Burst Bubble: Energy or Speculator?

By: Doug Noland | Sat, Aug 9, 2008
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For the week, the Dow jumped 3.6% (down 11.5% y-t-d) and the S&P500 gained 2.9% (down 11.7%). The Transports surged 5.4%, increasing 2008 gains to 14.1%. The Morgan Stanley Cyclicals rose 4.0% (down 11.1%). The Morgan Stanley Consumer index jumped 4.4% (down 5.2%), and the Utilities added 1.2% (down 12.3%). The small cap Russell 2000 increased 2.5% (down 4.1%), and the S&P400 Mid-Caps gained 1.6% (down 5.2%). Technology stocks were strong. The NASDAQ100 surged 5.5% (down 7.6%), and the Morgan Stanley High Tech index rose 5.1% (down 6.4%). The Semiconductors jumped 8.6% (down 10%). The Street.com Internet Index surged 7.2% (down 4.7%), and the NASDAQ Telecommunications index advanced 5.8% (down 1.2%). The Biotechs increased 1.0% (up 9.1%). The Broker/Dealers rallied 2.0% (down 25.4%), and the Banks gained 1.6% (down 22.9%). With Bullion sinking $54, the HUI Gold index sank 14.4% (down 18.4%).

One-month Treasury bill rates rose 4 bps this week to 1.60%, while 3-month yields were little changed at 1.70%. Two-year government yields were unchanged at 2.50%. Five-year T-note yields slipped one basis point to 3.19%, and 10-year yields were little changed at 3.94%. Long-bond yields declined 2 bps to 4.54%. The 2yr/10yr spread was little changed at 144 bps. The implied yield on 3-month December '09 Eurodollars declined one basis point to 3.80%. Benchmark Fannie MBS yields rose 5 bps to 5.99%. The spread between benchmark MBS and 10-year Treasuries widened 5 to 206 bps. The spread on Fannie's 5% 2017 note widened 2 bps to 73 bps, and the spread on Freddie's 5% 2017 note widened 2 bps to 74 bps. The 10-year dollar swap spread increased 0.75 to 73.0. Corporate bond spreads were mixed to wider. An index of investment grade bond spreads widened 2 to 142 bps, while an index of junk bond spreads was little changed at 560 bps.

Investment grade issuance this week included XTO Energy $3.0bn, CME Group $1.3bn, Caterpillar $850 million, Northern Trust $700 million, Public Service Colorado $600 million, and Ryder Systems $300 million.

Junk issuers included Texas Industries $300 million and Aeroflex $225 million.

Convert issuers this week included Massey Energy $690 million.

International dollar bond issuance included Trans-Canada Pipeline $1.5bn.

German 10-year bund yields dropped 9 bps to 4.26%. The German DAX equities index rallied 2.6% (down 18.7% y-t-d). Japanese 10-year "JGB" yields declined 4 bps to 1.47%. The Nikkei 225 added 0.6% (down 14% y-t-d and 22.7% y-o-y). Emerging markets mostly underperformed. Brazil's benchmark dollar bond yields rose 4 bps to 5.94%. Brazil's Bovespa equities index declined 1.8% (down 11.4% y-t-d). The Mexican Bolsa added 0.6% (down 8.1% y-t-d). Mexico's 10-year $ yields declined 4 bps to 5.46%. War worries pushed Russia's RTS equities index 11.3% lower (down 24.8% y-t-d). India's Sensex equities index gained 3.5%, reducing y-t-d losses to 25.2%. China's Shanghai Exchange index sank 7.0%, boosting 2008 losses to 50.5%.

Freddie Mac 30-year fixed mortgage rates were unchanged at 6.52% (down 7bps y-o-y). Fifteen-year fixed rates increased 3 bps to 6.10% (down 15bps y-o-y), while one-year ARMs declined 5 bps to 5.22% (down 43bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates down 6 bps this week to 7.50%.

Bank Credit increased $5.5bn to $9.405 TN (week of 7/30). Bank Credit has expanded $192bn y-t-d, or only 3.5% annualized. Bank Credit posted a 52-week rise of $727bn, or 8.4%. For the week, Securities Credit increased $16.5bn. Loans & Leases declined $11bn to $6.917 TN (52-wk gain of $557bn, or 8.8%). C&I loans gained $5.7bn, with y-t-d growth of 8.5%. Real Estate loans increased $2.9bn (up 1.7% y-t-d). Consumer loans rose $4.7bn, while Securities loans dropped $16.5bn. Other loans declined $7.8bn.

