"Didn't Really Get It"

By: Doug Noland | Fri, Sep 14, 2007
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Somewhat loosened Credit conditions supported stock prices. For the week, the Dow jumped 2.5% (up 7.9% y-t-d), and the S&P500 gained 2.1% (up 4.7%). The Utilities increased 2.4% (up 7.3%) and the Morgan Stanley Consumer index 2.1% (up 3.4%). The Morgan Stanley Cyclical index added 0.8% (up 13.3%), and the Transports rose 1.3% (up 5.2%). The small cap Russell 2000 increased 1% (down 0.5%) and the S&P400 Mid-cap index 1.1% (up 7.2%). The NASDAQ100 rose 2%, inceasing y-t-d gains to 13.9%. The Morgan Stanley High Tech index added 1.2% (up 12.7%), while the Semiconductors declined 1.2% (up 4.1%). The Street.com Internet Index rose 1.7% (up 16.1%) and the NASDAQ Telecom index 1.4% (up 16.1%). The Biotechs gained 1.7% (up 6.6%). Financial stocks rallied sharply. The Broker/Dealers surged 4.7% (down 6.2%), and the Banks rose 2.6% (down 9.8%). With bullion gaining another $6.80 this week, the HUI gold index rose 2.1% (up 8.1%).

Three-month T-bill rates fell 7 bps this week to 3.99%. Meanwhile, two-year U.S. government yields jumped 14bps to 4.05% and five-year yields 13 bps to 4.18%. Ten-year Treasury yields rose 8 bps to 4.46%. Long-bond yields ended the week up 3 bps to 4.73%. The 2yr/10yr spread ended the week at 41 bps. The implied yield on 3-month December '07 Eurodollars rose 6.5 bps to 4.885%. Benchmark Fannie Mae MBS yields gained 13 bps to 5.90%, this week somewhat outperforming Treasuries. The spread on Fannie's 5% 2017 note narrowed one to 49, and the spread on Freddie's 5% 2017 note narrowed one to 49. The 10-year dollar swap spread increased 1.5 to 67.25.. Corporate bond spreads were mixed to narrower. The spread on a junk index ended the week 2 bps wider.

Investment grade debt issuers included IBM $3.0bn, Schering-Plough $2.0bn, Wachovia $1.7bn, Bank of America $775 million, Florida Power $750 million, Blackrock $700 million, Hasbro $350 million, and Conn L&P $200 million.

September 11 - Bloomberg (Steve Rothwell): "Defaults by U.S. companies will more than double in the coming year as investors shun riskier debt, Moody's...said. Companies will be unable to meet payments on about 4% of bonds and loans with high-risk, high-yield credit ratings as they run out of cash and are unable to refinance existing debt... Dwindling investor demand forced companies to cancel or overhaul more than $100 billion of planned debt sales since June, according to...Bloomberg. Corporate treasurers need to repay $26 billion of high-risk, or junk bonds by the end of 2008, Moody's said."

September 14 - Bloomberg (Bryan Keogh): "Investors pulled $154 million from high-yield bond funds, reversing two weeks of inflows, according to JPMorgan Chase & Co..."

Junk issuers included DCP Midstream $450 million, FPL Group $250 million, and HRPT Properties $250 million.

Foreign dollar bond issuance included Enel Finance $3.5bn and Asian Development Bank $1.0bn.

German 10-year bund yields rose 5 bps to 4.17%, as the DAX equities index rallied 1.1% (up 14% y-t-d). Japanese 10-year "JGB" yields fell 4.5 bps to 1.54%. The Nikkei 225 was unchanged (down 6.4% y-t-d). Emerging debt markets mostly rallied and equity markets were generally quiet. Brazil's benchmark dollar bond yields fell 14 bps to 5.93%. Brazil's Bovespa equities index added 0.2% (up 22.9% y-t-d). The Mexican Bolsa slipped 0.6% (up 13.8% y-t-d). Mexico's 10-year $ yields declined 3 bps to 5.49%. Russia's RTS equities index jumped 2.4% (up 1.1% y-t-d). India's Sensex equities index added 0.1% (up 13.2% y-t-d). China's Shanghai Composite index added 0.7% to close at yet another record high (up 99% y-t-d and 214% over the past year).

Freddie Mac posted 30-year fixed mortgage rates dropped 15 bps to a 17-wk low 6.31% (down 12bps y-o-y). Fifteen-year fixed rates this week declined 18 bps to 5.97% (down 14bps y-o-y). One-year adjustable rates fell 8 bps to 5.66% (up 6bps y-o-y).

Bank Credit surged $45.8bn (week of 9/5) to a record $8.860 TN. After a notable six-week $219bn expansion, Bank Credit has now increased $564bn y-t-d, or a rate of 9.8%. For the week, Securities Credit rose $12.7bn. Loans & Leases surged $33.1bn to $6.490 TN (6-wk gain of $162bn). C&I loans gained $13.5bn and Real Estate loans $9.4bn. Consumer loans rose $5.6bn. Securities loans were about unchanged, while Other loans expanded $4.9bn. On the liability side, (previous M3) Large Time Deposits were little changed.

Following last week's big rise, M2 (narrow) "money" declined $33.6bn to $7.366 TN (week of 9/3). Narrow "money" has expanded $323bn y-t-d, or 6.6% annualized, and $491bn, or 7.1%, over the past year. For the week, Currency added $0.2bn, while Demand & Checkable Deposits surged $56bn. Savings Deposits sank $92.6bn, while Small Denominated Deposits increased $3.0bn. Retail Money Fund assets slipped $0.2bn.

Total Money Market Fund Assets (from Invest. Co Inst) jumped another $27.2bn last week to a record $2.829 TN (7-wk gain of $245bn). Money Fund Assets have increased $447bn y-t-d, a 26.4% rate, and $599bn over 52 weeks, or 26.8%.

