| The Dow and the S&P500 gained 0.4% and 0.6%. Economically sensitive issues outperformed. The Transports gained 2.4% (up 10.4% y-t-d), and the Morgan Stanley Cyclical index rose 0.9% (up 9.4% y-t-d). The Morgan Stanley Consumer index rose 0.9%, while the Utilities dipped 0.2%. The broader market rally continued. The small cap Russell 2000 and S&P400 Mid-Cap indices both gained 0.7%. The NASDAQ100 added 0.2%, and the Morgan Stanley High Tech index increased 0.6%. The Semiconductors declined 0.7%. The Street.com Internet Index was unchanged, while the NASDAQ Telecommunications index rose 0.6%. The Biotechs surged 1.6%. The Broker/Dealers added 0.4%, while the Banks declined 0.3%. With bullion up $10.15, the HUI Gold index rallied 2.9%. Two-year government yields rose 4bps to 4.76%, the high since February 26th. Five-year yields gained 3bps to 4.685%, and 10-year Treasury yields added 2bps to 4.76%. Long-bond yields rose one basis point to 4.93%. The 2yr/10yr spread ended the week at zero. The implied yield on 3-month December ’07 Eurodollars jumped 5 bps to 5.115%, a 2-month high. Benchmark Fannie Mae MBS yields (which didn’t trade Friday) jumped 8 bps to 5.86%. The spread on Fannie’s 5 1/4% 2016 note narrowed one to 33, and the spread on Freddie’s 5 1/2% 2016 note narrowed one to 33. The 10-year dollar swap spread declined 0.25 to 53.5. Corporate bond spreads were little changed to narrower, with a junk bond spread index declining 7bps. Investment grade issuers included Burlington Northern $1.3bn, Union Pacific $500 million, Apache $500 million, John Deere $400 million, Valspar $350 million, Florida Power & Light $300 million, Amvescap $300 million, Source Gas $325 million, Magellan Midstream $250 million, and Equity One $150 million. Junk issuers included KAR Holdings $1.025bn, IPCS $475 million, United Surgical $440 million, and Max USA $100 million. At $26.3bn, first quarter convert issuance was more than double the year ago $11.7bn (from Merrill Lynch). This week’s issuance included General Growth Properties $1.55 billion, RAIT Financial $350 million, Trizetto Group $200 million and Franklin Bank $100 million. International issuers included Buenos Aires $400 million and AJAX RE $100 million. Japanese 10-year “JGB” yields were unchanged at 1.66%. The Nikkei 225 declined 0.7% (up 0.8% y-t-d). German 10-year bund yields surged 13bps to 4.23%, the high since June 2002. Key emerging equity markets shot to new record highs, while debt markets continue to hold their own. Brazil’s benchmark dollar bond yields rose 5 bps this week to 5.67%. Brazil’s Bovespa equities index jumped 2.7% to a new record (up 7.8% y-t-d). The Mexican Bolsa gained 1.3% to new highs (up 12.5% y-t-d). Mexico’s 10-year $ yields rose 5 bps to 5.55%. Russia’s RTS equities index rose 2.8% to a new record (up 4.1% y-t-d). India’s Sensex equities index rallied 4.1% for the week (down 2.9% y-t-d). China’s Shanghai Composite index jumped 5.9% to a record high, increasing 2007 gains to 31.5%. Freddie Mac posted 30-year fixed mortgage rates rose 5 bps to a 7-wk high 6.22% (down 27bps y-o-y). Fifteen-year fixed rates gained 3 bps to 5.90% (down 24bps y-o-y). One-year adjustable rates added one basis point to 5.47% (down 14bps y-o-y). The Mortgage Bankers Association Purchase Applications Index gained 2.7% this week. Purchase Applications were down 0.9% from one year ago, with dollar volume up 0.5%. Refi applications declined 4% for the week, although dollar volume was up 37% from a year earlier. The average new Purchase mortgage declined to $237,000 (down 0.3% y-o-y), and the average ARM dipped to $391,800 (up 11% y-o-y). Bank Credit surged $69bn (week of 4/4) to $8.418 TN. For the week, Securities Credit jumped $46.1bn. Loans & Leases expanded $22.9bn to $6.117 TN. C&I loans gained $8.5bn, while Real Estate loans declined $11.8bn. Consumer loans increased $2.9bn, and Securities loans added $3.2bn. Other loans rose $19.9bn. On the liability side, (previous M3) Large Time Deposits surged $33.9bn, with a 3-wk gain of $66bn. M2 (narrow) “money” was little changed at $7.203 TN (week of 4/2). Narrow “money” has expanded $159bn y-t-d, or 8.4% annualized, and $446bn, or 6.6%, over the past year. For the week, Currency added $0.4bn, and Demand & Checkable Deposits gained $11.0bn. Savings Deposits fell $14bn, while Small Denominated Deposits rose $2.5bn. Retail Money Fund assets slipped $0.7bn. Total Money Market Fund Assets (from Invest. Co Inst) jumped $15.4bn last week to a record $2.466 TN. Money Fund Assets have increased $84bn y-t-d, a 12.2% rate, and $407 billion over 52 weeks, or 19.9%. Total Commercial Paper jumped $9.9 bn last week to $2.051 TN, with a y-t-d gain of $76 bn (13.4% annualized). CP has increased $370bn, or 22%, over the past 52 weeks. Asset-backed