M2 (narrow) "money" supply declined $14.2bn to $7.729 TN (week of 7/28). Narrow "money" has expanded $266bn y-t-d, or 6.2% annualized, with a y-o-y rise of $439bn, or 6.0%. For the week, Currency added $1.2bn, and Demand & Checkable Deposits rose $9.7bn. Savings Deposits fell $35.8bn, while Small Denominated Deposits increased $8.4bn. Retail Money Funds added $2.2bn.

Total Money Market Fund assets (from Invest Co Inst) jumped $58.5bn to $3.560 TN, with a y-t-d increase of $447bn, or 24.1% annualized. Money Fund assets have posted a one-year increase of $903bn (34.0%).

Asset-Backed Securities (ABS) issuance slowed to less than $1.0bn. Year-to-date total US ABS issuance of $118bn (tallied by JPMorgan's Christopher Flanagan) is running at 26% of comparable 2007. Home Equity ABS issuance of $303 million compares with 2007's $212bn. Year-to-date CDO issuance of $17bn compares to the year ago $261bn.

Total Commercial Paper outstanding declined $2.8bn this week to $1.725 TN, with a y-t-d decline of $60bn (5.5% annualized). Asset-backed CP fell $14.2bn last week to $730bn, boosting 2008's decline to $43.1bn (9.1% annualized). Over the past year, total CP has contracted $498bn, or 22.4%, with ABCP down $466bn, or 38.9%.

Fed Foreign Holdings of Treasury, Agency Debt last week (ended 8/6) jumped $28.0bn to a record $2.396 TN. "Custody holdings" were up $339bn y-t-d, or 26.8% annualized, and $389bn y-o-y (19.4%). Federal Reserve Credit declined $3.6bn to $889bn. Fed Credit has expanded $15.6bn y-t-d (2.9% annualized) and $38.6bn y-o-y (4.5%).

International reserve assets (excluding gold) - as accumulated by Bloomberg's Alex Tanzi - were up $1.315 TN y-o-y, or 23%, to $6.992 TN.

Global Credit Market Dislocation Watch:

August 8 - Dow Jones: "Fannie Mae swung to a second-quarter loss as the largest buyer of home loans booked $5.35 billion in credit-costs from boosting loss provisions and charge-offs... The company... also announced plans to cut annual operating costs 10% by the end of 2009, increase its guaranty fees and manage its balance sheet to conserve capital. Such balance-sheet moves include eliminating higher-risk loans - namely newly originated Alt-A acquisitions - by year-end, boosting efforts to revamp delinquent loans and opening offices in Florida and California to more closely manage sales of foreclosed properties. As of June 30, Alt-A mortgage loans represented 11% of Fannie's total mortgage book of business... The government-sponsored provider of funds for home mortgages posted a net loss of $2.3 billion... The credit-related expenses, up more than tenfold from last year, include a $3.7 billion addition to its loss reserves... As of June 30, the serious delinquency rate... was 1.36%, up from 0.98% as of Dec. 31, 2007 and 0.64% a year ago. Loan charge-offs, excluding fair value losses, were $945 million in the second quarter, up 50% from the first quarter..."

August 6 - Bloomberg (Dawn Kopecki): "Freddie Mac... slashed its dividend at least 80% after posting a quarterly loss that was three times wider than analysts' estimates... The results, combined with (CEO) Syron's delay in selling $5.5 billion in stock, increased speculation U.S. Treasury Secretary Henry Paulson will use his new power to pump money into Freddie. Syron said the... company will wait to sell shares at 'a more propitious time.' Meantime the company may slow purchases for its $792 billion portfolio of mortgages and slice the dividend to avoid breaching regulatory capital requirements... The company has 22,000 properties in foreclosure, the most since it was created in 1970 during the Vietnam War and now anticipates losing 26% on each loan, up from 22%. The fair value of its assets fell to a negative $5.6 billion... Almost one out of every 10 mortgages in the U.S. was in trouble during the first quarter, the highest in records dating to 1979, according to the Mortgage Bankers Association... Credit losses were 17.3 bps over the average total mortgage portfolio, up from 11.6 bps in the first quarter. The company is no longer forecasting losses because the decline has been too hard to predict... Freddie had projected credit losses of 12 bps or $2.2 billion for this year and 14 bps or $2.9 billion in 2009... Freddie is also searching for a new CEO, a process that is 'taking longer than we'd hoped,' Syron said."

