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October 05, 2007

Financial Structures
by Doug Noland

The greed and fear quotient swang decidedly back to the bullish camp. For the week, the Dow gained 1.2% (up 12.9% y-t-d) and the S&P500 jumped 2.0% (up 9.8%). The Transports surged 3.2% (up 9.6%), and the Morgan Stanley Cyclical index rose 2.2% (up 21.5%). The Morgan Stanley Consumer index added 1.0% (up 8.5%), and the Utilities advanced 2.6% (up 10.9%). The broader market rallied strongly. The small cap Russell 2000 surged 4.7% (up 4.9%), and the S&P400 Mid-Cap index gained 3.2% (up 13.6%). The NASDAQ100 jumped 2.7%, increasing 2007 gains to 22.4%. The Morgan Stanley High Tech index increased 1.6% (up 19.5%), while the Semiconductors dipped 0.2% (up 6.6%). The NASDAQ Telecommunications index gained 2.3% (up 25.9%), and The Street.com Internet Index jumped 3.4% (up 21.5%). The Biotechs rose 2.5% (up 11.8%). The financial stocks rallied sharply. The Broker/Dealers jumped 5.3% (up 0.7%), and the Banks rallied 4.1% (down 6.0%). With Bullion slipping only $1, the HUI Gold index added 0.3% (up 16.5%).

It was a volatile week throughout the interest-rate markets. Three-month T-bill rates jumped 9.5 bps this week to 3.97%. Two-year U.S. government yields rose 9 bps to 4.07%. On the back to today's 13bps surge, five-year yields ended the week 8.5 bps higher to 4.33%. Ten-year Treasury yields increased 5 bps to 4.64%, and long-bond yields added 3 bps to 4.87%. The 2yr/10yr spread ended the week at 57 bps. The implied yield on 3-month December '07 Eurodollars surged 18 bps to 5.025% - the high since August 8th. Benchmark Fannie Mae MBS yields added 2 bps to 5.99%, this week outperforming Treasuries. The spread on Fannie's 5% 2017 note narrowed 4 to 39, and the spread on Freddie's 5% 2017 note narrowed 3 to 39. The 10-year dollar swap spread was little changed at 62.75. Corporate bond spreads narrowed. The spread on a junk index ended the week 15 narrower .

October 3 - Financial Times (Saskia Scholtes and Michael Mackenzie): "Companies are selling US high-grade bonds in record amounts, putting the market on track for its first $1,000bn year and suggesting better-rated issuers are finding ways around the credit squeeze. Analysts say the growing popularity of investment-grade bonds is a consequence of the difficulties companies are having to sell commercial paper - shorter-term, floating-rate debt... US investment-grade issuance hit a record $94.2bn in September, bringing this year's total to $766bn, Thomson Financial says. Investment-grade issuance was just under $700bn this time last year. Issuance for all of 2006 was $938bn."

Investment grade debt issuers included Target $1.25bn, TIAA Global Markets $1.0bn, Clorox $750 million, Viacom $750 million, Northwest Airlines $450 million, Lincoln National $375 million, Schwab Capital Trust $300 million, Florida P&L $300 million, and Compass Bankshares $250 million.

Junk issuers included RH Donnelley $1.5bn, Delta Airlines $1.4bn, Steel Dynamics $700 million, Ryerson $575 million and Lamar Media $275 million.

Convert issuers included Molina Healthcare $175 million and Excel Maritime $125 million.

Foreign dollar bond issuance included TNK-BP Finance $1.7bn, Trans-Canada Pipelines $1.0bn, Jamaica $365 million, and EMP Distribuidora $220 million.

October 1 - Financial Times (Stacy-Marie Ishmael): "Record-high commodity prices and rising cash reserves have reduced emerging economies' need to tap international debt markets, meaning corporate bond issuance will continue to outstrip sovereign borrowing, according to JPMorgan. Developing countries issued $36bn bonds up until the end of September, compared with $124bn raised by emerging corporate borrowers over the same period... 'Sovereign issuance needs are very limited," said Joyce Chang, JPMorgan's global head of emerging markets. "A lot of these countries are commodities exporters and are flush with cash and record reserve levels." While emerging corporates have accessed international debt markets with increasing frequency, their sovereign counterparts have steadily reduced their borrowing over the years."

German 10-year bund yields rose 2 bps to 4.35%, as the DAX equities index added 1.6% (up 21.2% y-t-d). Japanese 10-year "JGB" yields increased 2 bps to 1.695%. The Nikkei 225 rallied 1.7% (down 0.9% y-t-d). Most emerging debt and equities Bubbles enjoyed a bountiful week. Brazil's benchmark dollar bond yields fell 4 bps to 5.80% - the low since May. Brazil's Bovespa equities index increased 3.1% to a record high (up 40.1% y-t-d). The Mexican Bolsa jumped 4.1% (up 19.3% y-t-d). Mexico's 10-year $ yields added one basis point to 5.62%. Russia's RTS equities index gained 2.1% (up 10.1% y-t-d). India's Sensex equities index jumped 3.6% to another record (up 28.9% y-t-d and 43.5% y-o-y). China's Shanghai Exchange took a holiday-week respite (up 107.5% y-t-d and 216.8% y-o-y).

