Another week of trading, a further melt-up in Treasuries... Three-month Treasury bill rates sank 25.5 bps the past week to 2.845%. Two-year government yields fell 21 bps to 2.345%. Five-year T-Note yields fell 20 bps to 2.84%, and ten-year yields fell 15.5 bps to 3.63%. Long-bond yields were 9 bps lower to 4.28%. The 2yr/10yr spread ended the week at 128 bps. The implied yield on 3-month December ’08 Eurodollars sank 24 bps to 2.66%. Benchmark Fannie MBS yields fell 10 bps to 5.06%, this week under-performing Treasuries. The spread on Fannie’s 5% 2017 note was one wider at 50 bps and Freddie’s 5% 2017 note little changed at 50 bps. The 10-year dollar swap spread increased 1.8 to 62. Most corporate bond spreads were wider, with the spread on an index of junk bonds ending the week another 16 bps wider.
Investment grade issuance included Target $4.0bn, Cargilll $1.25bn, National Rural Utility Coop $700 million, Southern California Edison $600 million, State Street $500 million, ITC Holdings $385 million, John Deere $350 million, ITC Midwest $175 million, and Textron $100 million.
Junk issuance included Atlas Energy $250 million and Theravance $150 million.
Convertible issuers included Pioneer Natural Resources $440 million,
Foreign dollar debt issuance included Oester Kontronbk $2.0bn.
German 10-year bund yields dropped 10 bps this week to 3.97%, while the DAX equities index sank 5.2% (down 9.3% y-t-d). Japanese “JGB” yields declined 2 bps to 1.39%. The Nikkei 225 fell 3.7% (down 9.5% y-t-d). Emerging equities markets took it on the chin, while debt markets were mixed-to-lower. Brazil’s benchmark dollar bond yields jumped 10 bps to 5.69%. Brazil’s Bovespa equities index sank 7.2% (down 10% y-t-d). The Mexican Bolsa fell 7.0% (down 9.6% y-t-d). Mexico’s 10-year $ yields dropped 10 bps to 5.11%. Russia’s RTS index was hammered for 6.7% (down 5.7% y-t-d). India’s Sensex equities index sank 8.7% (down 6.3% y-t-d). China’s Shanghai Exchange dropped 5.5%, reducing y-t-d performance to a loss of 1.5% (up 88% y-o-y).
Freddie Mac posted 30-year fixed mortgage rates dropped 18 bps this week to 5.69% (down 54bps y-o-y). Fifteen-year fixed rates sank 22 bps to 5.21% (down 77 bps y-o-y), with a two-week decline of 47 bps. One-year adjustable rates fell 11 bps to 5.26% (down 25 bps y-o-y).
Bank Credit jumped $24.8bn during the most recent data week (1/9) to a record $9.304 TN (4-wk gain of $140bn). Bank Credit posted a 25-week surge of $660bn (15.9% annualized) and a 52-week rise of $1.005 TN, or 12.1%. For the week, Securities Credit dipped $1.7bn. Loans & Leases surged $26.5bn to a record $6.831 TN (25-wk gain of $507bn). C&I loans declined $2.2bn, with one-year growth of 21.4%. Real Estate loans gained $9.4bn (up 7.7% y-o-y). Consumer loans rose $6.6bn. Securities loans gained $11.1bn, and Other loans added $1.7bn. On the liability side, (previous M3) Large Time Deposits increased $2.9bn.
M2 (narrow) “money” supply slipped $5.9bn to $7.456 TN (week of 1/7). Narrow “money” expanded $399bn y-o-y, or 5.6%. For the week, both Currency and Demand & Checkable Deposits were little changed. Savings Deposits fell $10.1bn, while Small Denominated Deposits added $1.4bn. Retail Money Fund assets increased $2.9bn.
Total Money Market Fund assets (from Invest. Co Inst) surged $23.8bn last week (2-wk gain $75.8bn) to a record $3.189 TN. Money Fund assets have posted a 25-week rise of $605bn (49% annualized) and a one-year increase of $810bn (34.1%).
Total Commercial Paper rose $35.5bn to $1.849 TN. CP has declined $375bn over the past 23 weeks. Asset-backed CP jumped $26.4bn (23-wk drop of $390bn) last week to $805bn. Over the past year, total CP has contracted $147bn, or 7.4%, with ABCP down $265bn (24.8%).
Fed Foreign Holdings of Treasury, Agency Debt last week (ended 1/14) jumped $14.4bn to a record $2.072 TN. “Custody holdings” were up $299bn year-over-year (16.9%). Federal Reserve Credit declined $1.7bn last week to $867.5bn. Fed Credit expanded $21.5bn y-o-y (2.5%).
International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $1.334 TN y-o-y, or 27.1%, to a record $6.270 TN.