The pace of Commercial Paper market contraction slowed notably the past week. Total CP declined $8.2bn last week to $1.917 TN, increasing the five-week decline to $306.4bn. Asset-backed CP dropped another $14.2bn (5-wk drop of $228.6bn) to $944.8bn. Year-to-date, total CP is now down $57.2bn, with ABCP declining $139.1bn. Over the past year, Total CP is up $53bn, or 2.9%.

Asset-backed Securities (ABS) issuance was a still tepid $4bn this week. Year-to-date total US ABS issuance of $447bn (tallied by JPMorgan) is now running about 28% behind comparable 2006. At $209bn, y-t-d Home Equity ABS sales are 47% of last year's pace. Year-to-date US CDO issuance of $244 billion is now running only slighlty ahead 2006 sales.

Fed Foreign Holdings of Treasury, Agency Debt last week (ended 9/12) increased $1.1bn to $1.981 TN. "Custody holdings" were up $229bn y-t-d (18.4% annualized) and $299bn during the past year, or 17.8%. Federal Reserve Credit last week expanded $0.6bn to $857bn. Fed Credit has increased $5.0bn y-t-d and $30.8bn over the past year (3.7%).

September 13 - Bloomberg (Maria Levitov): "Russia's foreign currency and gold reserves rose for a second consecutive week after registering a record weekly decline last month, the central bank said. The reserves, the world's third biggest, reached $417.1 billion in the week ended Sept. 7..."

International reserve assets (excluding gold) - as accumulated by Bloomberg's Alex Tanzi - were up $924bn y-t-d (27% annualized) and $1.142 TN y-o-y (24.9%) to $5.735 TN.

Credit Market Dislocation Watch:

September 11 - Bloomberg (John Glover): "The dollar may weaken this week as banks and companies seek to refinance about $700 billion of commercial paper in the U.S. currency this week, according to analysts at Citigroup Inc. Borrowers in the commercial paper market are struggling to sell new notes... The shortage of investors in the market has spurred expectations the Federal Reserve will cut interest rates, sending the dollar lower, the analysts said in a report. 'The situation is really exacerbating the strains on the dollar,' Michael Hart, one of the authors of the report, said... 'After an initial phase where people were viewing Treasuries and the dollar as a safe haven, we're entering a second phase where concerns over the U.S. financial system are causing a weaker dollar.' Hart wrote the report, titled 'Can You Spare $700 Billion This Week?' with Tom Fitzpatrick and Todd Elmer in New York. About $600 billion of commercial paper comes due in the U.S. this week, taking account of $265 billion the Federal Reserve in Washington says is maturing and last week's sales of paper due in nine days or less. In Europe, a another $94 billion needs financing, according to the report'"

September 14 - Financial Times (Mark Schieritz and Gerrit Wiesmannin): "UK banks have emerged as keen bidders for emergency cash from the European Central Bank as they grapple with home-market liquidity restrictions given the Bank of England's refusal to do more than offer overnight funds to commercial banks. The FT's sister paper FT Deutschland has learned that eurozone subsidiaries of British banks have been participating in the ECB's longer-term lending to commercial banks."

September 14 - Bloomberg (Ben Livesey and Jon Menon): "Northern Rock Plc got emergency funding from the Bank of England, the biggest bailout of a British lender in 30 years, after rising credit costs left the mortgage provider unable to make new loans.

September 14 - Financial Times (Chris Hughes): "Fears about the future of Northern Rock grew on Friday as shares in the Newcastle-based lender slumped and customers lined up to withdraw funds. Northern Rock said in a statement on Friday that the Bank of England had agreed to provide it with as much funding "as may be necessary" as it warned that it would otherwise be incapable of refinancing maturing liabilities and flagged that full-year profits would be 20 per cent below consensus forecasts... The Newcastle-based mortgage lender said that a severe liquidity squeeze in the wholesale markets had left it able to raise funds only in the short-term wholesale markets, and in insufficient quantities to refinance maturing liabilities and to write business at previous levels."

September 10 - Bloomberg (Christine Harper): "Wall Street is getting no benefit from the biggest bond market rally in five years. Lehman Brothers Holdings Inc. faces higher borrowing costs today than it did in June, even after the steepest quarterly drop in U.S. Treasury yields since 2002 pushed interest rates down for everyone from Procter & Gamble Co. to AT&T Inc. Investors are so leery of Bear Stearns Cos. that its 10-year bonds trade at a discount to Colombia, the South American nation that's barely investment grade. Goldman Sachs Group Inc. is being punished with a higher yield than Caterpillar Inc.... Bond buyers view the nation's largest securities firms as no safer than taking a flier on subprime mortgages. That's a nightmare scenario for the industry's chief executive officers, who relied on cheap financing for leveraged buyouts, real estate lending and proprietary trading to produce record profits - and paychecks of $40 million or more for themselves."

September 11 - Financial Times (James Mackintosh and Paul J Davies): "Hedge funds investing in structured finance took another hit on Tuesday when it emerged that the flagship fund of London's Wharton Asset Management had lost a quarter of its money in one month and a small Swiss-run fund had collapsed. Wharton's Y2K Finance fund said...it was suspending calculation of asset values, withdrawals and subscriptions, until December... The fund plummeted 25.04% July, after dropping 7.3 per cent in June, as the European asset-backed securities...were marked down savagely by brokers. Meanwhile, Avendis, which, like Wharton, specialises in structured finance products such as collateralised debt obligations, said its Enhanced Fixed Income fund had filed for liquidation in the Cayman Islands... Y2K...is Wharton's only hedge fund forced to mark its book to market values. Its other vehicles, backed by long-term finance, can sit out the volatility, as they are instead exposed to the risk of default by the underlying borrowers."

