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October 18, 2008

The "Arb" Game is Over
by Doug Noland

For the week, the Dow rallied 4.7% (down 33.3% y-t-d) and the S&P500 rose 4.6% (down 35.9%). Economically-sensitive issues, however, were under more pressure. The Morgan Stanley Cyclicals fell 4.7% (down 44.2%), and the Transports declined 1.3% (down 19.2%). The Utilities jumped 8.3% (down 34.1%), and the Morgan Stanley Consumer index gained 3.8% (down 23.3%). The small cap Russell 2000 added 0.8% (down 31.3%), and the S&P400 Mid-Caps gained 0.9% (down 35.3%). The NASDAQ100 increased 3.3% (down 37.1%), and the Morgan Stanley High Tech index rose 2.2% (down 40.3%). The Semiconductors declined 2.8% (down 41.4%). The Street.com Internet Index rallied 3.2% (down 33.1%), and the NASDAQ Telecommunications index jumped 4.1% (down 35.8%). The Biotechs rose 4.7% (down 17.7%). Financial stocks rallied. The Broker/Dealers surged 12.6% (down 52.4%), and the Banks jumped 8.2% (down 35.4%). With Bullion sinking $67, the HUI Gold index fell 18.1% (down 50.4%).

One-month Treasury bill rates rose to 0.12% and three-month yields increased all the way to 0.80%. Two-year government yields added 2 bps to 1.62%. Five-year T-note yields rose 6 bps this week to 2.82%, and 10-year yields gained 6 bps to 3.92%. Long-bond yields jumped a notable 19 bps to 4.31%. The 2yr/10yr spread increased 7 to 230 bps. The implied yield on 3-month December '09 Eurodollars dropped 34.5 bps to 2.555%. Benchmark Fannie MBS yields declined 13 bps to 5.79%. The spread between benchmark MBS and 10-year T-notes narrowed 18 to 186 bps. Agency 10-yr debt spreads increased 7.8 to 97.8 bps. The 2-year dollar swap spread declined 27.5 to 122, and the 10-year dollar swap spread declined 5.25 to 53.75. Corporate bond spreads were mostly wider. An index of investment grade bond spreads widened slightly to 218 bps, and an index of junk bond spreads widened a notable 62 to 827 bps.

Investment-grade debt issuance included Occidental Petroleum $1.0bn, Pacific G&E $600 million, PPL Electric Utilities $400 million, and Ohio Edison $275 million.

I saw no junk or convert issuance again this week.

International debt issuance included Diageo PLC $1.0bn.

German 10-year bund yields added 2 bps to 4.01%. The German DAX equities index rallied 5.2% (down 40.7% y-t-d). Japanese 10-year "JGB" yields rose 6 bps to 1.58%. The Nikkei 225 sank another 5.1% (down 43.2% y-t-d). Emerging markets were somewhat mixed and generally unimpressive. Brazil's benchmark dollar bond yields dropped 63 bps to 8.57%. Brazil's Bovespa equities index gained 2.2% (down 43.0% y-t-d). The Mexican Bolsa rallied 2.0% (down 31.2% y-t-d). Mexico's 10-year $ yields jumped 53 bps to 8.00%. Russia's RTS equities index fell 21% (down 70.9% y-t-d). India's Sensex equities index dropped 5.2%, with y-t-d losses rising to 50.8%. China's Shanghai Exchange declined 3.5%, boosting y-t-d losses to 63.3%.

Freddie Mac 30-year fixed mortgage rates surged 52 bps to 6.46% (up 6bps y-o-y). Fifteen-year fixed rates jumped 37 bps to 6.14% (up 6bps y-o-y), while one-year ARMs added one basis point to 5.16% (down 60bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates up 24 bps this week to 7.62% (up 88bps y-o-y).

Bank Credit rose $24.5bn to a record $9.871 TN (week of 10/8), with a 5-wk gain of $479bn. Bank Credit has now expanded $658bn y-t-d, or 9.1% annualized. Bank Credit posted a 52-week rise of $860bn, or 9.5%. For the week, Securities Credit surged $51.6bn. Loans & Leases declined $27.1bn to $7.213 TN (52-wk gain of $583bn, or 8.8%). C&I loans jumped $20.2bn, with y-t-d growth of 13.3%. Real Estate loans fell $18.5bn (up 6.6% y-t-d). Consumer loans added $1.8bn, while Securities loans dropped $32.9bn. Other loans increased $2.3bn.

M2 (narrow) "money" supply declined $31.9bn to $7.828 TN (week of 10/6). Narrow "money" has expanded $365bn y-t-d, or 6.4% annualized, with a y-o-y rise of $443bn, or 6.0%. For the week, Currency rose $3.3bn, while Demand & Checkable Deposits dropped $48.1bn. Savings Deposits declined $9.4bn, while Small Denominated Deposits jumped $18.8bn. Retail Money Funds increased $3.4bn.

Total Money Market Fund assets (from Invest Co Inst) jumped $60.8bn to $3.519 TN, with a y-t-d expansion of $405bn, or 16.5% annualized. Money Fund assets have posted a one-year increase of $598bn (20.5%).

There was little Asset-Backed Securities (ABS) issuance again this week. Year-to-date total US ABS issuance of $129bn (tallied by JPMorgan's Christopher Flanagan) is running at 25% of comparable 2007. Home Equity ABS issuance of $351 million compares with 2007's $228bn. Year-to-date CDO issuance of $24bn compares to the year ago $283bn.

Total Commercial Paper outstanding dropped $40.3bn this week to $1.511 TN (5-wk decline $305bn), with CP down $275bn y-t-d. Asset-backed CP was little changed, with 2008 posting a decline of $65bn. Over the past year, total CP has contracted $356bn, or 19.1%.

