolio and MBS guarantees) increased $40.3bn, or 9.3% annualized, during July to a record $5.241 TN. Combined Retained Portfolios expanded $34.1bn, or 27% annualized, for the month to $1.541 TN (2-month growth of $75.5bn!). Year-to-date, the combined Books of Business have expanded $249bn, or 10% annualized, with Retained Portfolios up $152 bn, or 16% annualized.

Speculator Watch:

August 1 - Bloomberg (Saijel Kishan): "Highland Capital Management LP, the Dallas-based manager of $38 billion in assets, said investors seeking redemptions from its Crusader hedge fund will have to wait as long as nine months to get all their money back. The $2.3 billion fund, which invests in shares and debt of troubled companies, has seen a 'significant' increase in withdrawal notices, the firm said in an Aug. 1 letter to investors. Much of the funds investments can't immediately be sold because of the 'current dislocated market environment' or restrictions on sales."

July 27 - Financial Times (James Mackintosh): "Hedge funds are having their worst month in eight years after popular bets against banks and in favour of rising commodity prices went badly wrong. Among those hit by the unwinding of the bank/energy trade, according to letters to investors, are two of the best-performing hedge funds of the past 18 months - Harbinger Capital and Clarium Capital. ...Harbinger, which manages $26bn, lost 12% in the first two and a half weeks of July, while San Francisco's Clarium plunged 10% in a week to leave it down 4.3% for the month to the 18th... 'There has been a ferocious bear squeeze in banks and it is becoming apparent that financials/energy position was much more widely held than had been understood,' one investor said. The... Hedge Fund Research's daily index said hedge funds were down 2.77% for the month to Wednesday."

July 29 - Financial Times (Deborah Brewster): "Hedge funds of funds, which have been among the more widely used ways of investing in hedge funds in the past few years, have recently been declining in popularity. New York State's $150bn pension fund is one of several that have shifted money out of funds of funds... A fund of funds, for a small additional fee, selects a basket of hedge funds for an investor. These vehicles became popular because, in a rather secretive industry, investors often found it difficult to get information about which hedge funds were worth investing in... Last year, funds of funds accounted for 42.7% of the industry's $1,800bn assets under management, according to Hedge Fund Research."

July 30 - Wall Street Journal (Jenny Strasburg and Andrew Morse): "Lone Star Funds' $6.7 billion dive into mortgage-backed assets dumped by Merrill Lynch & Co. shows how ready some investors are to move into this market when the pickings are right. Last week, Lone Star closed its last wave of fund raising on two pools totaling $10 billion..."

July 31 - Bloomberg (Jason Kelly and Katherine Burton): "Carlyle Group, the world's second- largest private-equity firm, is liquidating its Blue Wave hedge fund after assets fell by a third during the credit-market collapse."

Fiscal Watch:

July 28 - Bloomberg (Roger Runningen): "The U.S. budget deficit will widen to a record of about $490 billion next year, an administration official said, leaving a deep budget hole for the next president. The projected deficit for the fiscal year that begins Oct. 1 is far higher than the $407 billion forecast by President George W. Bush in February. The... deficit this year will be less than the $410 billion estimated in February."

August 1 - New York Times (Jeremy W. Peters): "Amplifying his case that New York faces a grave financial crisis, Gov. David A. Paterson asked the federal government on Thursday for assistance and said that social programs like education and health care were not immune from cutbacks."

California Watch:

July 31 - Los Angeles Times (Nancy Vogel and Michael Rothfeld): "Gov. Arnold Schwarzenegger today ordered his administration to lay off thousands of part-time state workers and to work with the state controller to temporarily slash the pay of most full-time employees to the federal minimum wage of $6.55 an hour. Schwarzenegger administration officials said the move will help give the state enough cash to get by until a state budget is signed. The budget was due July 1 but is still being negotiated by the governor and legislative leaders... About 10,300 part-time employees will receive pink slips starting today... Schwarzenegger says a 2003 State Supreme Court decision requires the pay cuts for most of the 200,000 full-time state employees in the absence of a budget."