September 13 - Financial Times (Paul J Davies, Jennifer Hughes and Gillian Tett): "When Synapse Investment Management, a London asset manager, revealed last week that it was closing a $300m fund, its decision sent an ominous message for bankers and accountants around the world. That was because the death knell came not as a result of huge tangible losses on the fund's investments; instead, the main trigger was that the fund had become embroiled in a bitter, secretive fight with Barclays Capital, its prime broker, about valuation issues - how to price the debt instruments the fund held. 'The fund was closed due to the severe illiquidity in the market, which led to an inability to properly value the assets,' says Mark Holman, one of Synapse's founding partners, who notes that the fund held none of the subprime assets at all that have been at the centre of recent market upheavals. The tale highlights a much bigger battle about valuation that has already brought down other funds and still rages behind the scenes in numerous offices at banks, hedge funds and accountancy firms on Wall Street and in the City of London. One of the biggest problems spooking the markets is the sheer uncertainty about just how large the losses on many financial instruments might be - and which institutions will be hit. This uncertainty has in turn created a crisis in trust among banks worried about the creditworthiness of their peers and therefore wary of lending to each other..."

September 13 - Financial Times (James Mackintosh): "Proof that the crisis in credit markets is hitting those who are 'warehousing' assets to create structured products came yesterday when Airlie Opportunities, a $650m hedge fund, put the blame for heavy losses last month on the cancelling of two planned structured vehicles. Airlie estimated it lost 11.25% in August as it sold at a discount bank loans it had been holding ready for two collateralised loan obligations (CLOs). Airlie, based in Greenwich, Connecticut, is thought to be the first fund to confirm losses from the unwinding of assets held ready to put into CLOs, a practice known as warehousing. But analysts say billions of dollars of bank loans have already been anonymously dumped into the market as investment banks and hedge funds have been forced by the credit crunch to abandon plans for CLOs."

September 14 - Bloomberg (Neil Unmack): "Structured investment vehicles, funds that borrow in the commercial paper market, sold about $25 billion of assets since mid-July as their financing costs soared, according to Moody's... The so-called SIVs, which borrow to buy longer-dated assets, hoarded cash as commercial paper rates jumped to a six-year high of 6.35%. Fund holdings dropped 6% to about $370 billion..."

September 14 - The Wall Street Journal (Sudeep Reddy): "Borrowing from the Federal Reserve's discount window soared in recent days, which some analysts said may have been the result of the Fed's efforts to restore overnight interest rates to the Fed's target level. Discount borrowing under the Fed's primary credit program for banks surged to more than $7.1 billion outstanding as of Wednesday, up from about $1 billion a week earlier... It was the highest level since the day after the Sept. 11, 2001, terrorist attacks."

September 10 - Financial Times (David Wighton and Jeremy Grant): "The leading commercial and investment banks have been in private talks about how to account for losses in their leveraged lending and securities businesses due to the credit squeeze. The discussions reflect concerns that the various banks could make very different judgments about the impact of the market turmoil. Banks have a high degree of discretion about how to value the losses but top executives believe too much variation will undermine market confidence... The issues are particularly urgent for Wall Street banks such as Goldman Sachs, Morgan Stanley, Lehman Brothers, and Bear Stearns, which next week start reporting their results for the three months to August."

September 12 - Financial Times (Saskia Scholtes): "As the effects of the US subprime mortgage crisis have rippled out into the broader credit markets, bond insurers - an important but normally staid group of companies - have increasingly fallen victims to the turbulence. These companies have seen their share prices tumble and the cost of protecting their debt against default spike higher as investors have punished all industries with exposure to the stricken mortgage market... Problems for such insurers have important implications for the bond market. These companies lend their high credit ratings to securities issued by others in return for a fee... Standard & Poor's said last week that it may change the way it measures the capital requirements of bond insurers to reflect more accurately the way bond insurance has changed. "Financial guarantors have expanded their activities far beyond solely insuring debt issued by US municipalities,' S&P said. "This, in turn, calls for more sophisticated portfolio risk models and methodologies incorporated in the quantitative analysis of risk.'"

September 10 - Financial Times (Michael Mackenzie, Saskia Scholtes and David Oakley): "High-yield bond and loan investors have shunned new debt sales so far this month, extending a buyers' strike for risky assets into the traditionally busy first week of September as concerns linger over the shaky state of the credit markets. Just one $50m bond issue was sold last week, marking the lowest new issue volume for the first week of September in more than a decade... Just under $2bn of high-yield debt was sold in the US in August, the lowest amount since 2002... Investors and analysts say the coming weeks will be crucial for the credit markets, as banks attempt to sell $300bn of high-yield bonds and loans linked to this year's record levels of leveraged buy-out activity."

Currency Watch:

September 14 - Bloomberg (Min Zeng): "Canada's dollar rose for a fifth day, pushing the currency to the highest since 1977 against its U.S. counterpart, amid speculation gains in commodities including oil will bolster economic growth."

The dollar index fell 0.4% to 79.64. On the upside, the Brazilian real increased 2.6%, the New Zealand dollar 2.3%, the Canadian dollar 2.1%, the Australian dollar 2.0%, the Swedish krona 1.5%, and the Nowegian krone 1.0%. On the downside, the Japanese yen declined 1.4%, the Briish pound 1.0%, and the Swiss franc 0.2%. The Euro added 0.5%.

Commodities Watch:

September 13 - Bloomberg (Claudia Carpenter): "China may become the world's largest gold producer this year, toppling South Africa's unbroken century long run, London-based researcher GFMS Ltd. said. South Africa's production in the first six months of this year was 134 tons, down 7%, while China's output surged 18% to 129 tons, making China the second-largest producer..."

September 11 - Bloomberg (Jeff Wilson): "Wheat inventories in Canada, the world's second-largest exporter of the grain this year, plunged 29% at the end of July from a year earlier as global demand increased... Stockpiles on farms and in commercial storage fell to 6.8 million metric tons from 9.6 million, Statistics Canada said..."

