One-month Treasury bill rates have "spiked" all the way to 13 bps, while three-month bills ended the week at 23 bps. Two-year government yields rose 7 bps to 0.84%. Five-year T-note yields surged 22 bps this week to 1.81%. Ten-year yields jumped 23 bps to 2.83%. Long-bond yields rose 28 bps to 3.67%. The implied yield on 3-month December ’09 Eurodollars jumped 20 bps to 1.535%. Benchmark Fannie MBS yields rose 36 bps to 4.33%. The spread between benchmark MBS and 10-year T-notes widened 13 to 147 bps. Agency 10-yr debt spreads widened 6 to 89 bps. The 2-year dollar swap spread increased 4.25 to 69.75 bps; the 10-year dollar swap spread increased 8.25 to 23.25 bps, while the 30-year swap spread declined 1.25 to negative 21.25 bps. Corporate bond spreads were mixed. An index of investment grade bond spreads narrowed 6 to 213 bps, while an index of junk bond spreads widened 16 to 1,279 bps.
Investment grade issuance included Bank of America $8.35bn, ConocoPhillips $6.0bn, AT&T $5.5bn, Goldman Sachs $2.0bn, Hell $1.25bn, General Mills $1.15bn, Huntington National $600 million, Entergy Texas $500 million, and Washington Post $400 million.
Junk issuers included Chesapeake Energy $1.0bn, Hess $250 million, and Inergy $225 million.
International issuers included ING Bank $6.0bn, Petroleos Mexicanos $2.0bn and Intelsat $400 million.
U.K. 10-year gilt yields added 2 bps to 3.70% (high since November), and German bund yields increased 6 bps to 3.29%. The German DAX equities index rallied 3.8% (down 9.8%). Japanese 10-year "JGB" yields ended the week 6 bps higher at 1.29%. The Nikkei 225 gained 3.2% (down 9.8%). Emerging markets were mixed. Brazil’s benchmark dollar bond yields dipped one basis point to 6.62%. Brazil’s Bovespa equities index gained 3.1% (up 4.7% y-t-d). The Mexican Bolsa rallied 1.1% (down 12.6% y-t-d). Mexico’s 10-year $ yields added 4 bps to 6.30%. Russia’s RTS equities index rallied 7.4% (down 15.3%). India’s Sensex equities index jumped 6.9% (down 2.3%). China’s Shanghai Exchange increased 1.8% (up 9.3%).
Freddie Mac 30-year fixed mortgage rates dipped 2 bps to 5.10% (down 58bps y-o-y), with a notable 13-wk decline of 136 bps. Fifteen-year fixed rates were unchanged at 4.80% (down 37bps y-o-y). One-year ARMs declined 2 bps to 4.90% (down 15bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates up 3 bps this week to 7.03% (up 47bps y-o-y).
Federal Reserve Credit dropped $59.4bn to $1.990 TN, with a historic 20-wk increase of $1.1 Trillion. Fed Credit expanded $1.125 TN over the past 52 weeks (130%). Fed Foreign Holdings of Treasury, Agency Debt last week (ended 1/28) rose $7.0bn to a record $2.548 TN. "Custody holdings" were up $438bn over the past year, or 21%.
Bank Credit fell $42.3bn to $9.801 TN (week of 1/21). Bank Credit expanded $468bn year-over-year, or 5.0%. Bank Credit jumped $409bn over the past 20 weeks. For the week, Securities Credit sank $28.1bn. Loans & Leases declined $14.2bn to $7.067 TN (52-wk gain of $198bn, or 2.9%). C&I loans added $2.1bn, with 52-wk growth of 8.5%. Real Estate loans jumped $10.6bn (up 4.7% y-o-y). Consumer loans added $0.9bn, while Securities loans fell $9.7bn. Other loans dropped $18.1bn.
M2 (narrow) "money" supply jumped $36.6bn to a record $8.257 TN (week of 1/19). Narrow "money" has now inflated at a 20% rate over the past 18 weeks and has jumped $794bn over the past year, or 10.6%. For the week, Currency jumped $3.7bn, while Demand & Checkable Deposits slumped $55.2bn. Savings Deposits surged $97.4bn, while Small Denominated Deposits declined $2.0bn. Retail Money Funds fell $7.1bn.
Total Money Market Fund assets (from Invest Co Inst) dropped $28.8bn to $3.904 TN, with a 52-wk expansion of $589bn, or 17.8% annualized.