Securities (ABS) issuance was a slow $6.0bn. Year-to-date total ABS issuance of $197bn (tallied by JPMorgan) is running only slightly behind comparable 2006. At $103bn, y-t-d Home Equity ABS issuance is about 30% below last year’s pace. Year-to-date US CDO issuance of $94 billion is running 22% ahead of comparable 2006. Fed Foreign Holdings of Treasury, Agency Debt surged $18.7bn last week (ended 4/11) to a record $1.911 TN, with a y-t-d gain of $159bn (31.5% annualized). “Custody” holdings expanded $319bn during the past year, or 20%. Federal Reserve Credit last week declined $2.8bn to $849.4bn (down $2.8bn y-t-d). Fed Credit was up $31.5bn y-o-y, or 3.9%. International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up a stunning $422bn y-t-d (30.4% annualized) and $908bn y-o-y (21%) to a record $5.233 TN. April 11 – Market News International: “China’s foreign exchange reserves jumped a massive $135.7 bln in the first quarter of the year to $1.20 trln, including tens of billions of dollars that don’t seem to be accounted for amongst official data on capital flows. The mystery, like similar China reserve riddles in the past, isn’t likely to be fully explained.” Currency Watch: The dollar index dropped 1% to 81.925. On the upside, the New Zealand dollar gained 2.4%, the Iceland krona 2.3%, the Norwegian krone 1.9%, the Australian dollar 1.7%, the Canadian dollar 1.2%, and the Euro 1.2%. On the downside, the South African rand declined 0.9%, the Thai baht 0.7%, and the Mexican peso 0.3%. . Commodities Watch April 12 – Bloomberg (Maria Levitov): “Russia’s central bank may double the share of gold in its gold and foreign currency reserves, Interfax said today, citing the head of the bank’s reserves management Maria Gegina.” April 11 – Financial Times (Kevin Morrison): “Metal markets are in the middle of another price boom that may eclipse the one seen last spring, with copper, nickel, lead and tin all rising strongly in trading yesterday. This boom is more broadly-based than last year’s, but supported by the same cocktail of factors: strong Chinese and global demand, constrained supplies, low levels of metal stockpiles and heightened financial speculation. Metal prices had a shaky start to the year amid expectations of slowing global economic demand, rising supplies and concerns about the knock-on effects of the US housing slowdown. But sentiment has turned since mid-February, particularly towards copper, the flag-bearer of the base metals markets, on the assumption of stronger-than-expected demand in China… That view was supported by Chinese customs data yesterday, showing a record 307,740 tonnes of copper were imported last month, with imports up 58% in the first three months of the year.” For the week, Gold gained 1.5% to $685.15 and Silver jumped 2.5% to $14.09. Copper surged 4.8%. May crude declined 87 cents to $63.41. May gasoline gained 1.9% and May Natural Gas 2.0%. For the week, the CRB index added 0.1% (up 3.5% y-t-d), and the Goldman Sachs Commodities Index (GSCI) gained 2.0% to the highest level since August (up 9.7% y-t-d). China Watch: April 10 – Bloomberg (Ying Lou): “China’s crude oil imports rose 8.9% to a record in March as energy demand increased in the world’s fastest-growing major economy. Imports climbed to 13.86 million metric tons (3.3 million barrels a day) last month…” April 10 – Bloomberg (Irene Shen): “China’s vehicle sales rose 17% in March to a record… Sales of passenger cars and commercial vehicles totaled 847,200 last month…” April 10 – Market News International: “China’s trade surplus fell to $6.86 bln last month from February’s near-record… Exports for the first three months were up 27.8% at $252.09 bln while imports rose 18.2% at $205.65 bln.” April 12 – Bloomberg (Nipa Piboontanasawat): “China’ money supply grew by more than the central bank’s target for a second month… M2…increased 17.3% in March from a year earlier…” April 10 – Bloomberg (Lee Spears): “China’s retail sales will surge 14% in 2007 as demand grows for vehicles and oil, the official Xinhua News Agency reported…” India Watch: April 10 – Financial Times (Jo Johnson): “A surge in capital inflows that has pushed the Indian rupee almost to an eight-year high against the dollar and boosted foreign exchange reserves to $200bn will prompt India’s conservative central bank to delay further moves towards the full convertibility of the currency, economists said… Non-foreign direct investment inflows account for 75% of the increase in reserves, leading to fears India could be vulnerable to a herd-like exit of foreign investors…The bulk of the build-up in reserves has been due to overseas borrowings by Indian companies and inflows of ‘hot money’ equity portfolio investments.” April 12 – Bloomberg: “India’s industrial