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April 07, 2007

"Vintage 2007"
by Doug Noland

For the week, the Dow and S&P500 gained 1.6%. The Transports jumped 2.2%, increasing y-t-d gains to 7.8%. The Utilities rose 1.8% to trade at a record high this week, while increasing 2007 gains to 10.4%. The Morgan Stanley Cyclical index increased 1.4% (up 8.5% y-t-d), and the Morgan Stanley Consumer index gained 1.3% (up 2.3% y-t-d). The broader market rally continued. The small cap Russell 2000 gained 1.6% (up 3.3% y-t-d), and the S&P400 Mid-Cap index rose 1.5% (up 7.1% y-t-d). The Biotechs, surging 3.4%, rose to the highest level since year 2000 (up 4.9% y-t-d). The NASDAQ100 gained 2.2% (up 3.2% y-t-d), and the Morgan Stanley High Tech index jumped 2.9% (up 0.8% y-t-d). The Semiconductors rose 2.1% (up 1.6% y-t-d). The Street.com Internet Index advanced 1.5%, and the NASDAQ Telecommunications index rallied 2.2% (up 3.3% y-t-d). The Broker/Dealers gained 1.9% (down 1.0% y-t-d), while the Banks declined 0.3% (down 3.4% y-t-d). With bullion gaining $11.05, the HUI Gold index jumped 4.7%.

Two-year government yields jumped 14 bps to 4.72%. Five-year yields rose 12 bps to 4.65%, and 10-year Treasury yields gained 9.5bps to 4.74%. Long-bond yields gained 7 bps to 4.92%. The 2yr/10yr spread ended the week at positive 2 bps. The implied yield on 3-month December '07 Eurodollars surged 19 bps to 5.065%. Benchmark Fannie Mae MBS yields apparently did not trade today. The spread on Fannie's 5 1/4% 2016 note narrowed 3 to 34, and the spread on Freddie's 5 1/2% 2016 note narrowed 3 to 34. The 10-year dollar swap spread increased one to 53.75. Corporate bond spreads generally narrowed, with junk spreads compressing about 10bps.

Investment grade issuers included Time Warner Cable $5.0bn, National Rural Utilities $570 million, PPF Funding $500 million, and Monumental Global Funding $230 million.

Junk issuers included Realogy $3.15bn, PTS Acquisition $565 million, Stater Brothers $285 million, Corn Products Intl $300 million, Northwest Pipeline $185 million, Pegasus Solutions $105 million, and Altra Industrial Motion $105 million.

The convert issuance boom this week included General Mills $1.15bn and Chattem $85 million.

International issuers included Brazil $2.025bn and BCP Finance Bank $1.5bn.

Japanese 10-year "JGB" yields were little changed this week at 1.66%. The Nikkei 225 gained 1.1 % (up 1.5% y-t-d). German 10-year bund yields rose 5 bps to 4.10%. Emerging markets posted mostly positive gains. Brazil's benchmark dollar bond yields declined 4 bps this week to a record low 5.63%. Brazil's Bovespa equities index gained 1.8% (up 4.9% y-t-d). The Mexican Bolsa jumped 2.1% to another record high (up 11.1% y-t-d). Mexico's 10-year $ yields dipped one basis point to 5.50%. Russia's RTS equities index increased 0.6% (up 1.3% y-t-d). India's Sensex equities index declined 1.0% for the week (down 6.8% y-t-d). China's Shanghai Composite index surged 4.4% to a fresh record high, increasing 2007 gains to 24.2%.

Freddie Mac posted 30-year fixed mortgage rates added one bp to 6.17% (down 26 bps y-o-y). Fifteen-year fixed rates also gained one bp, to 5.87% (down 23 bps y-o-y). One-year adjustable rates rose one bp to 5.44% (down 13 bps y-o-y). The Mortgage Bankers Association Purchase Applications Index declined 2% this week. Purchase Applications were down 7.8% from one year ago, with dollar volume 5.5% below. Refi applications fell 4.5% for the week, although dollar volume was up 32% from a year earlier. The average new Purchase mortgage declined to $239,800 (up 2.5% y-o-y), while the average ARM fell to $392,800, (up 10.4% y-o-y).

