Changed Financial Landscape

By: Doug Noland | Sat, Sep 27, 2008
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The stock market was almost a sideshow... For the week, the Dow dropped 2.2% (down 16% y-t-d), and the S&P500 was hit for 3.3% (down 17.4%). Economically-sensitive stocks were under pressure. The Transports sank 6.9% (up 3.9%), and the Morgan Stanley Cyclicals dropped 7.3% (down 19.4%). The Utilities declined 1.4% (down 18.7%) and the Morgan Stanley Consumer index fell 1.6% (down 8.9%). The broader market gave back a chunk of recent gains. The small cap Russell 2000 dropped 6.5% (down 8.0%), and the S&P400 Mid-Caps sank 6.4% (down 12.2%). The NASDAQ100 fell 4.2% (down 19.8%), and the Morgan Stanley High Tech index dropped 4.5% (down 20.1%). The Semiconductors declined 3.7% (down 21.2%); The Street.com Internet Index fell 3.9% (down 13.9%); and the NASDAQ Telecommunications index sank 8.5% (down 17.4%). The resilient Biotechs dipped 0.6% (up 2.2%). The Broker/Dealers dropped 9.1% (down 37.3%), and the Banks fell 10.5% (down 16.6%). With Bullion gaining another $6.20, the HUI Gold index rose 1.6% (down 19.6%).

One-month Treasury bill rates dropped to 0.16%, and three-month yields dropped to 0.84%. Two-year government yields ended the week down 5 bps to 2.12%. At the same time, five-year T-note yields added 3 bps this week to 3.07%, and 10-year yields rose 4 bps to 3.85%. Long-bond yields dipped 2 bps to 4.37%. The 2yr/10yr spread increased 10 to 173 bps. The implied yield on 3-month December '09 Eurodollars jumped 18 bps to 3.555%. Benchmark Fannie MBS yields rose 7 bps to 5.475%. The spread between benchmark MBS and 10-year T-notes widened 3 to 162 bps. Agency 10-yr debt spreads were 13 wider at 77.3 bps. The 2-year dollar swap spread increased a notable 21.5 to 140, and the 10-year dollar swap spread added 0.75 to 67. Corporate bond spreads were mostly wider. An index of investment grade bond spreads ended 7 wider at 170 bps, while junk bond indices were mixed.

September 24 - Bloomberg (Daniel Kruger and Kyoungwha Kim): "Investors outside the U.S., who own more than half of all Treasuries outstanding, say the government's $700 billion plan to revive the banking system will diminish the appeal of the nation's bonds. Treasury Secretary Henry Paulson's proposal... would drive the country's debt to more than 70% of GDP. The last time taxpayers owed as much was in 1954, when the U.S. was paying down costs from World War II. 'The image of U.S. Treasuries as a safe haven has been tainted by the ongoing financial debacle,' said Kwag Dae Hwan, head of global investment... with South Korea's $220 billion National Pension Fund... 'A big question mark hangs over whether the U.S. can deal with an unprecedented amount of debt. That is unnerving all the investors, including me.'"

Investment-grade debt issuance included Caterpillar $1.3bn, American Honda $1.25bn, EOG Resources $750 million, Peco Energy $300 million, South Carolina E&G $300 million, Wisconsin Electric Power $300 million, Stanley Works $250 million, and UGI Utilities $100 million.

Junk issuance included Perkins & Marie $130 million.

September 24 - Bloomberg (Pierre Paulden): "Prices of high-risk, high-yield loans fell to record lows... The price of the average actively traded leveraged loan fell 0.42 cent to 83.74 cents on the dollar, according to S&P... Prices have slumped 3.84 cents since Sept. 11..."

September 25 - Bloomberg (Emma O'Brien): "[Russia's] benchmark 30-year sovereign bond has slipped this month, pushing the yield 118 basis points to 6.91% yesterday. The yield on OAO Gazprom's 6.95% note due 2009 has surged 295 bps to a record 10.5%, since Sept. 1."

German 10-year bund yields fell 4 bps to 4.16%. The German DAX equities index declined 2.0% (down 24.8% y-t-d). Japanese 10-year "JGB" yields dipped 2 bps to 1.46%. The Nikkei 225 rallied 3.5% (down 22.3% y-t-d). Emerging markets were all over the board but mostly under pressure. Brazil's benchmark dollar bond yields jumped 17 bps to 6.43%. Brazil's Bovespa equities index sank 4.3% (down 10.5% y-t-d). The Mexican Bolsa slipped 0.4% (down 13.4% y-t-d). Mexico's 10-year $ yields rose 8 bps to 6.04%. Russia's RTS equities index declined 0.8% (down 43.9% y-t-d). India's Sensex equities index sank 6.7%, with y-t-d losses of 35.4%. China's Shanghai Exchange rallied 10.5%, cutting 2008 losses to 56.4%.

Freddie Mac 30-year fixed mortgage rates surged 31 bps to 6.09% (down 33bps y-o-y). Fifteen-year fixed rates jumped 42 bps to 5.77% (down 32bps y-o-y), and one-year ARMs increased 13 bps to 5.16% (down 44bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates this week up 17 bps to 7.18% (up 26bps y-o-y).

Bank Credit surged $134bn to $9.554TN (week of 9/17). Bank Credit has still expanded only $341bn y-t-d, or 5.1% annualized. Bank Credit posted a 52-week rise of $658bn, or 7.4%. For the week, Securities Credit jumped $32.2bn. Loans & Leases rose $101.8bn to $7.026 TN (52-wk gain of $478bn, or 7.3%). C&I loans increased $19.2bn, with y-t-d growth of 8.3%. Real Estate loans declined $5.1bn (up 1.1% y-t-d). Consumer loans slipped $3.4bn, while Securities loans jumped $41.4bn. Other loans surged a notable $41.4bn.

