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March 14, 2008

Wishing for Another Z.1
by Doug Noland

For the week, the Dow was up 0.5%, while the S&P500 declined 0.4%. Stating the obvious, these minor index changes don't do justice to daily wild volatility. The NYSE Financial Index declined 2.2% Monday,surged 6.1% Tuesday, declined 1.1% Wednesday, was little changed Thursday, and was hit for 3.5% today. The Transports (down 1.4% y-t-d) and Utilities (down 11.3%) both rallied 0.4% this week. The Morgan Stanley Consumer index was little changed (down 9.9%), while the Morgan Stanley Cyclical index gained 1.2% (down 9.1%). The NASDAQ100 recovered 0.4% (down 18%), while the Morgan Stanley High Tech index declined 0.9% (down 17.4%). The Street.com Internet Index was unchanged (down 14%); the NASDAQ Telecommunications index slipped 0.6% (down 13.2%); and the Semiconductors fell 1.8% (down 17%). With Bear Stearns plummeting, the Broker/Dealers were clobbered for 7.2% (down 24.5%). The Banks were little changed (down 13.1%). With Bullion surging $27.40 to surpass $1,000, the HUI Gold index jumped 5.7% (up 25.8%).

Three-month Treasury bill rates sank 30 bps this past week to 1.17%. Two-year government yields declined 3 bps to 1.49%. Five-year T-note yields fell 3 bps to 2.40%, and ten-year yields dropped 9 bps to 3.45%. Long-bond yields sank 18 bps to 4.36%. The 2yr/10yr spread ended the week at 196 bps. The implied yield on 3-month December '08 Eurodollars dropped 20 bps to 2.035%. Benchmark Fannie MBS yields dropped 28 bps to 5.45%. The spread between MBS and Treasuries narrowed 18 to a still extraordinary 200 bps. Widening further, the spread on Fannie's 5% 2017 note jumped 11 to 99 bps and the spread on Freddie's 5% 2017 note surged 10 to 98 bps. The 10-year dollar swap spread narrowed 15.2 to 70.80. Corporate bond spreads were volatile and ended wider. An index of investment grade bonds spreads widened to record levels this week, ending up 11 to 190. An index of junk bond spreads widened 13 to 636 bps.

Investment grade issuance included American Express $3.0bn, Medco Health Solutions $1.5bn, PPG Industies $1.55bn, Marathon Oil $1.0bn, General Mills $750 million, Burlington Northern $650 million, Lockheed Martin $500 million, Northern States Power $500 million, MassMutual $400 million, Equitable Resources $500 million, PPL Energy Supplies $400 million, Carolina P&L $325 million, Georgia Power $250 million and Consumers Energy $250 million.

Junk issuance included Stillwater Mining $180 million.

Convert issuance included Coeur D'alene Mining $200 million.

International dollar bond issuance included BP Capital $1.0bn.

German 10-year bund yields declined 5.5 bps to 3.73%, as the DAX equities index dipped 0.5% (down 18.1% y-t-d). Japanese "JGB" yields dropped 9 bps to 1.26%. The Nikkei 225 sank 4.2% (down 20% y-t-d and 26.6% y-o-y). Emerging markets were mostly lower. Brazil's benchmark dollar bond yields rose 11 bps to 5.87%. Brazil's Bovespa equities index added 0.2% (down 3.0% y-t-d). The Mexican Bolsa gained 1.5% (down 1.7% y-t-d). Mexico's 10-year $ yields fell 5 bps to 5.12%. Russia's RTS equities index increased 0.7% (down 9.9% y-t-d). India's Sensex equities index declined 1.3%, boosting y-t-d losses to 22.3%. China's Shanghai Exchange sank 7.9% this week, with y-t-d losses now at 24.7%.

Freddie Mac 30-year fixed mortgage rates jumped 10 bps this week to 6.13%, with rates down only one basis point from a year earlier. Fifteen-year fixed rates rose 13 bps to 5.60% (down 28bps y-o-y). One-year adjustable rates surged 20 bps to 5.14% (down 28 bps y-o-y).

Bank Credit surged $45.3bn (3-wk gain of $102.1bn) during the most recent data period (3/5) to a record $9.414 TN. Bank Credit increased $201bn y-t-d, or 11.3% annualized. Bank Credit has posted a 33-week surge of $770bn (14% annualized) and a 52-week rise of $977bn, or 11.6%. For the week, Securities Credit rose $23.4bn. Loans & Leases jumped $21.8bn to a record $6.916 TN (33-wk gain of $591bn). C&I loans increased $6.7bn, with one-year growth of 21.1%. Real Estate loans dipped $1.6bn (up 7.7% y-o-y). Consumer loans were unchanged, while Securities loans rose $13.2bn. Other loans gained $3.5bn. Examining the liability side, Deposits increased $22.3bn and Borrowings From Others jumped $32bn.