Bank Credit rose $13.1bn (week of 3/28) to $8.346 TN. For the week, Securities Credit gained $9.5bn. Loans & Leases expanded $3.6bn to $6.0 TN. C&I loans declined $4.7bn, while Real Estate loans gained $4.0bn. Consumer loans added $0.8bn, and Securities loans jumped $13.4bn. Other loans declined $9.9bn. On the liability side, (previous M3) Large Time Deposits jumped $17.6bn.

M2 (narrow) "money" surged $38.9bn to a record $7.203 TN (week of 3/26). Narrow "money" has expanded $159bn y-t-d, or 9.1% annualized, and $436bn, or 6.4%, over the past year. For the week, Currency added $0.9 billion, and Demand & Checkable Deposits increased $7.0bn. Savings Deposits jumped $26.1bn, and Small Denominated Deposits gained $2.3bn. Retail Money Fund assets rose $2.7bn.

Total Money Market Fund Assets (from Invest. Co Inst) rose $18.2bn last week to a record $2.451 TN. Money Fund Assets have increased $163bn over the past 20 weeks (18.9% annualized) and $390 billion over 52 weeks, or 18.9%.

Total Commercial Paper declined $14.5 bn last week to $2.041 TN, with a y-t-d gain of $66.3 bn (12.5% annualized). CP has increased $110bn (14.8% annualized) over 20 weeks and $359bn, or 21.3%, over the past 52 weeks.

Asset-backed Securities (ABS) issuance slowed to $6.0bn. Year-to-date total ABS issuance of $192bn (tallied by JPMorgan) is now running about in line with comparable 2006. At $100bn, y-t-d Home Equity ABS issuance is about one-third below last year's pace. Year-to-date US CDO issuance of $90 billion is running 24% ahead of comparable 2006.

Fed Foreign Holdings of Treasury, Agency Debt jumped $13.0bn last week (ended 4/4) to a record $1.893 TN, with a y-t-d gain of $141bn (29.8% annualized). "Custody" holdings expanded $299bn during the past year, or 18.8%. Federal Reserve Credit last week added $123 million to $852.2bn (unchanged y-t-d). Fed Credit was up $31.8bn y-o-y, or 3.9%.

International reserve assets (excluding gold) - as accumulated by Bloomberg's Alex Tanzi - were up $271bn y-t-d (21% annualized) and $812bn y-o-y (19.0%) to a record $5.082 TN.

April 3 - Bloomberg (Seyoon Kim): "South Korea's foreign-exchange reserves, the world's fifth-largest, rose for a ninth month... The reserves climbed by $1.1 billion from February to $243.9 billion... Asian nations make up for four of the world's top five foreign currency reserve holders..."

Currency Watch:

April 2 - Bloomberg (Maria Levitov): "Russia's central bank will reduce foreign currency purchases by a third to between $70 billion and $80 billion this year, Deputy Chairman Alexei Ulyukayev said. The bank 'plans to buy $40 billion to $50 billion less' than last year, Ulyukayev said..."

The dollar index rose slightly to 82.76. On the upside, the South African rand increased 1.7%, the Colombian peso 1.5%, the Turkish lira 1.5%, the Israeli shekel 1.4%, and the Brazilian real 1.4% (to a 6-year high). On the downside, the Iceland krona declined 1.7%, the Japanese yen 1.3%, and the Swiss frank 0.5%.

Commodities Watch

April 4 - Bloomberg (Chanyaporn Chanjaroen and Brett Foley): "Nickel and lead rose to records in London on speculation that supply will lag behind demand this year. Zinc posted the biggest gain in almost a year and copper jumped to the highest in more than four months."

For the week, Gold gained 1.7% to $675 and Silver 2.2% to $13.74. Copper surged 7.3% to a near record high. May crude declined $1.59 to $64.28. May gasoline gained 3.4%, while May Natural Gas declined 1.6%. For the week, the CRB index added 0.2% (up 3.4% y-t-d), while the Goldman Sachs Commodities Index (GSCI) dipped 0.3% (up 7.6% y-t-d).