M2 (narrow) "money" supply jumped $20.6bn to $7.734 TN (week of 9/15). Narrow "money" has expanded $272bn y-t-d, or 5.1% annualized, with a y-o-y rise of $358bn, or 4.8%. For the week, Currency added $0.7bn, and Demand & Checkable Deposits rose $15.5bn. Savings Deposits gained $7.7bn, while Small Denominated Deposits were about unchanged. Retail Money Funds declined $3.3bn.

Total Money Market Fund assets (from Invest Co Inst) declined $14.8bn (2-wk decline $185bn) to $3.398 TN, reducing the y-t-d expansion to $285bn, or 12.5% annualized. Money Fund assets have posted a one-year increase of $543bn (19%).

There was little Asset-Backed Securities (ABS) issuance again this week. Year-to-date total US ABS issuance of $129bn (tallied by JPMorgan's Christopher Flanagan) is running at 27% of comparable 2007. Home Equity ABS issuance of $303 million compares with 2007's $223bn. Year-to-date CDO issuance of $24bn compares to the year ago $283bn.

Total Commercial Paper outstanding sank $61bn this week to $1.702 TN, with CP down $83bn y-t-d. Asset-backed CP dropped $7.8bn last week to $754bn, with 2008 now showing a decline of $19bn. Over the past year, total CP has contracted $153bn, or 8.3%.

Fed Foreign Holdings of Treasury, Agency Debt last week (ended 9/23) increased $13.0bn to $2.422 TN. "Custody holdings" were up $365bn y-t-d, or 23.7% annualized, and $427bn y-o-y (21.4%). In a historic development, Federal Reserve Credit ballooned $203.6bn (2-wk gain $246.7bn) to a record $1.135 TN. Fed Credit has expanded $261.4bn y-t-d (40% annualized) and $275.4bn y-o-y (32%).

International reserve assets (excluding gold) - as accumulated by Bloomberg's Alex Tanzi - were up $1.211 TN y-o-y, or 21.2%, to $6.926 TN.

Global Credit Market Dislocation Watch:

September 26 - Wall Street Journal (Robin Sidel, David Enrich and Dan Fitzpatrick): "In what is by far the largest bank failure in U.S. history, federal regulators seized Washington Mutual Inc. and struck a deal to sell the bulk of its operations to J.P. Morgan Chase & Co. The collapse of the Seattle thrift, which was triggered by a wave of deposit withdrawals, marks a new low point in the country's financial crisis."

September 26 - Bloomberg (Shannon D. Harrington and Abigail Moses): "The cost to protect against a default by Wachovia Corp., the fourth-largest U.S. bank, soared to distressed levels after Washington Mutual Inc. was seized by regulators in the biggest U.S. bank failure. Credit-default swap sellers demanded 24.5 percentage points upfront and 5 percentage points a year to protect Wachovia bonds from default for five years... Wachovia's $2.5 billion of 5.75% bonds due in 2018 plunged 22 cents today to 48 cents on the dollar..."

September 25 - Bloomberg (Kim-Mai Cutler): "Sean Maloney, a fixed-income strategist at Nomura International Plc in London, comments after money-market rates around the world soared as financial institutions hoarded cash. The three-month London interbank offered rate, or Libor, that banks charge each other for dollar loans jumped today by the most since 1999 and the euro rate rose to the highest level since November 2000. 'Basically, it's just a complete breakdown of the interbank lending market,' Maloney said. 'Effectively, Lehman's failure instilled such a shock into the system. People thought there was a safety valve when Bear Stearns broke down. There was a perception that lenders would be guaranteed to get their money back. The Lehman failure brought that perception crashing down. We are now in a very fear-driven environment. Banks are no longer lending to each other.'"

September 22 - Bloomberg (Christine Harper and Craig Torres): "The Wall Street that shaped the financial world for two decades ended last night, when Goldman Sachs Group Inc. and Morgan Stanley concluded there is no future in remaining investment banks now that investors have determined the model is broken. The Federal Reserve's approval of their bid to become banks ends the ascendancy of the securities firms, 75 years after Congress separated them from deposit-taking lenders... 'The decision marks the end of Wall Street as we have known it,' said William Isaac, a former chairman of the Federal Deposit Insurance Corp. 'It's too bad.'"

September 26 - Dow Jones (Anusha Shrivastava): "The commercial paper market, where companies go for short-term funding needs, is showing renewed signs of serious dysfunction on Friday morning on the stalled government bailout of the financial system... If companies are unable to find financing in this market to meet payrolls and other day-to-day operations, they will have to look at other options like drawing on their bank lines or raising money in the corporate bond market."

September 25 - Bloomberg (Jeremy R. Cooke): "Tax-exempt bonds fell for the 10th day this month, driving 30-year benchmark yields to the highest in more than six years, as fallout from upheaval in the financial industry roiled the U.S. municipal market. Variable interest rates on tax-exempt debt soared to a record, higher than long-term, fixed-rate yields... Issuers have postponed more than $7 billion in planned borrowing... State and local governments also face costs as high as 9% on variable-rate demand notes amid outflows from money-market mutual funds... 'Current conditions arguably represent the most stressed fixed income market in our lifetimes,' Mike Nicholas, co-chief executive of the Regional Bond Dealers Association, said..."

September 24 - Bloomberg (Jeremy R. Cooke): "Tax-exempt money-market mutual funds yielded twice as much as taxable funds, as rates on variable municipal debt issued by borrowers including New York City more than tripled amid upheaval on Wall Street. Tax-free money funds offered an average one-day annualized yield of 4.19% yesterday, compared with 2.08% for taxable funds... For income taxpayers in the top 35% federal bracket, the tax-exempt yield represents a taxable equivalent of 6.45%... 'I'll eat my hat if that's not a record,' said Peter Crane, president of the money-fund research firm... Yields on variable-rate demand notes, state and local government debt favored by money funds, rose as high as 10% as banks that set the interest daily or weekly seek to avoid being overwhelmed by inventories of unsold securities."

