04/26/2001 Bermuda Call Structures *

Much of the stock market rallied strongly again this week, with the Dow gaining 2% and the S&P500 adding 1%. The Morgan Stanley Consumer index jumped 4%, while the Morgan Stanley Cyclical index increased 2%, and the Transports ended unchanged. The broad market was quite strong, with the small cap Russell 2000 jumping 4% and the S&P400 Mid-Cap increasing 3%. Biotechs gained 1%. Financial stocks generally rose as well, with the S&P Bank and AMEX Securities Broker/Dealer indices both increasing more than 1%. The HUI Gold index jumped 6%. Technology stocks were the exception, with selling pressure developing this week after recent strong gains. For the week, the NASDAQ100 dropped 6%, the Morgan Stanley High Tech index lost 5%, Semiconductors and The Street.com Internet index 4%, and the NASDAQ Telecommunications index sank 7%.

Today’s stronger than expected 2% GDP growth should put to rest any doubts that the Fed has been focused more on financial issues than economic weakness. The key consumer spending component increased at a 3.1% rate, up from the fourth quarter’s 2.8%. Real final sales (incorporating a draw down of inventories) increased 4.6% versus the fourth quarter’s 1.7%, led by 11.9% growth in durable goods spending. Investment in residential structures increased 3%, with 11% growth for non-residential structures. Personal savings came in at a negative $74.3 billion during the quarter, deteriorating from the previous quarter’s negative $51.6 billion. Measures of inflation accelerated, including the personal consumption price index that increased at a 3.3% rate, up from 1.9%.

The credit market was none too happy with news of continued economic growth and heightened inflation. Two-year Treasury yields jumped 11 basis points to 4.28%, 5-year yields 15 basis points to 4.86%, and 10-year yields 14 basis points to 5.33%. Today marked the highest yield on the key 10-year Treasury note since mid-December. The yield on benchmark Fannie Mae mortgage-backs jumped 13 basis points and agency yields generally increased 14 basis points. Spreads were relatively flat this week. The dollar gained about 1% this week.

Today’s report comes as no surprise to those of us who have been following this extraordinary monetary expansion. It runs unabated, with broad money supply (M3) expanding by $42 billion last week. It has now surged $210 billion during just the past 10 weeks. The past week saw Demand Deposits increase $11 billion, Institutional Money Fund assets and Repurchase Agreements both added $9 billion, and Retail Money Fund assets expanded $4 billion. This continues a monetary explosion that began during last year’s second half. Broad money supply has increased a staggering $713 billion since the end of June 2000 (42 weeks), an outrageous growth rate of 13%. And the ECB is concerned with money supply growth rates of just under 5%… Even those that focus on narrower definitions of money must look with discomfort at M2 money supply expanding at a 12.6% rate over the past three months. During the past twelve months, Institutional Money Fund assets have expanded $270 billion, or 42%, to $913 billion. During the past year, Large Time Deposits have increased 13%, Repurchase Agreements 10%, Eurodollars 12%, Savings Deposits 12%, and Retail Money Fund assets 11%. I will be the first to admit that there will be no liquidity crisis as long as the financial sector creates additional liabilities ("money") at this incredible rate. The test will come with higher interest-rates and the tempering of the current mortgage-refinancing boom.

It is my view that the Federal Reserve, by moving aggressively to sustain spending and financial market liquidity, is but perpetuating a momentous policy error and virtually ensuring financial dislocation in the future. Over the past few years, both the household and business sectors embarked on an historic borrowing and spending boom that created clearly unsustainable demand. In particular, the Fed stubbornly refused to acknowledge that a credit-induced bubble economy was fostering a most conspicuous spending bubble throughout the Internet/telecom/technology super-sector ("you cannot know if you are in a bubble until after the fact"). The subsequent collapse of this historic bubble was unavoidable, it was only a matter of from what point and at what cost. The longer bubble-induced spending continued, the more dramatic and problematic the inevitable adjustment, as we have begun to witness.