China Watch:

March 31 - Bloomberg (Yanping Li): "China faces inflationary pressures in 2007 as the country's trade surplus expands, a central banker said... 'If the trade surplus continues to expand over the next few months, the central bank will strengthen its macro control measures and will be more pre-emptive in taking the tightening measures,' Wu Xiaoling, vice governor of the People's Bank of China told reporters..."

April 5 - Bloomberg (Li Yanping and Josephine Lau): "China ordered banks to set aside more money as reserves for the sixth time in less than a year to slow inflation as economic growth shows no sign of moderating. The deposit-reserve ratio, the amount banks must hold rather than lend, will rise by 0.5 percentage point to 10.5%... Central Bank Governor Zhou Xiaochuan wants to cut excess investment as he tries to cool an economy that probably grew 11% last quarter... 'Chinese authorities have a significant liquidity problem on their hands,' said Tim Condon, an economist at ING Bank..."

April 5 - XFN: "China's business confidence index rose to a record 142.0 points in the first quarter, led by gains in the manufacturing and construction sectors, the National Bureau of Statistics said...The rise in the NBS index mirrors that of the Xinhua Finance/MNI Business Sentiment survey."

April 2 - Bloomberg (Nipa Piboontanasawat): "Hong Kong's retail sales rose in February at the fastest pace in more than 15 years as people bought more food and clothes during the Lunar New Year holidays and tourists increased. Retail sales jumped 28.4% by value from a year Earlier..."

India Watch:

April 2 - Bloomberg (Kartik Goyal): "India's exports rose 8% to $9.7 billion in February, the Commerce and Industry Ministry said. Imports rose 25.1% to $14.36 billion, widening the trade deficit to $4.66 billion..."

Asia Boom Watch:

April 2 - Bloomberg (Seyoon Kim): "South Korea's exports growth accelerated more than expected in March, led by sales of ships and chips used in computers, cameras and mobile phones. The nation's currency and shares rose. Exports climbed 14% from a year ago..."

Unbalanced Global Economy Watch:

April 5 - Bloomberg (Greg Quinn): "Canadian employers added 54,900 jobs in March, five times what economists forecast, suggesting the Bank of Canada may raise interest rates to control inflation. The jobless rate stayed at a three-decade low of 6.1%..."

April 5 - Bloomberg (Jennifer Ryan and Brian Swint): "U.K. house-price inflation accelerated to the fastest pace in two years in the first quarter, a sign higher interest rates may be needed to cool the property market, a report by HBOS Plc showed. In the three months ended March, home values rose 11.1% from the same period a year earlier...to an average 194,362 pounds ($384,000)..."

April 2 - Bloomberg (John Fraher): "Britons borrowed the most against the value of their homes in almost three years during the fourth quarter, a sign surging property prices are fueling consumer spending in Europe's second-largest economy."

April 3 - Bloomberg (Brian Swint): "Construction growth in London and the southeast of England reached the fastest pace in at least 12 years during the first quarter, leading a pickup in the U.K. building industry, a survey showed."

April 4 - Bloomberg (Svenja O'Donnell): "Russia's economy grew 7.8% in the final three months of 2006, accelerating from the third quarter... Gross domestic product growth in the period compares with a revised 6.8% in the third quarter and 7.9% in the same period a year earlier, the Federal Service of State Statistics said..."

April 6 - Bloomberg (Maria Levitov): "Russia, the world's largest energy exporter, raised its forecast for economic growth through 2010, citing higher-than-expected manufacturing and metals output. The country's $1 trillion economy will probably grow 6.5% this year, up from the previous estimate of 6.2%..."

April 2 - Bloomberg (Ben Holland): "Turkish exports rose to a record $8.94 billion in March, according to preliminary data from the Turkish Exporters' Assembly. Exports rose 19% in the month from a year earlier... In the first quarter, exports rose 25% to $23.2 billion."