August 8 - New York Times (Mary Williams Walsh): "American International Group, the big insurer, lost $5.3 billion in the second quarter as housing values slid and disruptions continued in the credit markets. Securities analysts had been expecting A.I.G. to post a small net gain. Still, its loss was less than the $7.8 billion it lost in the first quarter of this year... The continued red ink underscored the way A.I.G. has been battered by the troubles that have been spreading through the financial sector since late last summer. In the second quarter of 2007, before the collapse of mortgage-backed securities began to cause runs on hedge funds and huge losses at banks, A.I.G. earned $4.2 billion."

August 7 - Bloomberg (John Glover): "Defaults on bonds may rise to as much as 10% worldwide within a year as economic growth slows, according to Moody's... While defaults on high-yield, high-risk bonds are likely to reach 6.3% in 12 months, the rate may be higher should the housing slump lead to a 'protracted U.S. recession,' the... company said... 'The global default rate will climb sharply over the next 12 months,' Kenneth Emery, director of default research, said... 'The pace of corporate defaults increased considerably in July as economic conditions weakened and more companies experienced financial distress.'"

August 8 - Bloomberg (Tom Cahill): "The $1.9 trillion hedge fund industry, mired in its worst performance in two decades, faces 'much worse' conditions than in 1998, when Long-Term Capital Management LP collapsed, a veteran of that fund said. 'It's definitely a trickier environment,' said Hans Hufschmid, CEO of GlobeOp Financial Services LP, and a former partner at LTCM... 'The market is much worse that it was in 1998. Then it was just LTCM, but this impacts everybody.' Hedge funds are concerned for the first time about risks related to prime brokers after Bear Stearns Cos.' forced merger with JPMorgan Chase & Co., said Hufschmid... whose ...company is administrator to funds managing about $104 billion... 'Hedge funds live on credit and leverage and the ability to finance esoteric positions for a long time,' said Hufschmid. 'To the extent liquidity is drying up as it is now, that becomes more difficult.'"

August 6 - Bloomberg (Pierre Paulden): "Prices of high-risk, high-yield loans fell in the week ended yesterday as shrinking sales hurt U.S. automakers and the number of companies filing for bankruptcy rose. The average actively traded loan fell to 88.5 cents on the dollar, from 89.26 on July 29, according to S&P's LCD. Loan prices have fallen 3.2 cents since the start of June to near record-low levels... 'Certain sectors, especially consumer-related and homebuilding have been heavier hit than others,' said Chris Taggert, an analyst at research firm CreditSights... 'Fundamentals continue to weaken.'"

August 7 - Bloomberg (John Glover): "A year after losses on U.S. subprime mortgages caused a seizure in credit markets worldwide, European companies are starting to default. As many as 6% to 7% of corporate borrowers may fail to pay debts on time in the next year, a tenfold increase from June, according to Dresdner Kleinwort... That would be the highest since July 2003... 'Companies that would have refinanced a year ago find now that they can't,' said Andy Stoneman, managing partner at MCR Corporate Restructuring in London..."

August 7 - Bloomberg (Lisa Brennan): "The Oakland, California, agency that runs toll bridges across the San Francisco Bay is proving that the era of cheap money for municipal borrowers is over. This week the Bay Area Toll Authority sold more than $700 million of bonds at rates as high as 5.34% to refinance debt that cost 4% last year... 'The cost of money just went way up,' said Brian Mayhew, the agency's chief financial officer. 'You may have projects on the cusp that are going to be difficult to do.' Almost a year after the Federal Reserve began to cut its target rate for overnight loans between banks to 2%... borrowing costs for states, cities, hospitals and municipal authorities are going in the opposite direction... 'The world is falling apart' for borrowers, said Robert Doty, the president of American Governmental Financial Services, an advisory firm in Sacramento."