August 1 - AFP: "California Gov. Arnold Schwarzenegger on Thursday dismissed 20,000 temporary state employees and slashed the pay of 200,000 more workers in the latest twist to a budget standoff. "

New York Watch:

July 29 - Bloomberg (Henry Goldman): "New York Governor David Paterson said the state's economic slide has created a fiscal crisis so severe the Legislature must meet in special session next month. Paterson... said the deficit for the budget year beginning April 1, 2009, has ballooned to $6.4bn from a previously projected $5bn amid a slump on Wall Street... New York state, where Wall Street's workers and businesses provide about 20% of state tax revenue, has been hurt as financial firms posted more than $468 billion in writedowns and credit losses... Sixteen of the state's largest banks sent taxes totaling $5 million to the state treasury in June, a 97% decrease from a year earlier..."

July 26 - New York Times (Patrick McGeehan): "Government officials in New York are preparing for what could be the biggest single-year decline in pay on Wall Street in history and with it a vexing shortfall in city and state revenues. A review of the latest statements from the largest financial companies based in the city shows that they intend to hand out about $18 billion less in pay and benefits in 2008 than in 2007. The cutting of payrolls is well under way, but the full effect will not be felt until the year's end, when bonuses for employees based in New York could shrink by $10 billion or more... A decline in bonuses of that magnitude would easily eclipse the drop of 2001, the year of the 9/11 terrorist attacks, when total bonuses declined by $6.5 billion, according to the state comptroller's estimates. City and state officials said the coming plunge in pay would have wrenching effects on the local and regional economies. It would mean about $10 billion less in taxable income and several billion dollars less to be spent on apartments, furniture, cars, clothing and services. For many investment bankers and traders, year-end bonuses traditionally account for at least three-fourths of their income."

July 28 - Bloomberg (Michael Quint and Henry Goldman): "Wall Street's slump is forcing New York City and state to consider service and spending cuts to cope with future budget gaps that may grow larger amid declining revenue, officials said today. 'Our financial sector, the backbone of our local economy and the engine of our nation's, is clearly struggling,' New York City Mayor Michael Bloomberg said... 'For the first quarter of 2008, Wall Street firms posted $22.8 billion in losses, and the results for the second quarter will not make for pleasant reading either.'"

July 30 - Bloomberg (David M. Levitt): "New York City office buildings cost more than two times more to build than in comparable cities and have risen by almost one-third since 2004 for all types of real estate. Building costs now exceed $400 a square foot in New York, the most expensive U.S. city for construction, compared with $180 in Chicago and $150 in Atlanta, the New York Building Congress said..."

Muni Watch:

July 29 - Bloomberg (Jeremy R. Cooke): "U.S. municipal borrowers insured 10% of the bonds they sold last week, down from 49% during all of last year, based on... data cited by Merrill Lynch... The use of insurance on new municipal-bond issues fell to 17% for the month... from 19% during all of June and 23% in May..."

Crude Liquidity Watch:

July 29 - Bloomberg (Fiona MacDonald and Matthew Brown): "Kuwait's inflation rate fell to 11.1% in May from a record 11.4% in April as increases in the cost of food slowed."

The Uppers:

The U.S. Bubble economy has burst. I sympathize with those that would argue this is old news. But the probabilities are now high that GDP turns decisively negative during the second half - if it hasn't already. Instead of the year-long Credit crisis showing signs of improvement or even stabilization, a further tightening of Credit Availability is taking hold broadly throughout the economy.

The so-called "subprime" crisis has, of late, invaded "prime" and "conventional" mortgages. This is a major additional blow for home prices and the economic support provided from built-up home equity. The securitization markets remain in shambles. Even corporate debt issuance dropped to a 5-year low in July. Meanwhile, the increasingly impaired banking system has sharply curtailed lending virtually across the board - to households; to students; and to businesses both small and large. Bank Credit is basically unchanged over the past nine weeks. And without sufficient Credit creation, the finance-driven U.S. "services" economy is an unmitigated bust. It is my view that this bust has over the past few weeks gained critical - and self-reinforcing - mass.

The subprime mortgage fiasco provides a convenient poster child for this boom's egregious excesses. I would argue, however, that its role in fueling the economic boom is much less than presumed. It actually wasn't a critical source of finance for the overall Bubble Economy. Or, stated differently, the relative brief period of subprime excess was not a major factor in the protracted period of financial excess that spurred imbalances and deep structural economic impairment. Likewise, last year's subprime bust wasn't a decisive development for the Bubble Economy generally. Its overall impact on system employment and incomes was not great - its effect on tax receipts only marginal.

