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January 11, 2008

Mortgage Crisis to Corporate Debt Crisis
by Doug Noland

It was another tense week in the markets. For the week, the Dow declined 1.5% (down 5.0% y-t-d) and the S&P500 0.8% (down 4.6%). Pressure continued on the economically-sensitive sectors. The Morgan Stanley Cyclical index sank 2.7% (down 8.7%), and the Transports fell 1.7% (down 8.4%). The more defensive Morgan Stanley Consumer index added 0.1% (down 3.3%), and the Utilities increased 2.3% (up 1.8%). The small cap Russell 2000 dropped 2.3% (down 8.0%), and the S&P400 Mid-Caps declined 2.6% (7.2%). Last year's favorites are off to a bad start. The NASDAQ100 dropped 2.6% (down 8.3%), and the Morgan Stanley High Tech index sank 4.1% (down 10.1%). Continuing last year's trend, the Semiconductors were hit for 5.1% (down 13.3%). The Street.com Internet Index sank 3.6% (down 8.9%), and the NASDAQ Telecommunications index dropped 2.9% (down 8.6%). The Biotechs jumped 4.4% (up 2.7%). With Bullion surging $35.80 to close at 895.40, the HUI Gold index jumped 7.1% (up 16.1%).

The Treasury melt-up continues. Three-month Treasury bill rates declined 12 bps the past week to 3.09%. Two-year government yields sank 18 bps to 2.56%. Five-year T-Note yields fell 14 bps to 3.04%, and ten-year yields dropped 9 bps to 3.785%. Long-bond yields were unchanged at 4.37%. The 2yr/10yr spread ended the week at 122.5 bps. The implied yield on 3-month December '08 Eurodollars sank 20 bps to 2.88%. Benchmark Fannie MBS yields dropped 14 bps to 5.16%, this week again outperforming Treasuries. The spread on Fannie's 5% 2017 note was one narrower at 49 bps and Freddie's 5% 2017 note one narrower at 50 bps. The 10-year dollar swap spread declined 2.6 to 60.2, the low since early October. Most corporate bond spreads were wider, with the spread on an index of junk bonds ending the week a notable 49 bps wider.

Investment grade issuance GE Capital $8.5bn, UPS $4.0bn, Goldman Sachs 3.0bn, Berkshire Hathaway $2.0bn, Duke Energy $900 million, Kroger $750 million, Alabama Power $500 million, Florida Power & Light $400 million, Emerson Electric $600 million, Commonwealth Edison $450 million, Cintas $300 million, Buckeye Partners $300 million, South Carolina E&G $250 million, and Questar Pipeline $200 million.

Junk issuance included Block Financial $600 million, Southwestern Energy $600 million and Jabil Circuit $250 million.

Foreign dollar debt issuance included KFW $5.0bn, European Investment Bank $4.0bn, Colombia $3.5bn, Indonesia $2.0bn, Petrobras $1.75bn, Mexico $1.5bn, Canadian Natural Resources $1.2bn, and Korea Development Bank $1.0bn.

German 10-year bund yields fell 4.5bps this week to 4.085%, while the DAX equities index fell 1.2% (down 4.3% y-t-d). Japanese "JGB" yields dropped 4.5bps to 1.42%. The Nikkei 225 sank 4.0% (down 7.8% y-t-d). Emerging equities were mixed to higher, while debt markets generally added to recent gains. Brazil's benchmark dollar bond yields declined 3 bps to 5.61%. Brazil's Bovespa equities index gained 1.5% (down 3.0% y-t-d). The Mexican Bolsa rose 1.4% (down 2.8% y-t-d). Mexico's 10-year $ yields fell 7 bps to 5.21%. Russia's equities markets gained 1.0% (1-yr gain 28.5%). India's Sensex equities index added 0.7% (1-yr gain 53%). China's Shanghai Exchange gained 2.3%, increasing y-o-y gains to 98%.

Freddie Mac posted 30-year fixed mortgage rates sank 20 bps this week to 5.87% (down 34bp y-o-y). Fifteen-year fixed rates dropped 25 bps to 5.43% (down 53bps y-o-y). One-year adjustable rates fell 10 bps to 5.37% (down 7bps y-o-y).

Bank Credit expanded $23.3bn during the most recent data week (1/2) to a record $9.280 TN (3-wk gain of $115bn). Bank Credit posted a 24-week surge of $636bn (15.9% annualized) and a 52-week rise of $987bn, or 11.9%. For the week, Securities Credit surged $48.1bn. Loans & Leases dropped $24.7bn to $6.806 TN (24-wk gain of $481bn). C&I loans added $3.6bn, with one-year growth of 21.6%. Real Estate loans increased $0.5bn (up 7.9% y-o-y). Consumer loans fell $5.0bn. Securities loans declined $9.3bn, and Other loans dropped $14.4bn. On the liability side, (previous M3) Large Time Deposits rose $12.6bn.

M2 (narrow) "money" supply increased $4.3bn to a record $7.472 TN (week of 12/31). Narrow "money" expanded $411bn during 2007, or 5.8%. For the week, Currency added $0.8bn, and Demand & Checkable Deposits increased $8.2bn. Savings Deposits fell $13.1bn, and Small Denominated Deposits dipped $0.3bn. Retail Money Fund assets rose $8.7bn.

Total Money Market Fund assets (from Invest. Co Inst) surged $52bn last week to a record $3.165 TN. Money Fund assets have posted a 24-week rise of $582bn (49% annualized) and a one-year increase of $775bn (32.4%).