M2 (narrow) "money" supply rose $14.4bn to a record $7.645 TN (week of 3/3). Narrow "money" expanded $182bn over the past nine weeks, or 14.1% annualized, with a y-o-y rise of $512bn, or 7.2%. For the week, Currency added $0.9bn, while Demand & Checkable Deposits jumped $23.1bn. Savings Deposits fell $12.7bn, and Small Denominated Deposits declined $3.4bn. Retail Money Fund assets increased $6.5bn.

Total Money Market Fund assets (from Invest Co Inst) gained $3.5bn last week (10-wk gain $341bn) to a record $3.454 TN.. Money Fund assets have posted a 33-week rise of $870bn (53% annualized) and a one-year increase of $1.046 TN (43.5%).

Total Commercial Paper dropped $15.1bn to $1.845 TN. CP has declined $379bn over the past 31 weeks. Asset-backed CP declined $5.7bn (31-wk drop of $411bn) to $785bn. Over the past year, total CP has contracted $150bn, or 7.5%, with ABCP down $272bn, or 26%.

Fed Foreign Holdings of Treasury, Agency Debt last week (ended 3/12) increased $1.2bn to a record $2.151 TN. "Custody holdings" were up $94.5bn y-t-d, or 21.8% annualized, and $291bn year-over-year (15.7%). Federal Reserve Credit fell $4.1bn to $869bn. Fed Credit has declined $4.4bn y-t-d, while having expanded $17.6bn y-o-y (2.1%).

International reserve assets (excluding gold) - as accumulated by Bloomberg's Alex Tanzi - were up $1.384 TN y-o-y, or 27.4%, to a record $6.432 TN.

Global Credit Market Dislocation Watch:

March 11 - Bloomberg (Thomas R. Keene and Alex Lange): "Henry Kaufman, president of his own consulting firm and former chief economist at Salomon Brothers, comments... On the crunch: 'This credit crisis is deeper and wider and has been exceedingly opaque in contrast to earlier credit crises in the post-World War II period.'"

March 14 - Dow Jones (Jed Horowitz): "Bear Stearns Cos.' (BSC) troubles graduated from problematic to crisis size in the past week as fellow banks and customers changed their concerns from worries about profit declines stemming from its large mortgage exposure to sheer ability to fund its businesses. With Bear Stearns now making history as the first investment bank to require a Federal Reserve bailout, indirectly through J.P. Morgan...its problems are far from over. 'Once this happens, no one will deal with them,' said Joseph Rizzi, a veteran banker who focuses on risk-management. He equated the crisis of confidence to the one that caused Barings Bank to collapse after its massive trading scandal. 'The remaining franchise value, customers and employees, will evaporate,' he said."

March 14 - Financial Times (Michael Mackenzie, Aline van Duyn, and Peter Thal Larsen): "Bear Stearns is hardly Wall Street's biggest investment bank but its travails have far-reaching consequences for the global financial system because of its crucial behind-the-scenes role in some of the world's most troubled markets. Bear is a significant underwriter of mortgage securities, an active trader of derivatives and leading financier of hedge funds. Analysts said it was almost impossible to know what impact Bear's problems would have on its clients, its counterparties and on other investors holding securities or derivatives that Bear is trying to liquidate. 'The ripples could be widely felt because Bear Stearns has so many points of contact with everyone else in the financial industry,' said Matt D'Amico, partner in the banking business at law firm Bryan Cave. Evidence of bubbling contagion in the financial markets can be seen in the dramatic surge in the cost of credit insurance for global banks. Many banks have double-A credit ratings, but the price charged to insure their debt is more typical of lower-rated companies."

March 14 - Bloomberg (Shannon D. Harrington and Caroline Salas): "The cost to protect the largest financial institutions from default soared after Bear Stearns Cos.' emergency bailout stoked concerns that other companies may also be on the brink of failure... 'This is the worst case scenario that's playing out right now,' Tom Houghton, who manages $2 billion of corporate bonds at Advantus Capital Management... 'It just raises all the fears now about counterparty risk, and it's just a snowball effect.'"

March 10 - Bloomberg (Tom Cahill and Katherine Burton): "The hedge-fund industry is reeling from its worst crisis in a decade as banks are now demanding more money pledged to support outstanding loans even when the investment is backed by the full faith and credit of the United States. Since Feb. 15, at least six hedge funds, totaling more than $5.4 billion, have been forced to liquidate or sell holdings because their lenders -- staggered by almost $190 billion of asset writedowns and credit losses caused by the collapse of the subprime-mortgage market -- raised borrowing rates by as much as 10-fold with new claims for extra collateral."

March 12 - Financial Times (James Mackintosh): "Another three big hedge funds have been forced to close down or to suspend investor withdrawals as the credit squeeze persists. Drake Management, a $12bn New York manager, wrote to investors in its three hedge funds on Wednesday offering them the choice of winding up the funds after about half asked for their money back. Global Opportunities Capital, $870m Amsterdam hedge fund, said it would block withdrawals until the end of the year to prevent firesales of shares... It also emerged that Blue River Asset Management, a Colorado-based hedge fund manager specialising in municipal bonds, was to shut its main fund after nearly 80% losses, even after raising $110m for a fresh fund. 'These are very tough times,' said Angelos Metaxa, a director of CM Advisors, a Geneva-based fund of hedge funds. 'Anyone with significant amounts of leverage is going to be in trouble.'"