September 24 - Bloomberg (Shannon D. Harrington, Caroline Salas and Pierre Paulden): "The $62 trillion market for credit- default swaps, created to protect banks from loan losses, helped fuel a near-meltdown in the financial system and now may be regulated for the first time. The derivatives precipitated plunges in the shares and debt of Wall Street firms, accelerating the collapse of Lehman Brothers Holdings Inc. and the U.S. takeover of American International Group Inc., the biggest U.S. insurer. Now, regulators want to bring oversight to a part of the credit market that may be more susceptible to manipulation than selling stocks short... Banks 'are suffering the consequences of their own actions,' said Thomas Priore, CEO of Institutional Credit Partners... a hedge fund with $13 billion in assets. 'They created a mechanism through default swaps to reflect a view on credit that has taken on a life of its own.' The swaps became one-way bets on the demise of financial institutions as traders hedged the risk that their partners might implode, said Gary Kelly, a strategist at broker Tradition Asiel Securities Inc."

September 25 - Bloomberg (Bryan Keogh): "Corporate short-term borrowing plunged as rates around the world soared on concern that the resolution of credit crisis is being delayed in Congress. The U.S. commercial paper market slumped $61 billion... 'The declines reflect the seizing up of the credit market and withdrawals of monies from money market funds, which held $700 billion of commercial paper at the end of the second quarter,' Tony Crescenzi, chief bond market strategist at Miller Tabak & Co. in New York, wrote... 'The declines add to the urgency for fixes to the credit crisis.'"

September 26 - Bloomberg (Pierre Paulden): "Prices of high-risk, high-yield loans tumbled to record lows as hedge funds sold assets in the wake of the Lehman Brothers Holdings Inc. bankruptcy filing. The price of the average actively traded leveraged loan fell 1.26 cent to 82.48 cents on the dollar..."

September 26 - Wall Street Journal (Tom Lauricella): "The Securities and Exchange Commission's ban on short selling of financial stocks has effectively shut down much of the convertible-bond market, a crucial area of financing for struggling companies."

September 22 - Bloomberg (Tom Cahill): "Hedge fund prime brokerage assets held by Lehman Brothers Holdings Inc. won't be returned for a 'considerable time,' according to PricewaterhouseCoopers, administrator for the largest bankruptcy. 'Our current view is that this process could take several months to conclude,' PwC said... Lehman had the right to lend clients' prime brokerage securities as collateral for loans and margins in the stock loan and repo markets, PwC said. 'The assets, once 'used,' were no longer held for the client on a segregated basis, and as a result the client may cease to have any proprietary interest in them,' PwC said in the statement."

September 26 - Bloomberg (Katherine Burton and Saijel Kishan): "The financial crisis that crippled mortgage lenders, shut down leveraged buyouts and ended the era of independent investment banks is bearing down on the $1.9 trillion hedge-fund industry. Managers are bracing for a surge in client withdrawals after average returns fell 8% through Sept. 19, the worst first nine months of a year since Chicago-based Hedge Fund Research Inc. started tracking the data in 1990. Investment gains are being squeezed by higher bank lending rates, and regulators are now clamping down on short selling, undermining hedge-fund managers' trading strategies... Since 1990, the industry has posted one losing year, in 2002, when funds dropped an average 1.45%..."

September 23 - Wall Street Journal (Elizabeth Williamson): "Automobile-finance companies lead a growing list of liquidity-starved industries trying to get in on the huge government rescue plan targeted originally at cleaning up bad mortgage bets. As Congress crafts a $700 billion federal government plan to buy up financial companies' troubled assets, auto-finance-company lobbyists are pressing for specific language including them in the plan, according to a lobbyist for one of the Big Three auto makers. Other businesses, such as student and credit-card lenders, also could eventually access the program."

September 26 - Bloomberg (Oliver Biggadike): "The fastest-growing part of the global corporate debt market, samurai bonds, has come to a standstill since Lehman Brothers Holdings Inc. became the first borrower to default on the securities since Argentina in 2002... 'The Lehman shock is fatal to the samurai bond market for now,' said Koyo Ozeki, head of Asia-Pacific credit research at... Pacific Investment Management Co... 'Investors believed Lehman and others were too big to fail.'"

September 23 - Wall Street Journal (John Hechinger): "About a quarter of the nation's banks lost a combined $10 billion to $15 billion in the wake of the federal government's takeover of mortgage giants Fannie Mae and Freddie Mac... In the survey, the American Bankers Association reported that 27% of the nation's 8500 banks held preferred shares in Fannie and Freddie in their investment portfolios. The shares are expected to be worthless. The survey found that 85% of the affected institutions were community banks -- those with less than $1 billion in assets... Until recently, the shares were considered rock-solid investments... It says the losses are galling to small bankers because they took pains to avoid the exotic loans and loose underwriting standards that have hobbled Wall Street titans and some huge banks."

September 22 - Bloomberg (Bei Hu): "Treasury Secretary Henry Paulson's $700 billion plan to buy devalued assets from financial companies is 'a joke' because it doesn't go far enough to calm markets, said Kenichi Ohmae, president of Business Breakthrough Inc. Ohmae, nicknamed 'Mr. Strategy' during his 23 years as a McKinsey & Co. partner, called for a $5 trillion 'international facility' to be made available to financial institutions. The system could be modeled on one used by Sweden during its banking crisis in the early 1990s, he said. 'This is a liquidity crisis. The liquidity has to be so big that people won't get panicky.'"

September 22 - Bloomberg (Pierre Paulden and Jody Shenn): "The U.S. Treasury may purchase 10%, or $1 trillion, of non-agency residential and commercial mortgages at distressed prices under plans to revive capital markets, Merrill Lynch & Co. analysts said. The government is likely to buy the assets at above the prices financial firms could sell to private-sector buyers... strategists Akiva Dickstein, Roger Lehman and Kamal Abdullah wrote..."