Global Credit Market Dislocation Watch:
January 18 – Bloomberg (Christine Richard): “Ambac Financial Group Inc., the second-largest bond insurer, was stripped of its AAA credit rating by Fitch Ratings after the company abandoned plans to raise new equity… The downgrade ‘reflects the significant uncertainty with respect to the company’s franchise, business model and strategic direction,’ Fitch said. Without its AAA rating…Ambac may be unable to write the top-ranked bond insurance that makes up 74% of its revenue…. The downgrade throws doubt on the ratings of $556 billion in municipal and structured finance debt guaranteedby Ambac. ‘This makes Ambac insurance toxic,’ said Matt Fabian, senior analyst and managing director at Municipal Market Advisors… ‘The market has no tolerance for a ratings-deprived insurer.’”
January 18 – Bloomberg (Shannon D. Harrington and Christine Richard): “MBIA Inc. and Ambac Financial Group Inc., the two biggest bond insurers, have a more than 70% chance of going bankrupt, credit-default swaps show. Prices for contracts that pay investors if…MBIA can’t meet its debt obligations imply a 71% chance the company will default in the next five years, according to a JPMorgan Chase & Co. valuation model. Contracts on…Ambac imply 72% odds.”
January 17 – Bloomberg (Emma Moody): “MBIA Inc.’s AAA insurance rating may be cut by Moody’s… Moody’s also said it may cut the Aa2 rating of surplus notes sold by MBIA last week. The ratings review reflects potential losses from subprime mortgage securities including collateralized debt obligations, Moody’s said…”
January 18 – Bloomberg (Mark Pittman): “ACA Capital Holdings Inc. has until midnight in New York to convince trading partners to give the insurer more time to get out of $60 billion in credit-default swap contracts it can’t pay, the company’s regulator said.”
January 17 – Bloomberg (Mark Pittman): “Merrill Lynch & Co., the biggest underwriter of collateralized debt obligations, said it will write off $2.6 billion in default protection from bond insurers including ACA Capital Holdings Inc. because it’s worthless… Merrill Lynch’s writedowns demonstrate how a downgrade of bond insurer credit ratings can spread throughout financial markets. Losing the AAA stamp would cripple the bond insurers and throw doubt on the ratings of $2.4 trillion of securities.”
January 18 – Bloomberg (Shannon D. Harrington): “The risk of U.S. companies defaulting on their debt rose for the fourth day on concern that the world’s two biggest bond insurers will lose their top AAA ratings, trading in credit-default swaps shows. The Markit CDX North America Investment-Grade Index, a benchmark gauge of default risk tied to the bonds of 125 companies, rose 3.25 bps to a near-record 110.5 bps, according to Deutsche Bank… The index has soared 13.25 bps in the past four days…”
January 18 – Bloomberg (Jody Shenn): “The cost of protection against defaults on commercial-mortgage-backed securities ended this week at records after Fitch Ratings tightened standards and some borrowers were unable to make their payments. A Markit CMBX index of credit-default swaps tied to 25 bonds rated AAA when created in mid-2007 surged to 122.19 basis points, or 45% higher than Jan. 11… The CMBX-NA-BBB- 4 index, tied to bonds with the lowest investment-grade ratings and backed by the same loan pools, jumped 26% to 1,564 basis points.”
January 16 – Financial Times (Ben White and Justin Baer): “Citigroup’s announcement yesterday that it lost nearly $10bn in the fourth quarter and would write down $18.1bn on subprime mortgage-related losses was not cheering to investors. Nor was the bank’s decision to slash its dividend by 40% and raise $14.5bn in fresh capital…But these things at least did not come as much of a surprise… What came as more of a shock, and left analysts scurrying to reassess Citi’s earnings power in the future, was the jump in credit costs to $5.4bn, which included a charge of $3.31bn to increase US consumer loan-loss reserves, up from a net release of $127m a year ago. The increase reflects rising delinquencies on first and second mortgages, unsecured personal loans, credit cards and auto loans. And the increase in reserves indicates Citi believes the health of the consumer is likely to get significantly worse before it gets better as the US heads into a downturn.”
January 16 – Bloomberg (Shannon D. Harrington): “The worst may still be ahead for the world’s biggest financial companies, trading in credit-default swaps shows. Prices for contracts tied to the bonds of MBIA Inc., Bear Stearns Cos. and Washington Mutual Inc., which protect lenders and creditors against the possibility that debt payments won’t be made, are higher for one year than for five, according to data compiled by Bloomberg. Longer-term protection is usually more expensive because the risk of nonpayment is greater… Lenders hold more than $200 billion of bonds and loans used to finance leveraged buyouts that they can’t sell and are falling in value, based on data compiled by JPMorgan Chase & Co.”