Federal Reserve Credit surged another $245bn to a record $1.740 TN, with a historic 5-wk increase of $851.8bn. Fed Credit has expanded $866.6bn y-t-d (123% annualized) and $851.8bn y-o-y (103%). Fed Foreign Holdings of Treasury, Agency Debt last week (ended 10/14) increased $1.1bn to a record $2.486 TN. "Custody holdings" were up $430bn y-t-d, or 25.9% annualized, and $468bn y-o-y (23.2%).

International reserve assets (excluding gold) - as accumulated by Bloomberg's Alex Tanzi - were up $1.035 TN y-o-y, or 17.5%, to $6.947 TN.

Global Credit Market Dislocation Watch:

October 13 - Bloomberg (John Fraher and Simone Meier): "The U.S. Federal Reserve led an unprecedented push by central banks to flood financial markets with dollars, backing up government efforts to restore confidence in the banking system. The ECB, the Bank of England and the Swiss central bank will offer unlimited dollar funds in auctions with maturities of seven days, 28 days and 84 days at a fixed interest rate... The Bank of Japan may introduce 'similar measures.' The dollar declined and some money-market rates fell. Policy makers from the Group of Seven nations pledged at the weekend to take 'all necessary steps' to stem a market panic after the MSCI World stock index plunged 20% last week. Central banks last week cut interest rates in tandem for the first time since 2001..., the U.S. plans to buy $700 billion in distressed assets from banks and in Europe, the U.K. is leading a push to keep lenders afloat with taxpayers' money. 'By providing unlimited dollar funds they are acting on the back of the G-7 plan to ensure the system is fully liquidized,' said Lena Komileva, an economist at Tullet Prebon Plc... 'We're going to see even more liquidity provided and more aggressive rate cuts are coming.'"

October 13 - MarketNews International (Steven K. Beckner): "The Federal Reserve announced yet another set of unprecedented emergency liquidity measures in coordination with other central banks in the wee hours of Monday morning to address the credit crisis. Having already greatly expanded the reciprocal currency swap lines with foreign central banks, the Fed essentially made those swaps unlimited, to enable other central banks to provide ample dollar funding to their constitutent financial institutions. The action comes on the heels of weekend agreements in Washington by the world's top finance ministers and central bankers to coordinate their efforts to unfreeze credit markets. Among other things, the Group of Seven, as well as the Group of 20 and the International Monetary Fund's policymaking body agreed to: 'Take all necessary steps to unfreeze credit and money markets and ensure that banks and other financial institutions have broad access to liquidity and funding.'"

October 17 - Financial Times (Haig Simonian in Zurich and Chris Hughes): "Switzerland moved to restore confidence in its banking system yesterday, agreeing to fund a vehicle that would take on most of the toxic debts held by UBS and injecting SFr6bn ($5.3bn) to help recapitalise its former national banking champion. The intervention in UBS came as its cross-town rival, Credit Suisse, raised SFr10bn from strategic investors including the Qatar Investment Authority. The proceeds of the fundraising by UBS will be immediately ploughed back into the bail-out vehicle, which is backed by the central bank and designed to hold up to $60bn in mainly US mortgage assets... Switzerland's action follows bank bail-outs across Europe and comes amid fears that the country might be accused of not pulling its weight internationally."

October 17 - Bloomberg (Emma Ross-Thomas): "European Union Monetary Affairs Commissioner Joaquin Almunia said that the economic fallout from the current financial crisis will be similar to that of the Great Depression and will lead to more bank mergers and a tightening of regulation. 'The conditions are different, but the depth of the crisis and probably the consequences of the crisis will be of the dimension and depth' seen in 1929., Almunia said..."

October 16 - Bloomberg (Liz Capo McCormick): "Failures to deliver or receive Treasuries in the $7 trillion-a-day market for borrowing and lending securities held close to a record high last week even after the Treasury Department stepped up debt sales to alleviate protracted shortages... Failures, an indication of scarcity, fell less than one percentage point to $4.767 trillion... Fails have averaged $190 billion a week to date. The Treasury sold $40 billion in notes last week... to relieve 'protracted shortages.' The Treasury said Oct. 6 it 'will continue to increase auction sizes' as needed."

October 15 - Bloomberg (Shannon D. Harrington and Pierre Paulden): "The cost of protecting high-yield, high-risk corporate debt from default rose amid concern that hedge funds are being forced to liquidate as the financial crisis depresses asset prices and investors withdraw... The Markit CDX North America High-Yield Index Series 11 fell 1 percentage point to 79.25% of face value..."

October 17 - Bloomberg (Sarah Mulholland): "Yields relative to benchmark rates on securities backed by credit-card debt and automobile loans reached record highs this week as hedge funds and other money managers faced redemptions and margin calls on their securities. The difference between yields on credit-card bonds rated AAA that mature in two years and London interbank offered rates widened 100 bps to 425 bps... Spreads on similar-maturity auto-loan bonds rose 125 bps to 450 bps over Libor."

October 17 - Bloomberg (John Glover): "Borrowing costs for high-yield, high-risk companies in Europe soared to a record... Merrill Lynch & Co.'s Euro High Yield Constrained Index... rose 56 bps to 1,686, surpassing the 1,682 basis points it reached in October 2001 after the terror attacks in the U.S. 'It's dawning on everyone that we're going to have a fairly deep recession and that defaults are going to rise,' said Adam Cordery... director of fixed income at Schroder Investment Management Ltd. in London."

October 16 - Bloomberg (Josh Fineman and Bradley Keoun): "Merrill Lynch... reported a fifth straight quarterly loss as the credit crisis saddled the firm with at least $13.5 billion of writedowns. The third-quarter net loss of $5.15 billion was more than double the year-earlier deficit of $2.24 billion... Merrill, hobbled by $52.2 billion in losses and writedowns from subprime-contaminated securities before today, has plunged about 80%... from a peak... last year."