For the week, Gold added 1.0% to $707.60, while Silver was little changed at $12.71. Copper recovered 4.3%. October crude traded to a record high $80.20 today before ending at $79.10, up $2.40 on the week. October gasoline jumped 2.5%, and October Natural Gas rallied 14.2%. December Wheat posted a slight advance to $846, increasing 6-month gains to 83%. For the week, the CRB index rose 2.8% (up 4.4% y-t-d), and the Goldman Sachs Commodities Index (GSCI) surged 3.7% (up 21.3% y-t-d).

Japan Watch:

September 13 - Bloomberg (Tomoko Yamazaki): "Hedge funds investing in Japan had their worst monthly performance for seven years in August... The Eurekahedge Japan Hedge Fund Index, which tracks 124 funds investing in Japan, fell 3.4% in August..."

China Watch:

September 13 - Financial Times (Richard McGregor): "Pressure grew on Tuesday for China to raise interest rates sharply in the coming months after inflation hit 6.5% in August, the highest in more than a decade. Inflation was pushed up from July's 5.6% rate by rapidly rising food prices, which were up 18.2% year-on-year in August, as a shortage of pigs and pork, a staple meat, and higher feed costs buffeted grocery and vegetable markets. High and rising inflation, particularly when driven by food prices, will reduce the living standards of Chinese workers, threatening unrest unless wage rates rise to compensate. But wage inflation would risk fuelling more general price inflation, similar in effect to an appreciation of the Chinese currency."

September 14 - Bloomberg (Zhang Dingmin and Nipa Piboontanasawat): "China raised interest rates for the fifth time since March to curb the fastest inflation since 1996 and cool a surging stock market. The benchmark one-year lending rate will increase to a nine-year high of 7.29% from 7.02%..."

September 11 - People's Daily: "China's motor vehicle industry continues to grow rapidly, with both production and sales rising by around 25% in the first eight months of this year... Production was up 23.57% to 5.75 million..."

September 13 - Bloomberg (Nipa Piboontanasawat and Zhang Dingmin): "China's industrial production rose 17.5% in August from a year earlier, slowing for a second month after the government increased taxes on exports."

September 12 - People's Daily: "House prices in 70 large and medium-sized Chinese cities were up 8.2% in August compared with last year, as the rising trend continues to show no sign of stopping..."

September 12 - Bloomberg (Li Yanping and Nipa Piboontanasawat): "China's money supply expanded more than 18% for a second straight month, adding pressure on the central bank to raise interest rates. M2...rose 18.1% in August from a year earlier after gaining 18.5% in July..."

September 12 - People's Daily: "The retail price of pork in China, the country's staple meat, soared 77.6% in August from the same month a year ago though it began to decline in the middle of the month, according to the National Development and Reform Commission."

India Watch:

September 11 - Financial Times (Amy Yee): "Rising salaries for Indian software professionals will add to margin pressures at technology outsourcing companies in India, according to a survey released on Tuesday that showed wages rose an average of 18.7% this year. The average annual salary for a software worker in India has risen to Rs620,000 ($15,500), according to a nationwide survey of employees... The rise is slightly above the 18.3% salary increases recorded last year... Wage inflation is an ongoing concern as Indian companies try to maintain their cost advantage. Employers are combating high attrition rates as workers vie for better-paying jobs."

Unbalanced Global Economy Watch:

September 14 - Bloomberg (Theophilos Argitis): "Canada's factory shipments surged in July, and the cost of paying workers to produce goods rose at their fastest pace in 16 years in the second quarter, supporting the central bank's assertion that the economy is at capacity."

September 14 - Bloomberg (Jennifer Ryan): "London house prices fell the most since 2004 this month after five interest rate increases in a year and turmoil in financial markets sapped buyers'confidence, according to a Rightmove Plc report. The average asking price for a home in the U.K. capital declined 2.5% from August to 384,439 pounds ($774,000)..."

September 10 - Bloomberg (Jonas Bergman): "Swedish apartment prices rose an annual 26% in the three months through August, up from a 23% increase in the month-earlier period... The average apartment price rose to 1.36 million kronor ($200,441)... Prices of single-family homes increased 11%..."

September 10 - Dow Jones (Christopher Witkowsky): "Russia's economy grew 7.8% on the year in the second quarter of 2007, the Federal Service for Statistics, or Rosstat, said... That would represent a very slight slowdown from 7.9% registered in the year through the first quarter."

Latin America Watch:

September 13 - Bloomberg (Svenja O'Donnell): "Argentina's central bank governor Martin Redrado said... 'The central bank is concerned, deeply concerned, about the level of inflation,' Redrado said... 'There is no room for complacency.' Consumer prices rose 8.7% in the 12 months through August."

Bursting Bubble Economy Watch:

September 10 - Bloomberg (Bradley Keoun): "The worst U.S. housing slump in 16 years may lead mortgage companies to eliminate almost 100,000 jobs, more than double the number already cut this year. As many as 20% of the nation's real estate loan officers and mortgage brokers will be fired, according to Josh Rosner, managing director at...investment research firm Graham Fisher & Co. That's in addition to the 10% reduction from December to July... 'Originations are going to decline dramatically,' Rosner said. 'We are just at the front-end of seeing the large banks and investment banks start to cut their capacity.'"

September 13 - Financial Times (David Wighton): "More than 100,000 jobs may well be lost from the US mortgage industry in the next few months as the turmoil in the credit markets begins to bite. Industry experts predict that lenders and brokers will cut at least 20% of their headcount as volumes look set to fall more than 25% next year. 'It could be considerably more,' said Guy Cecala, of Inside Mortgage Finance. 'The boom brought tons and tons of people into the business, which has been carrying excess weight for several years.'"