Unfortunately, along the lines of the old adage "throwing good money after bad," the Federal Reserve has nonetheless responded aggressively to the inevitable and necessary technology industry adjustment, with every intention of stimulating general demand and maintaining boom-time spending levels for the economy as a whole. Apparently, they see no alternative, perhaps coming to recognize the current state of acute financial fragility. However, only by sustaining current gross financial excesses can the Fed pursue its goal of keeping the U.S. out of recession (more aptly stated "throwing bad policy after bad"). Rule number one for central bankers should be: under no circumstances should extreme financial imbalances be accommodated. Amazingly, the Fed is quite open with its stated policy of stimulating greater borrowing and spending by the U.S. household sector that is already consuming at an unsustainable rate, with a significant negative savings rate fueling massive trade deficits. It is patently obvious that the precarious U.S. bubble economy is in desperate need of retrenchment, not its perpetuation. Like the technology bubble, a major adjustment to consumer spending is inevitable, the unknowns are when, how dramatic, and at what cost. The meter is running.

I am left in somewhat bewilderment as for the complete disregard of the profound ramifications from the U.S. financial system and economy having diverged wildly from a stable "equilibrium" and sound position. More cheap money and credit is certainly not the answer. Importantly, years of credit and speculative excess have over time carved indelible and increasingly dysfunctional monetary processes. With current policy, the Fed is simply fighting a losing war with its extreme accommodation only perpetuating the Great Credit Bubble and guaranteeing that already dangerous financial and economic distortions will only broaden and become more entrenched. And nowhere are dangerous monetary processes and intractable credit excess more apparent today than in the ever-expanding real estate bubble. Ignoring this bubble poses much greater systemic risk than the Fed’s disregard for the tech bubble. Moreover, stimulating continued credit excess at this very late stage of the business cycle (with unemployment near 30-year lows, rising wages, surging energy prices, and already heightened general inflationary pressures) should be recognized as an obvious misadventure in monetary management. Clearly, the present policy course that fosters continued credit excess, accommodates a dysfunctional financial sector, and strives to "sustain unsustainable demand" is fraught with great risk to both the U.S. financial system and economy.

For months, there has been the repeated presentation of analysis correlating NASDAQ performance and consumer spending. The expectation was for an abrupt decline in consumer expenditures that, in fact, did not materialize. I was reminded of a most memorable example from my Economics 101 course. Our professor presented us with the following fact: "There is empirical data documenting the strong correlation between a rise in consumption of ice cream and the number of sexual assaults." I can remember being rather surprised by this revelation. Looking at such data, one could be left believing that ice cream consumption caused crime, and that the neighborhood would be a much safer place with the closure of all the ice cream parlors. Yet, both premises would be categorically untrue. The professor’s point was made when he identified that there was a key missing variable: daily high temperatures. It was unusually hot weather that was the cause behind two notable effects: increased ice cream consumption and an unusually large number of assaults. With this example in mind, one should recognize that gains in NASDAQ and increases in consumer spending were both "effects," with credit growth the key causal variable. While NASDAQ stocks have declined sharply, excessive money and credit growth continues to fuel strong (I argue unsustainable) consumer spending. NASDAQ was not THE bubble, but only one component of THE Credit Bubble.

As mentioned in previous commentaries, it is my view that economists do not appreciate the ramifications for what I see as the return of inflationary psychology on the wage front. Furthermore, as the economic consensus fixates on NASDAQ, it goes unrecognized that continued credit excesses at this late stage in the cycle will likely manifest into heightened inflationary wage pressures. While technology may be in an industry-wide bust, there has developed a strong inflationary bias in both worker wages and benefits. And with the cost of housing having risen sharply and surging energy prices now making their way through higher general prices, why should it be a surprise that workers are demanding and receiving higher wages? This week from Bloomberg: "The income of U.S. residents rose 7.3 percent last year, the largest increase since 1989, led by double-digit gains in California and Colorado, a government report showed. Measured per person, income from wages, dividends, rents and other sources totaled $29,676 in 2000, the U.S. Commerce Department's Bureau of Economic Analysis said. Incomes ranged from $40,640 in Connecticut to $20,993 in Mississippi…. Personal income for all residents totaled $8.4 trillion in 2000, compared with $7.8 trillion in 1999. The annual increase was the largest since a 7.7 percent gain 11 years earlier." "All states shared in the strong growth in the nation's personal income. All 50 states and the District of Columbia had increases in personal income that substantially outpaced the 2.4-percent increase in prices paid by U.S. consumers." I would argue that general inflationary pressures are as well likely the strongest in 11 years.