Freddie Mac posted 30-year fixed mortgage rates declined 5 bps this week to 6.37% (up 7bps y-o-y). Fifteen-year fixed rates fell 6 bps to 6.03% (up 5bps y-o-y). One-year adjustable rates dipped 2 bps to 5.60% (up 12bps y-o-y).

Bank Credit expanded $26.8bn for the week (9/26) to $8.923 TN. Bank Credit is now up $280bn over the past ten weeks, with a $627bn, or 10.1% annualized, y-t-d gain. For the week, Securities Credit added $0.8bn. Loans & Leases surged $25.9bn to a record $6.574 TN (10-wk gain of $249bn). C&I loans rose $6.2bn, increasing the y-t-d growth rate to 20.2%. Real Estate loans jumped $17.9bn. Consumer loans slipped $2.6bn. Securities loans declined $2.0bn, while Other loans gained $6.4bn. On the liability side, (previous M3) Large Time Deposits jumped $16.6bn.

M2 (narrow) "money" increased $5.7bn to a record $7.377 TN (week of 9/24). Narrow "money" has expanded $333bn y-t-d, or 6.3% annualized, and $473bn, or 6.9%, over the past year. For the week, Currency added $1.6 bn, while Demand & Checkable Deposits fell $15.0bn. Savings Deposits rose $11.5bn, and Small Denominated Deposits increased $5.0bn. Retail Money Fund assets increased $2.6bn.

Total Money Market Fund Assets (from Invest. Co Inst) jumped $37.1bn last week to a record $2.892 TN. Money Fund Assets have now posted a 10-week gain of $308bn and a y-t-d increase of $501bn (27.8% annualized). Money fund asset have surged $646bn over 52 weeks, or 28.8%.

Total CP gained $4.5bn to $1.860 TN, stabilizing after a dramatic seven-week swoon. This reduced the eight-week decline to $364bn. Asset-backed CP added $1.3bn (8-wk drop of $250bn) to $924bn. Year-to-date, total CP has declined $114bn, with ABCP declining $160bn. Over the past year, Total CP has contracted $48bn, or 2.5%.

Asset-backed Securities (ABS) issuance increased to $8.0bn this week. Year-to-date total US ABS issuance of $470bn (tallied by JPMorgan) is running 30% behind comparable 2006. At $211bn, y-t-d Home Equity ABS sales are 52% off last year's pace. Year-to-date US CDO issuance of $268 billion is running slightly below 2006 sales.

October 4 - Bloomberg (Steve Rothwell): "Sales of collateralized debt obligations slumped to the lowest in 21 months during September, according to Morgan Stanley. Banks sold 20 CDOs totaling $16 billion worldwide last month..."

Fed Foreign Holdings of Treasury, Agency Debt last week (ended 10/3) rose $3.2bn to $1.998 TN. "Custody holdings" were up $246bn y-t-d (18.3% annualized) and $324bn during the past year, or 19.3%. Federal Reserve Credit last week expanded $2.0bn to $862bn. Fed Credit has increased $9.4bn y-t-d and $31.9bn over the past year (3.8%).

International reserve assets (excluding gold) - as accumulated by Bloomberg's Alex Tanzi - were up $935bn y-t-d (25% annualized) and $1.122 TN y-o-y (24%) to $5.746 TN.

October 5 - Market News International: "Japan's foreign reserves hit a record $945.60 billion at the end of September, rising for the fourth consecutive month and

surpassing the previous record high of $932.16 billion marked at end of August."

October 4 - Bloomberg (Maria Levitov): "Russia's foreign currency and gold reserves climbed for a fifth consecutive week to a record $425.1 billion on Sept. 28, the central bank said. The reserves, the world's third biggest, rose $2.6 billion..."

Credit Market Dislocation Watch:

October 5 - Financial Times (James Mackintosh): "Investment banks are offering finance to 'vulture funds' on improved terms if the money is used to buy debt from them, according to bankers and managers of the funds. Banks keen to shift a backlog of well over $200bn of leveraged buy-out debt are tying leverage for recovery, or vulture, funds run by hedge funds and private equity to the sale of the debt. The financing amounts to a hidden discount, allowing the banks to minimise public discounts on LBO debt they are having to sell at below face value... 'The banks are offering different terms depending on whether you take their loans or other people's loans,' said one hedge fund manager... 'Most of the leverage being provided by banks is only being provided if you buy their loans,' said another. The improved terms, typically via total return swaps, which package the financing and sale, are most widely available from so-called universal banks with access to deposits, fund managers said."

October 5 - Financial Times (James Mackintosh): "...Banks have upwards of $200bn - some estimates say as much as $400bn - of unsold loans used to back leveraged buy-outs (LBOs) sitting on their balance sheets, and they are desperate to dump them. But the buyers also have a problem. Private equity and hedge fund groups typically borrow to invest, and the credit squeeze which caused the banks' LBO problems has also made it harder for the funds to secure finance. Now big banks are trying to solve both problems by offering to lend to the funds - as long as they use the money to buy the unwanted LBO loans from the banks. 'The banks are saying, 'If you buy my loan above market, we will give you more leverage,' said one investment banker. 'They are taking market risk and turning it into counterparty risk.'"