Latin American Boom Watch:

April 6 - Bloomberg (Adriana Brasileiro and Carla Simoes): "Brazil's real held near a six-year high as foreign investors moved money into the country to tap into a rally in the stock and bond markets... Yesterday, the currency touched 2.0276 per dollar, its strongest since... March 6, 2001. The real has gained 5.1 percent against the dollar this year, making it the best performer of the 16 most active currencies."

Central Banker Watch:

April 2 - Bloomberg's Craig Torres and Scott Lanman quoting William Poole, St. Louis Federal Reserve Bank President: "'There would have to be a high hurdle rate for me to want to be cutting rates if the economy is only marginally and tentatively on the weak side' and inflation isn't slowing toward 2 percent..."

Bubble Economy Watch:

April 5 - Bloomberg (Alan Bjerga): "Easter eggs will cost U.S. consumers about 25% more than last year as ethanol demand drives up feed prices, USA Today reported, citing American Farm Bureau Federation senior economist Terry Francl. The average U.S. retail price for a dozen large eggs was $1.51 in the first quarter, 43 cents more than a year earlier... The increase stemmed mostly from higher corn and soybean prices..."

Financial Sphere Bubble Watch:

April 4 - Financial Times (Deborah Brewster): "When Deutsche Bank's fund management arm raided rival Amvescap a few weeks ago and lured away 17 money managers, it highlighted a global shake-up occurring in the formerly cautious world of fixed-income money management. Pension funds are under pressure to shift more money into bonds in order to more closely match their liabilities, but they are also trying to lift returns. These twin goals have helped fuel an explosion of new, more aggressive fixed-income strategies using leverage, short selling, and derivatives. 'These are the biggest changes I have seen in 10 to 15 years,' says Peter Knez, head of fixed income at Barclays Global Investors. 'The confluence of these trends and the momentum, the rapid evolution of products. Fixed income is starting to look more like equities.' His comments are echoed by leading money managers, who report seeing a dramatic shift in demand for new bond strategies that could have a long-term impact on both the bond markets and on the way pension fund money is managed. Calpers...recently shifted its $6.7bn international fixed-income portfolio to a so-called 130/30 strategy, which involves using about one-third of the money to sell assets short, and leveraging one third of it. The new strategies, which also include investments in collateralised loan obligations, currencies and credit default swaps, carry higher fees... They also reinforce trends in debt markets, in parts of which CLOs are replacing banks as lenders and in which trading in credit default swaps and other derivatives now dwarfs activity in the more staid bonds that underlie them. 'The derivatives market [in fixed income] now is much larger than the cash market,' says Jim Hirschmann, president of Legg Mason..."

Mortgage Finance Bubble Watch:

April 6 - Reuters: Citigroup Inc., largest U.S. bank and one of the largest U.S. mortgage lenders, is telling brokers that on Monday it will stop making some riskier home loans... The move follows decisions by Countrywide Financial Corp., Wells Fargo & Co. and other major mortgage lenders to tighten their underwriting standards as homeowner delinquencies and defaults increase."

April 6 - Bloomberg (Jody Shenn): "Fannie Mae and Freddie Mac, the largest packagers of home loans into securities, last quarter had their greatest share of U.S. mortgage-backed bond issuance since 2004, Inside MBS & ABS reported... The government-chartered companies accounted for 45.9% of mortgage-securities issuance, or $246.2 billion, up from 39.9% for all of 2006..."

MBS/ABS/CDO Watch:

April 2 - Fitch: "As the U.S. subprime market stresses continue to materialize, 2005 and 2006 vintage structured finance (SF) CDOs will be under greater ratings pressure as they have substantially larger concentrations of subprime RMBS, according to Fitch... Ratings volatility arising from later vintage subprime RMBS will likely be experienced in 12-18 months as the actual loss experience becomes clearer, according to Senior Director Derek Miller."