Clearly, lower interest-rates are providing a potent stimulant for an extraordinarily powerful financial infrastructure (monetary processes) that has developed to funnel enormous credit to the real estate sector. I would strongly argue that this is the greatest financial and economic distortion to the U.S economy, one that is only being exacerbated by extreme central bank accommodation

Rising wages, historically low interest-rates, and the extreme nature of credit availability certainly throw additional fuel on an historic real estate bubble. This week the Commerce Department reported that new homes were sold at a seasonally adjusted all-time record pace of 1.02 million units during March, a 4.2 percent increase from February. Similar results were reported for home resales. From the National Association of Realtors (NAR): "Spurred by lower mortgage interest rates, existing single-family home sales rose to a near-record pace in March…Existing-home sales increased 4.8 percent to a seasonally adjusted annual rate of 5.44 million units in March from a pace of 5.19 million units in February -- reaching the second highest monthly rate on record. Last month’s sales activity was 3.8 percent above the 5.24-million unit pace in March 2000. Dr. David Lereah, NAR’s chief economist, described sales as ‘phenomenal’: ‘This is just shy of the all-time record pace of 5.45 million in June 1999, and is the second-highest level of sales activity ever recorded. Clearly, mortgage interest rates that are near 30-year lows are bringing many buyers into the market at the beginning of the traditional home-buying season, and we’re counting on the Federal Reserve to continue its accommodative interest rate policy to keep housing strong’…NAR President Richard A. Mendenhall said current sales are the hallmark of a historically strong year. ‘We’ve been making upward revisions to our forecast all year, and we now expect existing-home sales to rise 1.6 percent for all of 2000 to a total of 5.19 million, which will be the second highest on record.’"

It is certainly also worth noting that existing home sales prices jumped strongly in March, with the average (mean) nationwide price increasing $5,000 to $179,600. Average prices added $7,800 during the month in the South to $165,900, and $7,400 to $240,000 in the West. It is quite interesting, and I think clearly illustrative of the continued powerful mortgage credit boom, to do a "transactions dollars" calculation. Using annualized volume of 5.44 million units and an average price of $179,600, total "transaction dollars" for March are calculated at about $81 billion ($977 billion annually!). Comparing this to numbers from March 1998 (avg. price of $153,300 and sales rate of 4.95 million units), we see current "transaction dollar" volume running almost 30% above just three years ago. "Transaction dollars" ran a remarkable 67% above March 1997 (avg. price of $143,800 and sales rate of 4.06 million units). The surge in "transaction dollars" is indicative of mortgage credit growth, and gives a clear indication of the profound degree of credit excess that continues to fuel this real estate bubble. It should also be noted that this exercise excludes the significant credit creation associated with the current surge in equity extraction from borrowings against inflated values both through home-equity loans and mortgage refinancings. If there were one key "causal variable" for consumer spending, I would argue strongly it lies in mortgage credit growth and not NASDAQ. I will be quite surprised if current mortgage credit growth does not set all-time records.

It is certainly not a laborious exercise to trace the source of this explosion in mortgage credit. First quarter numbers are in from Freddie Mac, and they provide good fodder for financial and economic historians. Quoting a bullish Wall Street research report: "Excellent 43%-annualized retained portfolio growth in March, leading to 37%-annualized growth for the quarter." I guess "excellence" is in the eye of the beholder. But one can argue that it’s today much easier to report strong accounting profits by aggressively lending money than it is by producing products. This is certainly not something to celebrate. Unfortunately, financial history is strewn with too many disastrous episodes marking the dangerous consequences of reckless credit expansion.

For the quarter, Freddie Mac total assets increased almost $39 billion, compared to $19 billion for the first quarter of last year. This credit expansion is second only to 1998’s historical 4th quarter "reliquefication". Year-over-year, total assets increased $92 billion, or 23%, to $498 billion. In three years of historic credit excess, total assets have ballooned from $227 billion, a simply amazing increase of $271 billion, or 120%. Freddie Mac management also raised their estimate for 2001 portfolio growth by about 40% (from December estimates) to between $70 and $85 billion. Company growth was fueled by purchases of $20 billion (100% annualized growth rate) of "non-Freddie mortgage-backed securities," which management "for competitive reasons…declined to provide specifics on…" All I can say is that there will be severe effects come the day the U.S. financial system and economy must be weaned from the unprecedented liquidity so freely dispensed by the incredible GSE "money" machine.