October 5 - Financial Times (Chris Giles, Gillian Tett and Jane Croft): "Northern Rock borrowed another £2.9bn ($5.9bn) last week from the Bank of England... Three weeks after Northern Rock went to the Bank for support, it owes nearly £11bn [$22bn], equal to 45% of its deposit base at the end of June."

October 2 - Bloomberg (Sandrine Rastello): "European Central Bank board member Christian Noyer said turmoil from the plunge in U.S. subprime mortgages is still roiling markets. 'The liquidity crisis is not over,' Noyer, governor of the Bank of France, told French lawmakers today in Paris. 'Normal market conditions are far from restored,' he said, adding that it was 'difficult to restart the interbank' credit market."

October 3 - Financial Times (David Wighton): "'If it went wrong, we were in it, we were bigger in it and we were slower to react,' said one senior Citigroup executive summing up yesterday's profit warning. The surprise was not just that the 60% forecast fall in third-quarter earnings was bigger than expected, but that the problems were spread so widely across the group. Within Citigroup's investment bank there were $1.4bn of writedowns on leveraged loan commitments, $1bn of net writedowns on mortgage-backed securities, $250m of writedowns on collateralised loan obligations and $600m of other credit trading losses. Moreover, Gary Crittenden, chief financial officer, said that the performance of its markets and banking business was 'below expectations - even taking in account turbulent market conditions'. At the same time, Citi's consumer business, which is supposed to cushion the swings in its more volatile capital markets activities, also disappointed. Citi had signalled that higher credit costs were inevitable as the very favourable recent credit environment reverted to more normal levels. But the $2.6bn rise in credit costs in the consumer arm was higher than expected..."

October 5 - Bloomberg (Bradley Keoun): "Merrill Lynch & Co., the world's largest brokerage, will report its first quarterly loss in six years and faces 'continued challenges' in credit markets the rest of this year. The 50 cents-a-share loss for the three months...resulted from about $5 billion of writedowns on mortgages, asset-backed securities and loans for leveraged buyouts, Merrill said..."

October 5 - Bloomberg (Neil Unmack): "Structured investment vehicles, funds that borrow in the commercial paper market, sold about $75 billion of assets in the past two months as financing costs rose, according to Moody's... The so-called SIVs, which borrow to buy longer-dated securities, are struggling to raise cash because of investor concern over links to money-losing subprime mortgages."

October 5 - Financial Times (Peter Thal Larsen, David Wighton and Ben White): "Bankers are counting the cost of the crisis... The numbers are large: this week alone, Citigroup, Deutsche Bank and UBS have announced asset writedowns of almost $13bn between them for the third quarter of the year. This comes on top of losses already disclosed by Goldman Sachs, Morgan Stanley, Lehman Brothers and Bear Stearns. Merrill Lynch and JPMorgan Chase have yet to outline their own exposures but are also expected to have suffered setbacks. et this splurge of red ink has been surprisingly well received... Analysts at Morgan Stanley describe the blood-letting as 'cathartic'. Indeed, it even produced some apparently perverse results. 'It seems the more money you lose, the more your shares go up,' one investment banking chief observes."

Currency Watch:

The dollar index rallied 0.7% to 78.25. For the week on the upside, the Canadian dollar increased 1.1% (31-yr high), the South African rand 0.5%, the Mexican peso 0.4%, the Australian dollar 0.4%, and the Singapore dollar 0.4%. On the downside, the Japanese yen declined 1.0%, the Swiss franc 0.8%, the Norwegian krone 0.8%, and the Euro 0.7%.

Commodities Watch:

October 4 - Bloomberg (Jae Hur and Marianne Stigset): "Wheat rose for a second day on signs near-record prices...aren't slowing global demand and as Australian crops wither in the country's worst drought. Japan bought 160,000 metric tons of milling wheat at a tender today, the largest purchase in almost a month by Asia's biggest importer..."

October 5 - Financial Times (Chris Flood): "Lead prices continued a record-breaking run yesterday with the three-month price spiking to $3,655 a tonne. Profit-taking later dragged the metal down 0.9% to $3,607.5."

October 3 - Financial Times (Jeremy Grant): "The number of cases involving manipulation and false price reporting in commodity and commodity futures markets caught by US regulators has reached record levels in the past 12 months. The Commodity Futures Trading Commission, which oversees such markets, yesterday revealed it had collected a record $540m in civil penalties, restitution and disgorgement (the return of ill-gotten gains made as a result of a fraud) from cases involving fraud, manipulation and other misconduct. It said this was a record. The disclosures are a sign that unprecedented volumes in commodity markets are giving rise to a corresponding increase in enforcement actions."

For the week, Gold held virtually all of recent gains, while Silver fell 3.1% to $13.49. December Copper jumped 3.2% to a record high. November crude declined 44 cents to $81.22. November gasoline added 0.4%, and November Natural Gas rose 3.0%. December Wheat ended the week 5.2% lower. For the week, the CRB index declined 1.3% (up 7.1% y-t-d). The Goldman Sachs Commodities Index (GSCI) slipped 0.8% (up 24.8% y-t-d).