September 22 - Bloomberg (Haris Anwar): "Banks and companies in emerging markets may struggle to refinance $111 billion of bonds maturing over the next year because of the credit crisis, the Financial Times reported, citing ING Wholesale Banking. 'Many corporates and banks in the emerging markets are highly levered without cash to fall back on,' said David Spegel, global head of emerging markets strategy at ING... 'These will struggle should they need to raise money in the markets.'"

September 25 - Dow Jones (Rob Curran, Geoffrey Rogow and Joseph Checkler): "The short-selling ban is taking the 'hedge' out of hedge funds. The Securities and Exchange Commission has banned short sales of roughly 950 financial-related stocks until Oct. 2... With their hands tied on those stocks and the algorithms that do much of their trading running into technical hitches, many quantitative and other 'market neutral' hedge funds are drastically reducing trading activity... Once major buyers and sellers on the stock market, these funds may have to reinvent their models in the event of an extension of the rule beyond Oct. 2. 'There are very, very few short-only funds on Wall Street, so the ban mainly removed long/short funds from the market,' said Dan Mathisson, head of the algorithmic trading unit at Credit Suisse... 'If they can't put on their short positions, they can't put on their long positions, either. It's just breaking down a lot of their models, and the end result is they're walking away. A lot of funds are reducing the size of their books.'"

September 25 - Dow Jones (Joseph Checkler): "Dude, where's my arbitrage? That's what merger arbitrage hedge funds are asking in the Bank of America Corp. purchase of Merrill Lynch & Co.. The typical arb play in an all-stock deal is to buy shares of the acquirer and short the target, but Bank of America's stock is on the Securities and Exchange Commission's 'do-not-short' list, which also puts it on the 'do not arbitrage' list."

September 24 - Bloomberg (Cathy Chan): "Private equity dealmakers' pay may drop by 75% after the credit crunch as firms take longer to invest their funds, British financier Guy Hands said. 'Compensation for everyone in the financial services industry is clearly going to fall over the next few years,' Hands, 49, said..."

September 26 - Bloomberg (Jeremy Naylor and Ben Sills): "Marc Faber, managing director of Marc Faber Ltd. in Hong Kong, said the U.S. government's rescue package for the financial system may require as much as $5 trillion, seven times the amount Treasury Secretary Henry Paulson has requested."

Currency Watch:

September 26 - Wall Street Journal (Andrea Thomas): "The Wall Street financial crisis will reconfigure the world economy and the U.S. will fade as the world's dominant economic force, German Finance Minister Peer Steinbruck said in German parliament Thursday. 'The U.S. will lose its status as the superpower of the global financial system, not abruptly but it will erode,' Mr. Steinbruck said. 'The global financial system will become more multipolar.'"

September 24 - Bloomberg (Garfield Reynolds): "Treasury Secretary Hank Paulson's $700 billion proposal to bail out the U.S. financial system may send the dollar to record lows by swelling the budget deficit. Paulson's proposal to buy devalued securities from banks would drive government debt above 70% of gross domestic product, the most since 1954. The annual deficit may balloon to as much as $1 trillion..."

The dollar index declined 0.9% to 76.95. For the week on the upside, the Swiss franc increased 1.4%, the Japanese yen 1.4%, the Canadian dollar 1.3%, the Euro 1.0% and the Danish krone 1.0%. For the week on the downside, the South African rand declined 2.0%, the South Korean won 1.9%, the Mexican peso 1.2%, the Brazilian real 0.8%, and the New Zealand dollar 0.5%.

Commodities Watch:

Gold added 0.7% to $880, while Silver surged 7.4% to $13.395. November Crude jumped $4.32 to $107.07. October Gasoline rose 2.6% (up 7.7% y-t-d), while October Natural Gas slipped 0.8% (unchanged y-t-d). December Copper dropped 3.7%. December Wheat and Corn were little changed. The CRB index rallied 1.4% (up 1.6% y-t-d). The Goldman Sachs Commodities Index (GSCI) gained 2.6% (up 7.7% y-t-d and 20.3% y-o-y).

China Watch:

September 26 - Bloomberg (Judy Chen and Belinda Cao): "China's banks are limiting foreign- exchange transactions with U.S. and European financial companies on concern tighter global credit markets will cause more failures. Domestic banks are cutting trading with international firms in the interbank market, according to Zhuang Zhiqiang, a trader at Xiamen International Bank Co., which is partially owned by the Asian Development Bank. The move aims to control risks after the bankruptcy of Lehman Brothers Holdings Inc. stunned domestic investors, said Zhao Qingming, an analyst in Beijing at China Construction Bank Corp., the nation's second-largest lender."

September 23 - Bloomberg (Luo Jun): "Chinese banks face worsening asset quality and slower profit growth as the nation's tight monetary environment and a worsening global credit crisis cause more borrowers to default, Fitch Ratings said. The nation's 14 publicly traded banks... have already shown signs of rising borrower defaults and tighter liquidity, the ratings agency said. 'Chinese banks appear to be approaching their first real test of resilience,' ... analysts Charlene Chu and Chunling Wen wrote... 'Increased vigilance is warranted as Chinese banks take on the growing challenges ahead.'"

Asia Bubble Watch:

September 25 - Bloomberg (Kelvin Wong and Theresa Tang): "Hong Kong's government, regulators and richest man came to the aid of Bank Of East Asia Ltd. after 'malicious rumors' about its financial stability spurred the city's first bank run in more than a decade. Financial Secretary John Tsang said the rumors were 'unfounded' and the bank has enough capital to serve its clients. Joseph Yam, head of Hong Kong's central bank, urged depositors to stay calm and pumped $500 million into the banking system. Li Ka-shing, chairman of Cheung Kong, bought the stock."