March 13 - Bloomberg (Edward Evans): "Carlyle Group said creditors plan to seize the assets of its mortgage-bond fund after it failed to meet more than $400 million of margin calls on mortgage- backed collateral that plunged in value. Carlyle Capital Corp....said in a statement it defaulted on about $16.6 billion of debt as of yesterday."

March 13 - Bloomberg (Jason Kelly): "Carlyle Group, the world's second- largest private-equity firm, was caught off guard by the failure of negotiations to save its publicly traded mortgage fund, co- founder David Rubenstein said. 'We were surprised,' Rubenstein said... 'The banks have a lot of their own credit problems. They didn't have any flexibility.'"

March 14 - Financial Times: "Last summer, Wall Street seemed to try quite hard to avoid seizing collateral from a Bear Stearns mortgage hedge fund, hammered by margin calls. The fear then was that a forced liquidation of all those complex securities might spark a panic. The banks are more battle-hardened now. As the highly-leveraged Carlyle Capital fund, with about $21bn in assets, started to default on its debt, the banks moved in quickly. This is, after all, repo land: a financing market where there is no wriggle room. If the value of the collateral falls, the banks have to protect themselves with extra cash. Repo desks are not paid to take on masses of market risk. What is shocking is that Carlyle Capital has been done in by wobbles in agency triple-A mortgage-backed securities, the only assets in its portfolio... These securities carry the implicit guarantee of the US government. But even these have not been immune from the stress in the credit markets."

March 14 - Financial Times (Joanna Chung and Peter Garnham): "The collapse of the dollar, which suffered another sharp fall on Thursday, is causing growing difficulties for economies whose currencies are tied to the greenback. A sliding dollar, whose decline has been accelerated by a series of interest rate cuts in the US, is feeding growing inflationary pressures in countries as varied as China, Saudi Arabia and Russia. These pressures, which could lead to significant economic and social problems, may get worse if, as expected, the US Federal Reserve slashes its main interest rate by 75 basis points...next week. Indeed, some analysts believe that the Fed's aggressive policy-easing to stabilise the US economy may end up destabilising those emerging-market economies with fixed or quasi-fixed dollar pegs..."

March 14 - Bloomberg (Jeremy R. Cooke): "Billionaires Bill Gross and Wilbur Ross and the U.S. Securities and Exchange Commission failed to restore confidence in the $330 billion auction-rate bond market, as borrowing costs for states and municipalities rose... More than 67% of auctions failed this week..."

March 14 - Dow Jones: "Only 24 of a total of 129 public auction rate securities up for resale succeeded Friday, according to a document provided by a person familiar with the situation. By way of comparison, 75% of the auctions up for resale failed, although there were more auction sales. Out of 190 securities on offer Thursday, 142 failed while 48 succeeded."

March 11 - Bloomberg (Tom Cahill): "Citigroup...will provide $1 billion to six of its leveraged municipal bond funds, the second time in a month it has bailed out funds hurt by tightened lending. The funds...have $15 billion in assets and about $2 billion in capital."

March 11 - Bloomberg (Abigail Moses): "The risk of losses on U.S. Treasury notes exceeded German bunds for the first time ever amid investor concern the subprime mortgage crisis is sapping government reserves, credit-default swaps prices show. Contracts on 10-year Treasuries traded at a record 16 basis points earlier today, compared with 15 basis points on German government notes... In July, U.S. credit-default swaps were at 1.6 basis points, compared with 2.5 basis points on bunds."

March 11 - The Wall Street Journal (Peter Grant): "Even optimistic commercial-property developers are stacking sandbags to hold back a financial deluge in the market for office towers, hotels, shopping malls and other commercial real estate... In recent weeks, sales of commercial property have nearly hit a standstill. And the market value of such properties -- and the mortgages on them -- have declined as the spreading fallout from the crisis in risky, or subprime, mortgages has made credit practically evaporate."

March 11 - Bloomberg (Jody Shenn): "Rising downgrades on Alt-A mortgage securities may boost by $42 billion the amount of collateralized debt obligations causing writedowns and higher capital needs at banks and bond insurers, according to Barclays Plc analysts... Downgrades on Alt-A securities may affect 'high grade' CDOs, which repackage highly rated asset-backed securities into new debt, by creating so-called events of default, according to... Barclays analysts."

March 12 - The Wall Street Journal (Robin Sidel): "Here comes another headache for banks suffering from the mortgage downturn: Losses on home-equity loans are soaring, even at some lenders that avoided big blunders on subprime loans. When times were good, banks raked in billions of dollars in profit from home-equity loans, which allow borrowers to tap the accumulated value in their property with either a loan for a specific amount or a line of credit. As long as home prices were rising, lenders had little to worry about. But falling home values are leaving banks with little or nothing to collect on many home-equity loans in case of default. Some stretched borrowers are keeping up with their mortgage and credit cards -- but not their home-equity loan."