I tend to view subprime as chiefly a "lower end" issue with respect to the real economy. And it is my view that the greatest - as well as least appreciated - Bubble Economy Excesses were at The "Upper-middle" to "Upper-end." It is in The Upper-ends where years of Credit excess had the most pronounced effects on incomes, household net-worth, spending, and government revenues.

It was the at The "Uppers" where loose finance encouraged many to stretch to buy the expensive home, to lease the luxury vehicle, and to finance the upscale lifestyle - Credit creation that then further stoked the overall economy and asset markets. And it was the Uppers that enjoyed spectacular gains in income and financial wealth. It was the momentous changes in Uppers' spending patterns that spurred enormous real economy investments in a multitude of new businesses and services - a great deal of this spending of the discretionary and luxury variety. It was the Uppers' windfalls that encouraged state, local and federal governments to rapidly boost spending. These were the inflationary distortions that had a profound impact on the underlying economic structure - over years spurring the transformation to a "services"-based Bubble Economy.

It is my view that The Uppers are now in the process of being hit with rapidly tightening Financial Conditions. This year will see a historic decline in financial sector compensation, led by collapsing Wall Street bonuses and unprecedented layoffs throughout the financial services industry. This week also saw the announcement of major "white collar" job losses at General Motors, an employment trend that I expect to spread throughout the real economy. Many companies and industries must today respond to collapsing profitability (as Financial Conditions tighten and spending patterns and levels adjust), and there will be no alternative than to shrink "Upper-end" employment and compensation.

This week also saw evidence of a significant tightening of Credit Availability for the Uppers. BMW, GM, Ford and Chrysler all announced that major changes in vehicle leasing terms are in the offing - especially for SUVs. BMW apparently has recognized that it is problematic that 60% of its U.S. unit sales are leases. Surging gas prices and other economic worries have hit used vehicle residual values hard, turning the leasing business into a losing proposition. Leasing terms are now being tightened significantly - a dynamic that will further depress used vehicle prices. It is worth noting that July new vehicle sales were reported at the lowest level since 1992. They will most certainly go lower.

This week also saw higher rates and additional withdrawal from the Jumbo mortgage marketplace. At 7.56%, 30-year fixed jumbo borrowing rates this week were almost 100 bps higher than a year ago. And one can assume that lending standards continue to tighten, with downpayment requirements putting many buyers out of the market for "Upper-end" homes in neighborhoods throughout the country. And keep in mind that, to this point, home prices have actually held up reasonably well in many locations, a dynamic that will likely not withstand a further tightening of Credit in prime jumbo and conventional mortgages. A more broad-based downturn in housing prices will spur a more broad-based decline in spending - especially for The Uppers.

This week was also notable for bankruptcy announcements from a few national restaurant and retail chains. Increasingly, the post-boom adjustment in spending patterns is challenging the profitability of scores of businesses. This dynamic is poised to feed on itself, as more business closures and layoffs severely impinge incomes. And what I expect to be rapidly deteriorating business Credit conditions will surely worsen the financial crisis.

For years now, the leveraged speculating community has profited handsomely from taking leveraged positions in higher-yielding business loans. Borrowing from Wall Street was easy, and it was just as easy during the boom to extend Credit to profitable businesses. But this dynamic is changing profoundly. With business and economic prospects now deteriorating rapidly, I would expect significant tumult to unfold in the corporate Credit market. And a reversal of speculative flows away from leveraged business lending would be a major blow to both corporate Credit Availability and the vulnerable leveraged speculating community, a dynamic with negative ramifications for the Uppers.

And when it comes to states with huge exposure to Uppers, California and New York sit at the top of the list. Not surprisingly, both states are today in the grips of intense fiscal pressure. And with my expectation that economic prospects are now worsening by the week, it is not at all clear how California, New York and other states will deal with ballooning deficits. Drastic spending cuts and tax increases are inevitable to get budgets back somewhat in line with post-boom receipts. And this will prove one more problematic dynamic for the bursting U.S. Bubble Economy.

Doug Noland
The Credit Bubble Bulletin
PrudentBear.com

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