January 17 – Financial Times (Ben White): “Citigroup and Merrill Lynch turned to foreign investors for an unprecedented bail-out yesterday, saying they will raise a total of $21.1bn in fresh capital - mainly from outside the US - to shore up balance sheets devastated by the subprime mortgage crisis. Citigroup also unnerved investors by warning of losses to come from consumer loans as it revealed a 40% dividend cut, a $9.83bn fourth-quarter loss, $18bn in subprime-related credit writedowns and remaining exposure of $37bn to subprime mortgages. ‘No one can say this whole thing is over.’ Gary Crittenden, Citi chief financial officer, said… ‘These are not optimistic assumptions. But there are always circumstances under which things could get worse.’ Citigroup is raising $14.5bn and Merrill $6.6bn, largely from private investors and governments in the Middle East and Asia, representing the biggest-ever single transfer of capital to American banks from abroad. It could raise pressure from US politicians concerned about foreign influence on the banking system. ‘Not since before World War I have companies gone looking for foreign capital as much as they are now,’ said Charles Geisst, a Wall Street historian. ‘It poses a number of significant problems.’”
January 16 – Bloomberg (John Glover): “Bondholders in structured investment vehicles, caught in the collapse of the subprime mortgage market, have seen the value of their investments fall by almost 50%, according to Moody’s… The net asset value of SIVs, funds that use commercial paper and medium-term notes to buy higher-yielding debt, fell to 53% at the end of last year from 100% in July… Investors who own the funds’ lowest-ranking bonds, called capital notes, would lose an average 47% should the SIVs be forced to liquidate.”
January 17 – Dow Jones (Anusha Shrivastava): “Growing worries about the health of the commercial mortgage bond market gripped investors Thursday, sending a derivative index based on those bonds into a tailspin. The triple-B minus slice of the Markit CMBX 4 series, which is based largely on deals from early 2007 through the summer of last year, widened by 175 bps…”
January 17 – Financial Times (David Oakley): “Bank and corporate bond issuance has recorded the worst start to a year since 1997 as growing fears of a US recession and concerns over company results weigh on the market. Fundraising in the debt capital markets stands at $152bn this year, down 35% compared with the same period last year, according to Dealogic… This marks the slowest start to a year since $77.9bn was raised in the first two weeks of 1997.”
January 15 – Bloomberg (Mark Deen and Kitty Donaldson): “The U.K. Treasury said it may nationalize Northern Rock Plc in order to recover more than 25 billion pounds ($49 billion) in loans it made to the bank and to protect depositors. ‘Conditions are difficult,’ Chancellor of the Exchequer Alistair Darling said… ‘I would like to find a private sector solution, but all options, including nationalization, have to be considered.’”
January 15 – Bloomberg (Laura Cochrane): “Centro Properties Group, the Australian owner of 700 U.S. shopping malls, said Chief Executive Officer Andrew Scott resigned and asked lenders to extend a Feb. 15 deadline to refinance A$3.9 billion ($3.5 billion) of debt… Centro fell 30% to a record in Sydney trading, valuing the company at A$502 million.”
January 16 – Bloomberg (Patricia Kuo): “The risk of Asian banks defaulting on their debt rose to a record… Contracts on Kookmin Bank, South Korea’s largest by market value, jumped 10 bps to 140 bps… Credit-default swaps on ICICI Bank Ltd., India’s biggest, moved out 20 bps to 330 bps, according to Barclays.”
January 17 – Financial Times (Peter Garnham): “The current turmoil in financial markets has revealed the extent to which the low-yielding yen has funded soaring global asset prices in recent years. Last year, the yen tumbled to multi-year lows against a raft of currencies as carry trade investors sold the currency to finance the purchase of riskier, higher yielding assets elsewhere. But now, as asset prices falter, the yen is threatening to climb sharply… The Japanese currency has soared in recent days as fears of US recession have prompted a fresh exodus from carry trades. Yesterday it surged to a 2½-year high…”
January 15 – Financial Times (Gillian Tett): “The US looks poised to lose its mantle as the world’s dominant financial market because of a rapid rise in the depth and maturity of markets in Europe, a study suggests. The change may have occurred already, not least because US markets are beset by credit woes, according to research by McKinsey Global Institute… ‘We think the differential growth rates are so significant that it is quite likely Europe has overtaken the US,” said Diana Farrell, author of the report. ‘They are now neck and neck, which means exchange rates are very important. It is a real change.’”
The dollar index rallied 0.5% this week to 76.50. For the week on the upside, the Japanese yen increased 1.4%, the Mexican peso 0.1%, and the Taiwanese dollar 0.1%. On the downside, the South African rand declined 4.7%, the Norwegian krone 3.9%, the New Zealand dollar 3.8%, the Brazilian real 3.2%, the Swedish krona 2.2%, the Australian dollar 2.1%, the Danish Krone 1.8%, and the Euro 1.7%.