October 16 - Bloomberg (Christine Richard): "Ambac Financial Group Inc. and other bond insurers are working on a plan to send to the U.S. Treasury that would enable them to sell troubled assets to the government... The companies also may present a proposal next week that would allow the insurers to guarantee some assets with government backing... The Treasury's $700 billion program to buy troubled assets may allow the two guarantors to dispose of bonds backing collateralized debt obligations that they guaranteed..."

October 14 - Dow Jones (Paul Ziobro): "Domino's Pizza Inc. may look to raise additional funding after the bankruptcy of Lehman Brothers... reduced the amount of capital available under its credit revolver. A Domino's spokeswoman... identified Lehman as the primary lender of the pizza chain's revolving credit facility. Lehman provided $90 million of a $150 million revolving credit line, but the total available would fall to $60 million if Domino's is unable to raise additional funding."

October 15 - Bloomberg (Tom Cahill): "Lehman Brothers... hedge-fund clients may have to pay more collateral on $65 billion of assets frozen when the investment bank went bankrupt a month ago. Lehman's London-based prime brokerage has about 3,500 active clients including hedge funds that own about $45 billion in securities, Steven Pearson, the partner at PricewaterhouseCoopers responsible for unraveling the unit, said... They hold an additional $20 billion in short positions, or bets that prices will fall. While investors are largely unable to access their Lehman accounts, the value of the securities continues to fluctuate along with the markets. The clients may be required to put up more collateral if the value of those securities drops, a process known as a margin call... 'Who is the holder of the risk of the securities? The hedge funds. If the value of the securities fell, they have to meet margin calls.' Lehman's bankruptcy, the world's biggest, has rocked hedge funds that relied on the firm to provide loans, clear trades and handle administrative tasks."

October 13 - Bloomberg (Nadja Brandt): "German financial regulator BaFin said the costs from Lehman Brothers Holdings Inc.'s bankruptcy totaled about $300 billion outside the U.S., Reuters reported, citing the regulator's president Jochen Sanio."

October 13 - Bloomberg (Peter Woodifield): "London's office market is suffering the most in Europe as the global credit crisis curbs demand for space in the U.K. capital's main financial district and Canary Wharf, Moody's... said. Rising vacancies, slumping demand and a glut of space make the City of London, as the main district is called, the worst in Europe, while Canary Wharf deteriorated faster than any other market in the first half, Moody's analysts wrote..."

October 16 - Bloomberg (Rebecca Keenan and Brian Lysaght): "Lend Lease Corp., the Australian developer building London's Olympic Village, is facing delays in talks to fund the 1 billion-pound ($1.7bn) project after credit markets froze worldwide. The U.K. government has paid 95 million pounds so far for construction at the site... The government is paying because Lend Lease can't find a lender to finance the project."

October 14 - Dow Jones (Rogerio Jelmayer): "After four high-profile Brazilian companies reported significant losses in the foreign exchange derivatives market, investors are beginning to wonder who's next. 'We will certainly have more companies reporting these kinds of losses,' said Jose Augusto de Castro, vice president of the Brazilian Exporters Association. The companies reporting such losses tend to be exporters because their U.S. dollar revenues make them natural foreign exchange hedgers. 'But they are not financial market specialists,' said De Castro. 'They were convinced by their bankers to take risky positions, but when the currency reversed, they were caught off guard.'"

October 15 - Bloomberg (Rebecca Keenan and Jesse Riseborough): "Rio Tinto Group may delay the planned sale this year of $10 billion of assets and Sterlite Industries (India) Ltd. shelved its $2.6 billion purchase of Asarco LLC because of the global financial crisis. Rio, battling an $86 billion takeover bid from BHP Billiton Ltd., said today it's also reviewing its spending timetable and project costs.... 'Acquirers will find it harder to source funds and even if they can source funds, they'll have to pay more,' said Steve Robinson, a senior investment manager with Alleron Investment Management in Sydney..."

October 15 - Bloomberg (Alexander Ragir and Fabiola Moura): "Brazilian companies may report as much as $28 billion of write-offs because of currency bets gone awry as they prepare to release third-quarter results. Potential losses of 60 billion reais ($28 billion) threaten the solvency of several businesses after the real's unexpected 30% drop against the dollar since Aug. 1, said Paulo Vieira da Cunha, a hedge fund manager and former Brazilian central bank deputy governor."

October 13 - Wall Street Journal Asia (Reem Shamseddine and Andrew Critchlow): "The United Arab Emirates said it would guarantee domestic bank deposits and, with Saudi Arabia, promised fresh financial support Sunday to domestic banks. Officials from both nations have said their banking systems are adequately capitalized and relatively unexposed to plummeting foreign assets that have dragged down firms in the U.S. and Europe. But they and other Persian Gulf leaders have struggled to shore up investor confidence amid the global financial crisis."

October 13 - Bloomberg (Farhan Sharif): "Police surrounded Pakistan's biggest stock exchange to thwart violence by investors demanding a halt in trading as price curbs imposed after the biggest slump in a decade locked up their funds. 'There are no longer any small investors left in the stock market, they have all been destroyed,' said Kausar Qaimkhani, chairman of the Small Investors Association"

Currency Watch:

October 14 - Bloomberg (William Sim): "South Korea's National Pension Service plans to sell about $7 billion of $20 billion it holds in U.S. Treasuries to the Bank of Korea this month, MoneyToday reported, citing an unidentified official at the fund. The state fund may sell more of its U.S. government debt holdings if necessary to help increase the central bank's foreign-exchange reserves..."

The dollar index dipped 0.7% to 82.41. For the week on the upside, the Brazilian real increased 9.2%, the Australian dollar 7.1%, the New Zealand dollar 2.9%, the Mexican peso 1.7%, the British pound 1.4%, the Singapore dollar 0.2%, and the Swiss franc 0.2%. On the downside, the South African rand declined 5.4%, the Norwegian krone 4.1%, the Swedish krona 2.8%, the South Korean won 1.2%, the Japanese yen 1.0%, and the Canadian dollar 0.7%. In the emerging currencies, the Iceland krona dropped 13.2%, the Turkish lira 4.4%, and the Hungarian forint 3.0%.