Total Commercial Paper rose $14.4bn to $1.813 TN. CP has declined $411bn over the past 22 weeks. Asset-backed CP added $4.8bn (22-wk drop of $417bn) last week to $779bn. Over the past year, total CP has contracted $177bn, or 8.9%, with ABCP down $290bn (27%).

Fed Foreign Holdings of Treasury, Agency Debt last week (ended 1/7) declined $3.6bn to a record $2.057 TN. "Custody holdings" are up $287bn year-over-year (16.2%). Federal Reserve Credit dropped $22.5bn last week to $869bn. Fed Credit expanded $24.7bn y-o-y (2.9%).

International reserve assets (excluding gold) - as accumulated by Bloomberg's Kristy Scheuble - were up $1.363 TN y-o-y, or 28%, to a record $6.221 TN.

Global Credit Market Dislocation Watch:

January 11 - Dow Jones (Steven D. Jones): "The burning question in the markets earlier this week was whether home lender Countrywide Financial would file for bankruptcy. Friday's news that the California company was being sold for $4 billion, or about 30 cents on the dollar, points to the likely answer. Now that Bank of America has spread a safety net beneath Countrywide, the new question is by how much will Bank of America have to write down Countrywide's $209 billion balance sheet to merge into its own?"

January 11 - Bloomberg (Shannon D. Harrington and Hamish Risk): "The risk of Bank of America Corp. defaulting rose to the highest since at least November 2001 after the biggest U.S. bank by market value said it will rescue Countrywide Financial Corp. Credit-default swaps tied to the bonds...Bank of America increased 12 bps to 92..."

January 9 - Bloomberg (Hamish Risk and Shannon D. Harrington): "The risk of companies defaulting on their debt soared to a record after Goldman Sachs Group Inc. said the U.S. economy is probably slipping into recession and bond insurer MBIA Inc. said it will cut its dividend to preserve its top credit rating. Credit-default swaps tied to...MBIA and ...Countrywide Financial Corp. rose to all-time highs, while the Markit CDX North America Investment Grade Index and Markit iTraxx Hi Vol index both jumped to the widest since they were created in 2004."

January 11 - Bloomberg (Christine Richard and Pierre Paulden): "MBIA Inc., the largest bond insurer, paid a yield of 14% on the sale of $1 billion of AA rated notes, a rate usually charged to the lowest-ranked borrowers."

January 9 - Financial Times (Stacy-Marie Ishmael): "The extent of damage in credit markets from recent turmoil was starkly underlined yesterday when the credit rating of one of the largest independent structured investment vehicles was slashed by 13 notches.The downgrade of the $6bn Victoria SIV by Standard & Poor's takes its rating deep into 'junk' territory, to B minus. Just three months ago it was rated AAA. Analysts yesterday warned that Victoria's fate was being echoed across the SIV sector as this corner of finance suffers a barrage of downgrades. SIVs issue cheap, short-term debt to fund investments in longer-term and higher-yielding securities. The wave of downgrades is now threatening to create painful shocks for investors, not least because many of the supposedly ultra-safe securities were sold to risk-averse institutions such as pension funds."

January 10 - Financial Times (Sam Jones and Stacy-Marie Ishmael): "Investors in collateralised debt obligations face further downgrades and the possibility that the value of their investments will plummet or be wiped out. About $58bn worth of CDOs, which repackage slices of other structured deals such as mortgage-backed bonds, are understood to have hit 'events of default'. A growing number of those are being pushed towards liquidation, which means a fire sale of some assets and the unwinding of the large derivatives contracts that make up much of the structure of these CDOs."

January 10 - Bloomberg (Rhonda Schaffler and Christine Richard): "MBIA Inc., the largest bond insurer, may need to raise $10 billion in capital to keep its AAA credit rating, said William Ackman, president of Pershing Square Capital Management."

January 11 - Financial Times (David Wighton): "Merrill Lynch and Citigroup are in talks to raise new capital from sovereign wealth funds ahead of earnings announcements next week that are expected to include further losses on mortgage-related investments.Bankers say the groups, which together raised $14bn at the end of last year, are looking for more capital to repair the damage caused by mounting mortgage losses."

January 7 - Bloomberg (Jody Shenn): "A third of planned U.S. home sales were canceled or delayed in September, October and November as consumers had fewer borrowing options, according to a survey of 2,416 real-estate agents. Thirteen percent of transactions failed because of loan problems... In California...more than half of planned deals were postponed or scuttled, the survey found."

January 9 - Bloomberg (Neil Unmack): "Structured investment vehicles have $70 billion of medium-term debt maturing this year, according to Merrill Lynch...analysts. Dresdner Bank AG's K2 Corp., Bank of Montreal's Link Finance Corp. and nine other SIVs have to repay $21 billion of medium-term notes before April... SIVs...have been unable to borrow since August... U.S. Treasury Secretary Henry Paulson initiated talks to set up a fund to avert a firesale of SIV assets further roiling credit markets. Banks abandoned the initiative after cutting SIV assets to about $282 billion from a peak of $400 billion last year..."

January 8 - Bloomberg (Edward Evans): "Citigroup Inc. may post a larger loss than previously estimated because the biggest U.S. bank may have to take a $16 billion writedown in the fourth quarter, Merrill Lynch & Co. analyst Guy Moszkowski said."

January 9 - Financial Times (Jennifer Hughes): "Companies could be forced to develop a 'parallel' balance sheet to better explain their off-balance sheet vehicles if preliminary ideas being discussed by international accounting standard- setters are developed further.The International Accounting Standards Board is discussing the issue and is due to publish a consultation paper - the first public step in its standard-setting process - later this year. Off-balance sheet accounting practices have been criticised for their role in the credit crunch, where they are blamed for potentially obscuring the true risks banks face."