production growth slowed for a third month in February, gaining 11%,as higher interest rates cooled demand for cars and homes.” Asia Boom Watch: April 9 – Bloomberg (Shamim Adam): “Southeast Asian nations may grow at a faster pace this year, defying forecasts for a slowdown, as shipments to new export markets offset easing demand from the world’s biggest economies. Economic growth among the members of the Association of Southeast Asian Nations may accelerate to as much as 6%, exceeding last year’s 5.8% pace…” April 10 – Bloomberg (Yu-huay Sun and Theresa Tang): “Taiwan’s exports rebounded in March on higher electronics demand from China, the island’s biggest market abroad. Overseas shipments rose 10.4% from a year earlier…” April 11 – Bloomberg (Kyunghee Park): “Hyundai Heavy Industries Co., the world’s biggest shipbuilder, and its competitors will be able to keep charging record-high prices for at least two more years because rising demand has outpaced supply, shipowners said… Sea carriers ordered a record $105.5 billion in new ships last year, enough to keep the largest yards working at full capacity until 2010.” April 10 – Bloomberg (Shamim Adam): “Singapore’s economy grew faster than expected in the first quarter, buoyed by record property prices and a stock market at its highest ever. Gross domestic product expanded an annualized 7.2% in the three months ended March…” Unbalanced Global Economy Watch: April 11 – Bloomberg (William McQuillen): “The world economy will withstand a worse-than-forecast slowdown in the U.S. and expand close to 5% for a fourth straight Year, the International Monetary Fund said… The fund predicts global growth of 4.9% this year…following a 5.4% expansion in 2006… Europe, Japan and China will help carry the global economy as a housing slump cuts growth in the U.S., which accounts for a fifth of world output.” April 13 – Bloomberg (Jennifer Ryan): “British wage bargainers negotiated the biggest median salary increases in the first quarter since 2001, led by pay for staff at U.K. banks, a report by Incomes Data Services showed. The median pay settlement rose to 3.5%...” April 13 – New York Times (Mark Landler): “For those seeking the elixir that has given new life to Germany’s economy, a visit to this ancient university town in the eastern part of the country would be a good place to start. Jena is booming these days, as local companies like Jenoptik, which makes lasers and sensors, rack up orders from China, Russia, Europe and the United States. Even the surging euro, which is near record levels against the dollar and the yen — making German exports more expensive in many foreign markets — has not yet dented demand. “There’s no better proof that our products are superior than to have an indirect price increase of 30 percent without losing any sales,” said Alexander von Witzleben…chief of Jenoptik. Germany’s transformation from Europe’s sick man to its most stalwart performer is by now well entrenched.” April 13 – Market News International: “German federal tax revenues continued their strong upward trend in March, rising 16.8% on the year, the finance ministry said… First quarter federal tax revenues were up 22.3% on the year…” April 10 – Bloomberg (Simone Meier): “Swiss unemployment fell in March, pushing the jobless rate to the lowest in more than four years, as stronger economic growth encouraged companies to hire workers… The jobless rate dropped to 2.9%...” April 10 – Bloomberg (Robin Wigglesworth): “Norway’s annual inflation rate rose to 1.5% in March, the highest since April 2003, adding to pressure on the central bank to raise interest rates this month for the fifth consecutive meeting.” April 13 – Bloomberg (Alistair Holloway): “Finland’s inflation rate rose to 2.6% in March, more than expected and the highest in almost six years, driven by house prices, rents and increased borrowing costs.” April 12 – Bloomberg (Hans van Leeuwen and Gemma Daley): “Australian employment climbed in March and the jobless rate fell to a 31-year low as builders and retailers hired more workers…The jobless rate dropped to 4.5%...” April 13 – Bloomberg (Tracy Withers): “New Zealand’s retail sales rose almost four times the forecast pace in February, driving the nation’s currency to a 23-month high on expectations central bank Governor Alan Bollard will carry out his threat to raise interest rates.” Latin American Boom Watch: April 13 – Bloomberg (Patrick Harrington): “Mexico’s industrial output was unchanged in February from the same month a year earlier, dragged down by a drop in production of automobiles and fewer construction projects.” Central Banker Watch: April 13 – Bloomberg (Simone Meier): “European Central Bank council members Axel Weber and Yves Mersch said the bank is ready to raise interest