Total Commercial Paper outstanding sank $98.9bn this week to a 13-wk low $1.590 TN. CP has declined $267bn over the past year (14.4%). Asset-backed CP declined $7.2bn to $742bn, with a 52-wk decline of $94bn (11.3%).
Asset-Backed Securities (ABS) issuance remains very light. Year-to-date total US ABS issuance of $1.3bn (tallied by JPMorgan's Christopher Flanagan) is a fraction of the $23.7bn for comparable 2008. There has been no home equity ABS issuance in months. Year-to-date CDO issuance is less than $300 million.
International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $468bn y-o-y, or 7.4%, to $6.757 TN. International reserves have declined $190bn over the past 15 weeks.
Global Credit Market Dislocation Watch:
January 29 – Bloomberg (Alan Purkiss): “George Soros, the billionaire U.S. investor, said President Barack Obama is confronted with challenges even more daunting than those that faced Franklin D. Roosevelt in 1933. Writing in the Financial Times, Soros said total credit outstanding at the onset of the crash last year was 365%, compared with 260% in 1932, and it’s certain to reach 500%. The pervasive use of derivatives, which was absent in the 1930s, is a complicating factor, he said.”
January 27 – Wall Street Journal (Greg Hitt and Elizabeth Williamson): “The U.S. economic stimulus package neared $900 billion in the Senate, as President Barack Obama wooed Republicans ahead of an expected House vote… The rare trip by a president to Capitol Hill revealed the urgency in Congress and the White House over a cure for the souring economy.”
January 30 – Wall Street Journal: “What if nearly half of U.S. banking assets turn out to be bad? As the Obama administration readies a plan for the stressed financial system, it is no doubt trying to work out the potential size of the bad-asset pool. It is no longer just subprime mortgages and exotic credit-boom securities that are considered toxic. A wide range of other assets -- from certain prime mortgages to commercial real estate to plain old credit-card loans -- are now experiencing soaring defaults as the economy worsens. Indeed, Goldman Sachs Group estimates that troubled assets could exceed $5 trillion…”
January 30 – Bloomberg (Ari Levy): “Banks in Florida, Maryland and Utah were closed today as regulators wrapped up the busiest month for failures since the housing slump began in 2006. Ocala National Bank in Florida and Suburban Federal Savings Bank of Crofton, Maryland, were shut by federal regulators…”
January 26 – Wall Street Journal (Mark Maremont): “In the latest effort to prop up a sector of the finance industry, federal regulators… guaranteed $80 billion in uninsured deposits at the powerful institutions that service the nation's credit unions -- a maneuver that shows how the economic crisis continues to ripple across the U.S. Regulators also injected $1 billion of new capital into the largest of these wholesale credit unions, U.S. Central Federal Credit Union of Lenexa, Kan., after the firm on Wednesday posted an unexpected $1.1 billion loss for 2008. U.S. Central serves essentially as a main clearinghouse for the others in the network. The vast majority of regular credit unions -- the bank-like cooperatives familiar to millions of account-holders nationwide -- are considered financially sound. Wednesday's moves affect only these wholesale credit unions, which number 28 and operate in the background to service regular credit unions.”
January 29 – Bloomberg (Rebecca Christie): “The U.S. Treasury agreed to commit as much as $60 billion to shore up the market for student loans and help reduce the illiquid assets clogging banks’ balance sheets, according to three people familiar with the matter. The department will use its Federal Financing Bank to provide a backstop… The program, which is outside of the $700 billion financial-rescue fund and doesn’t need new congressional action…”
January 30 – Bloomberg (Shelley Smith): “Nokia Oyj, the world’s largest mobile-phone maker, and Toyota Motor Corp. led the busiest month of bond sales in Europe for two years as companies rushed to benefit from investors’ increased appetite for corporate debt. Sales surged to 123 billion euros ($159 billion), a four- fold increase from December, and more than double the 51.2 billion euros of issuance in January 2008…”
January 30 – Bloomberg (Caroline Salas and Lynn Thomasson): “For the first time since August, the interest rate banks charge each other for three-month loans is less than 1 percentage point more than what the U.S. government pays to borrow. American companies sold $138 billion of bonds in January, the most since May, and even high-yield, high-risk junk debt had the best start to a year since 2001.”
January 30 – Bloomberg (Jeremy R. Cooke): “U.S. state and local government bond sales rose at least 25 percent this month, as borrowers revived deals delayed by last year’s record jump in tax-exempt yields. Issuers including New York state, Chicago and the Salt River Project utility in Arizona sold $21.8 billion of municipal bonds this month…”
January 27 – Bloomberg (Bryan Keogh): “Seventeen months after seizing up at the onset of the credit crisis, the $1.69 trillion commercial paper market may be the first to cut its reliance on federal bailout programs. About $245 billion of 90-day commercial paper that companies sold to the Federal Reserve starting in October will mature this week and next, central bank data show. As much as $50 billion to $70 billion of the debt may be rolled over and bought by investors, according to Barclays Capital in New York.”