September 11 - Bloomberg (Joe Richter): "Chief financial officers this quarter were the most pessimistic on the U.S. economic outlook since at least the last recession, an industry survey showed. Almost two-thirds of executives held a darker view on growth than in the previous three months, outnumbering optimists by a four-to-one margin, according to the September Duke University/CFO Magazine Business Outlook index. The gauge was at the lowest level since its inception in June 2001, when the U.S. was in the midst of an eight-month contraction."

September 11 - Bloomberg (Leon Lazaroff): "U.S. advertising spending declined in consecutive quarters for the first time in six years as retailers and automakers trimmed their marketing budgets, TNS Media Intelligence reported. Spending fell 0.2% to $38.1 billion in the second quarter after a 0.3% drop in the first...'There's fundamental weakness in retail combined with declining rates in corporate profit growth,' research director Jon Swallen said... Retail spending dropped 1.3% to $8.4 billion... Spending by U.S. automakers fell 11% to $3.4 billion. General Motors...trimmed its budget by more than $100 million in the three months ended June, marking the fifth consecutive quarter in which GM cut ad expenditures by more than 15%. Spending on network television advertising fell 3.6% to $11.8 billion while newspaper ads declined 5.8% to $12.9 billion in the first half. Radio ad spending fell 2.7% to $5.14 billion."

September 11 - Bloomberg (Aliza Marcus): "Health-insurance premiums paid by U.S. businesses for their workers rose 6.1 percent this year, continuing to outpace inflation and wages, a study found. The average family plan offered by a company now costs $12,106, or $62 less than a full-time worker earning the U.S. minimum wage makes, according to...the journal Health Affairs. Companies pay an average of $8,824 for such a policy, with the worker paying the difference ... Since 2001, premiums for family coverage have increased 78%, while wages have gained 19% and inflation 17%..."

Speculator Watch:

September 10 - Bloomberg (Katherine Burton): "Hedge Funds fell 1.31% on average in August, the worst monthly performance since May 2006... Emerging-markets funds dropped 2.5%, and macro funds decreased 2%...Hedge Fund Research Inc. said... High-yield bond funds fell 1.97%."

September 13 - Bloomberg (Jenny Strasburg and Katherine Burton): "Goldman Sachs Group Inc.'s Global Alpha hedge fund fell 22.5% in August, its biggest monthly decline, on losses from currency and stock trades..."

Central Banker Watch:

September 13 - Financial Times (Chris Giles and Gillian Tett): "A clear divide between the world's leading central banks over how best to respond to the credit squeeze emerged yesterday after Mervyn King, Bank of England governor, warned that efforts by his counterparts to shore up the financial system could sow 'the seeds of a future financial crisis'. In a trenchant defence of the Bank's refusal to address the abnormally high interest rates for longer-term lending between banks, Mr King questioned the effectiveness of the kind of measures taken by the European Central Bank and said their approach could encouraging 'excessive risk-taking'. His comments were later re-inforced by David Dodge, the Canadian central bank governor... In a written submission to the Commons Treasury select committee, Mr King warned of the hazards of providing central bank insurance to those institutions that have engaged in reckless lending. 'The provision of large liquidity facilities penalises those financial institutions that sat out the dance, encourages herd behaviour and increases the intensity of future crises. Central banks should not 'sensibly entertain' such cash injections just to maintain the status quo,' he added."

California Watch:

September 13 - Los Angeles Times: "Home prices fell in most Southern California neighborhoods and the number of sales tumbled to a 15-year low for August -- driven down by tougher lending standards, mounting foreclosures and skittish buyers. Sales for the month plunged 36% from a year earlier. What's more, 71% of the Southland's ZIP Codes showed price declines, according to...DataQuick... 'Prices are falling everywhere,' said Christopher Thornberg, a former UCLA business professor who is now a principal at...Beacon Economics. In recent years, the housing market had been propped up by the widespread use of home loans with low introductory teaser rates -- allowing prices to outpace income growth, he said. But with those easy-credit loans all but gone, values are coming back into balance. 'People just don't have the income to support these prices except with crazy mortgages -- and now the mortgage money is going away, and people are walking away from their homes,' Thornberg said. Nearly 9% of the homes sold last month were foreclosure properties, DataQuick reported, up from 2.2% a year earlier."

September 12 - Los Angeles Times (Annette Haddad): "As the global credit markets were melting down in mid-August, the percentage of transactions in which borrowers used so-called jumbo mortgages -- loans of more than $417,000 that are widely used to purchase homes in Southern California's pricier neighborhoods -- started to decline. Before Aug. 17, 43.4% of all Southland home purchases involved jumbo financing, DataQuick found. After Aug. 17, the percentage dropped to 39.7%. What's more, mortgage brokers have reported that about a fifth of the most credit-worthy home buyers were unable to complete their purchases as lenders stopped approving mortgages because they couldn't turn around and sell the debt to investors."

September 10 - Los Angeles Business Journal (Howard Fine): "The expanding mortgage crisis and credit crunch slammed the Los Angeles housing market in August, with home sales plunging 50% from the same month last year and 25% from July. Sales of new and existing homes in Los Angeles County slid to 4,107 units in August...according to...HomeData Corp... Similar carnage took place in the condo market with year-over-year sales plummeting 40% to 1,168 units. Sales were off 27% from July... 'These numbers are the first to show the beginning of the impact of the credit crunch that materialized in the last couple months,' said Robert Kleinhenz, deputy chief economist with the California Association of Realtors... The differing trajectories - home sales down but median prices up - has been due to a strong market for high-end homes with sale prices exceeding $2 million. But last month, even this market took a hit as borrowers had a much more difficult time obtaining so-called jumbo loans, or those exceeding $417,000. 'Everything was great until about a month ago. Then, on one day - Thursday, Aug. 9 - everything changed as lenders shot up rates on jumbo loans to 9% and further tightened guidelines,' said Syd Leibovitch, owner of Beverly Hills-based Rodeo Realty, which mostly deals in homes worth more than $2 million. 'It became almost impossible to find a jumbo loan.'"