Japan Watch:

October 1 - Bloomberg (Lily Nonomiya): "Japan's key barometer of business confidence unexpectedly held near a two-year high and companies increased spending plans..."

October 3 - New York Times (Ken Belson): "The United States may be the world's largest economy, but when it comes to Internet connections at home, many Americans still live in the slow lane. By contrast, Japan is a broadband paradise with the fastest and cheapest Internet connections in the world. Nearly eight million Japanese have a fiber optic line at home that is as much as 30 times speedier than a typical DSL line."

China Watch:

October 3 - Bloomberg (Michele Batchelor): "Chinese coal producers offered supplies to South Korean utilities at 7.5% above prices concluded in May with Japanese rivals because shortages of the fuel have worsened, said buyers involved in the talks."

October 1 - Bloomberg (Nipa Piboontanasawat): "Hong Kong's retail sales jumped by the most in more than three years as tourists flooded in and rising incomes and stock prices boosted consumer spending. Sales by value rose 15% in August from a year earlier..."

India Watch:

October 1 - Bloomberg (Cherian Thomas): "India's trade deficit widened in August as companies stepped up imports of oil and machinery to meet demand in the world's second-fastest growing major economy. The trade deficit jumped to $6.8 billion from $5 billion in July.... Imports rose 32.6% to $19.5 billion. Exports in August grew 18.9% to $12.6 billion."

Asia Bubble Watch:

October 5 - Bloomberg (Chinmei Sung and James Peng): "Taiwan's inflation accelerated to a two-year high in September on food costs, adding pressure for another interest-rate increase. Consumer prices advanced 3.08% from a year earlier..."

October 1 - Bloomberg (Jean Chua): "Singapore's third-quarter private home prices rose 8% to a 10-year high, buoyed by the city-state's economic expansion. The government said it may sell more land next year to ease demand."

Unbalanced Global Economy Watch:

October 1 - Dow Jones (Ilona Billington and Joe Parkinson ): "The U.K. housing market looks set to cool further as mortgage lending slumped to an 18-month low in August... Digesting the news, economists said the risk of a sharper correction was growing as lending conditions tighten. BoE data showed that mortgage lending grew GBP8.5bn in August, down from July's GBP8.9bn and the lowest gain since February last year."

October 3 - Bloomberg (Svenja O'Donnell): "Growth in U.K. service industries from banks to hotels weakened to a 13-month low in September, a sign rising borrowing costs are starting to slow the pace of economic growth."

October 4 - Bloomberg (Jennifer Ryan): "U.K. house prices fell in September for the first time in nine months as mortgage rates rose and lenders grew more cautious, a report from HBOS Plc showed... Prices rose 10.7% in the quarter through September from a year earlier."

October 5 - Bloomberg (Tim Barwell): "HSBC Holdings Plc said the U.K. may face the withdrawal of significant amounts of so-called 'hot money' if growth slows and funds start to lose confidence in the management of Britain's economy... Investors who have in recent times invested large amounts of money in the U.K. for short periods -- known as 'hot money' -- may take it elsewhere, with serious consequences for the London financial industry and the pound..."

October 4 - Bloomberg (Fergal O'Brien): "Irish house prices fell for a second month in August as rising borrowing costs and concerns about a property slump deterred homebuyers. Prices fell 1.9% from a year earlier, after declining 0.7% in July, according to a monthly index... by Irish Life & Permanent Plc... The decline in July was the first annual drop since the series began in 1996."

October 3 - Bloomberg (Ben Sills and Fergal O'Brien): "European service industries grew at the weakest pace in two years in September after a jump in credit costs hurt banks."

October 5 - Bloomberg (Christian Vits): "European banks may make it harder for companies and consumers to borrow money in the next three months after the slump in the U.S. subprime mortgage market increased the cost of credit, the European Central Bank said. 'Banks generally reported' that the recent credit-market turmoil 'may hamper funding over the next three months,' the Frankfurt-based ECB said in its quarterly bank lending survey..."

October 5 - Bloomberg (Maria Levitov): "Russian consumer prices rose more than expected in September as sunflower oil, dairy and other food products became more expensive, the Federal Statistics Service said. Consumer prices increased a monthly 0.8%... Consumer prices increased 7.5% in the first nine months of the year..."

Latin America Watch:

October 3 - Bloomberg (Eliana Raszewski and James Attwood): "Chilean consumer prices climbed more than economists projected in September, pushing the annual nflation rate to its highest in at least eight years. Consumer prices rose 1.1% from the previous month and 5.8% from a year ago, led by steeper food costs..."

Bubble Economy Watch:

October 2 - Bloomberg (Bill Rochelle): "Bankruptcy filings in the U.S. averaged 3,541 each business day in September and are on track to reach 807,000 for the year, a 37% increase over...2006. September had the 'highest average daily filings in all of 2007 and the largest since' an October 2005 federal bankruptcy law made it harder to eliminate debt..."