Commodities Watch:

October 13 - Bloomberg (Winnie Zhu and Wang Ying): "China, the world's second-largest energy user, increased crude-oil imports to a record last month, taking advantage of falling prices, as domestic refining capacity climbed. Crude imports surged 46% to 20 million metric tons or 4.87 million barrels a day in September from a year earlier... August purchases were 15.65 million tons."

October 14 - Bloomberg (Yi Tian): "Paul Reinhart Inc., one of the biggest U.S. cotton merchants, told farmers last month it faced a 'severe liquidity crisis' after suffering 'significant losses' when futures prices jumped to a 12-year high in March. An 'unexpected, historic run-up' in cotton led to margin calls on futures contracts, stripping the company of 'virtually all available cash,' R. Dale Grounds, president of... Reinhart, said... In the six days ended March 5, cotton jumped 15%... Reinhart, which began as a Swiss cotton importer in 1788, was considering selling its assets to competitor Allenberg Cotton Co."

Gold sank 7.8% to $783, and silver dropped 11.8% to $9.345. November Crude fell $5.79 to $71.91. November Gasoline declined 5.5% (down 33% y-t-d), while November Natural Gas rose 4.4% (down 8.8% y-t-d). December Copper gained 0.5%. December Wheat rallied 0.5%, while Corn slipped 1.3%. The CRB index declined 2.7% (down 21.3% y-t-d). The Goldman Sachs Commodities Index (GSCI) dropped 5.5% (down 22.2% y-t-d), having now declined 47% from highs posted only 15 weeks ago.

China Watch:

October 14 - Bloomberg (Kevin Hamlin and Li Yanping): "China's foreign-exchange reserves rose to a world record $1.906 trillion, helping to strengthen the nation's finances as the credit crisis threatens to trigger a global economic slump. Currency holdings rose 32.9% at the end of September from a year earlier... 'Close to $2 trillion in foreign reserves provides China with a strong foundation and more room to adjust policies to enable it to maintain relatively fast growth,' said Isaac Meng, senior economist at BNP Paribas SA in Beijing."

October 13 - Bloomberg (Nipa Piboontanasawat and Li Yanping): "China's trade surplus widened to a record in September as exports withstood the global economic slowdown and falling commodity prices reduced the import bill. Exports rose 21.5% from a year earlier to $136.4 billion after gaining 21.1% in August... The trade surplus climbed to $29.3 billion..."

October 13 - Bloomberg (Dune Lawrence): "China's Communist Party aims to double rural incomes in a bid to boost domestic consumption amid global financial turmoil that threatens to slow economic growth. The government aims to achieve those goals and eliminate 'absolute' poverty in rural areas by 2020, the party's ruling Central Committee said in a statement distributed late yesterday by the official Xinhua News Agency."

October 17 - Bloomberg (Zhao Yidi and Zhang Dingmin): "China's securities regulator said the government will unveil measures to stabilize the country's markets, while exhorting banks to avoid 'excessive' financial innovation. The U.S. credit crisis 'poses grave challenges to China yet the country's economy is functioning well, Shang Fulin, chairman of the China Securities Regulatory Commission, said... 'We must pay attention to the risks involved when we pursue financial innovations,' Shang said."

October 14 - Bloomberg (Li Yanping): "The global financial crisis will have a limited and 'controllable' effect on China's economy, Premier Wen Jiabao said. China will adopt 'flexible and prudent' policies to 'maintain stability in the economy, in the financial system and in the capital markets,' Wen told British Prime Minister Gordon Brown..."

October 14 - Bloomberg (Kevin Hamlin and Li Yanping): "China's money-supply growth slowed for a fourth month even after the central bank loosened lending restrictions to stimulate economic growth. M2, the broadest measure, rose 15.3% to 45.3 trillion yuan ($6.6 trillion) at the end of September from a year earlier... after gaining 16% in August."

October 14 - Bloomberg (Chia-Peck Wong and Theresa Tang): "The Hong Kong Monetary Authority will use its foreign exchange reserves to guarantee bank deposits... The government will also set up a fund from which banks can access additional capital if needed, John Tsang, Hong Kong's financial secretary, told reporters..."

Asia Bubble Watch:

October 17 - Bloomberg (Bomi Lim): "Taesan LCD Co., which makes back- light units for computer screens, was ranked as South Korea's third-biggest start-up in June after posting record sales. Three months later, the supplier... collapsed after accumulating 80.6 billion won ($62 million) in losses on currency options that soured as the won slumped against the dollar... Hana Bank... assumed the losses when Taesan failed. Korean banks may lose billions of dollars on similar contracts and face lawsuits from exporters who say the options were sold without an explanation of the risks... The won fell 9.7% against the dollar yesterday, its biggest drop in 11 years..."

Latin America Watch:

October 13 - Bloomberg (Matthew Craze): "Argentine farmers face bankruptcy because of falling prices and rising costs, soybean producer Gustavo Grobocopatel told Radio 10... Grobocopatel called on the government and farmers to restart talks aimed at resolving a conflict over taxes and export restrictions that began in March this year..."

Central Banker Watch:

October 15 - Bloomberg (John Fraher and Gabi Thesing): "European Central Bank President Jean-Claude Trichet said officials reshaping the world's financial system should try to return to the 'discipline' that governed markets in the decades after World War II. 'Perhaps what we need is to go back to the first Bretton Woods, to go back to discipline,' Trichet said... 'It's absolutely clear that financial markets need discipline: macroeconomic discipline, monetary discipline, market discipline.'"

October 13 - Bloomberg (Craig and Scott Lanman): "Federal Reserve officials must be wary of concentrated risk and the rise of a new 'financial oligarchy' as banks merge amid the credit crisis, Kansas City Fed President Thomas Hoenig said. Regulators... should consider 'the degree to which we should be concerned and address the rising levels of concentration of financial resources among, if you will, a financial oligarchy that will wield vast powers in the future,' Hoenig said..."