September 13 - Bloomberg (Daniel Taub): "San Francisco Bay Area house and condominium sales fell 25% last month to the lowest level in 15 years as stricter lending standards pushed some buyers out of the market, DataQuick...said."

September 13 - The Orange County Register (Jeff Collins): "The O.C. home sales slump deepened in August with just 2,285 residences sold, down 33.9% from a year ago, DataQuick said... It was the 23rd straight month of year-over-year declines, the longest such stretch in the 20 years that DataQuick has been compiling local housing statistics. It also was the slowest August on record and the 11th worst of any month in the database... Last month also capped the worst selling season on record, DataQuick figures show. Just under 10,000 homes sold countywide during the peak May-through-August months this year, or 43.3% below the season's average of 17,600."

September 13 - The Press-Enterprise (Leslie Berkman): "Homes sales fell faster in Riverside and San Bernardino counties than anywhere else in Southern California last month as rising foreclosures and a credit crunch scared off homebuyers. Home sales plunged by more than 46% in Riverside County and by more than 47% in San Bernardino County, compared with the same month last year, according to DataQuick..."

Mortgage Finance Bust Watch:

September 10 - Bloomberg (Sharon L. Crenson and Dan Levy): "Anna Morita, a neuropsychologist in the San Francisco Bay Area with near-perfect credit, was certain she could get the loan of her choice to buy an $880,000 three-bedroom house. Morita, 34, with more than $300,000 for a down payment and a credit score of 825 out of a possible 850, was banking on a 30-year loan with interest-only payments for 10 years. That mortgage became too expensive when her lender quoted a rate of 7.6%. She's now applying for another mortgage. From buyers who can't afford costly loans to homeowners who can't find a buyer, the mortgage market is a mess. Home-loan defaults are at record levels and analysts predict property prices in the most-expensive metropolitan areas of New York, California and Washington, D.C., will fall in the next year in the broadest decline since 1995. Prices already have dropped in a third of U.S. markets tracked by the Chicago-based National Association of Realtors. 'No place will be immune,' said Ken Rosen, chairman of the Fisher Center for Real Estate and Urban Economics at the University of California in Berkeley. 'Inventory is increasing and the demand side is falling off. The psychology has become negative.'"

September 12 - San Francisco Chronicle (Carolyn Said): "Mortgage woes have moved upstream, landing even in tony neighborhoods. The credit crunch now is hitting homebuyers from all walks of life, not just subprime borrowers with poor credit. That in turn could mean fewer buyers - and lower prices. For instance, a multimillion-dollar deal in Larkspur in the Bay Area went belly-up earlier this month when the lender yanked the financing at the last minute. 'Everything was perking along smoothly. All contingencies were removed,' said Bill Hogan, a Realtor with Coldwell Banker...who sold the four-bedroom home for $2.45 million and expected to close the deal later this month. 'The loan was approved and locked in. People were ordering moving trucks, everyone was feeling euphoric.' But the couple buying the house learned that their lender was rescinding their loan because they were making only a 10% down payment. 'All of a sudden the lender, because it is backed by a series of investors that are feeling very shaky and panicky, decided it could no longer honor the loan commitment... This was not a subprime loan; this was fully documented, people with outstanding credit who own a $5 million home now and didn't need to sell it to buy this one. The buyers could have gotten a mortgage at a substantially higher rate - just under 8% - Hogan said, but 'they crunched the numbers and said, 'no, maybe this is a sign for us to get out.'"

September 10 - The Wall Street Journal (Liam Pleven): "Problems confronting title insurers may offer fresh clues about economic stress points in the nation's housing market. Title insurers issue policies that essentially guarantee a homebuyer is the rightful owner of a property. The industry's fortunes are closely tied to the health of the real-estate industry -- and some major firms are seeing claims rise sharply, particularly on policies issued during recent boom years. One of the nation's largest title insurers, First American Corp., recently said paid claims jumped 52% in the second quarter, compared with the same period last year. Rising title claims are significant because they can be a broader sign of economic pain than foreclosures. Claims are often filed even in the absence of a foreclosure. And they can be triggered not only by homebuyers, but also by complaints from another party, such as a subcontractor who has filed a lien for unpaid work on a house... 'In times of economic loss, title claims go up,' says Theodore L. Chandler Jr., chief executive of LandAmerica Financial Group Inc."

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

September 11 - Bloomberg (Jody Shenn): "Growth in agency mortgage-backed securities this year is poised this month to surpass the annual record of $341 billion as Fannie Mae and Freddie Mac benefit from demand for higher quality bonds, Citigroup Inc. said. Net issuance of $50 billion in August pushed total sales this year to $333 billion, just short of the full-year record set in 2003... The total amount of agency bonds outstanding is about $4.1 trillion...Sales of new mortgage securities that aren't guaranteed by federal agency Ginnie Mae or government-chartered Fannie Mae and Freddie Mac plunged to the lowest in five years last month..."

Real Estate Bubbles Watch:

September 10 - Bloomberg (Elizabeth Hester): "Washington Mutual Inc., the largest U.S. thrift, said today that conditions in the housing market are creating a `near-perfect storm' and may force the company to set aside more money to cover bad loans. Chief Executive Officer Kerry Killinger told the Lehman Brothers Holdings Inc. financial services conference the bank may have to increase its loan-loss provision by $500 million. Previously the bank forecast provisions of $1.5 billion to $1.7 billion for the full year. 'The combination of rising delinquencies, higher foreclosures, more housing inventories, increasing interest rates on many mortgages and greatly reduced availability of mortgages due to limited liquidity is creating what we call a near-perfect storm for housing,' he said."