October 2 - Bloomberg (Linda Sandler): "Contemporary art values rose 55% in the year through June as collectors paid record auction prices for artists such as Damien Hirst and Banksy, said insurer Hiscox Ltd."

Central Banker Watch:

October 4 - Bloomberg (Greg Quinn and Theophilos Argitis): "Canadian Prime Minister Stephen Harper picked Mark Carney, a finance ministry official and former investment banker at Goldman Sachs Group Inc., to succeed David Dodge as governor of the Bank of Canada. Carney, 42, will be only the second outsider to run the central bank since it was formed in 1934... Carney joins the growing ranks of Goldman Sachs alumni at top positions in the global financial system. "

California Watch:

October 4 - Bloomberg (Jeremy R. Cooke): "California is selling the first U.S. municipal bonds to finance human embryonic stem-cell research, leading states' efforts to attract scientists in the field amid restrictions on federal funding. California, the largest borrower in the municipal market, offered $250 million of taxable bonds at 1.15 percentage point more than three-year U.S. Treasuries, or about 5.16%..."

GSE Watch:

October 3 - Bloomberg (James Tyson and Alison Vekshin): "Fannie Mae and Freddie Mac, the largest U.S. mortgage-finance companies, would buy at least $120 billion in subprime home loans under a Democratic proposal intended to stem foreclosures, Senator Charles Schumer said..."

Mortgage Finance Bust Watch:

October 3 - Bloomberg (Jody Shenn): "About 17% of subprime-mortgage balances in bonds are too large for borrowers to refinance into loans from Fannie Mae or Freddie Mac, making them more likely to default, UBS AG analysts said. The loans exceed the $417,000 limit for what government-chartered Fannie Mae and Freddie Mac...can buy... Subprime borrowers with jumbo mortgages 'will probably have a more difficult time in the coming months... Borrowers are having difficulty refinancing or selling their homes at favorable terms as lenders have tightened standards and U.S. home prices have dropped."

October 3 - Market News International (Linda Lowell): "There is evidence that for various reasons, the mortgage industry's enhanced 'loss mitigation' effort is still faltering though Treasury Secretary Hank Paulson continues his efforts to push emergency refinancings. While a House committee was hearing testimony on mitigating and minimizing foreclosures...Moody's announced that most large servicers are still relying on the U.S. mail to initiate contacts with borrowers. According to a survey of subprime mortgage servicers, most servicers had only modified about 1% of loans subject to interest rate resets in January, April or July 2007."

October 5 - Bloomberg (Elizabeth Hester and Jody Shenn): "Washington Mutual Inc., the biggest U.S. savings and loan, said third-quarter profit fell about 75% after the worst housing slump in 16 years caused more borrowers to default. Earnings may be the lowest since the fourth quarter of 1998 on $1.39 billion of bad-loan provisions and writedowns..."

Foreclosure Watch:

October 4 - Financial Times (Saskia Scholtes): "US mortgage companies are being overwhelmed by the large numbers of homebuyers who need to renegotiate their loans to avoid default... Litton Loan Servicing estimates that costs have increased 20% in the last year for mortgage servicers... The result is that few subprime mortgages are being renegotiated. Moody's...found that lenders had eased terms on just 1% of subprime loans resetting at higher interest rates in January, April and July this year. 'Servicers have failed because there's a huge resourcing issue,' said Barefoot Bankhead, managing director at Navigant Consulting. 'As lenders have gone out of business, the servicing arms have been in transition without the resources to handle the enormous number of requests for loan modifications and restructuring.' The problem could grow more severe as more than $350bn in adjustable-rate mortgages reset at higher rates in the next 18 months. 'Servicer inactivity could turn the subprime traffic jam into a monumental pile-up, because the longer people wait to make decisions, the worse the situation gets,' said Don Brownstein, chief executive of Structured Portfolio Management..."

October 3 - ForeclosuresMass.com: "...foreclosures are up in 303 of the state's 351 communities, with 102 communities experiencing at least a doubling of foreclosures, and a total of 220 towns realizing at least 50% increases. The report also forecasts that Q3 foreclosure filings will set a new quarterly record with at least 7,000 new foreclosure filings over the months of July, August and September. The quarter began with July's record-breaking total of 2,478 filings. 'What is startling about our findings is the fact that so many cities and towns are being affected. The foreclosure crisis has no boundaries,' said Jeremy Shapiro, president and co-founder of ForeclosuresMass.com."

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

October 5 - Financial Times (Stacy-Marie Ishmael): "US subprime mortgages written during the first half of the year are going delinquent at the fastest rate this decade, according to a Moody's report... The average rate of 'serious loan delinquencies' in the 2007 bonds is higher than those created last year, a vintage considered to be one of the worst-performing ever... 'The early performance clearly shows that the 2007 vintage is worse than last year's,' said David Teicher, co-head of the Moody's residential mortgage-backed securities group...Almost 6% of subprime mortgages written in the first half and later used to back bonds went into delinquency within three months of securitisation..."