Unbalanced Global Economy Watch:

October 15 - Bloomberg (Chris Reiter): "European car sales fell for the fifth consecutive month in September, the longest stretch since 2005, as higher fuel prices and financial-market turmoil reduced demand for General Motors Corp. and Bayerische Motoren Werke AG models. Registrations declined 8.2% to 1.3 million vehicles..."

October 14 - Bloomberg (Svenja O'Donnell): "U.K. home sales fell in September to the lowest level in at least three decades, led by London, as the financial crisis prompted price drops across the nation, the Royal Institution of Chartered Surveyors said."

October 14 - Bloomberg (Jennifer Ryan): "U.K. inflation quickened to the fastest pace in at least 11 years in September, squeezing consumers with higher living costs as the financial market crisis curbed the availability of credit. Prices rose 5.2% from a year earlier, the most since records began in 1997, the Office for National Statistics said..."

October 15 - Bloomberg (Warren Giles and Elena Logutenkova): "Switzerland gave UBS AG, the European bank with the biggest losses from the credit crisis, a $59.2 billion bailout and pushed Credit Suisse Group AG to raise funds, joining authorities around the world in shoring up banks."

October 16 - Bloomberg (Benedikt Kammel): "Swedish unemployment rose to 5.9% in September as companies including Volvo... and Ericsson AB slashed their workforce to battle the fallout from the global financial crisis. The... rate rose from 5.2%..."

October 14 - Bloomberg (Kati Pohjanpalo): "Finland's inflation rate was unchanged at 4.7% in September, the highest in more than 17 years, led by the high cost of food. Inflation compares with 2.6% in September a year earlier..."

October 16 - Bloomberg (Alex Nicholson): "Russia's international reserves, the world's third largest, fell $15.5 billion last week after the central bank sold currency to prop up the ruble as investors pulled money out of the country. The value of the reserves slipped to $530.6 billion... after a $16.7 billion decline the previous week..."

October 15 - Bloomberg (Maria Levitov): "Russia's inflation rate in the year through Oct. 13 reached 11% as egg, poultry and hot dog prices rose."

October 14 - Bloomberg (Niklas Magnusson and Chad Thomas): "Karl Karlsson, a Reykjavik taxi driver, has canceled his winter vacation. The money he saved is being eaten up by his car loan payment, which has jumped more than 20% since June. Like thousands of Icelanders, Karlsson borrowed in foreign currencies to get a cheaper loan as the benchmark domestic interest rate soared to 15.5% this year. With trading in the krona virtually suspended after it plunged against the euro, dollar and yen, debtors now face skyrocketing bills."

October 14 - Bloomberg (Massoud A. Derhally): "Jordan's economy faces threats from accelerating inflation and a current-account deficit that has widened almost 50% in the past three years, Moody's... said. 'The most immediate economic risks are the high and rising inflation and the very wide current account deficit, the rating firm said..."

Bursting Bubble Economy Watch:

October 17 - Bloomberg (Bob Willis): "Housing starts in the U.S. fell more than forecast in September as construction of single-family homes plunged to the lowest level in 26 years, indicating the three-year real-estate slump is intensifying... Building permits, a sign of future construction, dropped 8.3% to a 786,000 pace, matching the lowest level since November 1981."

October 14 - Bloomberg (Greg Bensinger): "U.S. auto sales this month may fall to their lowest rate in at least 25 years as showroom traffic slows... Deutsche Bank AG analyst said. October's seasonally adjusted annual rate, or SAAR, will probably decline to 11 million vehicles, Rod Lache wrote... That would be the first time the rate has gone below 12 million since April 1983... 'Several automakers have commented on a dramatic falloff in customer traffic during the final week of September, and we believe that has continued,' Lache said."

October 14 - Bloomberg (Greg Bensinger and Alex Ortolani): "GMAC... may deepen the automaker's 18% U.S. sales slide this year by limiting car and truck loans to people with the best credit scores. GMAC said yesterday it's granting financing only to buyers with scores of at least 700, who represent about 58% of U.S. consumers."

October 17 - Bloomberg (Peter Robison and Pham-Duy Nguyen): "Weeks before Washington Mutual Inc.'s bankruptcy, Seattle arts philanthropist Jim Tune met with his staff at a wooded retreat to discuss how a lagging economy might hurt donations. The company that donated the meeting space: WaMu, the city's homegrown thrift. WaMu's collapse last month has sent chills through the city's charities... The 119- year-old bank sponsored an annual Fourth of July fireworks show, gave money to food and shelter programs, and supported the Seattle Symphony and theater groups... Philanthropy is one of the first things cut when companies get into trouble, said Tom Pollak, program director at the National Center for Charitable Statistics..."

October 14 - Dow Jones (Patrick Fitzgerald): "Petters Co. Inc. filed for bankruptcy protection Saturday amid allegations of massive fraud involving company founder Thomas Petters, who was arrested earlier this month on federal charges of mail and wire fraud, money laundering and obstructing justice. Petters Co., the venture capital arm of Thomas Petters' group of companies, filed for Chapter 11 protection Saturday... listing debts between $500 million and $1 billion. Federal authorities raided Petters' Minnesota headquarters last month seeking evidence of a Ponzi scheme orchestrated by Petters, who is accused of bilking individual investors and hedge funds out of as much as $3 billion... Based in Minnetonka, Minn., Petters Co.'s investments include Fingerhut, Polaroid and Sun Country Airlines."

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

October 15 - Bloomberg (Shannon D. Harrington): "Iceland's collapsed banks pose a 'substantial' risk to collateralized debt obligations that made bets on corporate debt, according to S&P. Kaupthing Bank hf, Landsbanki Islands hf and Glitnir Bank hf were included in 376 CDOs worldwide, S&P said. Another 297 made bets on two of the three banks. The CDOs sold credit-default swaps that pay investors if there is a default, and the government's placement of the banks into receivership triggered a settlement of the contracts. Because the so-called synthetic CDOs also bet heavily on bankrupt Lehman Brothers Holdings Inc. and Washington Mutual Inc., 'the impact of these exposures is likely to be significant, S&P said..."