For the week, Gold declined 1.2% to $885 and Silver 0.5% to $16.28. March Copper fell 2.1%. February Crude slipped $2.13 to $90.56. February Gasoline declined 0.7%, and January Natural Gas dropped 3.5%. March Wheat bucked the selling, gaining 5.9%. The CRB index fell 1.2%, reducing 2008 gains to 0.7%. The Goldman Sachs Commodities Index (GSCI) dropped 1.4%, with a y-t-d decline of 2.1% (52-week gain 48.3%).
January 16 – The Wall Street Journal (Andrew Batson): “China’s government moved to exert further control over increases in some food prices, signaling a heightened political concern over the high inflation that is threatening to erode the meager incomes of the nation’s rural majority. Under temporary measures announced yesterday, large producers of some food products -- including dairy, pork, mutton and eggs -- must now seek government approval before increasing prices. Wholesalers and retailers of those food products don’t have to seek permission for raising prices, but most notify the government when the gains cross certain thresholds.”
January 16 – Bloomberg (Li Yanping and Nipa Piboontanasawat): “China ordered banks to set aside larger reserves and imposed price curbs on grain, meat and eggs to try to prevent inflation at an 11-year high from triggering civil unrest. Lenders must park 15% of deposits with the central bank from Jan. 25, the People’s Bank of China said… up from 14.5%. The ratio is the highest in at least 20 years. ‘Significant price increases of some key commodities over the past few months have affected people’s lives, especially low-income households,’ the National Development and Reform Commission said… Inflation helped trigger the Tiananmen Square protests and crackdown of 1989 and stampedes for discounted food have injured and killed Chinese citizens over the past year.”
January 15 – Bloomberg (Michele Batchelor): “China, the world’s biggest user and producer of coal, increased purchases of the fuel from overseas by 34% last year as its economy expanded.”
January 15 – Bloomberg (Wang Ying and Ying Lou): “China has shut down more than 6% of the power generating capacity in its southern provinces because of a coal shortage, with the region bracing for the worst electricity shortage in at least five years… ‘The problem is serious,’ Xiao Peng, vice president of China Southern Power Grid Co., said. ‘We have sent an urgent request to the central government to address the issue,’ he said… China burns coal to generate about 78% of its electricity.”
January 16 - China Knowledge: “Due to the upcoming Chinese New Year…China’s major liquor producers have started increasing their liquor and spirits prices in succession… In response to the rising market demand, Kweichow Moutai, China’s leading spirit company, announced last Friday that it would increase the spirits prices by 20% on average, which would be the company’s second time to raise the producer prices since last March.”
January 16 – Financial Times (Lindsay Whipp): “Japanese producer prices jumped at their fastest pace in a year in December mainly because of higher oil and food costs, a burden companies may have to force their customers to bear to protect profits. Consumers are already paying higher oil and food costs even though most are not receiving higher wages, leaving them less to spend on items other than daily necessities such as petrol and noodles. Wednesday’s 2.6% increase in producer prices will only add to the burden. Oil and coal costs surged 24.4%...”
Asian Bubble Watch:
January 17 – Financial Times (John Aglionby): “Indonesia was yesterday forced to take emergency action to calm street protests over record soyabean prices. The record prices were triggered by US farmers opting to grow corn to supply the biofuel industry over soyabeans. Rising Chinese demand for soyabeans and bad harvests in Argentina and Brazil have also contributed to the jump, which saw Indonesia suffer the biggest food-related protests since last year’s Mexican tortilla crisis. Susilo Bambang Yudhoyono, Indonesian president, was forced yesterday to announce measures to boost local soyabean supply. The move came a day after 10,000 people took to the streets in Jakarta to complain about the rising cost of one of the country’s staple foods.”
Unbalanced Global Economy Watch:
January 16 – Bloomberg (Alan Purkiss): “European economies may suffer from ‘stagflation’ this year, with growth slowing even as inflation quickens, the Wall Street Journal reported. European Central Bank staff projections indicate that inflation in countries that have adopted the euro wll be about 2.5%, compared with the bank’s 2% target…”
January 16 – Bloomberg (Gabi Thesing and Chris Malpass): “German inflation accelerated last year to the fastest pace since records began in 1996… Consumer prices rose 2.3% in 2007…”
January 15 – Bloomberg (Gabi Thesing): “Investor confidence in Germany fell to the lowest in 15 years on concern that a U.S. recession will deepen the slowdown in Europe’s largest economy.”
January 15 – Bloomberg (Balazs Penz): “Hungarian inflation accelerated in December as oil prices advanced, making it more difficult for the central bank to reduce the European Union’s second-highest benchmark interest rate. The inflation rate climbed for a third month to 7.4%...”
January 16 – Bloomberg (Tracy Withers): “New Zealand’s inflation rate accelerated in the fourth quarter… Consumer prices rose 1.2% from the third quarter… From a year earlier, prices rose 3.2%.”