rates further to counter inflation in the economy of the 13 nations sharing the euro.” April 10 – Bloomberg (Craig Torres and Anthony Massucci): “Federal Reserve chairman Ben S. Bernanke said that a ‘light regulatory touch’ on hedge funds is justified because of the incentives that investors and creditors have to monitor risks. ‘Because hedge funds deal with highly sophisticated counterparties and investors, and because they have no claims on the federal safety net, the light regulatory touch seems largely justified,’ Bernanke said… Thus far, the market-based approach to the regulation of hedge funds seems to have worked well.’” April 13 – Bloomberg (Vivien Lou Chen and Craig Torres): “Federal Reserve Bank of Dallas President Richard Fisher said globalization is raising the economy’s ‘speed limit,’ allowing policy makers to relax a little on inflation.” Bubble Economy Watch: Producer Prices were up 3.2% y-o-y, the strongest gain since August. March Import Prices were up 2.8% y-o-y, also the highest level since August. April 10 – Bloomberg (Daniel Kruger): “Rising oil prices, Mideast conflicts and a U.S. president perceived as ineffective contributed to the stagflation of the 1970s. Today, in the bond market, where Yogi Berra’s immortal lines are increasingly invoked, ‘it’s déjà vu all over again.’ Nowhere is that more evident than with Treasury inflation-protected securities. The difference in yields between 10-year TIPS and conventional notes has widened to about 2.5 percentage points, a seven-month high, and up from 1.43 percentage points in 2002. The gap suggests so-called real returns on the fixed-rate notes will be eroded by about $2.5 million annually on $100 million of securities. ‘We have a measure of stagflation,’ said Paul Samuelson, who was the second recipient of the Nobel Prize in economics and helped popularize the term to describe slowing growth and accelerating inflation in the U.S. during the 1970s.” April 9 - The Wall Street Journal (Patrick Barta): “Soaring prices for farm goods, driven on part by demand for crop-based fuels, are pushing up the price of food world-wide and unleashing a new source of inflationary pressure. The rise in food prices is already causing distress among consumers in some parts of the world -- especially relatively poor nations like India and China. If the trend gathers momentum, it could contribute to lower global growth by forcing consumers to spend less on other items or spurring central banks to fight inflation by raising interest rates. Politicians in markets where food costs are a particularly sensitive matter are moving to counter rising prices before they take a bigger economic toll or fuel unrest.” April 10 – Associated Press: “A shortage of lobsters is forcing diners across the region to fork over bigger bucks for a taste of the king of New England seafood. At the Union Oyster House in Boston, the cost of a 1 1/2 pound lobster is $31.95, up from the usual $27.95, while other restaurants have opted to pull the item from their menus or have waiters warn diners before they order. ‘I hate to say it, but we’ve added a surcharge on the lobsters. We’ve raised the prices three times in the past 10 days’ Bill Coyne, Union Oyster House chef, told the Boston Sunday Globe.” April 11 – Associated Press: “Hilton Hotels Corp. said…that it broke ground for a resort development adjacent to Walt Disney World Resort. The 498-room Waldorf-Astoria at Bonnet Creek and the 1,000-room Hilton Bonnet Creek Hotel will be managed by Hilton, with the project’s total cost expected to be more than $500 million.” Financial Sphere Bubble Watch: April 11 – Financial Times (Paul J Davies): “Growing numbers of private equity groups are looking to protect their investments against a potential downturn by trying to strip out the covenants that protect lenders when businesses begin to underperform. The US market for leveraged loans, which finance the buy-outs sponsored by private equity of companies that usually are or become non-investment grade, has seen huge growth in the volume of so-called ‘covenant-lite’ deals. Meanwhile in Europe, the smooth ride given to the first such deal in the markets last month, arranged by JP Morgan…is now encouraging others to test the waters for similar debt. The ‘covenant-lite’ loan…looks like a traditional syndicated loan, but does not carry the legal clauses that allow investors to track the performance of a risky borrower or declare a default if financial guidelines are breached… The arrival of such debt in Europe illustrates the voracious appetite for loans of almost any kind among the rapidly expanding number of new investors in the markets. The loosening and, in some cases, removal of covenants goes hand in hand with increasing leverage levels and the growing