August 7 - Bloomberg (David Scheer and Karen Freifeld): "Citigroup Inc., the largest U.S. bank by assets, agreed to buy back or help clients unload as much as $19.5 billion in auction-rate securities and pay a $100 million fine to settle U.S. regulatory claims it improperly saddled customers with untradeable bonds. Citigroup will buy back about $7.5 billion in securities from individual customers, charities and small businesses under a settlement with New York State Attorney General Andrew Cuomo, the SEC and a group of states... It must also start 'restoring liquidity' to more than 2,600 institutions holding about $12 billion of the instruments, the SEC said."

August 7 - Bloomberg (David Scheer): "Merrill Lynch & Co. said it will offer to buy back about $10 billion in auction-rate securities from retail clients after Citigroup Inc. agreed to take similar steps under a settlement with U.S. regulators."

August 7 - Bloomberg (Abigail Moses): "Dexia SA, the owner of U.S. bond insurer Financial Security Assurance Inc., and Allianz SE led a jump in the cost of protecting corporate debt from default after writedowns caused by a worsening housing slump. Credit-default swaps on Dexia jumped 18 bps to 205... Allianz rose 2 to 62 as Europe's biggest insurer abandoned its earnings growth forecast because of subprime losses at its Dresdner Bank unit."

August 7 - Bloomberg (Hugh Son): "American Express Co., the largest U.S. credit-card company by purchases, may have its credit ratings downgraded by Moody's... after the lender's second-quarter profit fell 37%. The... company is under review to have its A1 rating lowered by one level because of future losses from soured credit-card loans... A downgrade would affect about $89 billion in securities and deposits. American Express may suffer further loan losses, 'particularly within geographic markets in the United States that have experienced sharp home price declines,' analyst Blaine Frantz said..."

August 5 - Bloomberg (Gonzalo Vina and Poppy Trowbridge): "Northern Rock Plc, the British bank nationalized six months ago, will receive as much as 3 billion pounds ($5.9 billion) from the government to strengthen capital after it posted a first-half loss."

Global Inflation Turmoil Watch:

August 4 - Financial Times (Raphael Minder): "Vietnam announced tough measures to contain rampant inflation on Monday, warning companies they could be prosecuted for passing on higher commodity costs to customers. The government will prosecute or revoke the licences of companies that increase the prices of goods without sufficient justification, part of a plan to freeze prices for the rest of the year on goods ranging from coal to public transport... Inflation accelerated to 27% in July, overtaking Sri Lanka as the fastest rate in Asia."

Currency Watch:

August 8 - Bloomberg (William Mauldin and Emma O'Brien): "The ruble dropped the most in 3 1/2 years, Russia's Micex Index fell to a 22-month low and bond yields climbed after Prime Minister Vladimir Putin said 'war has started' in the breakaway Georgian region of South Ossetia."

The dollar index shot 3.3% higher to 75.85. For the week on the downside, the South African rand declined 6.4%, the Australian dollar 4.4%, the Norwegian krone 4.3%, the Euro 3.7%, the Danish krone 3.7%, the New Zealand dollar 3.5%, the Swiss franc 3.1%, the Swedish krona 3.1%, the Mexican peso 2.9%, the Brazilian real 2.9%, the Canadian dollar 2.8%, the Singapore dollar 2.3%, the British pound 2.1%, and the Japanese yen 2.7%.

Commodities Watch:

Gold sank 6.0% to $856, and Silver was clubbed for 12.5% to $15.325. September Crude dropped $9.94 to $115.16. September Gasoline fell 6.3% (up 17% y-t-d), and September Natural Gas sank 11.6% (up 11% y-t-d). September Copper was hit for 7.1%. September Wheat declined 3.6%, and August Corn sank 11.8%. The CRB index dropped 6.9% (up 8.0% y-t-d). The Goldman Sachs Commodities Index (GSCI) fell 7.7% (up 15.4% y-t-d and 43.8% y-o-y).

China Watch:

August 6 - China Knowledge: "MasterCard International... predicted that retail sales in China will remain strong growth for the second half of this year despite growing concerns on the international financial market unrest, sources report... Retail sales in China are expected to reach RMB 5.566 trillion during the second half of 2008, representing a robust increase of 18% year-on-year."

August 7 - Bloomberg (Tian Ying): "China's passenger-car sales rose 6.8% in July, the slowest pace in two years, as rising fuel prices damped demand and people delayed purchases ahead of this month's Beijing Olympics."