January 17 – Associated Press (Riaz Khan and Ashraf Khan): “When the delivery truck finally arrives, laborer Sher Nawaz joins about 400 Pakistanis scrambling to buy a sack of wheat flour. He returns empty-handed. ‘We were told there was a bumper crop of wheat this season, but look at us,’ says Nawaz, 45, his voice trembling with anger. He waited three hours in a crowd of bearded men wrapped in woolen shawls and burqa-clad women at a Peshawar bazaar, only to have the state-subsidized flour run out before he and 100 others got any… While terror attacks have left hundreds dead, it’s flour shortages and rising food prices that will be the most pressing issues in elections next month in this poor nation of 160 million people. Food prices jumped by about 14% in 2007, on top of double-digit increases for the two previous years. Now Pakistanis wait in long lines at state-subsidized stores to buy flour for the flat bread usually eaten with every meal.”
Central Banker Watch:
January 15 – Dow Jones (Alan Purkiss): “The controversy over the Federal Reserve’s handling of the U.S. economic downturn has heated up, with former Chairman Paul Volcker now on record saying the central bank has lost its grip. ‘Too many bubbles have been going on for too long,’ Volcker said in an interview with Roger Lowenstein to be published in this Sunday’s New York Times magazine. ‘The Fed is not really in control of the situation.’”
January 15 – Fortune (Colin Barr): “Alan Greenspan keeps on cashing in. The former Fed chief is joining hedge fund Paulson & Co. as an adviser. The move, which comes on the same day that Merrill Lynch and Citi raise some $21 billion in new capital to offset losses tied to the collapse of the housing bubble, puts Greenspan on the advisory board of the firm that has been among the biggest winners in betting against subprime mortgage-related securities. Greenspan, who has also been busy promoting his book, already advises bond shop Pimco and Germany’s Deutsche Bank, The Wall Street Journal points out.”
Bursting Bubble Economy Watch:
January 16 – Financial Times (Krishna Guha and Daniel Pimlott): “The underlying rate of inflation remained uncomfortably high in December… highlighting the risk the Federal Reserve is taking as it turns its focus to fighting recession risk… the whole year data showed that overall consumer price inflation was 4.1% at an annual rate in 2007, the highest since 1990.”
January 17 – Financial Times (Krishna Guha and Matthew Garrahan): “California and Florida, two of the most important states in the US, are either in recession or on the brink of it, many economists now believe. The two states together account for nearly two-fifths of US gross domestic product. California alone would rank among the world’s top 10 economies, while Florida would rank in the top 20. State-level data is patchy, but it suggests economic activity is probably contracting in Florida and may be declining in California as well… California and Florida, along with Nevada and Arizona, represent a new group of housing boom-turned-bust states that could experience regional recession… Sales of existing homes fell 36% in California and 30% in Florida in the year to November 2007, while median sale prices fell 12% in California and 10% in Florida. Both states have large inventories of unsold homes. California’s high-cost property is particularly vulnerable to the continued dysfunction in the jumbo, or large-denomination, mortgage market. Labour market data show that job creation stalled in both states from August onwards.”
January 16 – Financial Times (Krishna Guha and Daniel Pimlott): “The underlying rate of inflation remained uncomfortably high in December… highlighting the risk the Federal Reserve is taking as it turns its focus to fighting recession risk…the whole year data showed that overall consumer price inflation was 4.1% at an annual rate in 2007, the highest since 1990. The higher-than-expected rise in core inflation will trouble the Fed, and raises fears of stagflation, as slowing growth in the US economy is complemented by higher rates of inflation.”
January 16 – Bloomberg (Tony C. Dreibus): “Food prices rose 4.9% in the U.S. last year, the most since 1990, as energy costs surged and the production of crops, livestock and dairy products failed to keep pace with increased global demand. The pace of price gains more than doubled from 2.1% in 2006… Food sold in grocery stores rose 5.6%, including a 13.4% jump in dairy products, the department said.”
January 17 – Financial Times (Justin Baer): “Mounting fuel costs could wipe out the US airlines industry’s profits this year, forcing consolidation in the sector as carriers seek to cut costs, according to Doug Parker, the chief executive of US Airways. ‘Speaking for US Airways, fuel prices are going to be $800m or so higher than what they were in 2007,’ Mr Parker told the Financial Times. ‘Everyone has that same equation. What we’re spending on oil this year, if all else stays equal, is more than enough to push them from a profit to a pretty big loss.’”
Latin America Watch:
January 15 – Dow Jones (Alan Purkiss): “Panama’s consumer prices rose 6.4% in 2007 - its fastest pace since 1980 - led by transportation and food and beverage costs, the Statistics and Census office said…”
MBS/ABS/CDO/CP/Money Funds and Derivatives Watch:
January 17 – Bloomberg (Jody Shenn): “Moody’s…last year downgraded $76 billion of collateralized debt obligations made from securities backed by assets such as U.S. subprime mortgages, and entered this year with $185 billion of deals under review.”