January 8 - Bloomberg (Erik Holm): "Marty Whitman and Al Zucaro... may be dripping in sweat after they snapped up U.S. mortgage insurers that shed more than 40% of their value in the past three months... Whitman bought into the slump to become the largest stakeholder in...Radian. Zucaro became the No. 1 investor in PMI...and the second-biggest for...MGIC."

January 10 - Bloomberg (Todd White): "Spanish bankers may call on the government to bail out any big real estate company that falls behind on its debt payments, hoping to help protect their own industry from losses, El Confidencial reported. Banks are considering requesting that the Instituto de Credito Oficial, a state-owned bank, aid any developer that 'crashed,' the news Web site said..."

January 8 - Bloomberg (Bryan Keogh): "The global default rate on high-yield, high-risk bonds, which finished 2007 at a 26-year low of 0.9%, will jump more than fivefold by the end of 2008, according to Moody's... The high-yield default rate will increase to 4.8% this year and reach 5% by the end of 2009 because a weakening economy and ratings cuts will cause more issuers to miss their interest payments, Moody's analyst Kenneth Emery...said... 'We believe December 2007 likely marks the low point of the current default rate cycle as several issuers have missed interest payments in recent weeks,' Emery said..."

Currency Watch:

The dollar recovered 0.2% during the past week to 75.98. For the week, the South African rand rose 2.3%, the Australian dollar 2.1%, the New Zealand dollar 1.8%, the Norwegian krone 1.4%, and the Swiss franc 1.4%. On the downside, the Iceland krona dropped 1.5%, Canadian dollar 1.4%, the British pound 0.7%, and the Mexican peso 0.4%.

Commodities Watch:

January 11 - Bloomberg (Pham-Duy Nguyen): "Gold futures rose to a record $900.10 an ounce on speculation the Federal Reserve will cut U.S. interest rates further, weakening the dollar and boosting the investment appeal of the precious metal. Silver also gained."

January 8 - Bloomberg (Ayla Jean Yackley): "Turkey, the world's fourth-biggest buyer of gold, imported 20 percent more of the precious metal last year as prices rose to their highest since 1980. Imports climbed to 230.8 metric tons last year, compared with 192.7 tons in 2006, according to...the Istanbul Gold Exchange."

January 11 - Bloomberg (Winnie Zhu): "China's crude oil imports rose 11% in December from a year earlier as refiners, straining to end a fuel shortage in the world's fastest-growing major economy, bought raw material to process at their plants."

January 11 - Bloomberg (Jeff Wilson and Tony C. Dreibus): "Soybeans jumped to a record, corn reached an 11-year high and wheat rallied after U.S. government reports showed that production is failing to keep pace with rising global demand for food and biofuels. The world soybean harvest will fall 6.5% this year, U.S. corn inventories will be 20% less than estimated a month ago, and wheat farmers in Kansas and Texas planted less even as the price of the grain doubled..."

January 11 - Bloomberg (Saijel Kishan): "Commodities will be 'well supported' by rising demand and curbs on supply even as the U.S. economy slows, Goldman Sachs Group Inc. said. 'Supply and demand offsets to the weaker economic backdrop will largely keep supportive fundamentals intact,' Goldman wrote... Any prices declines on concerns over economic growth are a 'buying opportunity,' it said. Goldman raised its six-month forecast for gold to $900 an Ounce..."

January 11 - Associated Press: "High dairy and wheat costs may draw extra attention during a meeting General Mills Inc. will host... General Mills, which makes Cheerios cereal, Yoplait yogurt and Progresso soup, is exposed to a wide variety of commodities. Grain and dairy costs rose sharply last year because of demand abroad and high prices for animal feed, which is made from corn, a main ingredient in the alternative energy ethanol. Earlier this week, JPMorgan analyst Pablo Zuanic said rising U.S. grain prices this year are expected to hurt cereal makers, like General Mills. In a note to clients, Zuanic said grain costs will climb 44% this year..."

Commodities were all over the place. During the week, Gold jumped 4.2% to $895.4 and Silver 5.9% to $16.37. March Copper rose 4.6%. February Crude sank $5.22 to $92.69. February Gasoline sank 7.5%, while January Natural Gas jumped 4.3%. March Wheat dropped 3.2%. For the week, the CRB index dipped 0.3%, reducing 2008 early gains to 1.9%. The Goldman Sachs Commodities Index (GSCI) dropped 3.1%, with a y-t-d decline of 0.7% (52-week gain 51%).

China Watch:

January 11 - Associated Press: "China's foreign exchange reserves hit $1.53 trillion at the end of 2007, up 43 percent from the end of the previous year... The bank said...that $461.9 billion was added to the country's foreign exchange reserves in 2007."

January 11 - Market News International: "Speculative capital inflows may have been a significant contributor to the growth of China's foreign exchange reserves during 2007 as US interest rates fell, Chinese asset prices rose and the pace of yuan appreciation tempted investors worldwide..."

January 11 - Bloomberg (Li Yanping): "China's money-supply grew at the slowest pace in seven months, evidence that central bank measures to cool inflation and prevent the economy from overheating are beginning to work. M2...rose 16.7%... from a year earlier..."

January 9 - Bloomberg (Li Yanping): "China will freeze price increases of oil products, natural gas and electricity in the 'near term,' Premier Wen Jiabao said, as the government tries to curb inflation at an 11-year high. The government will cap costs of daily goods when necessary, stop increases of fees for public transportation and school tuition and step up a crackdown on price manipulation, Wen said... 'Prices of crude oil, grains and other primary products are still rising on the international market, and China faces relatively large pressures of further price increases,' Wen said..."