October 3 - Bloomberg (Jody Shenn): "Issuance of new U.S. non-agency mortgage securities plunged 72% in September from the same month last year, newsletter Inside Mortgage Finance reported. On a monthly basis, production of mortgage bonds not guaranteed by government-chartered companies Fannie Mae and Freddie Mac or federal agency Ginnie Mae rose 3.7% from August to $33.5 billion... The totals include all securities backed by subprime, Alt-A and prime-jumbo mortgages... The newsletter said last month that its preliminary estimate for August of $31.1 billion represented a five-year low for the month... In September 2006, $119.6 billion of non-agency mortgage securities were issued."

October 2 - Bloomberg (Jennifer Ryan): "Former Federal Reserve Chairman Alan Greenspan said there will be 'some rethinking' of collateralized debt obligations after demand for them helped fuel the collapse of the U.S. subprime mortgage market. 'People always say it's the subprime market that created this crisis. It's the subprime asset-backed market' which did, Greenspan told investors... 'As a consequence of that there's going to be some rethinking about collateralized debt obligations.'"

Real Estate Bubbles Watch:

October 3 - Financial Times (Eoin Callan): "The number of Americans able to find prospective buyers for their homes fell to a record low in August in a sign that the global credit squeeze is worsening the downturn in the US housing market. The National Association of Realtors said signed purchase agreements for existing homes dropped 6.5% to the lowest level since record-keeping began in 2001. Compared with a year earlier, pending home sales were down 22%. The surprisingly sharp fall suggests that the housing market is entering a second phase of decline after lending conditions tightened and credit markets seized up over the summer. 'The existing homes market is now in freefall,' said Ian Shepherdson, an economist at High Frequency Economics."

October 5 - Bloomberg (Bob Ivry): "When D.R. Horton Inc., the second-biggest U.S. homebuilder, couldn't sell the one-bedroom condominium in San Diego it listed for $349,800, the property was auctioned as a last resort for 37% less. D.R. Horton, with annual revenue of about $11 billion, and Hovnanian Enterprises Inc. now face the worst choice in the worst residential real estate slump since the 1930s. They're selling homes at any price they can get. 'It's desperation time and some companies may not make it,' said Alex Barron, an industry analyst at Agency Trading... 'At this point in the housing cycle, if you have too much debt, it's hard to get out from under it.'"

October 2 - Bloomberg (Sharon L. Crenson): "Manhattan apartment prices rose 2.3% in the third quarter to a median of $864,400 as wealthy buyers swept up large, multimillion-dollar luxury condominiums. The median price of a condo in the nation's most expensive urban market jumped 5.2% from a year earlier to $1.12 million."

October 2 - Bloomberg (David M. Levitt): "New York office rents rose last quarter at the slowest pace since the second quarter of 2006, as demand from banks and securities firms began to slacken. The average Manhattan office rent rose 2.6% to $63.56 a square foot at the end of September from the previous quarter, according to...Studley Inc... Through September, office rents rose a record 28%..."

Speculator Watch:

October 3 - Financial Times (Martin Arnold and Gillian Tett ): "French financial market observers have a nickname for groups that switch roles from troublemaker to saviour, or vice versa: they are called pompiers pyromanes , which translates as pyromaniac firemen. A similar metaphor may be applied to Kohlberg Kravis Roberts and Citigroup after it emerged that the US private equity firm and the Wall Street bank have been in talks to raise $5bn of equity and $10bn of debt to buy impaired leveraged buy-out loans. The venture...would be designed to clear up the mess created by more than $300bn of debt that banks provided to fund the recent leveraged buyout (LBO) frenzy and that they are stuck with after the credit squeeze took hold. The irony is that KKR and Citigroup were leading protagonists in creating that mess in the first place... Details were still thin on the ground yesterday about the planned joint venture between the two titans of the buy-out industry... Leveraged finance bankers reacted with glee to the news of the KKR tie-up with Citigroup. 'A lot of people are raising funds at the moment and, if you add up all the special purpose vehicles, it could be incredibly helpful,' said one banker. There are rumours that the combined firepower of all the funds currently being raised to invest in the impaired LBO debt could equal as much as $170bn."

Crude Liquidity Watch:

October 3 - Bloomberg (Matthew Brown and Massoud Derhally): "Saudi Arabian inflation in August accelerated to its highest since at least 2002 as the cost of housing and food increased. The annual inflation rate in the largest Arab economy rose to 4.4% from 3.8% in July, the central Department for Statistics said... The cost of real estate rose 9.8% percent in August...The cost of food and beverages increased 6.6%..." 'The weakening of the dollar is continuing to result in imported inflation, which is reflected in the higher cost of food,' Monica Malik, economist at EFG-Hermes Holding, Egypt's largest investment bank, said..."

October 3 - Bloomberg (Matthew Brown): "Mortgage lending in the United Arab Emirates increased an annual 97% in the second quarter as foreigners bought property in the Gulf state."

October 3 - Bloomberg (Alex Nicholson): "Kazakh banks listed in London plunged after Standard & Poor's said it may reduce the country's investment-grade ratings as rising borrowing costs jeopardize an eight-year economic boom. AO Alliance Bank, the biggest retail lender in the energy-rich central Asian country, paced the declines. Alliance shares tumbled 11% to $6.65 in London. That's the biggest drop since the bank sold shares in July."