September 25 - Bloomberg (David Yong and Ron Harui): "Money market rates in Asia's biggest financial centers jumped on concern that U.S. lawmakers may delay or dilute the Treasury Department's $700 billion plan... Benchmark three-month rates in Hong Kong and Singapore climbed past the levels when Lehman Brothers Holdings Inc. filed for bankruptcy... Short-term rates on yen loans climbed to a two-month high and bill swap rates in Australia rose to the highest since August, suggesting more than $180 billion of cash injections by central banks have failed to unfreeze lending. 'The conditions are revealing a new level of breakdown in the global financial system that central banks appear powerless to fix,' Greg Gibbs, director of foreign-exchange strategy at ABN Amro... wrote. 'There's an element of end-quarter demand for liquidity intensifying the problem.'"

September 23 - Bloomberg (Patricia Kuo): "Hong Kong and Singapore regulators pledged to support individuals who claim they suffered losses on investments in credit-linked securities in the wake of Lehman Brothers Holdings Inc.'s collapse. Hong Kong's Securities and Futures Commission said it may take 'steps to protect' individual investors who complained structured notes arranged by Lehman were mis-sold. The Monetary Authority of Singapore said it would punish institutions found to have misled investors..."

September 24 - Bloomberg (Stephanie Phang and Ranjeetha Pakiam): "Malaysia's inflation held at the fastest pace in more than 26 years on higher food and fuel costs, as the central bank refrained from raising interest rates. Consumer prices rose 8.5% in August from a year earlier..."

Central Banker Watch:

September 26 - Wall Street Journal (Joellen Perry): "The U.S. Federal Reserve Friday boosted the amount of dollars it can funnel to foreign markets to $290 billion, in global central banks' latest bid to calm persistent money-market tension in the wake of the U.S.'s biggest-ever bank failure and ongoing uncertainty... The Fed upped its currency-swap line, which lets foreign central banks channel dollars to cash-strapped commercial banks on their shores, by $13 billion."

September 25 - Bloomberg (Janet Ong and Chinmei Sung): "Taiwan's central bank unexpectedly reduced interest rates for the first time since 2003, saying the global financial crisis has heightened the risk of an economic slowdown."

Unbalanced Global Economy Watch:

September 23 - Bloomberg (Alexandre Deslongchamps): "Canada's annual inflation rate rose to the highest in more than five years in August as prices for gasoline and food surged. Consumer prices rose 3.5% from a year earlier..."

September 25 - Bloomberg (Alexandre Deslongchamps): "The Canadian housing market is headed for a meltdown because households finances are in even worse shape than in the U.S. or the U.K., said David Wolf, chief strategist at Merrill Lynch & Co. Canada. Wolf said in a report published today that Canadian families in 2007 carried an average net debt load that was 6.3% of their disposable income, more than in the U.K. and 'not far off' from the 2005 peak in the U.S."

September 23 - Bloomberg (Brian Swint and Svenja O'Donnell): "U.K. mortgage approvals fell to the lowest level in at least a decade in August as slumping property values deterred buyers, a report by the British Bankers' Association showed. Banks granted 21,086 loans for house purchase, down 64% from a year earlier..."

September 22 - Bloomberg (Brian Swint): "U.K. house prices fell for a fourth month in September as the global credit crisis intensified, locking out homebuyers and forcing the sale of the country's biggest mortgage lender, a report by Rightmove Plc showed. 'The housing market is on its knees and will remain so until financial institutions address the disastrous state of the mortgage funding markets,' said Miles Shipside, commercial director at Rightmove. 'While this market provides a good opportunity to trade up, it requires a degree of bravery.'"

September 23 - Bloomberg (Fergal O'Brien): "Europe's manufacturing and service industries contracted at the fastest pace in almost seven years in September as the credit-market seizure intensified and companies scaled back production in response to slowing orders."

September 25 - Bloomberg (Gabi Thesing): "European money-supply growth slowed more than economists forecast in August as bank lending to companies and households cooled. M3 money supply... rose 8.8% from a year earlier after increasing 9.1% July..."

September 23 - Bloomberg (Rainer Buergin): "Germany's IG Metall labor union, representing 3.2 million workers, is seeking the biggest pay increase in at least 16 years for workers... The union, Germany's biggest, wants wages to rise 8%..."

September 26 - Bloomberg (Emma Ross-Thomas): "Mortgage lending in Spain fell for the 12th month in July... Mortgage lending, in terms of the amount of money disbursed, fell 29% from a year earlier..."

September 25 - Bloomberg (Johan Carlstrom): "Swedish household credit grew at the slowest pace in four years in August as the economy weakened on the back of rising interest rates, higher unemployment and accelerating inflation. Household lending grew an annual 10.2%, compared with 10.5% in July..."

September 25 - Bloomberg (Maria Levitov): "Russian inflation may 'slightly' exceed 12% this year, Interfax reported, citing President Dmitry Medvedev's adviser."

September 24 - Bloomberg (Michael Dwyer): "Pakistan President Asif Ali Zardari will ask the U.S., U.K. and other industrial nations for financial aid amid concern South Asia's second-largest economy is in danger of defaulting on its debt."

Bursting Bubble Economy Watch:

September 22 - Wall Street Journal (Kelly Greene): "Nancy Davis, a 59-year-old senior marketing manager for a law firm in San Diego, had hoped to ease into her retirement after her son finishes college in two years. But 'I may be 70 before I retire at this point,' she said Friday, after watching the markets take their toll on her 401(k). 'It's very unnerving.' For millions of Americans approaching retirement, events of recent weeks are delivering a clear message: Not so fast. With nest eggs shrinking, housing prices still falling and anxieties about their financial future growing, the oldest members of the baby-boom generation are putting the brakes on plans to leave the office. 'We'll see more and more people postpone' their retirement dates, says Helga Cuthbert, a certified financial planner... 'Their expectations about the future and the kinds of returns they would get were simply unrealistic.'"