Mortgage Finance Bust Watch:
January 17 – Bloomberg (Sharon L. Lynch and Bob Ivry): “Home appraiser Julian ‘Tony’ Perez conjured $7.5 million out of thin air in the first six months of 2001 by overvaluing 33 condominiums in the Atlanta area. Perez valued eight unfinished properties at the Deere Lofts development on April 2. Some were missing ceilings, cabinets or sinks. Each had been bought the previous week for $90,000 to $167,000. Perez said they were worth $177,000 to $330,000, according to the U.S. Attorney’s Office in Atlanta. ‘These are the worst condos ever,’ Perez said last January during testimony at the federal trial in Atlanta of developer Phillip Hill, who used the appraisals to resell the properties. ‘Those values are super over-inflated, probably double what the amount of that property is probably worth.’ Perez and appraisers like him helped exaggerate U.S. mortgage values by as much as 10%, or $135 billion, in 2006, according to Susan Wachter, a real estate professor at the University of Pennsylvania's Wharton School…”
January 17 – Bloomberg (Yalman Onaran): “Lehman Brothers…the largest U.S. underwriter of mortgage-backed bonds, will eliminate 1,300 jobs in the firm’s fourth round of cuts resulting from the collapse of the subprime market. Aurora Loan Services LLC, the Lehman unit that makes loans to customers with higher credit ratings than subprime borrowers, will also shut three offices in California, Florida and New Jersey…”
Real Estate Bubbles Watch:
January 17 – Financial Times (Daniel Pimlott): “New residential building in the US last year suffered its biggest drop in nearly three decades… Housing starts for 2007 fell by more than 25% to 1,376,100 homes. The largest previous drop was recorded in 1980, as the US entered a deep recession. Builders broke ground on fewer new homes in December, leaving the annual rate of construction at 1,006,000 – its lowest level since 1991, and down 14% from November and 38% from the same month a year earlier.”
January 16 – Bloomberg (Sharon L. Lynch): “Long Island and Queens home sales dropped 25% in the fourth quarter and the inventory of properties surged as the housing decline hit residential areas east of Manhattan, Miller Samuel Real Estate Appraisers said… The median price declined 3.2% to $425,000… A total of 38,769 homes were on the market, 41% more than a year ago. The survey excludes the Hamptons. ‘We’re seeing real price erosion across every major market,’ on Long Island, said Jonathan Miller, director of research for Radar Logic Inc…‘Their behavior over the last couple of years has been the opposite of the city.’”
January 15 – The Wall Street Journal (Conor Dougherty): “Slower growth in tax revenues, the result of a weakening economy, are prompting governors from New Jersey to California to consider an array of belt-tightening measures to balance their budgets for this year and next. Facing a severe revenue shortfall, Kentucky Gov. Steve Beshear has asked most state agencies to trim their spending by 3% in the current fiscal year, which ends June 30. New Jersey Gov. Jon Corzine has proposed raising tolls and freezing spending to reduce his state’s debt. And California Gov. Arnold Schwarzenegger, in a bid to avert a deficit in the coming fiscal year, has proposed closing state parks, eliminating dental care for the poor and cutting $4 billion from the state education budget. ‘There are going to be very difficult -- but very necessary -- reductions to close the spending gap," says H.D. Palmer, a deputy budget director for California. ‘By definition, closing a $14.5 billion budget gap is difficult.’”
January 15 – Reuters (Jim Christie): “Home sales in Southern California sank to their lowest in nearly two decades in December as buyers were sidelined or dropped out of the market because they could not obtain mortgages… A total of 13,240 new and resale houses and condominiums were sold in Southern California last month… 45.3% from a year earlier, according to DataQuick… ‘Last month’s sales were by far the lowest for any December in DataQuick’s statistics, which go back to 1988…’ ‘The sales count was 23.5% below the previous December low of 17,272 in 1990…’ The median price paid for a home in the region last month was $425,000, its lowest level in nearly three years and down 2.4% from November and 13.3% from a year earlier. Prices have fallen 15.8% from the peak during the spring and summer. Jumbo mortgages were used to finance about 22% of home sales in Southern California last month, down from nearly 40% before the credit crunch began in August, DataQuick said.”
January 14 – Bloomberg (Michael B. Marois): “California, the biggest U.S. seller of municipal bonds, may have the credit ratings on $49 billion of its debt lowered by Fitch Ratings as a slowing economy leaves the state with a $14 billion budget shortfall. Fitch…placed $43 billion of general obligation bonds and $5.9 billion of other debt paid for with state appropriations under review for a possible downgrade…”
January 17 - Dow Jones: “Hedge-fund assets increased by 30%, or $462bn, in 2007 to $1.997 trillion, Hennessee Group reports. The industry saw net inflows of $278bn, with the remaining $184B coming from performance gains. The net inflows represented a record, the firm says… Total assets for arbitrage and event-driven funds rose 35%, and 26% for long/short equity funds.”