October 15 - Bloomberg (Jody Shenn): "S&P may downgrade $280.1 billion of Alt-A mortgage securities from 2006 and 2007."

GSE Watch:

October 13 - Bloomberg (Dawn Kopecki): "Fannie Mae and Freddie Mac are ready to start purchasing $40 billion a month of underperforming mortgage bonds as the U.S. government expands its options to remove troubled assets from the slumping financial markets, according to three people briefed about the plan. Fannie and Freddie began notifying bond traders last week that each company needs to buy $20 billion a month in mostly subprime, Alt-A and non-performing prime mortgage securities, according to the people, who asked not to be identified because the plans are confidential. The purchases would be separate from the U.S. Treasury's $700 billion Troubled Asset Relief Program."

October 14 - Bloomberg (Jody Shenn): "Yields on Fannie Mae and Freddie Mac corporate debt rose to the highest on record relative to Treasuries as the government said it would guarantee borrowing by banks, providing bond buyers competing U.S.-backed investments. The difference between yields on Washington-based Fannie's five-year debt and similar-maturity Treasuries rose 15 bps to 117.2 bps..."

Real Estate Watch:

October 15 - EconoPlay.com (Gary Rosenberger): "The housing market took a most brutal turn in September as prospects of global economic collapse paralyzed a vulnerable industry that had already been enduring three years of slow torture, residential builders say. The Lehmann vanishing act, the off-again on-again bailout plan, and those stomach-churning sell-offs in the Dow sank new home sales to unprecedented lows and stopped new construction on its tracks with builders and buyers equally intimidated by those raging economic firestorms. A buyer stampede toward foreclosures and priced-to-sell standing inventory was the only vital sign in an otherwise comatose patient - but even that was hurt by rumors that no home loans were available to anyone at any price. Builders are now exiting the market in droves, seeing no prospects for a recovery this year or next, and many are looking to cut the friendliest deals with banks to avoid bankruptcy. Sentiment has never been so depressed. 'I'm a dead man walking,' one builder told us. Another talked about suicides in his industry, the sad outcome of years of unremitting calamity."

Speculator Watch:

October 17 - Financial Times (Henny Sender): "Troubles mounted for some of the world's biggest hedge funds yesterday as Highland Capital Management told investors it was shutting down two of its funds and details emerged of big losses at TPG-Axon. The problems in the sector have set in motion a vicious cycle in the markets as hedge funds sell holdings to return money to worried investors, triggering further price declines and prompting more withdrawals... 'Unfortunately, selling has begat selling as risk reduction and unwinding create spillover pressure on other funds with overlapping holdings,' Dinakar Singh, the founder of TPG-Axon said in a letter to investors..."

October 17 - Bloomberg (Tomoko Yamazaki and Bei Hu): "The global hedge fund industry lost $79 billion of assets on investment declines and investor withdrawals in September, according to an estimate by Singapore- based hedge-fund research and publishing company Eurekahedge Pte."

October 17 - Bloomberg (Saijel Kishan): "Assets managed by hedge funds fell 11% in the third quarter as investors pulled a record $31 billion from their accounts, according to... Hedge Fund Research Inc. The decline reduced industry assets to $1.72 trillion from $1.93 trillion as of June 30..."

October 15 - Bloomberg (Katherine Burton): "Citadel Investment Group Inc.'s biggest hedge fund fell as much as 30% this year, because of losses on convertible bonds, stocks and corporate bonds, said two people familiar with the... firm."

October 15 - Dow Jones (Steve D. Jones): "This doesn't compute. Quantitative funds, the investment pools driven by complex mathematical models designed to predict and profit from discrepancies in value, had fallen to levels nearly identical to major indexes they boast of beating."

October 16 - Bloomberg (Saijel Kishan): "Hedge funds may cut as many as 10,000 jobs this year as they struggle with their biggest losses in almost two decades, according to estimates by executive search firm Options Group. The industry has already eliminated 3,000 to 5,000 jobs, out of an estimated 150,000 worldwide, Michael Karp, CEO of the... firm, said... Layoffs may double by the end of 2008, he said. 'It's bad out there,' said Karp, whose firm has tracked hedge-fund hiring since 1995. 'Generating returns is not easy at the moment and as funds look to cut costs, the best way is to let go of people.'"

October 14 - Bloomberg (Jason Kelly): "Private equity funds' returns may drop by more than half as firms struggle to reap profits from companies acquired at the peak of the leveraged buyout boom, Thomas H. Lee Partners Co-President Scott Schoen said."

Fiscal Watch:

October 15 - UPI: "The U.S. government could rack up a $1 trillion budget deficit this fiscal year, depending on how the bank bailout program is accounted for, analysts say. The non-partisan Washington organization Committee for a Responsible Federal Budget arrived at the $1 trillion estimate by taking government projections and adding possible further economic stimulus spending and the potential cost of the bailout program..."

October 14 - Bloomberg (John Brinsley and Roger Runningen): "The U.S. government posted a record budget deficit for 2008 as financial market strains slowed economic growth and spending rose the most since 1990. The shortfall widened to $455 billion in the fiscal year ended Sept. 30, compared with a $162 billion deficit a year earlier and the previous high of $413 billion in 2004.... Total spending in 2008 rose 9.1% to $2.98 trillion from a year earlier, the biggest jump in annual outlays since a 9.6% gain in 1990. Revenue decreased 1.2% to $2.52 trillion, the first drop since 2003. For the month of September, the government posted a surplus of $45.7 billion, less than half the surplus of $112.9 billion the same month a year earlier..."