April 4 - Bloomberg (Jody Shenn): "Some collateralized debt obligations that invest in subprime mortgage bonds, related derivatives and other CDOs may be less diversified than they appear, raising investors' risks, according to Moody's... Greater use of credit-default swap contracts is creating more situations in which CDOs may be doubling up on exposures to the risks of specific bonds, either through multiple direct investments or purchases of other CDOs' bonds..."

Real Estate Bubbles Watch:

April 3 - Bloomberg (Sharon L. Crenson): "Manhattan's median apartment price rose 1.2% in the first quarter from a year earlier, the smallest quarterly gain in five years, appraiser Miller Samuel Inc. and broker Prudential Douglas Elliman Real Estate said. The median price of all co-ops and condominiums in Manhattan...rose to $835,000."

April 5 - Bloomberg (Brian Louis): "Manhattan office rents rose to a record in March as employers added to their payrolls and supply remained tight, real estate broker Colliers ABR, Inc. said. For Class A office space...asking rents rose 33% from a year earlier to an average of $72.57 a square foot... The vacancy rate fell to 6.1% from 8.1% on an annual basis."

April 4 - Bloomberg (Hui-yong Yu): "Real estate investment trusts that own regional shopping malls were the best-performing U.S. REITs in the first quarter, as rising retail sales and store rents lifted returns, said the National Association of Real Estate Investment Trusts. An index of nine mall landlords...delivered an average total return -- stock appreciation plus dividends -- of 13.9% last quarter..."

M&A and Private-Equity Bubble Watch:

April 2 - Bloomberg (Justin Baer and Edward Evans): "Bankers are salivating over about $2 billion of fees from leveraged buyouts in the first quarter, and that's just a fraction of what they're assured of earning in the busiest year so far for mergers and acquisitions. The value of announced LBOs surged 40% to $188 billion... 'What was deemed to be possible a year ago when we thought the limits were $25 billion to $30 billion have been easily beaten, particularly in the U.S.,' said Gavin MacDonald, the...head of European M&A at Morgan Stanley... A $100 billion deal 'isn't outside the realms of possibility,' he said. LBO firms have raised more than $210 billion since the start of 2006, while falling bond yields mean they can borrow enough to afford at least $2 trillion of acquisitions... At the same time, Blackstone and KKR are gathering $20 billion or more for new record-sized funds."

Energy Boom and Crude Liquidity Watch:

April 2 - Bloomberg (Arif Sharif): "Kuwait, the fourth-biggest Arab economy, said its 2006 trade surplus increased 44% to 11.5 billion dinars ($39.7 billion) as income from oil exports jumped and imports decreased. Kuwait's exports rose 23%..."

April 6 - Bloomberg (Sean Cronin): "Dubai, the Middle East's fastest-growing city, is running out of office space, according to the commercial property broker CB Richard Ellis Group Inc... 'There's a desperate shortage,' (CB Richard Ellis director) Maclean said in an interview. In some cases, companies are 'running their operations from other locations until the space eases up.'"

Climate Watch:

April 7 - Financial Times (Fiona Harvey): "Billions of people in Asia will be at risk of flooding as the effects of climate change take hold in the next few decades, the world's leading climate scientists said... The poor will be worst hit, as climate change is expected to bring some benefits to richer countries such as north America and northern Europe in the form of longer crop growing seasons, but countries that are already hot will suffer. Diseases borne by mosquitoes, such as malaria, dengue fever and yellow fever will also greatly extend their range... But the residents of the southern coastal states of the US will also be at much greater risk of hurricanes and tropical storms. The scientists of the Intergovernmental Panel on Climate Change delivered their verdict in Brussels after a four-day meeting..."

Speculator Watch:

April 2 - Financial Times (Doug Cameron): "Chicago's two dominant futures exchanges handled record trading volumes during March as rising volatility combined with more electronic trading by clients. The Chicago Board of Trade...reported a 30% rise in March volumes... That lifted the overall first-quarter total by 24%... The CME, which trails only Eurex by volumes, is likely to have overtaken its German-Swiss rival with a 30 per cent quarterly gain in trading volumes and a 45 per cent rise in March."