September 11 - National Association of Realtors: "Tighter credit for home mortgages will measurably dampen home sales in the short term and postpone an expected recovery for existing-home sales until 2008... Lawrence Yun, NAR senior economist, said unusual disruptions in the mortgage market are dampening the outlook for home sales... 'There's been an unusual hit to home sales, starting in March when subprime problems emerged and more recently when problems spread to jumbo loans, with many potential buyers on the sidelines.... Existing-home sales are projected at 5.92 million this year and then rise to 6.27 million in 2008, compared with 6.48 million in 2006. New-home sales should total 801,000 in 2007 and 741,000 next year, below the 1.05 million in 2006.'"

September 13 - Associated Press (Jeffrey Gold): "Hovnanian Enterprises Inc., struggling like other home builders, is offering six-figure discounts on some of its properties this weekend as it attempts to draw interest in a slumping market. The sales blitz involves dropping prices by more 20% on some of its prime real estate. The largest discounts are on the most expensive homes..."

September 11 - Bloomberg (Dan Levy): "California, anchored by two coastal cities with rising employment and rents, attracted almost $49bn in commercial property investment in the first half of the year, more than any other state. The most populous U.S. state had 29% more office, retail, hotel and industrial real estate sales by dollar amount than New York state and triple that of third-place Texas. California's total investment was up 48% from a year earlier, research firm Real Capital Analytics reported."

Crude Liquidity Watch:

September 10 - Financial Times (Javier Blas and Ed Crooks): "As ministers of the Organisation of the Petroleum Exporting Countries meet in Vienna today, the world's attention is focused on the group's contribution to oil supply. What has received much less attention is its significance for oil demand. Opec countries' demand for oil is growing prodigiously - it is rising at 2½ times the global average rate - reducing the amount they can supply to the rest of the world... According to the International Energy Agency, the rich countries' energy watchdog, Opec accounted for 22 per cent of the roughly 8m barrels a day increase in world oil demand between 2000 and 2006. In the same period, China's appetite for oil represented about 32% of the increase, while the US contributed 12.5%."

September 11 - Bloomberg (Matthew Brown): "Oman's annual M2 money supply growth, an indicator of future inflation, accelerated to 32% in June, its highest in at least a decade..."

"Didn't Really Get It.":

I found it ironic that during the same week Alan Greenspan admitted he "Didn't Really Get It" when it came to the risks associated with subprime lending, Chairman Bernanke publicly reiterated and expanded his "global savings glut" thesis.

"In a speech given in March 2005, I discussed a number of important and interrelated developments in the global economy, including the substantial expansion of the current account deficit in the United States, the equally impressive rise in the current account surpluses of many emerging-market economies, and a worldwide decline in long-term real interest rates. I argued that these developments could be explained, in part, by the emergence of a global saving glut, driven by the transformation of many emerging-market economies--notably, rapidly growing East Asian economies and oil-producing countries--from net borrowers to large net lenders on international capital markets. Today I will review those developments and provide an update. I will also consider policy implications and prospects for the future.

A principal theme of my earlier remarks was that a satisfying explanation of the developments in the U.S. current account cannot focus on developments within the United States alone. Rather, understanding these developments and evaluating potential policy responses require a global perspective. I will continue to take that perspective in my remarks today and will emphasize in particular how changes in desired saving and investment in any given region, through their effects on global capital flows, may affect saving, investment, and the external balances of other countries around the world."

It is worth noting that, following robust mortgage debt growth during the 1998-2000 boom, home mortgage debt growth accelerated to 10.4% in 2001, 13.0% in 2002, 12.5% in 2003, and then a blistering 14.9% in 2004. Mr. Greenspan now admits that he didn't really "Get It" until late 2005, while Dr. Bernanke's intellectual focus at the time was explaining how mounting U.S. Current Account Deficits were a phenomenon of global savings and investment dynamics. Both were more than intellectually content to sit back and marvel at U.S. economic "productivity" and the capacity of contemporary finance to Inflate Credit. Both also worked diligently to construct a framework rationalizing why the Fed needn't pierce Bubbles nor even go so far as administering a little "tough love". Both are curiously oblivious - at least publicly - to the notion of Pernicious Credit and Speculative Excess.

There is no reasonable excuse for our central bankers' failure to recognize and move to check intensifying Mortgage Credit Bubble dynamics by 2004 - at the latest. It was (and remains) similarly inexcusable to disregard the U.S. Credit system's prominent role in financing rapidly escalating Current Account Deficits and resultant worsening global imbalances. Fed funds began the year (2005) at a ridiculously low 2.25% and didn't baby step above 4% until mid-December. Not surprisingly, total mortgage debt expanded a record (not soon to be broken) $1.462 TN during 2005 (up another 13.7%) - having doubled in just about six years. Not coincidently, the Current Account Deficit finished the year at an unprecedented $812bn, twice the level of only four years earlier.

Clearer understanding of today's challenging environment rests on sound analyses of the respective rapid doubling of U.S. mortgage debt and Current Account Deficits. I have for some time argued a "global liquidity glut" thesis. This historic liquidity overabundance emanated directly from U.S. Credit system excess, with resulting rampant global dollar liquidity flows working at the same time to devalue the dollar; inflate global currencies, markets and economies; and stoke a self-reinforcing energy and commodities boom. The endless glut of (depreciating) dollar liquidity both inflated global prices generally and unleashed domestic Credit systems for unbounded - and ongoing - excesses across the world. Crude oil closed at $53.54, gold $442.13, and wheat $340 (trading today at $846) the afternoon Fed governor Bernanke first presented his "global savings glut" thesis (3/10/05).