September 24 - Wall Street Journal (Kara Scannell, Phred Dvorak, Joann S. Lublin and Elizabeth Williamson): "A rapid-fire series of moves Tuesday promised to extend Washington's reach into American business, illuminating the ways in which the financial crisis could reshape the relationship between government and the economy. During a Senate hearing, SEC Chairman Christopher Cox -- citing a 'regulatory hole that must be immediately addressed' -- issued a strong call for Washington to exert oversight of exotic types of financial instruments that previously were unregulated. Also moving forward: proposals from Congressional Democrats to allow the government to set limits on executive pay and to take equity stakes in companies that tap a possible $700 billion government-bailout fund... All told, the moves represent the early stages of what economists and policy makers say typically happens at moments of great economic turmoil: Government responds by crafting solutions that revolve around beefing up regulation and oversight."

September 22 - Wall Street Journal (Vanessa Fuhrmans): "As the credit crunch threatens to throw the economy into a deep slump, Americans are already cutting back on health care, a sector once thought to be invulnerable to recession. Spending on everything from doctors' appointments to preventive tests to prescription drugs is under pressure. The number of prescriptions filled in the U.S. fell 0.5% in the first quarter and a steeper 1.97% in the second, compared with the same periods in 2007 -- the first negative quarters in at least a decade... Despite an aging and growing U.S. population, the number of physician office visits also has been declining since the end of 2006... In a survey by the National Association of Insurance Commissioners last month, 22% of 686 consumers said that economy-related woes were causing them to go to the doctor less often. About 11% said they've scaled back on prescription drugs to save money."

September 23 - Bloomberg (Chris Burritt): "McDonald's Corp... told some U.S. franchisees to seek other ways to finance store improvements after Bank of America Corp. declined to increase lending. Store owners have exhausted financing used to pay for upgrades and equipment to make lattes and espressos, and Bank of America won't provide more money as it works on the planned purchase of Merrill Lynch & Co... Banks have tightened credit after Lehman Brothers... bankruptcy filing and the government takeover of Fannie Mae and Freddie Mac... Bank of America's reluctance to increase the loan may show that even well-known brands such as McDonald's face difficulties financing expansion."

September 23 - Dow Jones (Mark Peters): "The upheaval on Wall Street is cutting liquidity in the electricity market, but a wholesale evacuation from power trading by big banks is unlikely, with changes in the market expected to be more subtle. Financial companies are reassessing their appetite for risk and reshuffling operations following a series of rushed acquisitions."

September 25 - Bloomberg (Alex Lange): "Recreational-vehicle shipments for manufacturers including Winnebago Industries Inc. fell 44% in August to the lowest for the month in 16 years on near-record fuel costs and a sagging economy."

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

September 22 - Bloomberg (Abigail Moses): "Collateralized debt obligations backed by mortgages will have to be unwound to qualify for the Federal Reserve-backed plan to accept troubled assets from banks, according to Royal Bank of Scotland Group Plc analysts. 'The only way that CDO investors can take advantage is to unwind the entire structure and put the underlying assets to the Fed,' ...analysts led by Gregorios Venizelos wrote... 'The Fed plan makes liquidation potentially the best option.'"

September 25 - Bloomberg (Jody Shenn): "Debt issued by five collateralized debt obligations that invested in hedge funds may be downgraded, Fitch Ratings said."

GSE Watch:

September 24 - Bloomberg (Dawn Kopecki): "Fannie Mae and Freddie Mac became so 'overwhelmed' by deteriorating market conditions that the mortgage-finance companies told government officials they were unable to raise new capital without financing from the U.S. Treasury, their regulator said. 'As house prices, earnings and capital have continued to deteriorate, their ability to fulfill their mission has deteriorated,' Federal Housing Finance Agency Director James Lockhart said... 'The capacity to raise capital to absorb further losses without Treasury Department support vanished.'"

September 25 - Bloomberg (Dawn Kopecki): "Fannie Mae and Freddie Mac's efforts to protect themselves against mortgage losses may have gone so far as to hurt borrowers, and it was the government takeover of the companies that helped lower loan rates, their regulator said. 'Freddie Mac and Fannie Mae, in order to try to build capital, may have raised prices and tightened credit standards beyond what was necessary for sound underwriting,' Federal Housing Finance Agency Director James Lockhart said..."

September 22 - Bloomberg (Jody Shenn): "Freddie Mac Chief Executive Officer Richard Syron stood before investors at New York's Palace Hotel in May last year lauding his company's 'cautious' avoidance of the subprime-mortgage crisis. What Syron, who was ousted last week, didn't say was that Freddie Mac had been gorging on subprime and Alt-A debt. While it and the larger Fannie Mae bought the safest classes of the mortgage-loan pools, Freddie's purchases totaled $158 billion, or 13%, of all the securities created in 2006 and 2007, according to data from its regulator and Inside MBS & ABS... Fannie, which was also seized by the U.S. on Sept. 7, bought an additional 5%."

Real Estate Watch:

September 22 - Bloomberg (Dan Levy): "U.S. commercial real estate prices fell 9.7% in July from a year earlier as scarce financing limited transactions, Moody's said. Prices of office, retail, industrial and apartment properties all dropped as measured by Moody's REL Commercial Property Price Indices... The index is 11.4% below its October 2007 peak..."

September 23 - Bloomberg (Brian Louis): "American International Group Inc., selling assets to repay a U.S. government loan, may seek buyers for some of its $16 billion in global real estate holdings... In Manhattan alone, it controls three office buildings with 2 million square feet."