replacement of subordinated mezzanine loans with larger senior loans to highlight what some see as an overheating of Europe's loan markets.” Mortgage Finance Bubble Watch: April 10 – Bloomberg (James Tyson): “U.S. lawmakers want to stem the rising number of mortgage delinquencies by targeting investors who finance such lending through the purchase of bonds backed by home loans. The top Republican and Democrat on the House Financial Services Committee both said they want laws making investors that buy mortgage bonds liable for deceptive or bad loans. An agreement by lawmakers in two parties to increase investor liability for abuses in subprime lending increases the chances for legislation to pass this year.” April 10 – Bloomberg (Jody Shenn): “More homeowners with subprime adjustable-rate mortgages face tests of their ability to handle higher monthly payments starting later this year, RBS Greenwich Capital Markets Inc. said. Rates on about 3.25% of subprime-loan balances are scheduled to start to adjust in September, October and in April 2008… A total of 32% of balances face rate adjustments over the next 12 months…” April 13 – Dow Jones (Bob Sechler): “General Electric executives said the company’s WMC mortgage unit has tightened its lending requirements and substantially curtailed its mortgage originations in the wake of the meltdown in the subprime mortgage sector.” Foreclosure Watch: April 11 – Bloomberg (Hui-yong Yu): “More than 5,000 California houses and condominiums were offered for sale at foreclosure auctions in March, more than triple the number last September. Ninety percent of the properties failed to attract bids, a sign that falling prices are keeping real estate investors on the sidelines, according to data compiled by Foreclosure Radar, a new company that tracks such auctions. The U.S. housing slump…is spurring repossessions by lenders as homeowners struggle with mortgage payments. Most of March’s foreclosure sales came from loans made in 2005 and 2006 and anecdotal analysis suggests the majority were loans that were made with no down payment… ‘Foreclosures sold at auction now account for 15% of all home sales in California and continue to rise,’ Sean O’Toole, Foreclosure Radar’s chief executive officer and founder, said… ‘Folks with 100% financing and subprime credit are choosing to walk away rather than make payments on a house that’s now 10% under water.’ The 5,316 properties being auctioned last month had outstanding loan balances totaling $1.99 billion, up from 1,459 properties with loan balances of $512 million in September…” Real Estate Bubbles Watch: April 12 – Bloomberg (Sree Vidya Bhaktavatsalam and Brian Sullivan): “Kenneth Heebner, manager of the top-performing real-estate fund over the past decade, said U.S. home prices may plunge as much as 20 percent because of rising defaults on riskier mortgages. Subprime loans…and ‘Alt-A’ loans…account for about $2.5 trillion of the $10 trillion in outstanding mortgages… As much as 40 percent of these loans may default, flooding the real estate market, Heebner said. ‘It will be the biggest housing-price decline since the Great Depression,’ Heebner…said… Prices may fall by a fifth in some markets, he said.” April 12 – PRNewswire: “New Pacific Realty Corp. announced yesterday the sale of 9900 Wilshire to an affiliate of The CPC Group for $500 million. The half-billion-dollar price tag for the 7.95 acre site, which is adjacent to the Beverly Hilton Hotel and overlooks the prestigious Los Angeles Country Club, is one of the last remaining major development parcels in the City of Beverly Hills, and believed to be largest price ever paid in North America for a development site in the entitlement phase. New Pacific Realty acquired the site just three years ago for $33.5 million.” April 11 – Bloomberg (Hui-yong Yu): “The vacancy rate for U.S. shopping centers rose to 7.2% in the first quarter, from 6.9% a year earlier, and may climb further as new space is added and consumer spending slows, said research firm Reis Inc. More than 42 million square feet of space is projected to be completed in 2007, more than 50% higher than 2006 completion levels…” April 10 – Reuters: “New York City’s Manhattan office rents reached record highs in the first three months of 2007, as constrained supply more than offset a dip in leasing, real estate brokerage firm Cushman & Wakefield said… Sky-high rents, some surpassing $150 per square foot, are also sending tenants reeling from sticker shock to the city’s outer boroughs, the New York suburb of Westchester County and northern New Jersey. ‘There are some exciting things happening out there, particularly if you're a landlord,’ Joseph Harbert, chief operating officer of Cushman & Wakefield’s New York Metro Region, said.” M&A and