March 13 - Dow Jones (Lavonne Kuykendall): "Stung by rapidly growing subprime losses that pushed it to a record fourth-quarter loss, bond insurer Security Capital Assurance (SCA) said Thursday that it is in survival mode. The company said it will write no new business while it struggles to raise capital to pay off what could be massive losses in financial guarantees it wrote on subprime mortgage-backed securities. It will also try to get out of some of its troubled contracts to reduce its potential exposure to losses."

March 14 - Bloomberg (Erik Holm and Josh P. Hamilton): "The collapse of the subprime mortgage market will lead to record losses for insurance companies, overtaking Hurricane Katrina, the worst natural disaster in U.S. history. The amount of asset writedowns and credit losses reported by the industry has reached at least $38 billion, just short of the $41.1 billion in claims from Katrina..."

Currency Watch:

March 11 - Bloomberg (Kosuke Goto): "Japan's yen will rise to 80 per dollar in two years as Japan raises interest rates and the U.S. cuts borrowing costs, said Eisuke Sakakibara, the nation's former currency-policy chief."

The dollar index dropped 1.9%, ending the week at a dismal 71.66. For the week on the upside, the New Zealand dollar increased 3.1%, the Japanese yen 2.6%, the Australian dollar 2.4%, the Euro 2.1%, the Danish krone 2.1%, the Swiss franc 2.1%, and the Swedish krona 1.5%. On the downside, the South Korean won declined 2.8%, the Brazilian real 0.5%, and the Taiwanese dollar 0.3%.

Commodities Watch:

March 12 - Bloomberg (Li Yanping and William Bi): "China may import more grain and other food this year if necessary to secure supplies and curb rising prices, the Ministry of Commerce said. The country has made food security a top priority in 2008, and will make sure there is enough grain, meat and cooking oil for domestic consumption, the ministry said..."

March 10 - Bloomberg (Dinakar Sethuraman and Angela Macdonald-Smith): "Russia is forcing Exxon Mobil Corp. to abandon plans to export natural gas to China. Nigeria is requiring explorers to share output with its citizens. Indonesia will cut sales to Japan. Countries holding almost half the world's gas are curbing shipments to meet growing domestic use, hurting importers from the U.S. to Japan."

Gold jumped 2.8% to a record $1,001 and Silver 2.0% to $20.66. May Copper gave back 2.4%. April Crude surged $4.91 to a record $110.06. April Gasoline jumped 2.8%, and April Natural Gas increased 0.7%. March Wheat surged 6.2% (up 31% y-t-d). The CRB index gained 1.2% (up 16.1% y-t-d). The Goldman Sachs Commodities Index (GSCI) rose 2.8% to a new record (up 16.8% y-t-d and 62.7% y-o-y).

China Watch:

March 11 - Bloomberg (William Bi): "China's northern provinces, the country's biggest grain-growing region, may suffer an extended drought this month as winter wheat crops start to need rain, the China Meteorological Administration said. Heilongjiang, Jilin and eastern Inner Mongolia have had 1.8 millimeters of precipitation this year, the lowest since 1951, while other regions received as little as 80% of average rain or snow... Drought is afflicting northern China after the worst snowstorms in 50 years lashed its southern provinces, killing livestock and damaging crops there."

March 12 - Bloomberg (Kevin Hamlin): "China's retail sales climbed 20.2%, matching the fastest pace in at least nine years... The figure was boosted by the fastest inflation in 11 years. Spending fueled by a 17% increase in urban incomes last year helps the expansions in China of Wal-Mart Stores Inc."

March 12 - Bloomberg (Kevin Hamlin): "China's money-supply growth slowed in February. M2...rose 17.5% to 42.1 trillion yuan ($5.9 trillion) from a year earlier..."

March 11 - Bloomberg (Kevin Hamlin and Li Yanping): "China's inflation accelerated to the fastest pace in 11 years as the worst snowstorms in half a century disrupted food supplies, adding pressure on the central bank to raise interest rates. Consumer prices climbed 8.7% in February from a year earlier after gaining 7.1% in January... Food costs soared 23% after blizzards destroyed crops and snarled transport links..."

March 11 - Market News International: "Are the good times coming to an end for China's manufacturers? It certainly seems that way, as the protection that Beijing afforded them in recent years is quickly eroded by a confluence of factors, not least a rapidly appreciating currency. The strengthening yuan is just one of a series of costs to have hit Chinese manufacturers in recent years, and evidence is mounting that companies up and down the east coast are struggling to protect their margins and, in some cases, stay in business."

India Watch:

March 12 - Bloomberg (Kartik Goyal): "India's industrial production growth unexpectedly slowed in January as interest rates near a six-year high curbed demand for cars and other consumer goods. Production at factories, utilities and mines rose 5.3% from a year earlier after gaining a revised 7.7% in December..."

Asia Bubble Watch:

March 11 - Bloomberg (Seyoon Kim): "South Korea's retail sales rose in January as consumers bought more food and gifts ahead of the Lunar New Year holiday. Spending climbed 10%..."

Unbalanced Global Economy Watch:

March 13 - Bloomberg (Brian Swint and Jennifer Ryan): "Britons' inflation expectations rose to the highest in at least eight years in a Bank of England survey last month... Consumers predict prices will increase 3.3% in the next 12 months, up from 3% in November..."