Financial Structures:

October 2 - Market News International: "There is no such thing as the 'Bernanke Put', former Federal Reserve Chairman Alan Greenspan claimed tonight. Speaking to a City audience here, Greenspan said there had been no 'Greenspan Put' while he had been at the Fed, and added 'There is no Bernanke Put' now. This was an 'illusion', he said. Greenspan also rejected suggestions made by some commentators that he would have behaved differently if he had been still been at the helm of the Fed. 'This was not true,' he said."

Mr. Greenspan is delusional if he doesn't appreciate the market's now unwavering faith in the "Bernanke Put." Let's keep in mind a few facts related to the Federal Reserve's September 18th 50 bps cut in the Fed Funds Rate. The Bernanke Fed chose an aggressive ("shock & awe") 50 basis point reduction even though the market was anticipating 25. This decision was made with the U.S. employment rate at 4.6%. August's Personal Income was up 6.8% y-o-y. Both the ISM Manufacturing and Non-Manufacturing indices were firmly above 50; monthly Trade Deficits having settled stubbornly at around $60bn; and with Nominal Q2 GDP growth having accelerated to 6.6% (3.8% real) annualized, the highest in five quarters. Crude was trading at about $80 and gold above $700, as the Goldman Sachs Commodities index broke out to record highs.

Obviously, Dr. Bernanke responded to marketplace tumult, clarifying unmistakably to all that market trading conditions had, in fact, become the deciding variable in determining monetary policy. One can look at this as a fateful and, perhaps, unavoidable facet of the dangerous interplay of contemporary finance and central banking. And it follows by less than a month Bernanke's assurances to Senate Banking Committee Chairman Dodd that he would use 'all of the tools at his disposal' to stabilize the markets. If there were, on the morning of September 18th, any uncertainties with respect to veracity of the "Greenspan/Bernanke Put", they had been fully laid to rest by early in the afternoon.

It is worth nothing that the Dow Jones Industrial Average has surged 663 points (4.7%) to an all-time high since the Bernanke p/cut. The Broker/Dealers have rallied 7.9%. The NASDAQ100 has surged 7.7%, increasing y-t-d gains to 22.4%. The speculative NASDAQ Telecommunications index has shot 8.5% higher and The Street.com Internet Index 7.4%. Effects upon emerging equities - an asset class experiencing Acute Inflationary Biases (including rampant speculation) - have been even more spectacular. Brazil's Bovespa has surged 12.5%, increasing 2007 gains to 40%. Russia's RTS index is up 9.4% and India's Sensex 12.8% since The Bernanke Accommodation.

As a macro Credit and financial market analyst, recent developments have been nothing short of fascinating, as well as illuminating. My basic premise that the Credit Bubble has been pierced is, at this point, debatable. To be sure, the centerpiece of the analysis - first, that Credit and Economic Bubbles will be sustained only by enormous Credit expansion and, second, that this expansion will be inhibited by the impairment of "Wall Street finance" - remains very much unresolved.

I've written as recently as last week about the Deleterious Bubble Effects - especially late in the Credit Cycle - to Financial and Economic Structures. And while impairment to the real economy generally transpires over extended periods, Financial Structures are susceptible to much more rapid effects as well. Tremendous unappreciated damage has been inflicted over the past few years, only to escalate greatly over the past few months. I'll attempt to put a little meat on the "Financial Structures" analytical bone.

I've discussed extensively the "Moneyness of Credit" issue, and how the markets' perception of safety and liquidity has a profound impact on the capacity to expand Credit instruments. Importantly, marketplace perceptions of the safety and liquidity of certain categories of debt can over a period of time have a tremendous influence on the development of institutions, and these institutions then can have major influences on the development of markets, marketplace behavior, and certainly financial innovation. I've referred to the GSE's as the "Anti-Ponzi" - a highly atypical Financial Structure with an extraordinary capacity to expand liabilities especially in the midst of financial crisis - in the process sustaining Credit and liquidity creation. I have also noted Fannie and Freddie balance sheets constraints as an important variable with respect to crisis-mitigating liquidity creation.

Well, this perverse Financial Structure perseveres, in yet another example of contemporary financial institutions' capacity to adapt in order to fill a liquidity void. The Federal Home Loan Banks (FHLB) expanded assets about $170bn during the two-month period August through September, for them an unprecedented market intervention. For perspective, the FHLB expanded about $19bn during 2006 and $73bn in 2005. Even during tumultuous 1998, the FHLB limited asset growth to about $90bn. To my surprise, total GSE third-quarter Credit expansion will most likely approach $250bn. For the entire year 1998, Fannie, Freddie and the FHLB combined for $300bn of growth, at the time a record.

There is another "Anti-Ponzi" Financial Structure that has evolved over the years into a powerful force of market stabilization. Over the past 10 weeks, Money Market Fund assets have surged $308bn, a 60% growth rate. This pool of (of mostly Wall Street controlled) finance has expanded $510bn y-t-d, or 27.8% annualized, to almost $2.891 TN. Despite asset-backed commercial paper and special-purpose vehicle finance residing at the epicenter of the crisis, confidence that "money" funds won't "break the buck" has remained unshaken. "Moneyness" has been sustained, and Wall Street has retained great latitude in deploying readily available and now cheaper funds.