January 10 - Financial Times (Richard McGregor and Javier Blas): "China has vowed to 'temporarily intervene' in the market to prevent excessive price rises for food and daily necessities, raising the spectre of an enlarged state role in the economy as part of an anti-inflation campaign. The measures, announced yesterday by the State Council, China's cabinet, come after sharp rises in inflation, which has hit 11-year highs, driven by higher food prices. However, it is not clear whether the measures are an effort to talk down potential price rises or a more serious effort to force producers and retailers to forestall increases in line with government demands. The announcement said enterprises producing "general necessities" should register with local price bureaux if they wanted to lift prices."

January 11 - Market News International: "China's trade surplus fell to $22.69 billion in December from $26.28 billion the previous month... The report also said that China's trade surplus hit a record $262.2 billion in 2007, up 47.7% over the previous year's record $177.47 billion. The data indicate that Chinese exports grew 21.6% year-on-year in December while imports grew 25.5%..."

January 9 - Bloomberg (Denise Kee): "The risk of property developers in China defaulting on their debt rose to a record, according to traders of credit-default swaps. The cost to protect bonds sold by Agile Property Holdings Ltd., Shimao Property Holdings Ltd. and Hopson Development Holdings Ltd. rose by as much as 80 bps, the most on record..."

Japan Watch:

January 10 - Bloomberg (Jason Clenfield): "Goldman Sachs Group cut its economic growth estimate for Japan and said there's a 50% chance of a recession in the world's second-largest economy. 'The probability of a recession in Japan has risen to the danger level,' Tetsufumi Yamakawa, chief Japan economist at Goldman, said... 'We project weaker-than-expected growth in Japan.'"

January 11 - Bloomberg (Dinakar Sethuraman and Shigeru Sato): "Japan paid record prices for liquefied natural gas in November from Australia, Brunei, Malaysia and Indonesia... The world's largest LNG buyer imported 5.57 million metric tons in November at a cost of as much as $9.17 a million British thermal units... Brunei led price increases, earning 38% more than a month earlier."

January 7 - Bloomberg (Makiko Kitamura): "Japan's vehicle sales fell in 2007 to the lowest in 35 years, led by Nissan Motor Co. and Toyota Motor Corp., as declining wages and a shrinking population cut demand for automobiles. Sales of cars, trucks and buses excluding minicars dropped 7.6% to 3.4 million..."

India Watch:

January 11 - Bloomberg (Anil Varma): "Indian banks' loans rose by 732 billion rupees ($18.6 billion) in the month ended Dec. 28, taking outstanding advances to 21.5 trillion rupees... Credit climbed 21.4%..."

January 11 - Bloomberg (Cherian Thomas): "India's industrial production grew in November at the slowest pace in 13 months... Production at factories, utilities and mines rose 5.3% from a year earlier..."

Asian Bubble Watch:

January 9 - Financial Times (Raphael Minder and Joe Leahy): "Several nights a week, Reema Kapoor visits her local street market in Goregaon, an outer suburb of Mumbai, on her way home from work to buy the ingredients for her evening meal. Lately, that routine has been disrupted by rises in the prices of vegetables and other ingredients. Ms Kapoor, like millions of Indian shoppers, had grown to expect a seasonal slump in prices in a country short on cold storage as food keeps better in winter. But 'prices are not coming down, they're just going up', she says. China's battle with inflation...has drawn the most attention until now. But what Ms Kapoor is seeing in Mumbai is being repeated across Asia as higher food prices and oil at $100 a barrel combine to present a crucial test of the ability of politicians and central bankers to manage inflation. Asian consumers are confronting the fact that 'food inflation has moved from being cyclical to being driven by structural factors' says Glenn Maguire, Asia economist at Société Générale."

January 7 - Bloomberg (James Peng and George Hsu): "Taiwan's exports increased almost twice as much as economists forecast in December, buoyed by Chinese demand. Overseas shipments surged 19.8% to a record $23.5 billion from a year earlier..."

Unbalanced Global Economy Watch:

January 8 - Bloomberg (Fergal O'Brien): "European retail sales fell the most in at least 10 years in November as rising food and energy costs sapped consumer confidence. Retail sales declined 1.4% in November from a year earlier..."

January 9 - Financial Times (Leslie Crawford): "The City of London's skyline bristles with cranes clearing the ground for a gleaming new generation of developments... But if the credit squeeze develops into a full-blown recession, will there be anyone to fill them? The five biggest projects would create about 3.8m sq ft of new space, enough for up to 50,000 desk jockeys. In itself that would add only about 5% to the City's total stock. But as part of a wider picture it looks scary. Other new, largely speculative, builds should add another 8% to the stock by 2010. And demand will falter in the event of a recession. In the last downturn, between 2001 and 2003, space equivalent to about 10% of the total stock was vacated. That suggests a nightmare scenario of a supply overhang of 23%."

January 8 - Bloomberg (Brian Swint and Jennifer Ryan): "U.K. retail sales rose at the slowest pace since March 2006 and house prices declined for the first quarter in seven years, adding to the case for the Bank of England to cut interest rates again."

January 9 - Bloomberg (Gabi Thesing): "Retail sales in Germany unexpectedly declined in November, falling for a second month as inflation jumped to a record, eroding consumers' spending power. Sales, adjusted for inflation and seasonal swings, fell 1.3% from October, when they slid 2.3%... 'The figures are quite shocking bearing in mind the decline in the previous month," said Alexander Koch, an economist at UniCredit Markets & Investment Banking... 'Consumers are tightening their purse strings because prices are rising, but also because they perceive them as rising faster than they are.'"