Private-Equity Bubble Watch: April 13 – Bloomberg (Edward Evans and James M. O’Neill): “Blackstone Group LP is considering a $20 billion takeover offer for SLM Corp., the largest U.S. student-loan provider, a person familiar with the talks said.” Fiscal Watch: With spending up 5.2% y-o-y, March’s Fiscal Deficit jumped 12.9% to $96.27 billion. Fiscal y-t-d, Revenues are running 8.0% above and Spending 2.9% above year ago levels (y-t-d deficit down 14.7% to $302.9bn). April 11 - Dow Jones: “The U.S. federal government recorded a $257 billion budget deficit in the first six months of the fiscal year, $46 billion less than was recorded during the same year-earlier period, the Congressional Budget Office estimated… The CBO has estimated that the government will generate a $177 billion deficit for all of 2007, based on the assumption that revenues will continue to grow faster than federal spending… Revenue grew about $2 billion faster than expected, but expenditure grew faster still, driving up the deficit projection.” April 11 – AP: “The struggle to entice U.S. Army soldiers and Marines to stay in the military, after four years of war in Iraq, has ballooned into a $1 billion campaign, with bonuses soaring nearly sixfold since 2003… Besides underscoring the extraordinary steps the Pentagon must take to maintain fighting forces, the rise in costs for re-enlistment incentives is putting strains on the defense budget, already strapped by the massive costs of waging war and equipping and caring for a modern military.” Speculator Watch: April 10 – Financial Times (David Turner): “Investing in hedge funds by wealthy Japanese more than doubled in the year to last March, according to an authoritative survey from Japan’s financial watchdog. The report from the Financial Services Agency also showed a healthy 41% increase in all hedge fund sales by financial institutions.” More Minsky: The Morgan Stanley Cyclical index is up 9.4% y-t-d. So far this year, the Dow Transports have jumped 10.4% and the Morgan Stanley Retail index has gained 7.9% (52-week gain of 18.6%). Clearly, the stock market is not overly burdened by the prospect of subprime mortgage problems impacting the general economy. Trumpeting the irrepressible consumer, a pundit on CNBC this week suggested that, akin to the 2000-2002 stock bear market and years of stagnant wages, the onset of subprime problems and slowing housing inflation would have little restraining influence on consumer spending. With some justification, the bulls at this stage have attained great confidence in the resiliency of the U.S. consumer, stock market, Credit system and economy. The bears, on the other hand, continuously scratch their heads attempting to comprehend the amazing nine lives demonstrated by this protracted boom. When the financial and economic worlds are in such a state of crosscurrents and complexities, I instinctively fall back upon an Analytical Framework heavily influenced by the work of the great Hyman Minsky. Minsky: “No matter how industry and government finances are structured, as long as the economy remains capitalist and innovation in industry and finance continues, there will be business cycles.” (page xxiii) Minsky: “An understanding of the American economy requires an understanding of how the financial structure is affected by and affects the behavior of the economy over time. The time path of the economy depends upon the financial structure.” Minsky’s analyses fixated on the “complex, ever evolving financial institutions and structures.” Finance drives the economy - not vice versa – and the interplay of financial and economic evolution and attendant uncertainty and instability are all inherent to capitalistic systems. The complexities of his day – including the advent of the Eurodollar market, commercial paper, money market funds, REITs and “bought” deposits – seem rather rudimentary in our age of “repos”, multifarious CDOs, Credit default swaps, global 24/7 derivatives markets, proliferating hedge funds and sophisticated market-based leveraged trading strategies. At the minimum, we should remain leery of superficial and simplistic analysis of the workings of the U.S. and global economies. Minsky: “Innovations in financial practices are a feature of our economy, especially when things go well. New institutions…and new instruments…increase in volume and find new uses. But each new instrument and expended use of old instruments increased the amount of financing that is available and which can be used for financing activity and taking positions in inherited assets. Increased availability of finance bids up the prices of assets relative to the prices of current output, and this leads to increases in investment… The money of standard theory…does not catch the monetary