Speculator Watch:

September 25 - Wall Street Journal (Jenny Strasburg and Gregory Zuckerman): "September has piled on more pain for some of the hedge-fund industry's biggest players. The month has added to earlier declines for some prominent hedge-fund names, who are struggling with fierce volatility in commodities and stock and credit markets and intensifying troubles on Wall Street. Worsening the agony, rules to curb short-selling of hundreds of financial stocks caught many hedge-fund managers off-guard last week... TPG-Axon, the $14 billion hedge fund partially owned by private-equity firm TPG... fell 18% through mid-September... The largest fund run by Kenneth Griffin's Citadel Investment Group, with about $13 billion in assets, is down about 15.5% so far this year... Steve Cohen's SAC Capital Advisors is doing well by comparison, but is nevertheless down about 3.5%... Philip Falcone, who oversees about $21 billion at Harbinger Capital Partners, was trouncing most competitors with a gain of 43% in his biggest fund going into August. As of earlier this week, that year-to-date gain had narrowed to 4%... So far this year, many hedge funds in the most popular strategies across the industry have posted losses of between 5% and 9% on average through early this week, according to Hedge Fund Research Inc. The troubles have gained momentum amid uncertainty in the credit markets..."

September 22 - Wall Street Journal: "Just one in 10 hedge funds is currently receiving performance fees from their funds, raising questions about whether their business model is robust enough to survive the current downturn. Nine out of every 10 of the 4,000 hedge funds surveyed globally by data provider Eurekahedge are performing insufficiently well to beat their high-water mark-the level at which they can charge performance fees... All but 3% of funds of hedge funds were under the mark... The survey used figures compiled for July 31-the most recent available-and are likely to have worsened since then."

September 24 - Bloomberg (Chris Peterson): "U.S. billionaire T. Boone Pickens' hedge funds lost about $1 billion so far this year, with the investor admitting the slump in energy had blindsided him, the Wall Street Journal reported. One of his funds that focused on energy stocks lost almost 30% in value in August, while a smaller fund based on commodities was down 84%..."

September 25 - Bloomberg (Caroline Binham and Elisa Martinuzzi): "London is turning against the $450 billion hedge-fund industry that helped make the city a contender for the title of world financial capital. As Lehman Brothers Holdings Inc. filed for bankruptcy and HBOS Plc was pushed into a government-brokered takeover, U.K. regulators and lawmakers found a culprit: the estimated 980 hedge funds that reside in Britain... Harbinger Capital Partners Fund chief Philip Falcone was singled out by the Daily Mirror. The tabloid used a front-page story on Sept. 18 to brand him a 'greedy pig' for short selling, or making bets that Edinburgh-based HBOS would lose market value."

Fiscal Watch:

September 22 - Bloomberg (Bo Nielsen and Anchalee Worrachate): "Treasury Secretary Henry Paulson's plan to end the rout in U.S. financial markets may derail the dollar's three-month rally as investors weigh the costs of the rescue. The combination of spending $700 billion on soured mortgage-related assets and providing $400 billion to guarantee money-market mutual funds will boost U.S. borrowing as much as $1 trillion, according to Barclays Capital interest-rate strategist Michael Pond... While the rescue may restore investor confidence to battered financial markets, traders will again focus on the twin budget and current-account deficits and negative real U.S. interest rates. 'As we get to the other side of this, the dollar will get crushed,' said John Taylor, chairman of... International Foreign Exchange Concepts Inc., the world's biggest currency hedge-fund firm, which manages about $15 billion."

September 23 - Bloomberg (Matthew Benjamin): "Treasury Secretary Henry Paulson's $700 billion proposal to stabilize the banking system may push the national debt to the highest level since 1954, threatening an erosion of foreign appetite for U.S. bonds. The plan, which asks Congress for funds to buy devalued securities from financial institutions, would drive the debt above 70% of gross domestic product and the annual budget gap to an all-time high, possibly exceeding $1 trillion next year, economists estimated. 'This is sobering, absolutely sobering, even to someone who doesn't drink,' said Stan Collender, a former analyst for the House and Senate budget committees..."

September 25 - Bloomberg (David Evans): "As chief of staff of the Federal Deposit Insurance Corp. from 1999 to 2002, Mark Jacobsen was responsible for a safety net that protects U.S. savers. He now runs a company that critics say is designed to stretch that net to its breaking point. Jacobsen... is president and co-founder of... Promontory Interfinancial Network, a company that makes it easy for a wealthy depositor to keep FDIC-insured cash in separate accounts at multiple banks. It offers customers up to $50 million of FDIC insurance, 500 times the single-account limit approved by Congress. 'When I first saw Promontory, I was amazed that the regulators would let it fly,' says Sherrill Shaffer, a former chief economist at the New York Fed... 'It undermines a lot of the safeguards around the FDIC deposit fund. I'm astounded that the FDIC has not picked up on that and tried to shut down that loophole.'"

September 23 - Bloomberg (Dakin Campbell): "The U.S. may sell special bonds to fund the purchase of troubled mortgage securities in an effort to keep the credit risk from spreading through the Treasury market, according to Morgan Stanley's George Goncalves. 'They will probably initially issue more Treasuries until the program starts up, but then they will issue special bonds for this so as not to muddy the waters,' said Goncalves, the chief Treasury and agency debt strategist... at Morgan Stanley. 'The credit premium should shift to this new entity.'"

Muni Watch:

September 26 - Bloomberg (Michael McDonald and Jeremy R. Cooke): "The worst year on record for U.S. state and local government borrowers is getting worse. Yields on long-term, municipal bonds reached their highest compared with Treasuries this month... Interest costs on debt sold by issuers such as New York City, with rates set daily or weekly, climbed as much as fivefold in the past two weeks to 9% or more. Issuers from Chicago to Hawaii have postponed more than $9 billion of bond sales. The latest turmoil on Wall Street is pinching taxpayers already reeling from unprecedented upheaval in the $2.66 trillion municipal market. All but two of the seven top-rated firms that insured half the tax-exempt market lost their AAA grades. Municipalities were the biggest borrowers in the $330 billion market for auction-rate securities, which collapsed in February and produce penalty rates as high as 20%."