Japan Watch:

August 6 - Bloomberg (Jason Clenfield): "Japan's government said the economy is 'deteriorating,' acknowledging for the first time that the country's longest postwar expansion has probably ended. 'There is a high possibility the economy has entered a recession,' Shigeru Sugihara, head of business statistics at the Cabinet Office said..."

August 8 - Bloomberg (Patrick Rial and Kotaro Tsunetomi): "Japan's bankruptcies climbed to the highest level in five years in July, foreshadowing what one research group predicts could be the worst year since Japan's banking crisis as more property companies go bust."

India Watch:

August 5 - Bloomberg (Kartik Goyal): "India's inflation accelerated to the fastest pace in more than 13 years, making it more difficult for the central bank to contain prices and spur economic growth. Wholesale prices rose 12.01% in the week..."

Asia Bubble Watch:

August 8 - Bloomberg (William Sim): "South Korea's wholesale prices rose at the fastest pace in a decade in July because of higher oil and commodity costs. Prices paid to producers jumped 12.5% from a year earlier..."

August 7 - Bloomberg (William Sim): "The Bank of Korea unexpectedly raised its benchmark interest rate to an eight-year high of 5.25%, saying the fastest inflation in a decade poses a greater threat than slowing economic growth."

August 5 - Bloomberg (Tim Culpan and Chinmei Sung): "Taiwan's inflation accelerated to the fastest pace in almost 14 years after the government ended caps on power prices and storms led to an increase in food costs. Consumer prices rose 5.92% in July from a year earlier..."

August 5 - Bloomberg (Karl Lester M. Yap): "Philippine inflation accelerated for a ninth month, reaching a 16-year high in July... Consumer prices climbed 12.2% from a year earlier..."

August 5 - Bloomberg (Aloysius Unditu and Arijit Ghosh): "Indonesia's central bank raised its benchmark interest rate for a fourth straight meeting to tame inflation running at the fastest pace in almost two years. Governor Boediono... increased the policy rate by a quarter point to 9%..."

Latin America Watch:

August 5 - Bloomberg (Daniel Cancel): "Venezuelan President Hugo Chavez enacted a home lending law that allows banks to offer 100% financing to homebuyers, including land and construction costs, as part of a package of 26 statutes decreed on July 31... 'My concern is with the deterioration of the financial sector's credit portfolios with this sort of financing,' Asdrubal Oliveros said, director of Caracas-based Ecoanalitica."

August 7 - Bloomberg (Sebastian Boyd): "Chilean economists raised their forecasts for inflation this year to 8.0% in August from 7.5% in July, according to a survey published today by the Central Bank..."

Unbalanced Global Economy Watch:

August 8 - Bloomberg (Alexandre Deslongchamps): "Canadian employers unexpectedly shed jobs in July for the second straight month... Employers fired 55,200 workers..."

August 7 - Bloomberg (Jennifer Ryan and Svenja O'Donnell): "U.K. house prices declined the most in at least a quarter century in July as banks starved the housing market of credit and pessimism about the economy increased, an HBOS Plc report showed. The average cost of a home fell 8.8% to 177,351 pounds ($345,825) from a year earlier..."

August 5 - Bloomberg (Caroline Binham): "The number of repossessed British homes rose by 40% in the first three months of the year, the U.K. financial regulator said."

August 6 - Bloomberg (Svenja O'Donnell): "U.K. consumer confidence fell the most in at least four years in July after house prices slumped, unemployment rose and inflation accelerated, Nationwide Building Society said."

August 5 - Bloomberg (Jennifer Ryan and Svenja O'Donnell): "U.K. services from banks to airlines contracted in July and factory production unexpectedly dropped for a fourth month in June, evidence the economy may be shrinking."

August 6 - Bloomberg (Nicholas Comfort): "German air carriers plan to raise prices by as much as 20% in the coming winter to compensate for higher fuel costs, Bild reported, citing the German Airline Association."

August 7 - Bloomberg (Jurjen van de Pol): "Inflation in the Netherlands accelerated to the fastest in more than five years in July as utilities raised charges and the government increased taxes on diesel fuel. The inflation rate... rose to 3% from 2.3% in June..."