March 11 - Bloomberg (Jennifer Ryan): "The U.K. housing slump deepened in February, becoming the worst since the eve of the nation's last recession in 1990, a survey of real-estate professionals showed."

March 10 - Bloomberg (Jennifer Ryan): "U.K. producer-price increases matched the fastest annual pace since 1991 last month as factories passed on record raw-material cost gains to their customers, adding to inflation. Manufacturing output prices climbed 5.7% from a year earlier... Raw material costs rose an annual 19.4% in February, the most since records began in 1986..."

March 14 - Dow Jones: "The annual rate of euro-zone consumer price inflation was revised up to a fresh all-time high... Higher food and energy prices pushed the annual measure up to 3.3% in February from an estimate of 3.2%..."

March 12 - Bloomberg (Sandrine Rastello): "France's inflation rate remained at a 12-year high in February as energy and food costs reached records. Consumer prices climbed by an annual 3.2%..."

March 10 - Bloomberg (Simone Meier): "German exports increased the most in 16 months in January, led by demand from outside Europe."

March 13 - Associated Press: "Inflation in Spain has reached its highest level since 1995 with the National Statistics Institute reporting an annual 4.4% rate in February."

March 10 - Bloomberg (Tasneem Brogger): "Denmark's inflation rate unexpectedly rose in February, reaching the highest since July 2000 and indicating a shortage of workers is pushing the economy closer to overheating. Inflation accelerated to 3.1% from 2.9% in January..."

March 10 - Bloomberg (Robin Wigglesworth): "Norway's inflation rate unexpectedly rose to 2.2% in February, the highest since September 2002, adding to pressure on the central bank to raise interest rates even as global economic growth slows."

March 11 - Bloomberg (Alex Nicholson): "Russian Finance Minister Alexei Kudrin said net capital outflow may have reached $15 billion to $20 billion in the first two months of the year, Interfax reported..."

March 12 - Bloomberg (Jacob Greber): "Australian consumer confidence plunged to the lowest level in almost 15 years after the central bank raised interest rates and the share market tumbled on concern global economic growth is slowing."

March 12 - Bloomberg (Tracy Withers): "New Zealand house sales slumped and prices fell to a 12-month low in February, adding to signs record-high interest rates are cooling the property market and will slow economic growth. House sales dropped 32%..."

Latin America Watch:

March 12 - Bloomberg (Guillermo Parra-Bernal): "Brazil's economy expanded a greater-than-expected 6.2% in the fourth quarter, the fastest year-on-year quarterly expansion since June 2004, as consumer spending and business investment swelled."

Central Banker Watch:

March 14 - Bloomberg (Scott Lanman): "Federal Reserve Chairman Ben S. Bernanke invoked a law last used four decades ago to keep Bear Stearns Cos. from collapsing after the securities firm sought emergency funding from the central bank. The loan to Bear Stearns required a vote today by the Fed's Board of Governors because the company isn't a bank, Fed staff officials said. The central bank is taking on the credit risk from Bear Stearns collateral, lending the funds through JPMorgan Chase & Co. because it's operationally simpler to accomplish than a direct loan, the staff said on condition of anonymity. Bernanke took advantage of little-used parts of Fed law, added in the 1930s and last utilized in the 1960s, that allows it to lend to corporations and private partnerships with a special board vote. The Fed chief probably sought to stave off a deeper blow to the financial system from a Bear Stearns collapse, former Fed researcher Keith Hembre said."

March 11 - Bloomberg (Simone Meier and Gabi Thesing): "European Central Bank council member Axel Weber said he doesn't see any leeway to lower borrowing costs after oil prices jumped to a record. 'The surge in oil prices is a major concern and I don't think it leaves us any room for a loosening of our monetary policy,' Weber, who is also president of Germany's Bundesbank, said..."

Bursting Bubble Economy Watch:

March 13 - Los Angeles Times: "A recession has already started and the downturn is likely to last longer than in the recent past, with the economy recovering only late next year, according to a quarterly survey of corporate chief financial officers... Fifty-four percent of the CFOs said the United States was in recession, and another 24% said there was a high likelihood of one starting later this year, according to a Duke University/CFO magazine survey... About three-quarters of the CFOs said they were more pessimistic this quarter than in the prior quarter about the economy..."

March 9 - United Press International: "Food prices in the United States have increased at the fastest rate since 1990... Citing U.S. Department of Labor figures, The Boston Globe reported that prices for such staples as bread, milk, eggs and flour are rising sharply. Milk prices, for example, increased 26% during the past year, while egg prices climbed 40%..."

March 12 - The Wall Street Journal (Alex Frangos): "Affordable housing is the latest victim of the credit crunch that is reverberating through financial markets. Projects are being canceled because some of the nation's largest financial companies, including Fannie Mae, Freddie Mac and Bank of America, have scaled back their participation in the federal government's largest and most prolific affordable housing tax-credit program..."