phenomena that are relevant to the behavior of our economy.” (page 66) The resiliency of the U.S. consumption-based economy is readily explained by the unrelenting expansion of finance. When stocks faltered early in the decade, double-digit mortgage Credit growth and consequent housing inflation lifted household balance sheets – and animal spirits. Stagnant real wage growth became only a minor issue as mortgage finance and housing gains flowed freely. Now, with the mortgage financial Bubble faltering, corporate and financial sector Credit excesses engender the strongest income and securities market gains in years. The Wall Street Credit infrastructure simply switches gears. And while the process of extending inflated purchasing power to the household sector evolves over time, the end result is about the same (more spending). Minsky: “In our economy, money is created as bankers acquire assets and is destroyed as debtors to banks fulfill their obligations. Our economy is a capitalist economy with long-lived and expensive capital assets and a complex, sophisticated financial structure. The essential financial processes of a capitalist economy center around the way investment and positions in capital assets are financed. To the extent that the various techniques used to finance capital asset ownership and production lead to banks acquiring assets, money is an end product of financial arrangements. In a capitalism economy investment decisions, investment financing, investment activation, and profits and commitments to make payments due to outstanding debts are linked. To understand the behavior of our economy it is necessary to integrate financial relation into an explanation of employment, income, and prices. The performance of our economy at any date is closely related to the current success of debtors in fulfilling their commitments and to current views of the ability of today’s borrowers to fulfill commitments.” (page 17) In this age of non-bank, securities-based Credit creation, we’ll replace Minsky’s “money” with (an equally and inescapably ambiguous) “liquidity.” And instead of “money” being primarily created by banks financing tangible (“capital”) asset investment, the creation of liquidity through the expansion of financial asset holdings is today’s prevailing monetary dynamic. In Minsky’s day, the creation of new finance through business borrowing for real investment was the defining monetary process. Today, it is the expansion of leveraged securities speculation by a highly diverse cadre of players. Minsky: “Our analysis leads to a result that the way our economy functions depends on the level, stability, and prospects of profits. Profits are the lure that motivates business and they are the flow that determines whether decisions taken in the past are apt in the light of the way the economy is functioning now. The flow of aggregate profits is the link between the past and the present and the lure of future profits determines the flow of current profits.” (page 55) Real economy business profits were Minsky’s primary focus (although attention was certainly paid to bank earnings). The massive expansion in the Financial Sphere since his 1996 passing has relegated non-financial corporate profits to a virtual side show, at least in terms of the driving force of Credit creation and economic performance. These days, financial profits overwhelmingly dictate system behavior, a circumstance that goes far in explaining the proclaimed economic resiliency – as well as delusions of the nullification of the business cycle. And this is no mere academic debate. The current environment beckons us to delve into Minky’s focus on the crucial role of the “level, stability, and prospects of profits.” Profits drove business investment, but the vagaries of financing capital assets were at the heart of inherent system instability. As profits grew and finance expanded, disequilibrating forces destabilized the profit picture, especially for booming sectors. I argue passionately that today’s Financial Sphere profits boom is different in kind from the traditional Economic Sphere profit cycle. For one, the capacity to finance and speculate in (unbounded) new financial assets creates dynamics distinct from those typically at play in (resource constrained) capital assets. Ponder the variability of profits during the (relatively short) life of the technology boom and bust, and contrast it to the ongoing Wall Street profits bonanza. In the former, excess and massive overinvestment distorted and eventually destroyed industry profitability. In the latter, at least so far, escalating excesses have created ever increasing profitability: More finance, more financial profits. Outsized Financial Sphere profits will basically be sustained for as long as