August 8 - Bloomberg (Flavia Krause-Jackson): "Italy's economy unexpectedly shrank in the second quarter, edging it closer to the fourth recession in a decade as households and businesses struggle to cope with more expensive oil."

August 7 - Bloomberg (Johan Carlstrom): "Swedish inflation accelerated to 4.4% in July, the fastest pace in 15 years, increasing pressure on the central bank to raise its key lending rate even as economic growth slows."

August 5 - Bloomberg (Adam Brown): "Romanian annual wage growth... accelerated to 24.4% in June as investment boosted demand for workers... Central bank Governor Mugur Isarescu said yesterday that wages are rising too fast, helping boost the inflation rate above 9.1% in July..."

August 5 - Bloomberg (Alex Nicholson): "Russia's July inflation rate fell from the highest in 5 1/2 years to 14.7% as fruit and vegetables costs declined."

August 6 - Bloomberg (Jacob Greber): "Australian home-loan approvals fell to a four-year low in June, stoking speculation the central bank will cut interest rates for the first time since 2001... The nation's property market is mirroring housing slumps in the U.S. and U.K., with prices falling and lending to Australian home buyers plunging by 25% since January."

Bursting Bubble Economy Watch:

August 6 - Dow Jones (Marshall Eckblad): "On Wednesday, Morgan Stanley added some of its well-heeled clients to the long list of customers whose lenders have frozen or reduced their home equity loans... 'A segment of clients was recently notified of a change in the status of their home-equity line of credit due to a change in the value of their property and/or their credit profile,' a spokeswoman for Morgan Stanley said. Many other lenders, including JPMorgan Chase & Co. and Washington Mutual Inc., have recently made similar statements as they've moved to reduce the credit available to borrowers in declining housing markets."

August 6 - Dow Jones (Conning Chu): "American Express Co. said it plans to place greater emphasis on the general housing climate of areas where applicants for its card live when deciding to whom it will issue credit cards. As a result, applicants living in housing markets such as California and Florida, where home prices have dropped dramatically, may be considered more risky, President Al Kelly said..."

August 5 - Bloomberg (Bill Koenig): "U.S. auto sales may total 14.1 million next year, 'bottoming out' as fuel prices and the U.S. economy hold down the total, consulting firm A.T. Kearney Inc. said... U.S. auto sales tumbled 13% in July and may be headed to their lowest level in 15 years... The consulting company also said U.S.-based auto-parts suppliers will need to find an additional $38 billion in capital to stabilize their operations and may have trouble getting it. 'There is no single source of capital,' Cheng said."

August 6 - Bloomberg (Leon Lazaroff): "Four cities in Ohio and two in Michigan, all former manufacturing centers, topped the list of the 'fastest-dying' urban centers in the United States, according to a list compiled by Forbes magazine. Youngston, Canton, Dayton and Cleveland, Ohio joined Detroit and Flint, Michigan on the list of cities with rapidly declining populations and high rates of unemployment as lost industrial jobs haven't been replaced by new opportunities, the magazine said."

August 7 - Bloomberg (Shobhana Chandra): "U.S. consumers borrowed more than twice as much as economists forecast in June as a decline in home equity forced Americans to fund purchases with credit cards and other loans. Consumer credit rose by $14.3 billion, the most since November, to $2.59 trillion... Consumers are using credit cards and loans to cover expenses as falling home values cause banks to restrict access to home- equity lines."

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

August 7 - Wall Street Journal (Ruth Simon): "Mortgages issued in the first part of 2007 are going bad at a pace that far outstrips the 2006 vintage, suggesting that the blow to the financial system from U.S. housing woes will be deeper than many people earlier estimated... Freddie Mac reported... that 1.38% of the 2007-vintage loans it purchased were seriously delinquent after 18 months compared with 0.38% of 2006 loans at the same point in their life... Last month, J.P. Morgan Chase & Co. said it expects losses on prime mortgages that weren't securitized and remain on its books to triple from current levels. The increase in bad loans is driven mostly by jumbo mortgages originated in the second half of 2007, a company spokesman said."

August 8 - Bloomberg (Sarah Mulholland): "Yields on commercial real estate securities relative to benchmark rates rose to the highest since March on concern that retailers won't be able to repay debt as consumers cut spending. Spreads on AAA rated commercial mortgage-backed bonds widened 10 bps during the week... to 250.5 bps more than 10-year swap rates... Demand for commercial real estate securities is waning as retailers are forced into bankruptcy during the economic slowdown."