California Watch:

March 13 - Bloomberg (Daniel Taub): "Sales of houses and condominiums in Southern California and the San Francisco Bay area fell last month to the lowest for a February in two decades as buyers struggled to get loans and prices slumped, DataQuick...said. In Southern California, the number of sales dropped 39%, while in the Bay Area sales fell 37% from a year ago... 'The lending system has been in lockdown mode the last half year,' DataQuick President Marshall Prentice said... The median price in Southern California dropped a record 18% from a year earlier to $408,000. The median price paid for a Bay Area home was $548,000, down from $620,000 in February of last year. More than a third of the existing homes that sold in February in Southern California had been foreclosed upon at some point since the beginning of last year... In some parts of Southern California, 'there's virtually no activity going on,' DataQuick analyst John Karevoll said... 'Right now the only activity we can really monitor is this noisy, distressed stuff.'"

Mortgage Finance Bust Watch:

March 14 - Bloomberg (Bob Ivry and Sharon L. Lynch): "Ben S. Bernanke can't revive the housing market and the banks aren't helping him. The U.S. Federal Reserve has cut interest rates five times, pumped $200 billion into the financial system this week, and today its New York branch provided funds to help rescue Bear Stearns Cos. None of that has brought down mortgage rates for residential borrowers, whose success in refinancing or buying would help bolster the U.S. economy. The interest rate on a 30-year fixed-rate mortgage has climbed to 6.37% from 5.5% since Jan. 24..."

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

March 11 - Bloomberg (Mark Pittman): "Even after downgrading almost 10,000 subprime-mortgage bonds, Standard & Poor's and Moody's... haven't cut the ones that matter most: AAA securities that are the mainstays of bank and insurance company investments. None of the 80 AAA securities in ABX indexes that track subprime bonds meet the criteria S&P had even before it toughened ratings standards in February, according to data compiled by Bloomberg. A bond sold by Deutsche Bank AG in May 2006 is AAA at both companies even though 43% of the underlying mortgages are delinquent. Sticking to the rules would strip at least $120 billion in bonds of their AAA status.... 'The fact that they've kept those ratings where they are is laughable,' said Kyle Bass, chief executive officer of Hayman Capital Partners... 'Downgrades of AAA and AA bonds are imminent, and they're going to be significant.'"

March 11 - Financial Times (Anuj Gangahar): "The global volume of futures and options trading soared by 28% last year, the largest annual increase since 2003. More than 15bn futures and options contracts changed hands during 2007 at 54 exchanges across the world, according to the Futures Industry Association."

Real Estate Bubble Watch:

March 13 - Dow Jones: "Foreclosure filings for February soared 60% from a year earlier but dropped 4% from January... RealtyTrac said there were 223,651 foreclosure filings in February, or one for every 557 U.S. households. Chief Executive James J. Saccacio said February's decline was similar to a 6% sequential decline in February 2007. But the year-over-year increase was triple last February's growth rate, indicating 'we have still not reached the peak of foreclosure activity in this cycle.' The nation's highest foreclosure total again belonged to the most populous state - California - with 53,629 filings, more than double a year earlier but down 6% from January. It was followed by Florida, Texas, Michigan and Ohio."

Muni Watch:

March 12 - Bloomberg (Michael McDonald): "The risk of guaranteeing municipal debt is increasing because the economy is slowing, said Ajit Jain, head of Berkshire Hathaway Inc.'s new bond insurer. Fiscal stress in Vallejo, California, and Jefferson County, Alabama, may be the 'tip of the iceberg' for municipal defaults, said Jain, who runs Warren Buffett's Berkshire Hathaway Assurance Corp... 'While we are writing business at pricing levels that are economically attractive to us, I remain very concerned about the long-term viability of this product,' Jain said in testimony he plans to give today to the House Financial Services Committee..."

Fiscal Watch:

March 12 - Bloomberg (John Brinsley): "The federal government budget deficit widened to a record $175.6 billion in February as a weakening U.S. economy eroded tax revenue and spending on Social Security and the military climbed... 'Revenue forecasts are going to have to be revised down,' David Sloan, a senior economist at 4Cast...said... The shortfall in receipts was exacerbated by an extra day in February, due to the leap year, that meant more tax refunds, swelling the deficit by $14.6 billion... Spending since the fiscal year started Oct. 1 was up 10.2% to $1.23 trillion, while revenue increased 1.3% to $967.2 billion. That left the year-to-date budget deficit at $263.3 billion, more than the five-month cumulative $162.2 billion shortage a year earlier... The CBO is projecting a $396 billion deficit for the current fiscal year, 143% larger than the shortfall in 2007. The U.S. posted a record $413 billion deficit in 2004."

March 11 - United Press International (Tom Cahill and Alexis Xydias): "The foreclosure crisis is taking a toll on U.S. cities, causing a drop in tax revenues, a spike in crime and an increase in homelessness, a survey said. The National League of Cities survey of elected local officials indicated foreclosures are squeezing city coffers as officials try to cope with increased crime, homelessness and vacant property... 'There's a reduction in revenues at the same time that more services are needed,' says Cynthia McCollum, NLC president... 'Because of foreclosures, people are stealing, crime is on the rise and we don't have more money for cops on the street.'"