January 9 - Financial Times (Bertrand Benoit): "German government and union officials gather today in the baroque town of Potsdam outside Berlin to start wage negotiations for the country's 1.3m civil servants, kicking off what the head of the country's largest trade union predicted would be a year of 'mega-wage deals'. After years of wage stagnation in Europe's biggest economy, calls for substantial pay increases are growing louder - and prompting warnings from economists about the potential impact on jobs and inflation. Verdi, the services union, and the German Civil Servants' Federation have lodged an 8 per cent pay claim this year, which would represent the first increase in three years. In other sectors facing collective wage rounds, claims range from 8% to 4%."

January 9 - Financial Times (Leslie Crawford): "Only last September, José Luis Rodríguez Zapatero, the Spanish prime minister, announced that Spain had joined the 'Champions' League' of world economies. Europe's fifth largest economy was growing so robustly, and creating so many jobs, it would soon be richer than Germany in per capita terms, Mr Zapatero predicted. That euphoria was short-lived. December saw a spike in inflation, a rise in unemployment and a slowdown in the economy, as the international credit squeeze gripped Spain... Worse, house prices in many parts of the country have started falling, further undermining confidence in the economy. Some overindebted families now owe more to their banks than their houses are worth. International financial gridlock has brought Spain's credit-fuelled surge to a rude halt."

January 8 - Bloomberg (Robin Wigglesworth): "Norway's jobless rate fell in the three months through November as the joint-fastest economic expansion on record boosted demand for workers. The seasonally adjusted rate fell to 2.5% from 2.6%..."

January 9 - Bloomberg (Robin Wigglesworth): "Norwegian retail sales growth accelerated to 7.5% in November as falling unemployment, increased salaries and the receding danger of interest rate increases prolonged a spending boom."

January 9 - Bloomberg (Marketa Fiserova): "Czech inflation accelerated in December above the central bank's target for a second month... The inflation rate rose to 5.4% from 5% in November..."

January 9 - Bloomberg (Milda Seputyte): "Lithuanian's inflation rate rose in December to the highest level in a decade, adding to concern that the economy is overheating. The inflation rate rose to 8.1% from 7.8% in November..."

January 10 - Bloomberg (Milda Seputyte and Aaron Eglitis): "Latvian inflation accelerated to the fastest in more than 11 years as household expenses and service prices in restaurants advanced, adding to concern the economy is overheating. The rate, the highest in the 27-nation European Union, rose to 14.1% from 13.7% in the previous month..."

Central Banker Watch:

January 11 - Financial Times: "There go the choppers. 'Helicopter' Ben Bernanke is poised to unleash another batch of cheaper money on the struggling US economy. The Federal Reserve chairman's clear description of the risks facing the economy yesterday almost certainly means another half point interest rate cut this month."

January 7 - Market News International: "The European Central Bank remains prepared to act if necessary to contain increased inflationary pressure, ECB President Jean-Claude Trichet reiterated... 'The ECB's Governing Council stands ready to counter upside risks to price stability, in line with its mandate,' Trichet said."

January 10 - Bloomberg (Rich Miller): "The next bubble to deflate may be Alan Greenspan's reputation. Hailed as perhaps the greatest central banker who ever lived when he left the Federal Reserve in 2006, Greenspan is under attack from critics ranging from the New York Times to economists at the American Enterprise Institute for his handling of the 2000-2005 housing boom. The former Fed chairman has taken to the media to defend himself, writing in the Wall Street Journal and appearing on network television. 'He's had a bubble reputation that derived from the growth of U.S. household wealth,' said Edward Chancellor, author of 'Devil Take the Hindmost: A History of Financial Speculation.' 'As that goes down, his standing as a superstar will suffer.'"

Bursting Bubble Economy Watch:

January 11 - Financial Times (Francesco Guerrera, Aline van Duyn and Daniel Pimlott): "The US is at risk of losing its top-notch triple-A credit rating within a decade unless it takes radical action to curb soaring healthcare and social security spending, Moody's... said... The warning over the future of the triple-A rating - granted to US government debt since it was first assessed in 1917 - reflects growing concerns over the country's ability to retain its financial and economic supremacy... In its annual report on the US, Moody's signalled increased concern that rapid rises in Medicare and Medicaid...would 'cause major fiscal pressures' in years to come."

January 7 - Bloomberg (Saijel Kishan and Mark Barton): "The U.S. economy is heading for a recession that will be the worst 'in a while' and investors should sell the dollar as global currencies weaken, investor Jim Rogers said. 'It's going to be one of the worst recessions we've had in a while because we had so many excesses going into it,' Rogers...said... 'It's going to be bad for all of us as currencies come under more and more stress and we have more inflation in the world.'"

January 10 - Bloomberg (Mark Gilbert): "The U.S. economy risks stagnant growth combined with accelerating inflation, a condition known as stagflation, according to Tim Bond, head of global asset allocation at Barclays Capital in London. 'The current state of the U.S. economy almost merits the term stagflation, in the sense that growth is a long way below trend, while inflation is a long way above,' Bond wrote... 'Inflation has risen above 4%, with little sign from the wholesale commodity, agricultural and energy markets of much relaxation in these driving factors.'"

Latin America Watch:

January 7 - Bloomberg (Thomas Black and Valerie Rota): "Mexico's core inflation rose to the highest annual rate since 2002, led by higher leisure costs, increasing pressure on the central bank to raise interest rates... Consumer prices, excluding fresh food and energy costs, rose 4% in the 12 months through December... It was the most since May 2002."