"Vintage 2007":

Today's robust March payroll data should put to rest the view of imminent Fed rate cuts. Nonfarm Payrolls jumped a much stronger-than-expected 180,000 (consensus estimate: 130,000), a notable upswing from February's 113,000 (revised from 97,000) - raising the 3-month average monthly growth to 152,000. March's job gains were the strongest since December's 226,000. Goods Producing employment rose by 43,000, the most since January 2006. Certainly bolstered by the virtually nationwide commercial building boom, Construction employment actually increased 56,000. Service Producing jobs increased 137,000, with a 12-month gain of 2.006 million. The Unemployment Rate declined from February's 4.5% to 4.4% and has not been lower since May 2001. Average weekly hours worked, at 33.9, hasn't been higher since July 2001. Average Hourly Earnings were up 4.0% y-o-y.

On the news, December '07 3-month eurodollar yields surged 13.5 bps to 5.065%, the highest level since February 23rd. Two-year Treasury yields jumped 11 bps to 4.74%, with 10-year yields up 7 bps to 4.75%. The markets are now pricing almost no chance of a rate cut at the May 9th and June 28th FOMC meetings.

From a Macro Credit Perspective, persistently tight labor market conditions are no surprise. Total system Credit creation remains extreme, with corporate borrowings proceeding at a record pace. With marketplace liquidity, stock prices and executive salaries still demonstrating enticing inflationary biases, there remains ample impetus for business spending, hiring and the aggressive pursuit of revenues and profits. Especially for skilled workers, labor today retains significant - and in some cases extraordinary - pricing power. And while a small percentage of households suffer mightily from the subprime debacle, a larger share of the population enjoy banner income growth. As we've witnessed repeatedly, Bubbles have a powerful propensity to go to amazing extremes. The current Corporate Finance Bubble is no exception.

This week, Buffalo, New York, based M&T Bank Corporation confirmed that mortgage problems are anything but contained to subprime: "Unfavorable market conditions and lack of market liquidity impacted M&T's willingness to sell Alt-A loans in the first quarter. At a recent auction of such loans fewer bids than normal were received and the pricing of those bids was lower than expected."

Undoubtedly, mortgage problems are pervasive and festering. Considering the unprecedented degree of excess that prevailed across all income levels, property values and mortgage products throughout the protracted boom, there is every reason to expect the Credit loss pathosis to eventually infect the entire mortgage industry. The much more challenging aspect of the analysis remains the timing, circumstances and ramifications of the Unfolding Mortgage Credit Bust.

I'll posit that, typically, the general economy would have tended to respond much more promptly to major housing and mortgage developments than has been the case since the housing boom peaked about 18 month ago. For one, a major housing adjustment would have in the past initiated a major slowdown in new mortgage Credit and a marked slowing in Total System Credit (and liquidity). An increasingly risk-averse banking system - traditionally the originator, intermediator, and governor of much of the economy's finance - would have initiated a general tightening of Credit Availability. Stock prices would have almost immediately begun to discount much less favorable Credit, liquidity, corporate profit and income growth prospects, triggering an equities bear market that would have placed additional pressure on the Credit Cycle downturn.

Over the past year or so we have witnessed something quite - one could argue radically - different. Total mortgage debt growth has remained significantly elevated, while total system Credit and marketplace liquidity actually accelerated. While there have been some bouts of market nervousness, the feared deterioration in the general liquidity backdrop has not yet materialized. And instead of housing-induced consumer retrenchment, robust income growth and attendant home price resiliency have safeguarded interminable household spending excess. Rather than a general tightening of system Credit, the historic expansion of Wall Street and market-based finance has, ironically, created the loosest Financial Conditions imaginable.

The "2006 Vintage" of residential mortgage loans is now recognized as being in a class by itself (recalling the 1999/2000 Vintage of telecom debt). This predicament supports a central tenet of Macro Credit Theory: Credit losses (and maladjustment) expand in an exponential manner in the late stages of a Credit boom. Invariably, the benefits of prolonging frenetic "Ponzi" financial schemes will appear much more appealing than the alternative. The fundamental backdrop in 2005 (and earlier) beckoned for a major tightening in mortgage lending standards, one that rampant marketplace liquidity ensured was delayed for a number of perilous quarters. The upshot was a year of absolutely atrocious lending that is now coming home to roost, along with ongoing excesses ensuring that the roosting process has years to run.