New York Watch:

September 23 - Bloomberg (Henry Goldman): "New York City agencies must cut budgets by 2.5% for the remainder of the fiscal year and 5% in the 12-month period beginning July 1, the budget office said. The directive... aims to save $500 million through June 30, 2009, and $1 billion in the following fiscal year. The city, dependent upon Wall Street for as much as 9% of its revenue, projected a $2.3 billion budget gap in the 2010 fiscal year... 'It has become increasingly clear that our forecast future deficits will not be cured, as has been the case for the last few years, by an improvement in that forecast and higher than expected revenues.'"

California Watch:

September 25 - Bloomberg (Dan Levy): "California home prices tumbled a record 41% in August from a year earlier as foreclosure sales pushed down values in the most populous U.S. state. The median price... fell to $350,140, the lowest since March 2003... More than 101,000 California households received a default notice, were warned of a pending auction or foreclosed on last month, RealtyTrac... said..."

Changed Financial Landscape:

For our country's sake, I hope our Washington politicians can work out a mindful financial sector bailout package over the weekend. Not that I am pro-bailout or for government intervention. It's just that our financial system is teetering at the precipice. Last night's federal takeover and "sale" of Washington Mutual, our nation's largest bank failure to date, was yet another major body blow. Confidence has now been shaken so brutally that our policymakers can do little to repair the damage. Yet at this point, stop-gap measures to restrain collapse seem more appealing to me than no measures at all.

The Financial Structure that fueled myriad Credit Bubbles, asset Bubbles, economic Bubbles and overliquefied the entire world is today no longer viable. Wall Street finance is at this point an unmitigated bust, with a few of the "holdout" sectors (i.e. the Credit default market and the hedge fund community) now succumbing. The great Financial Alchemy of transforming endless risky loans into perceived safe and liquid "money"-like instruments has run its historic course. And with risky loans - household, financial sector, business, municipal and speculator - having come to play such a prominent role in the nature of spending and "output", the near elimination of risky lending will prove a momentous financial and economic development. The U.S. Bubble economy is today in dire straits.

We've reached the point where it has become difficult to secure new borrowing unless one is of quite sound Credit standing. This is the case for individuals seeking to buy automobiles and homes; to afford myriad discretionary and luxury goods and services; to finance educations; or to make the types of big ticket purchases that had been bolstering our Bubble Economy. Lenders are now moving aggressively to cut home equity and Credit card lines. And, importantly, recent developments have significantly tightened Credit Availability for businesses of all sizes. Securitization markets have been largely shut down for awhile now. Now acute stress has incapacitated the money markets.

Unless some dramatic development reverses the current course, it will not be long before a self-reinforcing cycle of company payroll and spending cutbacks takes hold. At the same time, the municipal bond market is in disarray. The economic impact from major cutbacks in state and local government spending will be significant. Today's finance-related economic headwinds are Cat-4 (and gaining) Hurricane Systemic Credit Seizure, compared to last year's Tropical Storm Subprime. Federal Reserve-dictated interest rates are extremely low - and the Fed and global central bankers have injected unfathomable amounts of liquidity - yet Credit Conditions have turned the tightest they've been in decades.

The Lehman bankruptcy marked a major inflection point in the confidence of contemporary "money." It was a decisive blow against trust in various money market instruments - the very foundation of our monetary system. "Money" has now tightened significantly for virtually all players that had previously enjoyed cheap short-term financings. This list certainly includes the hedge fund community.

The Lehman bankruptcy also marked a major inflection point in confidence for the various "daisy chain" players involved in intermediating risky loans into contemporary "money." The market was convinced Lehman was "too big to fail." Its failure inflicted thousands of market participants with losses - from Primary Reserve Money Fund investors caught with short-term Lehman paper to holders of Lehman's long-term bonds. Investors all over the world were impacted. The hedge fund community suffered mightily. The status of hundreds of billions of derivatives and counterparty obligations was suddenly up in the air or in the hands of the bankruptcy court. And, importantly, huge losses were suffered in the Credit Default Swap marketplace - the marrow of one of history's most spectacular speculative manias.

Trying to add a bit of simplicity to the Complexity of a Credit Market Breakdown, I'll say the Lehman collapse marked a critical inflection point in at least five major respects: First, the Crisis of Confidence jumped the "firebreak" from risk assets to contemporary "money," shattering trust in various facets of contemporary finance that was forged over decades. Second, it required the marketplace to reexamine exposures to various direct and indirect counterparty risks, a terminal blow for derivatives markets. Third, it pushed the Credit default swap marketplace into full-fledged dislocation and instigated a long-overdue regulator onslaught. Fourth, it decisively burst the "leveraged speculating community"/hedge fund Bubble. This has ushered in another round of problematic de-leveraging and accelerated the reversal of "Ponzi Finance" dynamics. Fifth, it instilled global fear with respect to the risks of participating in the inter-bank lending market with American institutions.

Basically, the Lehman collapse marked the end of "Wall Street" risk intermediation as a significant component of system financial intermediation. Going forward, Credit growth will be chiefly generated by the banking system, supported by various forms of government backing (Fed, FDIC, Washington bailouts/recapitalizations, etc.), the government-operated GSEs, and various forms of federal government debt issuance. Importantly, this new financial structure will ensure minimal risky lending as well as significantly reduced risk-taking. And from a global perspective, I believe newfound fears of lending to the American financial sector marks the beginning of the end of our economy's capacity for trading new financial claims for imports of energy and goods.

Over time the Changed Financial Landscape will have a profound impact on the underlying economic structure. Our economy will have no alternative than to get by on less Credit, less risk intermediation, and fewer imports. In the near-term, the effects will be a rapid and pronounced slowdown of our economy's "output." And while we'll only know over time, I'd bet this new financial structure will allocate much less finance to entrepreneurial activities, productive endeavors and the asset markets - while at the same time providing ample (government-directed) purchasing power to ensure stubborn consumer price inflation.

 


 

Doug Noland

Author: Doug Noland

Doug Noland
The Credit Bubble Bulletin
PrudentBear.com

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Source: The Contrarian Take http://blogs.forbes.com/michaelpollaro/
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