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

January 11 - Financial Times (Robert Cookson): "When Ned Bowers jumped ship from US bond insurance group Radian with a plan to clean up in the booming world of credit derivatives in the summer of 2006, he was riding the crest of a market wave. Little did he or anyone else know that a year later that wave would break violently, all but destroying his Dublin-based venture - and leaving financial players worldwide uncovering huge losses in the wreckage of this corner of the debt markets. His venture, Structured Credit Company, last month finalised a restructuring that will see its 12 trading partners receive just 5 per cent of what they are owed and so leave the banks, which include Merrill Lynch, Morgan Stanley, Bear Stearns, Deutsche Bank and HSBC, nursing losses of about $250m between them... 'There were a number of things that should have led the banks to question 'is this an appropriate counterparty?" says Joe Gavin, head of banking at law firm LK Shields... 'Has it got deep pockets? If this whole thing is stress-tested, will it crumble? As in fact it did.' It also raises questions about how well counterparty risk - the danger one party to a trade cannot honour their losses - has been understood and monitored by banks and others in complex corners of the exuberant markets of recent years, including credit derivatives. Andrea Cicione, credit strategist at BNP Paribas, says counterparty risk will be a big theme in 2008 and that losses from market players being unable to honour their derivatives contracts could exceed $150bn."

January 11 - Financial Times (Daniel Pimlott): "Capital One cut its profit outlook by more than 20% yesterday as delinquencies and losses on loans rose sharply last month and the credit card group increased its reserves in anticipation of a worsening slowdown in the US economy... The higher rate of late payments and writing-off of bad debts at the largest independent credit card company in the US is a sign that the housing slump is working its way into other areas of consumer credit... 'People are expecting trouble in the credit card industry, but they were expecting it in the next few months,' said Frank Braden, an analyst at...Standard & Poor's. 'To see it in December is a bit of a shock.'"

January 11 - Bloomberg (Hui-yong Yu): "Vacancies in U.S. neighborhood and community shopping centers rose to an 11-year high in the fourth quarter as the housing slump dented consumer spending, according to Reis Inc. The vacancy rate rose to 7.5% in the three months ended Dec. 31, from 7.3%... 'The retail sector is coming under increasing strain, both in terms of slower rent growth and falling occupancy,' said SamChandan, chief economist at Reis."

GSE Watch:

January 10 - Bloomberg (Patricia Kuo): "Freddie Mac, the U.S. mortgage company that reported its biggest loss last quarter, may be downgraded by Moody's...because the damage from loan defaults could be worse than the ratings company expected. Moody's said it may lower Freddie's financial strength rating from A-, the second-highest grade... Chief Executive Officer Richard Syron has attempted to shore up Freddie Mac's finances by selling $6 billion of preferred stock, slicing its dividend in half and reducing its mortgage assets by $30.9 billion to $701.4 billion in the three months to Nov. 30. The government-chartered company may need to take similar steps again, Moody's said."

Mortgage Finance Bust Watch:

January 9 - Bloomberg (James Tyson): "U.S. home prices may fall 12% from their peak through 2010 as 'the toughest housing correction in our lifetimes' drags on, Fannie Mae Chief Executive Officer Daniel Mudd said."

Real Estate Bubbles Watch:

January 10 - Bloomberg (Bob Ivry): "Lennar Corp.'s November sale of 11,000 properties in eight states set a price that may mark the bottom for the U.S. housing market: 40 cents on the dollar. That's how much Morgan Stanley Real Estate paid for an 80% stake in the 32 communities, 60% less than the price at which the properties were valued just two months earlier. That's also what some investors say they would pay for distressed land, condominiums, homes and whole developments, whether it's now or later this year."

January 9 - The Wall Street Journal (Kris Hudson): "A common real estate maxim states that retail development follows new housing. These days, though, retail real estate may be following the home market off a cliff. Sparked by the housing boom across the country, shopping-center and mall developers have gone on a tear in recent years, delivering millions of square feet of new space in Phoenix, San Antonio, Cleveland, Tampa, Fla., and numerous other markets. Since 2005, developers in the U.S. have produced more retail space than office space, rental apartments, warehouse space or any other commercial real estate category. But just as that new space is hitting the market, demand is declining. Mounting home foreclosures have sapped the strength of previously hot markets like Phoenix and California's Inland Empire near Los Angeles, leaving retail-property owners with rising vacancies and slower leasing rates for new space. And anemic sales gains in the just-completed holiday season fell short even of the retail industry's tepid preseason forecast."

January 7 - The Wall Street Journal (Jennifer S. Forsyth): "For the first time in four years, the national vacancy rate for office buildings rose in the fourth quarter, as an unusually large amount of new space came on the market and tenants shied way from signing new leases. Demand for commercial buildings has begun to slow and vacancy rates to climb in several markets... Coupled with last week's disappointing employment report, the weak office-market figures are another signal the nation's economy is weakening and possibly heading for a recession. Only last summer, commercial brokers were warning tenants that they needed to sign leases quickly at top rents because space was scarce. Now businesses in many markets are delaying leasing decisions in expectation that rents will fall."

January 8 - Bloomberg (Kathleen M. Howley): "The toughest place to sell a home in the U.S. in November was the Northeast. An index measuring signed contracts for previously owned homes fell 13% in the region, the most of any area in the country, the National Association of Realtors said... The index's drop in states including Massachusetts and Connecticut was triple other U.S. regions..."

January 7 - Bloomberg (Simon Packard): "LaSalle Investment Management put Condor House, a seven-story office building facing London's St. Paul's Cathedral, on the market for 130 million pounds ($256 million) six months ago. The building sold last month for about 117 million pounds... Appraisal values fell at a record rate in November and commercial real estate derivatives contracts indicate owners of British offices, shopping malls and warehouses may suffer their biggest annual losses in more than a quarter century. 'The U.K. market is falling apart,' said Peter Hobbs...head of research at RREEF Real Estate, a Deutsch Bank AG unit that manages about $100 billion."