March 14 - Bloomberg (Michael Quint): "New York Lieutenant Governor David Paterson, who takes over the state's top job when Eliot Spitzer steps down next week, refused to rule out an increase in personal income taxes for top earners as the economy slows and revenue dwindles. 'We have a huge economic problem in this country,' Paterson, 53, said yesterday... State officials reduced their forecast for next year's tax collections by $634 million since Spitzer presented his $124.3 billion budget in January..."

Speculator Watch:

March 12 - Bloomberg (Katherine Burton): "Drake Management LLC, the New York- based firm started by former BlackRock Inc. money managers, may shut its largest hedge fund after a 25% decline last year... Drake, which managed $13 billion as recently as the end of the year, is considering similar steps for its two other hedge funds. Hedge funds with more than $5.4 billion have been forced to liquidate or sell assets since Feb. 15..."

March 12 - Bloomberg (Tom Cahill and Alexis Xydias): "GO Capital Asset Management BV blocked clients from withdrawing cash from its Global Opportunities Fund, at least the seventh hedge fund in the past month forced to take steps to protect itself from falling markets. Frans van Schaik, the former head of equity research at ABN Amro Holding NV who founded the...fund wrote to investors that the fund is not leveraged and not facing margin calls. The fund, which bets both on rising and falling prices, has assets of about 570 million euros ($881 million). 'A temporary suspension of redemptions is the best defensive measure to protect the interests of the participants,' van Schaik and other members of GO Capital's management said... 'Current market circumstances do not allow the fund to sell investments at a reasonable price.'"

March 14 - UK Times (Miles Costello): "London's embattled hedge fund community is bracing for a spate of blow-ups in the wake of yesterday's $16 billion debt default by Carlyle Capital Corporation... Numerous small start-up credit hedge funds, managing between $10 million and $200 million of assets, are facing a funding squeeze, according to sources. The prime brokers that provide credit liquidity to these funds are beginning to withdraw financial support or heavily increase their margin calls, they said. Several bigger credit funds with as much as $2 billion under management are also looking vulnerable... 'It's basically any single-strategy hedge fund that is leveraged and invested in mortgage securities; it doesn't matter whether it is AAA or sub-prime paper; these guys are at risk,' one London hedge fund manager said. 'The smaller players with $10 million or so of funds, guys who jumped out of the investment banks to set up on their own, are under the greatest pressure. They don't have enough assets to generate proper alpha for their investors. They barely generate enough management fees to pay their wife's shopping bill,' the source said."

March 10 - Dow Jones (Marietta Cauchi): "Institutional investors are pressing the managers of alternative assets, including private equity and hedge funds, on issues of transparency and risk management, as returns come down and governance becomes as important as performance, PricewaterhouseCoopers said..."

Crude Liquidity Watch:

March 12 - Bloomberg (Maher Chmaytelli): "OPEC may earn $927 billion from oil exports this year, the U.S. government's Energy Information Administration said, raising its estimate 9%... OPEC got $676 billion from oil sales in 2007, a 10% increase from the previous year, the EIA said."

March 12 - The Wall Street Journal (Tahani Karrar): "Qatar, the world's largest exporter of liquefied natural gas, may revalue its currency or end its peg to the dollar as soon as next month, Qatari Central Bank officials said."

Wishing for Another Z.1:

This week offered further disconcerting confirmation that the 20 Year Experiment in "Wall Street finance" is failing miserably. Tuesday, the Federal Reserve was compelled to announce the implementation of an extraordinary $200bn liquidity facility for the Wall Street "primary dealer" community. Despite this action, it was necessary this morning for our central bank to orchestrate emergency funding for troubled Bear Stearns. We're now clearly in the midst of a precarious systemic crisis. I concur with the characterization made this morning by former Treasury Secretary Robert Rubin: We're in "uncharted waters."

To be sure, the Credit Crisis has accelerated to a ferocious clip. Last week it was a "white shoe" hedge fund leveraged in "AAA" securities that imploded. Earlier this week, a "white shoe" firm listed (in Europe) fund that had been leveraging in "AAA" Fannie and Freddie securities imploded. Today, one of Wall Street's white shoe firms required a Fed-assisted "bailout" to at least temporarily ward off implosion. It is neither hyperbole nor fear mongering to warn that scores of players throughout the expansive U.S. financial sector are now in jeopardy of finding themselves engulfed in a liquidity crisis.

I found the opening question from this afternoon's Bear Stearns conference call quite telling: "What is your current gross notional non-exchange traded derivative exposure?" The executive's response - "To be honest with you, I don't know this number off the top of my head..." - was not comforting. But to be fair, the company's derivative obligations are not today the most pressing issue facing management. It is, however, a deep concern for an increasingly panicked marketplace. The Bear Stearns funding crisis certainly brings somewhat to a head the market's festering worries with regard to the daisy-chain of derivative and counter-party exposures, liquidity risk, and a complete lack of transparency. Bear Stearns' management was quick to blame "false rumors and innuendo" for the funding crisis. Yet, how sound are the underpinnings for Bear Stearns, the U.S. Credit system, or the markets overall when market chatter can have such destabilizing effects?