It’s been awhile since I addressed the Federal Home Loan Bank System (FHLB), the third of the "Big Three GSEs." Like Freddie and Fannie, the FHLB system in many ways epitomizes contemporary U.S. finance: aggressive reliance on money market borrowings; the beneficiary of the implied backing of the U.S. taxpayer; and a business strategy that incorporates extreme leverage, enormous derivative positions, and other financial engineering (functioning with what is largely an unfettered capacity to create money and credit) to create a system of low-cost and uninterrupted liquidity for U.S. lenders. It is a great example of the "leverage on leverage" nature of the U.S. financial system, as well as the key role assurances of liquidity play in promoting the over availability of credit throughout the system. From 2000 year-end financial statements: "The FHLB serves the public by enhancing the availability of housing finance, including community investment credit, through their member institutions. They provide a readily available, low-cost source of funds to members and a means of liquefying home mortgages held in portfolio."

The FHLB ended the year (2000) with total assets of a staggering $654 billion, an increase of $361 billion (124%) during just the past three years. Total Assets included $438 billion of "Advances"(loans) to member "banks", $55 billion "Fed Funds Sold" (short term money market lending – "Historically, the FHLBanks have been one of the largest providers of federal funds"), $112 billion of securities (including $81 billion mortgage-backed securities, $12 billion agency securities, $9 billion commercial paper, $4 billion state and local government securities, $200 million of Treasuries, and $6 billion of other securities). Of the twelve regional FHLBanks, San Francisco is by far the largest, with total assets of $140 billion, more than double the next-largest institution. How is the massive FHLB balance sheet funded? Total liabilities of $632 billion included $17 billion of Deposits, $160 billion of (short-term money market borrowings) "Discount Notes", $14 billion "Other", and $432 billion of "Bonds." Just over half of these bonds are due by the end of next year (2002), so FHLB liabilities are, not surprisingly, heavily weighted to short-term borrowings. The FHLB uses derivatives aggressively to help insure against the obvious risk that comes with such a bloated balance sheet of financial assets financed with the narrowest of interest-rate margins. At year-end, the FHLB had notional "interest-rate exchange agreements" of $566 billion (versus $495 at 12/31/99). The FHLB ended the year with $187 billion of interest-rate swaps. During year-2000, this enormous interest-rate arbitrage saw average total assets of $604 billion yielding 6.44%, with average liabilities of $574 billion costing 6.21%. These exceptionally narrow spreads provided the FHLB with net income of $2.2 billion, or about one-third of 1% of average total assets. "We don’t recommend that you try this at home!"

"The FHLB Banks are cooperatives; only member banks may own the stock of each FHLBBank." The FHLB financial statements present "Capital" of about $31 billion. With Retained Earnings of less than $1 billion, system "Capital" is basically stock purchased by member banks – yes, the very same borrowers on the other side of the $438 billion of "Advances." Clearly, calling this "Capital" is quite a stretch. Imagine yourself forming a lending business by borrowing from a bank, lending it to your neighbor, and then having him purchase equity in your company. Sure, you can call it "Capital," but where is the protection to the lender if your business goes bust? Certainly, your banker wouldn’t accept your representation of this as "capital." This structure/arrangement works swimmingly for everyone involved during expansion phase of a business cycle and real estate bull market...

The FHLB, along with Fannie Mae and Freddie Mac, have developed into the crucial liquidity linchpins in the contemporary U.S. "managed liquidity" monetary regime. "The FHLBanks serve as a source of liquidity for members. Access to FHLBank advances for liquidity purposes can reduce the amount of low-yielding liquid assets a member would otherwise need to hold." As a GSE, the FHLB system has basically unlimited access to of low-costs funds in the money and capital markets. These funds are then funneled directly to its members and then into the marketplace (generally mortgage lending), in a case of virtually unfettered money and credit creation. One cannot overstate the role played by the FHLB and GSEs as they act to ensure marketplace liquidity through the ballooning of assets and liabilities, especially during periods of acute systemic stress.

Interestingly, I stumbled across a fascinating "report" this week from the Fixed Income Research Department at Morgan Keegan titled "Leverage Strategies Overview: Well-capitalized financial institutions are often searching for ways to enhance their earnings and return on equity (ROE). By utilizing the attractive advance program rates offered by the various Federal Home Loan Districts (FHLB), institutions can grow their asset base and gain incremental income. More specifically, financial institutions are able to borrow funds from the FHLB and invest those funds in higher-yielding assets to earn additional income over the cost of funds (COF)." What? Is the FHLB really providing cheap financing directly to the leveraged speculators for spread trades? When did this become part of the GSE mandate? Are Fannie and Freddie doing the same, providing speculator profits while increasing risk to the American taxpayer?