Examining the unfolding backdrop, one can envisage the scenario of heightened mortgage stress, intensifying downward pressure on real estate prices, unfolding debacles in California and other egregious real estate Bubbles across the country, faltering corporate profits, a vicious stock market bear, serious household sector financial problems, dollar confidence issues and the bursting of the U.S. economic Bubble. But this fundamental backdrop resonates within the marketplace today about as clearly as this year's subprime meltdown did a year ago.

When it comes to "Vintage 2007," certainly the M&A marketplace is working diligently to ensure subprime-like notoriety (infamy). Ditto the booming markets in Credit "insurance" and Credit "arbitrage." In general, this year's corporate debt issuance boom is highly suspect, especially the acutely vulnerable financial sector recklessly ballooning balance sheets with risky assets and depleting meager equity cushions through ridiculously excessive stock repurchases.

Much less distinct but definitely worth pondering is the possibility that the (by far) most problematic "Vintage 2007" debt issue will be the $1 Trillion or so of additional Credit the Rest of World extends this year to sustain U.S. Credit and Economic Bubbles. The financing circumstance associated with the U.S. Bubble is "Ponzi Finance" at its worst - although clearly the benefits of prolonging the boom appear more appealing than having it end. But to sustain the boom will require ever larger foreign purchases of ABS, MBS, CLOs, CDOs and such - structures susceptible to waning market confidence.

The U.S. Current Account Deficit doesn't get the Credit it deserves for its paramount role in fostering ongoing global liquidity excess. Basically, our Credit system now creates and disburses $1 Trillion of new IOUs - additional purchasing power - to the world each year. As long as global central banks and the leveraged speculating community step up to "recycle" much of this liquidity back to U.S. debt markets, this perpetual "money" machine works as well as subprime finance appeared to work in 2004/05. However, the Insuperable Credit Bubble Dilemma is that over time the quality of the underlying debt deteriorates progressively until - as it did recently with Wall Street and its subprime exposure - there reaches a point of recognition that risk has grown unacceptably high.

The problem for "Vintage 2007" U.S. "Ponzi" finance is that it has insidiously become acutely vulnerable to a flight away from U.S. securities markets. With major Credit problems on the horizon, U.S. mortgage finance is now dangerously vulnerable to any spike in market yields. The already suspect quality of much of the new M&A related debt is further vulnerable to a jump in rates, a stock market break, liquidity dislocation and/or economic downturn. And the massive agency debt market is an accident in the making, while the entire U.S. financial sector's debt structure is increasingly suspect. The greatest vulnerability could very well be "Vintage 2007" structured finance - CDOs, CPDOs, CDS and derivatives generally.

U.S. securities markets continue to lag much of the rest of the world. Yet there is an ingrained market perception that financial tumult/crisis is invariably instigated at The Periphery. Participants have been conditioned to believe that risks and excesses are greatest with the inherently fragile "emerging" markets. These markets have also tended in the past to perform as credible "canaries in the mineshaft," warning of more generalized financial turbulence. So with emerging markets again trading well and crude and commodities on the rise, complacency with respect to the general liquidity backdrop has returned with a vengeance.

Here's where the markets could have it gravely wrong: the greatest vulnerabilities associated with the most egregious (ongoing) excesses today reside not at The Periphery but at The Core. Indeed, current global liquidity excesses are now exacerbated by heightened excesses and flows away from The Core, in the process masking heightened securities market fragility throughout The Core. To be sure, the confluence of $1 Trillion "Ponzi" foreign-sourced funding requirements and suspect "Vintage 2007 and beyond" U.S. debt creation should keep us all on guard.

Doug Noland
The Credit Bubble Bulletin
PrudentBear.com

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