Financial Sphere Bubble Watch:

January 7 - Bloomberg (Elizabeth Hester): "Special-purpose acquisition vehicles, companies with no product, earnings or sales that make takeovers, are Wall Street's growing source of fees now that the market for subprime-mortgage securities has dried up. The trouble is that investors who have spent $18 billion since 2003 on U.S. initial public offerings by such shell companies would have been better off holding a mutual fund that tracks the S&P 500 Index."

January 7 - Bloomberg (Brian K. Sullivan and Matthew Keenan): "Yale University, whose $22.5 billion endowment is the second largest in the U.S., said it will increase spending from the fund by about 37% to pay for expanded medical and scientific research and more financial aid for students. Yale...plans to spend about $1.15 billion of its endowment in the academic year that ends in June 2009..."

January 11 - Bloomberg (David Scheer and Jesse Westbrook): "Countrywide Financial Corp. Chief Executive Officer Angelo Mozilo may reap $83 million in severance and other compensation after the company's takeover by Bank of America Corp., according to compensation consultant Brian Foley."

California Watch:

January 10 - Bloomberg (Michael B. Marois): "California Governor Arnold Schwarzenegger said he must slash aid to poor children and the elderly, shutter state parks, shrink school funding and release 22,000 inmates early to plug a $14 billion deficit. The governor proposed a $141 billion budget that cuts expenditures on every state program by 10% for the fiscal year beginning July 1."

January 9 - Bloomberg (Michael B. Marois): "California Governor Arnold Schwarzenegger is trying for a third time to overhaul state spending as he grapples with a growing deficit and resistance from Democrats who want higher taxes to fill the gap. The governor...called for a constitutional amendment requiring California to set aside a portion of surplus revenue during flush years to stabilize the budget in lean times. He said he will propose a spending plan tomorrow that cuts most programs in the state to eliminate a $14 billion shortfall in the coming fiscal year."

January 7 - Bloomberg (Michael B. Marois): "California and its local governments face costs of $118 billion to provide health benefits promised to retired public workers over the next 30 years, according to a new state report. California would need to set aside as much as $1.2 billion a year to fund just the state's $48 billion share of the expense, according to the report by the California Public Employee Post-Employment Benefits Commission... Cities, counties, school districts and other local governments owe the remaining $70 billion."

Fiscal Watch:

January 11 - Financial Times (Krishna Guha): "The economic downturn in the US is starting to hit government revenues, the head of the Congressional Budget Office has told the Financial Times. Peter Orszag, the CBO director, said the slowdown 'is showing up in revenue'. Tax receipts were softer 'across revenue as a whole' but 'the slowing is most marked in corporate tax receipts'. Mr Orszag said any further deterioration in growth would have a still larger effect on tax revenues. Revenues 'disproportionately fall when income weakens and rise when income strengthens', he said, in part because of the progressive tax code."

January 7 - Bloomberg (Michael Quint): "New York City's budget gap next year may widen to $3.1 billion because of a weaker economy and the cost of wage agreements, the Independent Budget Office said. The group's projected $3.1 billion budget gap for the year ended June 30, 2009, is about $360 million greater than city officials projected in October and twice as large as June projections. 'If the financial industry's condition worsens or the local housing market slumps more than expected, the city's fiscal picture could become even darker,' the report said."

Crude Liquidity Watch:

January 9 - Bloomberg (Glen Carey): "Saudi Arabia's net foreign reserves rose 4.9% in November to a record... Foreign assets held by the Saudi Arabian Monetary Agency, the Country's central bank, advanced to $290 billion..."

January 7 - Bloomberg (Will McSheehy): "The economies of the six Gulf Cooperation Council states will expand at a faster rate in 2008 than last year, giving their governments bigger surpluses to spend on overseas investments, EFG-Hermes Holding SAE forecast. Saudi Arabia's real rate of gross domestic product growth will jump to 5.2% in 2008 from 3.1%... Kuwait's growth will rise to 5.1% from 3%...and Qatar's to 9.8% from 8.5%... 'Higher oil and gas production is at the root of the forecasts,' Monica Malik, EFG senior economist, said... 'Bigger fiscal surpluses will undoubtedly boost the GCC's development of overseas assets as they seek to diversify their holdings.'"

Mortgage Crisis to Corporate Debt Crisis:

The financial system fell under intense stress Wednesday. The epicenter of the crisis was in the "Credit default swap," or CDS market, and "contagion" fears were building quite a head of steam. The pricing for Countrywide Financial default protection (5-yr CDS) surged a huge 469 basis points to a record 1,610 bps (it would cost $16,100 annually to insure $100,000 of Countrywide debt against default). For perspective, Countrywide default protection was priced at a mere 30 bps one year ago and didn't even trade above 600 during the subprime crisis this past summer and autumn. Rescap CDS surged an astounding 1,360 bps Wednesday to 3,746. This was up from the year earlier 95 bps. MBIA CDS increased 85bps to 849 (year ago 87) and Ambac 89 bps to 841 (year ago 70bps). Washington Mutual CDS increased 61 bps to 611 (year ago 54bps). Many indices of corporate debt spreads rose to their widest levels in years.

In the old Greenspan days, Wednesday's circumstance would have most-likely beckoned a "surprise" inter-meeting Fed rate cut. There were rumors for as much. And while chairman Bernanke did not ease rates, Thursday morning he provided the markets the next best thing: "We stand ready to take substantive additional action as needed to support growth and to provide adequate insurance against downside risks."