In this report, a number of different spread products were offered, beginning with "Bermuda Call Structures" that provided spreads as wide as 209 basis points by borrowing from the Federal Home Loan Bank System at 4.36% and purchasing 10-year Agency Securities yielding 6.45%. For those leveraged speculators with lower risk tolerance, narrower spreads were available with agency debt of shorter maturities. A wide range of spread products were available, offered under the headings "European Call Structures," "Pass-Through Strategies," "SBA (small business administration) Strategies," "ARM (adjustable-rate mortgages) Strategies," "Bank Municipal Strategies," and "Corporate Strategies." It is only a case of choosing one’s "weapon", with low-cost financing compliments of the FHLB!

I must admit to fascination with the "Bermuda Call Structures" option, which would appear to cater to offshore funds. It is my contention, of course, that massive leveraged "Hot Money" positions have accumulated to create a highly over leveraged U.S. financial system. It is furthermore my belief that what the bullish consensus heralds as enormous and sustainable inflows from foreign long-term "investors" are increasingly more likely speculative flows associated with myriad types of U.S. interest-rate bets and arbitrage – all too often speculations directly fostered by the proliferation of agency debt securities and the GSE’s aggressive liquidity operations. Certainly, I believe it is quite reasonable that a significant portion of the enormous inflows originating from the U.K. and Caribbean Banking Centers are speculative "Hot Money" flows and not long-term "investment." It is furthermore my contention that the unprecedented scope of this leveraged speculation by definition creates a highly unstable and acutely vulnerable financial system.

Just for "fun," let’s "follow the money" in what I view as a very realistic example. Let’s say that that we are going to structure a derivative trade with cash flows incorporating an interest-rate spread trade similar to "Bermuda Call Structure" above. We have a proprietary derivative trading operation domiciled in the Cayman Islands. This offshore entity borrows from the FHLB (another example would have borrowings in yen at near zero rates) to finance aggressive leveraged holdings of, let’s say, higher-yielding Freddie Mac bonds. This type of structure is certainly not dissimilar to those used in abundance by the leveraged speculators in their pursuit of "arbitrage" profits from the wide interest-rate differentials available in the mid-1990’s, borrowing in yen or U.S. dollars. and lending at high yields to institutions in Thailand, Indonesia, South Korea, Malaysia or the Philippines. The initial enticing returns to these types of trades created a proliferation of sophisticated and highly leveraged "spread" transactions and a flood of "Hot Money" into these economies. At the same time, such structures make it virtually impossible to identify inflows as favorable long-term "investment" or highly destabilizing speculative/"Hot Money." Inarguably, these enormous speculative flows greatly distorted both financial systems and economies, playing a critical role in the booms and subsequent financial and economic dislocations.

Let’s get back to our example. We have Morgan’s with a derivative operation domiciled in the Cayman Islands. We also have a large Hedge Fund seeking to profit handsomely during an environment where the Federal Reserve is cutting rates sharply and pursuing aggressive accommodation. The strategy will be to "arbitrage" interest-rate spreads, or borrow cheap short-term (from the FHLB) and lend dear long-term (to Freddie Mac). At the same time, we have Countrywide Credit that requires the sale of $1 billion of mortgages it has originated to ensure a continuing pool of liquidity for additional mortgage lending. Our community also includes the FHLB, Freddie Mac and Community Money Market Fund (CMM). The process begins with Hedge Fund having been contacted by Morgan with a derivative trade providing the spread on $1 billion notional – where Hedge Fund agrees to pay the short-term 90-day FHLB borrowing rate (4.36%), while receiving the much higher (6.45%) yield on 10-year Freddie Mac notes. This contract also stipulates that Hedge Fund accepts the risk of higher interest rates, but not until final settlement at the end of the three-year life of the derivative agreement.

As soon as the contract is signed, Morgan goes directly to the FHLB to obtain $1 billion of short-term ("Fed Funds") financing. At the same time, Morgan had been in contact with one of its favorite clients, the Central Bank of Taiwan, that has $1 billion US that it received in exchanges with local exporters. Seeking liquidity and safety, the central banks is pleased to place these funds in the safety of short-term FHLB discount notes. Easy enough. The $1 billion is then transferred immediately through the account of the FHLB directly to the account of Morgan’s offshore derivatives subsidiary in the Cayman Islands. At Morgan Cayman Islands (the operation is actually run out of NYC, but the "books" are kept "offshore"), these funds are instantly used to purchase $1 billion of newly issued Freddie Mac 10-year notes. Morgan now has the underlying positions necessary for its derivative "spread trade" created to provide a leveraged return for its Hedge Fund client. Freddie Mac immediately takes the $1 billion bond issuance proceeds and funds the purchase of $1 billion of mortgage loans that had been warehoused by Countrywide Credit, whereby the $1 billion is immediately transferred to the company’s account at CMM. Countrywide then originates $1 billion of new mortgages, providing the money and credit creation that gives American households the wherewithal to import $1 billion more of technology imports from Taiwan. The Central Bank of Taiwan, as it does every month, then exchanges local currency for $1 billion US with its exporters, which it then uses to purchase $1 billion more "safe and liquid" agency money market instruments. And the recycling and credit creation process begins anew.