January 17 – Bloomberg (Jenny Strasburg and Caroline Salas): “The main hedge fund of Sailfish Capital Partners LLC, run by former SAC Capital Advisors LLC bond trader Mark Fishman, has lost about half its assets since July because of soured investments and clients pulling money, according to two investors. Sailfish’s Multi-Strat Fixed Income fund, which had $1.9 billion in July, fell 13.5% last year on credit bets…”
January 17 – Dow Jones (Margot Patrick): “A $1 billion credit hedge fund run by London-based Elgin Capital LLP has barred investors from redeeming their capital, highlighting how some of the industry’s most experienced traders are feeling the pain of declines in leveraged-loan and high-yield bond markets.”
Crude Liquidity Watch:
January 16 – Financial Times (Simeon Kerr): “The net foreign assets of Gulf Arab states are set to rise to more than $2,000bn by the end of this year on rocketing oil prices, according to new research. The Institute of International Finance said the region’s public and private overseas wealth stood at $1,800bn at the end of 2007. ‘High oil prices are enabling the GCC [Gulf Co-operation Council] governments to place a growing volume of resources into reserve and wealth management funds, which will play increased roles in international financial markets,’ said Charles Dallara, managing director of the IIF… Sustained high oil prices will generate more capital spending and foreign investment as the GCC’s combined current account surplus should exceed $250bn in 2008, up from $215bn in 2007.”
January 16 – Bloomberg (Matthew Brown): “Saudi Arabian inflation accelerated to a record 6.5% in December, increasing pressure on the largest Arab economy to revalue its currency… Gulf states, including Saudi Arabia and the United Arab Emirates, are under pressure to revalue their currencies against the falling dollar to arrest rising inflation, which has accelerated to records in all six Gulf Arab states in the last 12 months.”
January 15 – Financial Times (Simeon Kerr and Roula Khalaf): “The central bank governor of the United Arab Emirates…called on the government to develop a comprehensive plan to tackle rampant inflation after ruling out de-pegging from the weak US dollar or revaluing the dirham. In an interview with the Financial Times, Sultan bin Nasser al-Suwaidi said rising rents were the main factor behind soaring inflation in the booming oil-driven economy.”
January 16 – Bloomberg (Matthew Brown): “Oman inflation accelerated to a record 7.6% in November as the cost of rents and food increased, the Ministry of Economy said. The cost of food increased 12.6%, while rents jumped 11%...”
The financial crisis took another giant leap this week. Credit insurer (“financial guarantor”) Ambac lost its AAA rating (from Fitch), in what will mark the onset of a devastating run of downgrades for the likes of Ambac, MBIA and the entire industry. The “monoline” insurance business, as we’ve known it, is done and the value of the insurance they’ve written is evaporating by the day. The market is now desperate to determine which financial institutions (and there are many) have purchased large amounts of (now suspect) insurance for hedging purposes, as well as other financial companies that have in one way or another participated in the Credit “reinsurance” market.
Virtually all the major financial players are embroiled in this Systemic Credit Fiasco. Importantly, the mind-blowing demise of the “financial guarantors” is fomenting a crisis of confidence in Credit insurance in all its various forms (certainly including the Credit default swap (CDS) and MBS guarantee markets). According to Bloomberg news, $2.4 TN of securities are at risk to the financial guarantor industry downgrades. I’m assuming that our policymakers will attempt to throw together some type of industry recapitalization strategy, although the complexity of the issue leaves one perplexed as to how any bailout plan would be structured. I suspect that our federal government will eventually be forced to enter the “financial guarantee” business, at least to the point of assuming the obligations of municipal bond (from the “monolines”) and mortgage-backed securities (from the GSEs) insurance.
The Credit system is today an incredible mess. Literally Trillions of securities, previously valued in the marketplace based upon confidence in the underlying financial guarantees, are now suspect. This has severely impacted marketplace liquidity. And perhaps tens of Trillions of Credit and other derivative contracts are now subject to very serious counterparty issues. Many players throughout the Credit market are now severely impaired and have lost the capacity to hedge against/mitigate further losses.
To be sure, Discontinuous and Illiquid Markets have Wreaked Bloody Havoc on “dynamic” trading strategies used commonly to hedge various risks. I don’t believe it is hyperbole to suggest that “dynamic hedging” (in particular shorting Credit instruments to provide the necessary cashflows to pay on Credit derivative contracts written) became the critical linchpin of contemporary Wall Street risk intermediation. Yet today the models behind so many strategies that have come to permeate “contemporary finance” have completely broken down; the strategies of thousands of financial institutions - big and small - have turned infeasible.