Bernanke didn't plan on rambling down the Greenspan path. Actually, I believe he and other members of the FOMC would have preferred to avoid it - resist responding directly to Wall Street pleas for aggressive Federal Reserve accommodation. "Let the chips fall...", as they say. But the Fed now knows what many on Wall Street have understood since this summer: The U.S. Credit system is extraordinarily fragile and the Fed simply will not risk sitting back and watching an implosion without resorting to extreme measures. If nothing else, inter-meeting "surprise" rates cuts are back on the table. Wall Street must be quite relieved to know this mechanism is available in the event market selling pressure turns unwieldy.

This week brought back memories of the 2002 Debt Crisis. Weighed down by the telecom debt collapse, Enron, and other frauds, intensifying Corporate Debt problems late in the year were at risk of smothering the consumer sector. The nexus at the time was the auto finance subsidiaries and Household International. Consumer finance Corporate Debt spreads were widening significantly, and Household, in particular, was facing a liquidity crisis in early November. The failure of a major financial institution at that juncture would have created a major systemic issue.

Well, on November 14 HSBC agreed to buy (bailout) Household International. A week later, FOMC governor Bernanke gave his now (in)famous "Deflation: Making sure 'it' doesn't happen here" speech. With rates at 1.0% (until June 2004!), the Fed was now publicly discussing "electronic printing presses," "helicopters" and other "unconventional measures." Wall Street was trumpeting "deflation" risk. Sure enough, the crisis was soon resolved and Wall Street was emboldened to perpetuate history's greatest Credit inflation and Mortgage fiasco.

The tables have been turned these days, with the Mortgage Crisis now evolving into a full-fledged Corporate Debt Crisis. The key nexus this time around has been Wall Street "structured finance," especially as it relates to the major Mortgage lenders (certainly including Countrywide, Rescap/GMAC, and Washington Mutual) and the "financial guarantors (in particular, MBIA and Ambac). The unfolding Mortgage implosion has destroyed the value of innumerable "structured products;" has annihilated legions of mortgage companies; has impaired scores of major lenders; and this week was in the process of taking down a few huge mortgage companies. Institutions with huge liabilities to the "money," "repo," securitization, and derivative markets - not to mention huge borrowings from the FHLB - were in serious jeopardy. The risk of a domino implosion in the Credit default market and the "financial guarantor" industry had become a very real possibility. System Risk Intermediation was in peril.

The Fed responded with what the market has interpreted as a promise of aggressive rate cuts, while Bank of America has apparently for now resolved the Countrywide debt issue. Citigroup's stock rallied on rumors of a major new investment from Prince Alwaleed and others. Washington Mutual's stock price rallied sharply on rumors of merger talks with JPMorgan. Countrywide's stock surged as CDS prices collapsed, a dynamic sure to have caused considerable grief to those shorting the stock to hedge against default protection written.

Curiously, the general market took little comfort from developments. A case can be made that the rally in CDS and financial stocks was destabilizing for much of the leveraged speculating community (including "market neutral" and "quants") keen to short financial stocks against (now sinking) technology shares. Overall, the market was hammered, while MBIA and Ambac CDS prices barely budged from record levels. An index of Junk bond spreads to Treasuries actually widened an additional 4 basis points today to 603 bps, this week above 600 for the first time since - not coincidently - the 2002 Debt Crisis.

But the general environment is nothing like 2002, and I don't expect Fed words and actions - in concert with financial bailouts - to have similar effects. For one, household mortgage debt expanded 13% in 2002, proving powerful financial and economic stimulus. With consumer Credit relatively stable, 2002's Corporate Debt Crisis was not a serious systemic issue. Moreover, "Wall Street finance" was in an aggressive expansionary mode and the global banking community was developing quite a hankering to participate in the U.S. Credit Bubble. The economy was emerging from a shallow recession.

The world is a much different place today. The Mortgage Finance Bubble is a bust, Wall Street finance is imploding, and foreign financial institutions are keen to cut and run from the business of providing U.S. Credit. Countrywide's mortgage problems will be absorbed - along with so many other risks - by our domestic banking system. Worse yet, the economy is quickly succumbing to recessionary forces. With a high degree of confidence we can proclaim that the Mortgage Crisis has now evolved into a Corporate Debt Crisis - and this crisis will not be resolved anytime soon - by rates, by helicopters, or by bailouts.

Unlike 2002, today's Credit crisis is systemic. Consumer and financial sector fragilities - the heart of our Credit system - are now impaired to the point of imperiling the capacity of the Credit system to finance business spending and intermediate corporate lending risk. To be sure, prospects for a faltering U.S. consumer sector, massive financial sector Credit losses, and an imminent economic downturn have quite negative ramifications for business lending and valuations. In particular, unfolding dislocation in the CDS and Credit "insurance" markets will severely restrict Credit Availability for small, medium and large firms - especially those less than top-tier borrowers.

I'll go further and suggest that a severe tightening of Financial Conditions has abruptly made many business borrowing plans unviable; many a balance sheet and debt load untenable; and vast numbers of business strategies - crafted in altogether different financial and economic times - much less viable. Some companies will make the necessary adjustments and many will not. The unfolding backdrop definitely makes a lot of stock buyback plans imprudent and growth strategies highly risky. The aggressive risk-taking business manager - having previously capitalized on the protracted boom - will now be at a similar handicap to that which afflicted the zealous home buyer and lender banker.

For those searching for explanations behind the stock market's dismal start to the New Year, I suggest contemplating the many serious ramifications of the Mortgage Crisis having now evolved into an Incurable Corporate Debt Crisis. This week, the Bursting Credit Bubble passed another significant inflection point - one perhaps subtle but with major economic consequences.

Doug Noland
The Credit Bubble Bulletin
PrudentBear.com

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