At least to this point, the banking system also enjoys great latitude. With its liabilities (deposits, "Fed funds," repos, and various market debt) retaining "moneyness" attributes, Bank Assets have expanded an astounding $425bn over the past 10 weeks, or 21.9% annualized (Bank Credit has inflated $280bn, or 16.8% annualized). Over this period, Commercial and Industrial Loans have expanded 36.2% annualized.

The combined expansion of "money"-like GSE, money market funds and bank obligations has been instrumental in sustaining Credit creation and marketplace liquidity. Importantly, this massive liquidity backstop stemmed what was poised to be a devastating liquidation/de-leveraging throughout the leveraged speculating community. There is today, in contemporary Credit systems, a precariously fine line between Credit meltdown and liquidity melt-up.

The hedge fund and broker/dealer communities - along with the gigantic derivatives markets they command - have also evolved into powerful Financial Structures. These highly geared vehicles enjoy windfall profits as long as Credit Bubble excess is sustained, which implies a robust Inflationary/expansionary Bias. They operate as massive if unstable risk repositories. They have ripened into the Ultimate Ponzi Finance Units, at acute risk of a (Northern Rock-style) run on their assets - and/or run away from their liabilities.

Barely dodging a devastating run of withdrawals, Renewed Bubble Dynamics have the banks scheming to extend further Credit (see Credit Dislocation Watch above) to the leveraged speculating community in the process of offloading bloated leveraged loan positions. I argue strongly that these are just the types of financial shenanigans that should not be allowed to fester. Recall how a few billion of savings and loan losses were nurtured into a multi-hundred billion debacle, and one can hopefully appreciate how we are today gambling with the future solvency of the entire Credit system.

The combined growth of Fannie and Freddie's "Books of Business" will approach $500bn this year (nearing $5.0TN). The (also thinly capitalized) FHLB is on track for unprecedented expansion (assets surpassing $1.2TN). The money fund complex is in the midst of unparalleled growth (approaching $3TN). These key interrelated Financial Structures are at once sustaining marketplace liquidity, while laying the groundwork for a much more perilous financial crisis. They are all ballooning exposures today at double-digit rates specifically because the market risk environment has deteriorated markedly while their liabilities (and GSE guaranteed MBS) retain coveted "moneyness."

But this does not alter the reality that this is an especially inopportune time to aggressively expand risk intermediation responsibilities. Indeed, the transformation of today's highly risky Credits into Trillions of perceived safe and liquid debt instruments is a seductively parlous expedient. I'll further add that these Financial Structures comprise the greatest distortion of risk in the history of finance. Fannie and Freddie are adding significantly to their exposure just as losses begin to mount - and mount mightily they will. The FHLB is aggressively lending as the risk profile of their borrowers deteriorates rapidly. And the money funds, well, I'll just posit that the risk of eventually "breaking the buck" is rising right along with their growth in assets. In short, the money funds' and GSE's aggressive risk intermediation and market stabilizer roles imperil future "moneyness" - with enormous systemic ramifications.

I'll remain dangling out on the analytical limb and opine that today's commanding Financial Structures virtually ensure a future meltdown. I write this not as some nut-ball but as a diligent analyst that is witnessing a system absolutely incapable of moderating excesses or self-adjusting imbalances. Excess begets only and everywhere greater excess. It's a system of Financial Structures that encourage and subsidize leveraged speculation. Meanwhile, various contemporary Financial Structures work to embolden market participants to remain fully exposed to highly inflated asset prices, while incorporating derivative insurance and other hedging strategies for protection. The resulting enormity of the hedging programs further destabilizes the system, fostering melt-up and eventual breakdown dynamics. As we've witnessed of late (recalling the last gasp of the NASDAQ Bubble), short covering and the unwind of bearish hedges provide a most powerful catalyst for a flurry of speculative excess - irrespective of unfolding fundamentals. Again, Financial Structures promote destabilizing excesses.

There is today an incredibly speculative financial sector hell bent on sustaining Credit and asset Bubbles - and perfectly content to adulterate our functional system of "money" in the process. The Federal Reserve is perceived to condone the whole affair and is openly willing to employ all measures to avoid bursting Bubbles. And in a contemporary world of Acutely Fragile Finance Structures, this ensures that bust avoidance translates briskly to Bubble Perpetuation and speculator delight.

And there are, let there be no doubt, prominent Financial Structures - from the gargantuan GSEs and the securitization marketplace; to the ultra-powerful Wall Street investment bankers and money fund complex; to a "banking" community willing to partner with the leveraged speculating community; to the opaque "repo" and "Fed funds" markets; to the ballooning markets in Credit and market risk derivatives; and to the bulging global central banks and sovereign wealth funds - virtually all working to profit from the perpetuation of Bubble excess. And there's surely nothing like record global equities prices to embolden. Meanwhile, back in reality, the stage is being set for one or both of the following: an eventual run on today's (ballooning) perceived "money-like" debt instruments and a run on our currency.

Doug Noland
The Credit Bubble Bulletin
PrudentBear.com

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