From a macro perspective, Wall Street Risk Intermediation has essentially crashed and the “risk markets” essentially “seized up.” Almost across the board, the major risk operators are moving aggressively to rein in risk-taking. The leveraged speculating community is in turmoil. The “quants” are in a quandary. Basically, the entire market today desires, at least to some extent, to reduce/mitigate/transfer Credit and market risk. Inevitably, however, when “the market” is keen to hedge there’ll be no one with the necessary wherewithal to take the other side of The Trade. I have so many fears I don’t even know where to begin, although I will say that I am less than comfortable these days discussing individual companies. Tonight the (brief) analysis will be in generalities.
There are scores of financial players – from small hedge funds to the major “money center banks” – with complex books of derivative trades that now have a very serious problem. These “hedged books” contain various supposedly offsetting risk exposures that, in there entirety, were to (through financial “alchemy”) have created a reasonable and manageable portfolio risk profile. But the breakdown in Wall Street finance has transformed these too often highly leveraged “books” into essentially unmanageable “toxic waste” and financial land mines.
First, correlations between various instruments have broken down (i.e. junk bond spreads widen while “dollar swap spreads” narrow). Second, the liquidity profile (hence pricing) of various sectors has diverged radically (i.e. agency MBS vs. “private-label” MBS/ABS) - with the Treasury market melt-up causing further destabilization. Third, with the breakdown in Wall Street’s “private-label” MBS market and the collapse in confidence in the “monoline” Credit insurers, liquidity has all but evaporated throughout huge cross-sections of the debt securities and related derivatives markets. This dynamic is fomenting dangerous counter-party risks and uncertainties. The capacity of a rapidly rising number of market participants to fulfill their obligations in various types of derivative and “insurance” contracts is in question.
Imagine you have a “hedged book” of securities and derivative – for example a portfolio of CDOs hedged with Credit Default Swaps (CDS) from one of the “monoline financial guarantors.” Today, the value of your CDO portfolio is declining while the “value” of your offsetting CDS hedge is impaired by the increasing likelihood of a default by the “monoline” (who provided the CDO default “insurance”). The reality is that the hedged position has broken down and risk now rises by the day. And, unfortunately, your options are decidedly limited - there is little if any liquidity to sell the underlying CDO. One could go into the market and attempt to buy additional protection, although in many cases the cost would be prohibitive. Besides, there’s today little assurance that counter-party risks wouldn’t emerge in the second hedge as well.
The Wall Street firms and many of the more sophisticated hedge funds run very complex “books” of securities and derivatives. The dilemma they face today is commensurate with the complexity of their strategies. Recent developments – in particular heightened marketplace illiquidity, rising probabilities of “monoline” defaults, dislocation in the CDS markets, and a breakdown in typical correlations between instruments/sectors/markets – makes the job of effectively comprehending, quantifying, analyzing and managing risk impossible. Do the managers, then, attempt the highly problematic task of recalibrating hedges based on current conditions (i.e. spiking hedging costs, likely counterparty defaults, and recent market correlations) and risk compounding the problem if market conditions begin to normalize? Is it feasible for these players to recalibrate hedges, knowing full well that our well-intentioned policymakers are destined to intervene clumsily in the marketplace?
It is difficult for me to believe the leveraged speculating community is not in serious jeopardy. It became all too commonplace to leverage illiquid (and difficult to price) securities, while even the previously liquid markets today barely trade. Few speculative Bubbles in history were as vulnerable to a “run.” None were remotely as gigantic or global in scope. This “community” today creates a systemic weak link on several fronts, certainly including the vulnerability to outsized losses and resulting redemptions instigating panic dynamics. Today, market illiquidity increases the likelihood that many funds will be forced to halt redemptions. This dynamic has commenced and it holds the potential to batter industry trust and confidence.
The leveraged speculators create various systemic risks. Their desire to hedge risk exposures – as well as seek speculative profits – during market turbulence has certainly exacerbated the Credit Crisis. During the cycle’s upside, their affinity for leveraging securities greatly amplified the liquidity bull run. Today, their selling/deleveraging/hedging foments liquidity crisis, fear and market dislocation. Importantly, the speculators are today keen to short stocks, sell futures, and purchase equity put options. The “hedge funds” have, after all, sold themselves as capable of minting money in any kind of market environment. This could prove a major systemic risk.
Leveraged speculator dynamics in concert with a Bursting Credit Bubble now places enormous strains on the stock market. Not only have faltering Credit Availability and Credit Marketplace Liquidity dramatically diminished the prospects for companies, industries and the general economy. Limited liquidity in the Credit market has also created a backdrop where those seeking to hedge (or profit from) heightened systemic risks have few places to go for relatively liquid trading outside selling stocks and equity index products. And sinking stock prices further aggravates the unfolding Corporate Credit Crisis, fostering only greater systemic stress and greater selling pressure. “Contemporary finance” is being exposed as a daisy-chain of interrelated weak underlying structures, unrecognized risks and acute fragilities.