Muni Watch:

October 15 - Bloomberg (Jeremy R. Cooke): "U.S. state and local government bonds fell, propelling an almost uninterrupted monthlong decline that's pushed long-term tax-exempt yields to the highest on record versus Treasuries and quashed most borrowing. Yields on top-rated general obligation bonds due in 30 years rose 8 bps to 5.99% today, almost 180 bps more than the taxable federal benchmark... 'It's surreal,' said Tom Boylen, managing director and municipal bond trader at BMO Capital Markets... Municipal borrowers delayed or canceled more than 200 planned debt offerings totaling at least $13 billion since mid-September. Issuers pressing forward with deals to raise needed funding... are offering long-term yields above 6% to attract buyers."

October 14 - Bloomberg (Michael McDonald): "At least 21 states and the District of Columbia face a combined $8.9 billion budget shortfall as income and sales taxes decline amid rising unemployment, according to the Center on Budget and Policy Priorities. 'Basically their revenues are not coming in as expected, and so they're facing shortfalls,' said Elizabeth C. McNichol...who wrote the report with Iris J. Lav."

October 15 - Bloomberg (Michael McDonald): "Massachusetts Governor Deval Patrick plans to eliminate 1,000 jobs as part of an effort to close a $1.4 billion gap that appeared in the state budget in the last 3 1/2 months."

New York Watch:

October 17 - Bloomberg (Michael Quint): "New York plans to turn to the bond market to finance an electronic slot machine parlor at Aqueduct Race Track and collect a $370 million up-front payment from the facility operator to narrow the state's $1.2 billion deficit."

California Watch:

October 16 - Bloomberg (Michael B. Marois): "California sold $5 billion of short- term notes to avert a cash shortage after taking record orders from individual investors this week following a sales pitch featuring Governor Arnold Schwarzenegger. State Treasurer Bill Lockyer added $1 billion to the size of the initial offering after individual investors bought more than $3.9 billion of notes. Lockyer also was able to reduce the yields on the two-part sale, which remained as much as 0.88 percentage point above what California paid last year."

October 14 - Bloomberg (Michael B. Marois): "The California Public Employees' Retirement System lost more than $66 billion in the last 12 months, or more than 25% of its value, hurt by tumbling stock markets. The largest U.S. public pension fund's market value declined to $193.7 billion as of Oct. 9..."

Crude Liquidity Watch:

October 16 - Bloomberg (Matthew Brown): "Kuwait M1 money supply growth... quickened to 20% in August from 13% in July, while M2, a broader measure that includes some time deposits, remained at 15%."

October 16 - Bloomberg (Matthew Brown): "Bahrain M1 money supply growth, an indicator of future inflation, accelerated to a record 44% in August from 25% in July."

The "Arb" Game is Over:

I'll admit to having warmed up a little to chairman Bernanke. He speaks clearly and candidly, in stark contrast to the years of Greenspan spin and deception. I certainly have sympathy for the predicament Bernanke finds himself in today, and I'll give the chairman Credit this week for comments suggesting that he is rethinking his flawed views with regard to Bubbles. Yet this doesn't change the reality that his infamous 2002 "helicopter Ben" speeches played an integral role in fostering terminal Credit and Asset Bubble "blow-off" excesses. I was a critic of his selection as Greenspan's successor, fearing that his appointment would bolster what had by that point evolved into Runaway Global Credit and Speculative Bubbles. And while I appreciated the frankness of chairman Bernanke's comments this week, for the record I'm compelled to take exception to his assertion that subsequent developments have proved the Fed adroit for commencing aggressive rate cuts a year ago last summer.

When the Fed unexpectedly reduced the discount rate on August 17, 2007, inflationary pressures were mounting and, despite subprime tumult, financial excesses were actually accelerating. Financial sector debt expanded at 16.8% rate and non-financial debt at a 9.1% rate during 2007's third quarter. Importantly, the dollar index was trading at about 81.50. Crude oil closed at $71 on August 16, 2007. The CRB index at the time was at about 300. Emerging debt and equity markets were Bubbling. The Bubble in the leveraged speculating community was out of control. Citigroup, Wall Street and the global banking community were struggling to dance in what had become a drunken global M&A blowout.

With a U.S. mortgage crisis brewing, the markets were keenly awaiting aggressive Federal Reserve largesse. They got it, and after six months of Fed rate cuts the dollar index had sunk another 15% to new bear market lows. During that period, crude oil surged almost 60% (to $110 and on its way to $145). Wheat and other commodities experienced spectacular speculative runs, provoking angst and bouts of food hoarding around the world. The CRB commodities index jumped about 40%. Emerging market Bubbles went to extremes. Brazil's Bovespa equities index quickly gained about a third, while their $ bond yields dropped from an already stunning 6.5% to below 5.8%. U.S. bank Credit surged at double-digit rates; GSE books of business expanded by record amounts; money fund assets ballooned at an almost 50% rate; and funds flooded into the booming hedge fund community. A world awash in excess dollars saw generalized global monetary excess wildly inflate world markets and economies (at least partially to chase the highly profitable weak dollar trade). At home, U.S. corporate borrowings expanded at a better than 13% rate during the second half of 2007 (and 13% overall for the year).

The ECB has been widely assailed for their hesitance to lower rates, while aggressive Fed moves have been applauded. Yet I believe it is important to recognize that the Bernanke Fed only compounded earlier mistakes by signaling their intentions so imprudently to a highly speculative marketplace. There is absolutely no doubt that today's global financial crisis was made much worse because of additional late-cycle excesses - and resulting Acute Monetary Disorder - fostered by the Fed's accommodative stance beginning in the summer of 2007. The scope of the Bubbles and today's spectacular collapses in global equities, energy, commodities, currencies, emerging debt and equity, corporate bonds, and the hedge fund community generally was exacerbated by the Fed's premature move to "mop up" after the bursting of the U.S. Bubble. Moreover, I see very little offsetting benefit to the system from lower Fed funds.