This example highlights a couple of important anomalies of the present extraordinary environment. For one, it may have appeared in the data that foreign "investors" were behind the $1 billion of agency bonds sold out of the Cayman Islands. In reality, this "foreign" purchase was part of an interest-rate derivative play by a U.S. based leveraged speculator. The true "foreign" flows were actually risk-averse dollars necessarily being recycled back to the U.S. financial system from overseas institutions. It is a wonderful – almost magical – arrangement. With the foreign central bank placing funds directly into the safety of what it views as U.S. governmental obligations, it is not necessary to bid up the price of its local currency by selling dollars in the open market. Hedge Fund profits mightily from the leveraged "spread trade" that it can put on in size, with the FHLB creating cheap liquidity. Freddie Mac is quite pleased as well, as it is able to lock in long-term financing for its ballooning balance sheet. Countrywide receives uninterrupted liquidity, while the unlimited availability of mortgage finance supports the American homeowner’s spending habits (including imports) through the inflation and extraction of home equity. Morgan profits handsomely as it takes a bit of commission on every trade and a little slice of every spread, profits that provide the means for it to more aggressively leverage its own balance sheet. The U.S. credit system operates with endless liquidity.

Last week I attempted to demonstrate (through journal entries) the process of the "infinite multiplier effect," whereby the powerful intermediation function provided by money market funds enables unfettered "money" and credit creation through the expansion of GSE and financial sector liabilities. There is, as well, a crucial international flows component of this process that I have attempted to illuminate with the above example. Once again, I am hoping to demonstrate the momentous role played by the GSEs, this time by their ability and willingness to create virtually limitless quantities of "riskless" securities on the one hand, and market liquidity on the other. This duel capability and the related monetary processes are a decisive factor in what has to this point been a painless "recycling" of massive U.S. trade deficits DIRECTLY back to the U.S. financial sector – an essential condition for the continuation of unrestrained monetary expansion and the perpetuation of the Great U.S. Credit Bubble. Importantly, never before has the U.S. (or any country’s) financial sector possessed the capability for creating an unlimited quantity of "safe and liquid" liabilities - never. It is this capability - largely through the GSEs and money market funds - that expedites this powerful "recycling" process so crucial in supporting the value of the dollar, while sustaining unprecedented money and credit creation and the U.S. bubble economy.

Typically, one would expect that the extended period of inordinate U.S. monetary inflation and consequential trade deficits would place considerable strain on the dollar. Not, however, under the highly unusual process I am describing. I would contend that current monetary processes are functioning much differently than in the past where dollars (in much smaller quantities) were being generally "recycled" back to the U.S. through foreign purchases of Treasury debt (funding fiscal deficits). This previous process tended to disperse monetary flows throughout the U.S. economy. Today, on the other hand, profoundly disparate processes function quite effectively to concentrate monetary flows, with the aggregation directed to U.S. money and capital markets – especially money market funds, liquid U.S. financial sector liabilities, and GSE issues. Evidence of this is provided by the continued extraordinary money and credit expansion, as well as the massive institutional accumulation of financial assets.

Ironically, heightened financial stress and general risk-aversion only exacerbates this monetary process, particularly toward the manufacturers of "safe" securities - the GSEs, - thereby intensifying their money and credit creation efforts. It is worth noting that total outstanding agency securities have increased almost $1.5 trillion during the past three years. It is now to the precarious point that their massive liquidity provisions are the market’s indispensable lifeline. At the same time, these current dysfunctional processes are perpetuating extreme excess throughout real estate finance. Not dissimilar to the technology bubble, massive investment and speculative flows are creating destabilizing asset inflation, excessive spending, a regrettable misallocation of resources, and acute financial instability. Not unlike the technology bubble, when it reached the point where it appeared that it simply could not inflate further, it commenced the current wild "terminal stage" of unbelievable and precarious excess. Story to continue…