August 7 - Bloomberg (Sarah Mulholland): "Almost two-thirds of mortgage-related collateralized debt obligations sold last year have experienced so-called events of default, according to Wachovia... signaling a deepening deterioration of the market. Of the 168 CDOs backed by home loans sold in the U.S. in 2007, 64% are in default, representing 70% of the total dollar volume, analysts David Preston and Justin Pauley... wrote..."

Real Estate Bust Watch:

August 6 - Bloomberg (Jerry Hart): "Florida homes, businesses and other real estate lost $153 billion in value between 2007 and 2008, the Miami Herald reported, citing state economists who appraise property for tax purposes."

August 6 - Bloomberg (Hui-yong Yu): "Home sales in the Seattle area fell 31% in July while the median home price dropped 5.5%, according to the Northwest Multiple Listing Service... The median home price fell to $401,500 from $425,000."

GSE Watch:

August 8 - Bloomberg (Jody Shenn): "Fannie Mae, the largest U.S. mortgage- finance company, will stop buying or guaranteeing Alt-A mortgages because of surging losses from home loans to borrowers without proof of their finances. Fannie won't accept new Alt-A loans after Dec. 31..."

Speculator Watch:

August 5 - Bloomberg (Katherine Burton): "Dow Kim, the former head of trading and investment banking at Merrill Lynch & Co., dropped plans to start a hedge fund after investors backed out... Kim had been in discussions with institutions that had agreed to invest about $1 billion... 'Investors don't want to put new money to work, much less give it to a new entity,' said Brad Balter, managing partner of Balter Capital Management LLC..."

Muni Watch:

August 8 - Bloomberg (Jeremy R. Cooke): "U.S. state and local governments led by New York City sold about $5.5 billion of bonds this week, below average for the year, as benchmark tax-exempt yields rivaled or exceeded those available on taxable Treasuries."

Crude Liquidity Watch:

August 7 - Bloomberg (Matthew Brown): "United Arab Emirates mortgage loan growth increased by 55% to 64.9 billion dirhams ($17.7bn) in the year to March, down from 90% in December. Loans, advances and overdrafts increased an annual 38% in March..."

August 5 - Bloomberg (Matthew Brown): "Bahraini M3 money supply growth, an indicator of future inflation, accelerated to 37% in June from 32% in May."

Burst Bubble: Energy or Speculator?

Here's how I see it. Many are rejoicing the bursting of the energy/commodities Bubble. Rapidly declining oil and resource prices are now expected to alleviate inflationary pressures, while bolstering household purchasing power. There'll be no pressure on the Fed to raise rates, while their global central bank compatriots can soon begin cutting. The consensus view is that this is bullish for the U.S. economy and stock market and, if nothing else, market action did take attention away from troubling financial and economic news.

I am not one to easily dismiss notions of bursting Bubbles, and perhaps there is something to the energy bust thesis. I'm just skeptical of the idea that a slumping global economy is behind recent stunning price declines. Examining the global market backdrop, I sense different dynamics at play - important dynamics. And I tend to believe rapidly retreating commodities markets should be viewed in the context of a Bursting Leveraged Speculating Community Bubble.

The leveraged speculators have struggled since this year's initial trading sessions. "Quant" and "market neutral" strategies in particular have foundered, although wild market volatility, illiquidity, and weak global securities markets have been an impediment for virtually all strategies. The hedge fund industry has been trying to adapt to tighter Credit conditions from the Wall Street firms and generally less liquid markets. Overall, leveraged strategies have been problematic, whether the underlying positions were in residential mortgages, commercial mortgages or corporate loans. The easy days of leveraged "spread trades" ("borrow cheap and lend dear") quickly became quite difficult. And the easy returns in emerging markets turned abruptly into painful losses. Overall, global equities have performed quite poorly and global bonds somewhat poorly. Not many things have performed well and, worse yet, various trades that were supposed to offer diversification all became too tightly correlated.