Clearly, the U.S. and global Credit systems are today suffering mightily from years of reckless lending, capped off by 2007's blowoff excesses (especially corporate and M&A-related debt). Fortunately, there were indications this week that recent unprecedented global policymaker response is having some positive impact. Dollar libor rates declined and there were other signs of an easing of conditions in the money and inter-banking lending markets. Commercial paper rates dropped to three-week lows. At the same time, however, it is becoming increasingly clear that there has been A Fundamental Transformation in the pricing of long-term finance for households, corporations and municipalities.

Over the past year, Fed funds were reduced 375 bps to 1.50%. At the same time, 30-year jumbo mortgage borrowing rates are up 88 bps to 7.62%. And despite "nationalization," benchmark Fannie Mae MBS yields are still 33 bps higher than they were a year ago. Spreads on benchmark Credit card and auto loan asset-backed securities (ABS) were said to have widened between 100 and 125 bps this week to record levels. Junk bond premiums (S&P) have surged from 380 to 830 bps. During the past twelve months, investment grade spreads have almost quadrupled to 200 bps. And while there was minimal investment grade issuance this week, it is worth noting that those deals that did make it to the market were sold (mostly utilities) at spreads above 400 bps. Meanwhile, an index of municipal bond yields has risen from 4.15% to 6.01%.

There is now recognition that "de-leveraging" is behind the jump in private-sector borrowing costs. And yes, the system has suffered through bouts of forced liquidations before (1994, 1998, and 2002 come to mind), although nothing in the past is relevant to the massive overhang of Credit instruments now weighing on the marketplace. There remains, however, hope that some degree of normalcy will return to the fixed income marketplace when policy measures have had time to take effect and liquidations have inevitably run their course. I will throw out a thesis that there will be no return to what we grew to accept as normal. Despite policymakers' best intentions (and resulting ballooning deficits and Fed Credit), market yields appear poised to surprise on the upside.

Wall Street finance is an unmitigated bust; Wall Street Alchemy - transforming endless risky loans into perceived "money-like" debt instruments - is a spent force. The greatest Credit and speculative Bubble in history is collapsing. Trust in innovative private-sector Credit instruments has been broken. Confidence in contemporary private-sector "money" has been severely shaken. Not in our lifetimes do I expect to again see booming securitization and derivatives markets. The days of unfettered leveraged speculation are over. And, importantly, the amount of Wall Street risk intermediation - through sophisticated securities, complex derivative structures, various types of Credit insurance, financial guarantees and liquidity arrangements, and unlimited speculator leveraging - will be significantly reduced for years and decades to come.

And it is my view that the demise of Wall Street risk intermediation means higher yields for household, corporate and municipal long-term borrowings. For years, there was virtually insatiable demand from Wall Street for high-yielding risky Credits - loans that could be transformed/intermediated into perceived safe and liquid debt instruments. Almost any risk could be sliced and diced, structured, and transferred to the "marketplace," with enticing securitizations emerging from the financial alchemy. In many cases, these securities were then accumulated by the leveraged speculating community, in the process creating additional financial sector leveraging and the perception of endless system liquidity. It seemingly didn't matter at all that we spent instead of saved.

Along the way, there were times when this Bubble found itself under some degree of stress. But with lower financing costs from the Federal Reserve and moves by speculators to arbitrage widening spreads, this financing mechanism would quickly right itself. Indeed, soon the Credit Bubble would more than regain any lost momentum. Importantly, the expanding scope of the speculator community and the endless amount of cheap Credit from the Wall Street firms (along with the global mega-"banks") nurtured the perception that this historic episode of Ponzi Finance could last forever.

Today, Wall Street risk intermediation is a bloody wreck; the securities and derivatives markets are in complete disarray; the deeply impaired Wall Street firms have no choice but to rein in lending for securities speculation; and the hedge fund industry is in the midst of a massive de-leveraging and industry collapse. The market for creating, pricing and distributing finance is in complete upheaval.

Not only is the capacity gone for Wall Street to transform risky long-term loans into palatable debt securities. Market dynamics have profoundly altered the appeal of speculative risk arbitrage. For one, there is now a multi-Trillion dollar inventory of risky debt securities overhanging the market (from speculator de-leveraging). Second, the capacity for speculators to procure cheap financing for securities leveraging has been greatly diminished. Third, since there will be scant Wall Street demand for new risky Credits (previously transformed into easily marketable securities), ongoing financing requirements for the real economy will burden an already stressed marketplace with an unrelenting supply of risky Credits. And, fourth, risky Credits are especially unappealing as the economy sinks into a deep downturn.

In summary, The "Arb" Game is Over. Both supply and demand dynamics have been radically altered, while the cost and availability of new borrowings is now so uncertain. And, truth be told, speculative risk arbitrage had evolved into a primary monetary policy stimulus mechanism under the Greenspan Fed. In the event of any kind of systemic shock - or at any point market liquidity began to wane - a Greenspan signal of lower financing costs was all that was required to incite risk-taking and leveraging. Today, in contrast, with Wall Street finance in crisis no amount of rate cutting or other policymaking can resuscitate leveraged speculation. Going forward, the price of long-term private-sector borrowings will be determined by unadulterated supply and demand dynamics.

For years, the Wall Street Bubble distorted the price of finance. In particular, high-yielding risky loans - the favored domain of Wall Street "Alchemy" - were dramatically mispriced. This under-pricing of risk led to a massive (and self-reinforcing) over-extension of risky loans - for real estate, for speculating in securities markets, for funding enterprising businesses and municipalities, and for consuming. Over the long life of the Credit Bubble, this historic expansion of risky Credits altered the very fabric of our Economic Structure. In particular, Wall Street finance fostered asset inflation, over-consumption, and a finance-driven "services" Bubble economy. The consequences were momentous, and the unavoidable economic restructuring has now commenced.

Doug Noland
The Credit Bubble Bulletin
PrudentBear.com

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