Candidly, I wish I had another of the Fed's Z.1 "flow of fund" reports to grind through this evening - conveniently providing the opportunity to keep most of my thoughts and fears to myself. Most unfortunately, we've been witnessing the worst-case scenario unfold before our very eyes - and it all imparts a bad feeling deep in my gut. Marketplace liquidity is all about confidence. Confidence that held sway for years can turn so fleeting, while once Revulsion takes hold, it tends to linger. That Tuesday's Fed announcement did not forestall a run on Bear Stearns suggests to me that this unfolding crisis has attained alarming momentum. At this point, confidence in leveraged securities finance appears to have been irreparably damaged.

I'll assume that two of the Critical Fault Lines for the Rapidly Escalating Crisis reside in the securities financing "repo" market and the Credit default swap (CDS) marketplace. Leading the list of companies that saw the prices of their CDS (default protection) surge significantly this week were GMAC, Bear Stearns, Ford, Sallie Mae, Countrywide, and Lehman Brothers. These six companies combine for (as of their most recent financial statements) Total Assets almost $2.0 TN, supported by Shareholders Equity of about $75bn. Or, stated differently, these six companies are leveraged (mostly in financial assets) to "capital" at a ratio in the neighborhood of 25 to 1.

In the context of the current backdrop, fear of default for such highly leveraged companies is more than justified. Expectations for contagion effects throughout the securities lending arena are similarly rational. We can safely assume that the marketplace has accumulated enormous CDS positions protecting against default for all six of these companies (and many others). I'll also presume that a default by any one of these companies (or a number of others) would pose a severe problem for the CDS market and for systemic stability overall. It is also likely that heightened counterparty fears will add a problematic dimension to those managing large "books" of offsetting Credit exposures. Evidence mounts by the day supporting the view of a problematic unfolding dislocation in the Acutely Fragile and Untested CDS Marketplace.

The Fed is in a real quagmire here. Because of the "daisy-chain" nature of contemporary risk intermediation (specifically in the derivatives and securities financing marketplaces), a failure these days in one of any number of institutions would quickly reverberate throughout the entire (frail) system. As such, today virtually any player of significant presence in the derivatives and "repos" markets is likely to be perceived by the Fed as "too big to fail."

The dollar sank to a record low against the Euro and to the weakest level against the Japanese yen since 1995. As far as I'm concerned, the currency markets this week "officially" attained the status "disorderly." Not surprisingly, the dollar responded quite poorly to the Fed's plan to accept $200bn of risky collateral from the "primary dealer" community, as it did to today's financing arrangement for Bear Stearns. The $200 billion is certainly only an opening "ante" and Bear the first of many bailouts.

Undoubtedly, currency markets have begun to increasingly discount the "nationalization" of U.S. Credit risk - both by the Federal Reserve and the federal government. The Fed may plan on 28-day terms for its exchange of Treasuries for other "street" collateral. Yet, the way things are developing, I see little prospect anytime soon for an environment conducive to the Fed reversing course and transferring such risk back to Wall Street. Indeed, this week likely marks a key inflection point for what will soon evolve into a huge expansion of Fed holdings (and various guarantees) of U.S. risk assets. And, at some point, the federal government will be similarly forced into accepting Trillions of "financial guarantee" obligations - for mortgages, municipal debt, student loans, various "deposits" and who knows what.

In past analyses, I have differentiated between the Financial Sphere and the Economic Sphere. At the Fed and throughout the markets, the current focus is on Financial Sphere developments and possible policy responses. Even assuming that the funding crisis at Bear Stearns and elsewhere is resolved in short order (a huge assumption at this point), I doubt even this would restrain the head winds now buffeting the Economic Sphere. Understandably, the focus now will be on inter-"bank" and securities financing markets. Meanwhile, recent developments will ensure a further tightening in already taut mortgage, municipal, and corporate lending markets. The economy will suffer mightily.

The release this week of Dataquick's California housing data (see "California Watch" above) provided strong support for our view that the Golden State housing market is crashing. Anecdotal accounts have markets throughout the state basically shut-down because of the inability to obtain mortgage Credit. And with liquidity quickly drying up for various endeavors including student loans, auto finance, small business lending, and business finance more generally, our dire economic prognosis is regrettably coming to fruition.

There are now forecasts for a 100 basis point cut in the Fed funds rate for next Tuesday. Many are arguing that financial and economic developments support more aggressive Fed rate slashing. I am reminded of the joke of the entrepreneur that loses money on every sale but is determined to make it up on volume. At this point, it should be apparent that rate cuts are destabilizing the system. They not only damage Federal Reserve credibility, they are battering confidence in the dollar and U.S. financial assets more generally. With the financial crisis having reached the "core" of the U.S. Credit system and the currency markets having turned "disorderly," we're now on Dollar Crisis Watch. One of my greatest fears has always been an unwieldy dislocation in the currency derivatives market.

Doug Noland
The Credit Bubble Bulletin
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