The "global liquidity glut" has fomented myriad Bubbles - and the reality that seemingly all of the global ones remain very much in force empowers Chairman Bernanke to stick steadfastly to his "savings glut" theorizing. "Savings" doesn't fuel Bubbles - excessive borrowings do. This morning we learned that the Q2 Current Account Deficit remained massive - at $191bn (in the neighborhood of $800bn annualized) despite booming exports. We can also presume that dollar weakness continues to encourage enormous ongoing speculative U.S. financial flows to non-dollar and commodities markets.

Conventional thinking has it that the world economic backdrop, outside of U.S. subprime and housing woes, is vibrant and sound. This favorable backdrop, it is believed, explains global equities markets resiliency in the face of mounting U.S. and global Credit woes. Just as the Mortgage Credit Bubble framework saw the 2003/2006 U.S. backdrop in much less favorable light than the bullish consensus, the Global Credit Bubble and "Liquidity Glut" perspective takes a quite negative view of the current global backdrop. Bubbles proliferate.

Admittedly, most global Bubbles have been impervious to the bursting U.S. Credit Bubble. China is a case in point. Yet there are important unappreciated dynamics to contemplate. First, domestic Credit Bubble dynamics have become well entrenched around the world, especially with U.S. dollar impairment working to decisively limit the risk of currency runs in, say, China, Russia, Brazil, India, Asia and "developing" economies in general. The weak dollar and unrelenting U.S. liquidity outflows (C.A. Deficits and speculative flows) have nurtured quite atypical stability for a group of currencies that would otherwise suffer the acute vulnerability incident to overheated domestic Credit systems, asset markets, and economies.

It is my view that today's backdrop would be altogether different had it not been for aggressive and concerted central bank intervention. Huge liquidity injections - and, as important, assurances from Chairman Bernanke to use "all of the tools at his disposal" - kept the U.S. and much of the global securities markets from seizing up. As it was, the extent of Acute Financial Fragility required an immediate and bold marketplace onslaught that, ironically, worked to underpin most global Bubbles. Certainly, not much froth was allowed to come out of global equities. No froth has been removed from global inflationary pressures. Lower global yields are destabilizing and portend only greater Global Monetary Disorder.

It is the view of the Bernanke Fed (as it would have been of Greenspan's) that a U.S. recession can and should be avoided. This is flawed and dangerous ideology. It is the market's view that the Fed will lower interest rates to whatever level necessary to sustain the U.S. expansion. This is wishful thinking. Recent history has spoiled both the Fed and the markets. Today, recession cannot be avoided and the weak dollar and robust global inflationary backdrop will limit the Fed's flexibility.

As for our economy, there will be no escaping the harsh consequences associated with the bursting of a historic Mortgage Finance Bubble. Our Bubble Economy has been left severely imbalanced and acutely vulnerable, and it is simply impossible to avoid major disruptions associated with an abrupt curtailment of mortgage finance. California will be the poster child for this unfolding dynamic, although it will play out throughout the country. I'll reiterate my expectation that upper-end real estate - too frequently Bubbles financed by ARM, teaser rate, reset and interest-only mortgages - will prove greatly more problematic than subprime. Commercial real estate will be anything but immune. We have only begun to experience upheaval from the mortgage bust, dynamics that will follow a similar path to the burst technology Bubble - except the wreckage will be significantly more widespread and economic impact broad-based.

Unprecedented central bank interventions and, here at home, six-week Bank Credit growth to the tune of $220bn have sustained financial system liquidity. I question the sustainability of both. Especially with this week's apparent loosening of Credit conditions, there are great expectations for an impending revival in the securitization marketplace. The banks and Wall Street are praying. With an eye on California, I fear another ("jumbo") leg down in the ongoing mortgage crisis and an increasingly vulnerable economy. Another eye is planted on the hedge fund community, where I suspect we are only another market dislocation away from serious withdrawals and reinforcing liquidations.

One, if not the greatest, errors in central banking was committed back in 2002 - with Messrs. Greenspan and Bernanke at their respective strict and intellectual helms. They mistakenly reckoned THE bubble had popped. They set in motion an aggressive post-Bubble "mopping up" reflation, failing to appreciate that while the tech Bubble had burst THE Credit Bubble was poised for "blow-off" excess.

The upshot is an unbalanced Bubble Economy sustained only by ongoing and enormous Credit creation. Importantly, the Wall Street Risk Intermediation Machine is today gravely impaired, forcing the banking system to Balloon Bank Credit. This works effectively on a short-term basis, yet is an unfolding predicament. Credits to sustain a Bubble Economy are inherently highly risky (think CA mortgages or junk bonds) and it takes too much of them. Bubble economies are replete with negative cash flow entities and others that become increasingly so as finance is curtailed and redirected. Today, the banking system is ill-prepared to play the role of lender of last resort for long. Moreover, the scope of required ongoing Credit inflation ensures dollar vulnerability.

An important aspect of my negative current view is the disconnect between unwavering marketplace confidence in the Fed's capacity to "reliquefy" and "reflate" and the reality of a limited arsenal and atypical lack of Federal Reserve control over unfolding developments. Importantly, Greenspan and Bernanke expended tremendous ammo in a historic reflation fight that, in the end, was a totally wasted cause. They misjudged and enfranchised the most profligate and wasteful Credit expansion in our history, while inciting a potent strain of inflation that now propagates largely outside of our control. They burned a major currency devaluation. Instead of a weaker dollar helping to soften a much needed financial and economic rebalancing, their reflation greatly exacerbated excesses and imbalances at home, while initiating global inflation dynamics much to the detriment of our citizens, economy and currency. We have today much greater financial fragilities, disastrous economic imbalances, and a feeble currency - whether the stock market chooses to discount it now or not.

 


 

Doug Noland

Author: Doug Noland

Doug Noland
The Credit Bubble Bulletin
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