sufficient financial sector growth is forthcoming. Importantly, the capacity for the contemporary Credit system to bankroll its own profits boom has engendered a momentous transformation in all three - the “level, stability, and prospects” – critical facets of system profits. With financial profits the key driver of economic performance and the expansive financial sector commanding its own profitability, system “resiliency” is no enigma. In no way, however, has the business cycle been repealed, although it definitely has been grossly distorted and extended. Minsky: “It should be noted that this stabilizing effect of big government has destabilizing implications in that once borrowers and lenders recognize that the downside instability of profits has decreased there will be an increase in the willingness and ability of business and bankers to debt-finance. If the cash flows to validate debt are virtually guaranteed by the profit implications of big government then debt-financing of positions in capital assets is encouraged. An inflationary consequence follows from the way the downside variability of aggregate profits is constrained by deficits.” (page 43) Minsky believed that large federal deficits worked to stabilize (business) profits, while buttressing the debt markets with relatively robust government debt. He was at the same time quite cognizant of the reality that Federal Reserve efforts to stabilize the economy would over time prove destabilizing (embolden risky behavior). I’ll this time argue passionately that the Fed’s efforts to stabilize system profits are a profoundly riskier proposition in today's environment where profits are largely dictated by financial sector expansion (as opposed to capital investment). With corporate profits, household income, asset prices and economic growth now all dependent on ongoing leveraged speculation and rampant financial sector ballooning, sophisticated market players aggressively seek their outsized share of profits with comfort knowing the Fed has no alternative than to sustain the boom. Minsky: “Looking at the economy from a Wall Street board room, we see a paper world – a world of commitments to pay cash today and in the future. These cash flows are a legacy of past contracts in which money today was exchanged for money in the future. In addition, we see deals being made in which commitments to pay cash in the future are exchanged for cash today. The viability of this paper world rests upon the cash flows that business organizations, households, and governmental bodies, such as states and municipalities, receive as a result of the income-generating process.” (page 63) Minsky was known for his conception of the American economic system’s evolution from Commercial Capitalism to Money-Manager Capitalism. I have humbly updated “Minskian” evolution analysis to include Financial Arbitrage Capitalism. This step I deemed justified by the radical departure in the character and outcomes engendered by contemporary Credit systems dictated by leveraged securities (“spread trade”) speculation. The securitization, “repo,” Credit insurance, and derivatives markets have profoundly changed finance, as well as the underlying economic structure. Inflation dynamics have been decisively altered, as has the interplay between finance and monetary policymaking. The nature and scope of financial instability has been transformed. Today, myriad global players - incorporating financial instruments, structures, funding sources and leverage to their liking, while operating outside the purview of central banks and other financial regulators – dictate the general financial and economic backdrop like never before. Minsky: “Ponzi financing units cannot carry on too long. Feedbacks from revealed financial weakness of some units affect the willingness of bankers and businessmen to debt finance a wide variety of organizations.” (page 67) I will wrap this up – as tornado warning sirens blare in the background - with the thesis that Financial Arbitrage Capitalism has radically extended the life expectancy of Ponzi Finance Units. Actually, Financial Arbitrage Capitalism is itself ultimately one massive Ponzi Finance Unit. This system is dependent upon continuous Credit excess, expanding leveraged speculation, and asset inflation. Ironically, when financial weakness is revealed in one sector – as it was recently in mortgage finance – the expectation of imminent Federal Reserve easing actually bolsters Ponzi finance dynamics elsewhere. I’ll surmise this evening that when this Ponzi scheme eventually succumbs, it will take a slug of Wall Street finance down with it. Note: All Hyman Minsky quotes are from "Inflation, Recession and Economic Policy", 1982. |
Wednesday, September 10, 2014
04/12/2007 More Minsky *