Crude ended the first half at $140. Major commodities indices concluded June at record highs - sporting spectacular y-t-d gains. There's no doubt that the speculator community had all crowded into the energy/commodities trade, one of a rapidly narrowing menu of speculations offering juicy (and desperately needed) returns. At the same time, the long energy/short financials "pairs trade" was also put on in great excess. The speculator community as well likely crowded further into dollar short positions, for years now an almost surefire winner. The more the crowded industry struggled for performance, the more they were forced to crowd into the same crowded trades. I would argue that the Bubble in the leveraged speculating community played a significant role in fueling energy/commodities prices inflation beyond what was justified by exceptionally bullish fundamentals. I wouldn't, however, write off energy and commodities as burst Bubbles.

A lot of things had to go right for the vulnerable leveraged speculator community not to be pushed over the edge. Of course, markets tend to not accommodate the impaired - and the current market is particularly ruthless in this regard. The energy trade has unraveled badly. Commodities markets have been in near freefall. The dollar has mustered its most ferocious rally in quite some time. At the same time, agency debt and MBS spreads have widened, while global bond prices have offered little performance help. Corporate debt prices have performed poorly, while "private-label" MBS and various mortgage-related derivatives have traded dismally. Meanwhile, the financial stocks and other heavily shorted equities have rallied significantly. In short, a whole host of popular trades have gone wrong at the same time - a huge problem for the fragile industry.

We're now in the midst of another one of these precarious periods. I believe global markets - equities, debt, currencies, and commodities - are all in some stage of dislocation (perhaps not emerging debt, at least yet). Trading conditions across the spectrum of markets are as chaotic as I've ever witnessed, a dislocation chiefly related to the now forced unwinds of speculative positions. Recent extreme global market volatility is part and parcel to the Heightened Monetary Disorder I have been addressing for months now. The Massive Global Pool of Speculative Finance has Run Amuck. The bulls will celebrate the rally, yet markets this unstable are prone to "melt-ups" that lead to breakdowns.

Earnings reports this week from Freddie Mac, Fannie Mae and AIG - three of our largest financial institutions - were horrendous. Financial sector hemorrhaging has actually accelerated, and definitely do not underestimate the impact of tightened Credit in the pipeline from Fannie, Freddie and others. With limited "capital" quickly evaporating, Freddie stated that its aggressive retained portfolio growth has come a conclusion. Fannie intimated about the same. Fannie will curtail purchases of alt-A loans, and it is clear that both companies have lost the capacity to provide the speculators a "backstop bid" in the MBS marketplace. This major additional tightening of mortgage Credit Availability and Marketplace Liquidity will further depress housing markets and bolster the headwinds buffeting our vulnerable economy.

Yet it is not the nature of dislocated markets to let fundamentals get in the way of price movement. Markets, after all, live on fear and greed. Sinking energy prices and a short squeeze ignited U.S. stocks this week. And surging stock prices always entice the optimistic viewpoint, with many viewing runs in stocks and the dollar as confirmation that the worst of the financial and economic crisis is behind us. The bursting of the so-called Energy/Commodities Bubble is also viewed in positive light.

Yet if the key dynamic is instead a Bursting Leveraged Speculating Community Bubble, entirely different dynamics are now in play. Enormous short positions have built up, the vast majority as part of "market neutral," "quant" and myriad risk hedging strategies. If today's dislocation develops into a significant unwind of these positions, the market immediately then becomes vulnerable to a disorderly "melt-up" followed almost inevitably by a sharp reversal and disorderly decline. The unwind of bearish speculations and hedges would be a most problematic market development, unleashing a final bout of speculative excess and disorder that would set the stage for a major market crisis.

It is not difficult to envision the backdrop for problematic market liquidation and deepening financial crisis. The hedge fund community is now susceptible to huge year-end redemptions, generally poor performance, shrinking assets & tighter Credit - all taking place in ia climate of inhospitable market conditions which dictate ongoing Credit system de-leveraging. The pool of players willing and able to acquire U.S. risk assets is being depleted by the week. To be sure, the unfolding change of fortunes for the leveraged speculating community is one more key facet of tighter system Credit and faltering Marketplace Liquidity - extremely problematic Financial Conditions for the finance-driven U.S. Bubble Economy. And this makes the current market dislocations in the face of rapidly deteriorating fundamentals such a dangerous development.

 


 

Doug Noland

Author: Doug Noland

Doug Noland
The Credit Bubble Bulletin
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Source: The Contrarian Take http://blogs.forbes.com/michaelpollaro/
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