January 27 – Wall Street Journal (Steve Stecklow): “Federal and state authorities are reporting a growing number of financial scams that echo the alleged Madoff fraud, as strapped investors seek access to their cash amid increasingly hard times. At least six suspected multimillion-dollar fraud cases have emerged this month alone, many of them alleged Ponzi schemes, in which investors are lured by promises of lofty returns but are actually paid off from new victims' funds."
January 30 – Bloomberg (Edward Evans and Christine Harper): “Jamie Dimon, chief executive officer of JPMorgan Chase… blamed banks and regulators for letting consumers amass debt like ‘weapons of mass destruction,’ leading to the global economic crisis. ‘God knows, some really stupid things were done by American banks and by American investment banks,’ Dimon said today… ‘To policy makers, I say where were they? They approved all these banks.’”
January 26 – Bloomberg (Tim Mullaney): “Venture-capital investment dropped 33% in the fourth quarter of 2008, hammered by a recession that drove software deals to their lowest levels in a decade and cut access to capital for alternative energy firms. Total investment in startup companies fell to $5.4 billion, the lowest total since early 2005…”
January 29 – Bloomberg (Mike Ramsey): “Ford Motor Co., the only U.S. automaker shunning federal loans, burned $5.5 billion in cash in the fourth quarter and said it will tap a revolving credit line after the worst annual performance in its 105-year history. Cash in Ford’s automotive business fell to $13.4 billion from $18.9 billion on Sept. 30...”
January 29 – Bloomberg (Matthew Leising): “Draft legislation that would change how over-the-counter derivatives are regulated might prohibit most trading in the $29 trillion credit-default swap market. House of Representatives Agriculture Committee Chairman Collin Peterson of Minnesota circulated an updated draft bill yesterday that would ban credit-default swap trading unless investors owned the underlying bonds. The document, distributed by e-mail by the committee staff in Washington, would also force U.S. trading in the $684 trillion over-the-counter derivatives market to be processed by a clearinghouse. ‘This would basically kill the single-name CDS market,’ said Tim Backshall, chief strategist at Credit Derivatives Research LLC… ‘Given the small size of many issuers’ bonds outstanding, this would make it practically impossible for the CDS market to exist.’”
January 26 – Bloomberg (Dawn McCarty and Tiffany Kary): “Smurfit-Stone Container Corp., a maker of cardboard packaging and one of the world’s largest paper recyclers, filed for bankruptcy… The petition… listed $5.6 billion in consolidated debt and $7.5 billion in consolidated assets as of Sept. 30.”
January 28 – Bloomberg (Neil Unmack): “U.K. commercial property prices may fall as much as 25% this year as banks curb lending to investors, according to Moody’s… By the end of the year, valuations in Britain may have dropped as much as 45% from their peak before the credit crisis started in 2007, Moody’s said… French real estate may fall as much as 20%, with a 15% decline in Germany…”
Currency Watch:
January 29 – Bloomberg (Emma O’Brien): “Russia’s ruble had its biggest two- day drop in a decade against the dollar… The ruble depreciated 3% today to 34.9189 per dollar, the weakest since January 1998.”
January 30 – Bloomberg (Theresa Barraclough and Shigeki Nozawa): “Forty percent of Japanese investors said there is a risk that the U.S. government will default on its debt, a survey published by Barclays Capital showed.”
The dollar index gained 0.4% this week to 86.55. For the week on the upside, the British pound increased 5.1%, the South Korean won 0.8%, the Canadian dollar 0.3%, and the Brazilian real 0.3%. On the downside, the New Zealand dollar declined 4.0%, the Australian dollar 3.0%, the Swedish krona 2.4%, the Mexican peso 2.2%, the Euro 1.5%, the Danish krone 1.5%, the Japanese yen 1.4%, and the Swiss franc 0.7%.
Commodities Watch:
January 29 – Bloomberg (Alex Morales): “The world is facing an ‘enormous’ challenge to feed a growing population because climate change is altering rainfall patterns and fresh water is becoming scarcer, the U.K. government’s top scientist said. Governments need to boost spending on agricultural research and reconsider options such as genetically-modified foods… John Beddington told the Environment, Food and Rural Affairs Committee.”
Gold surged 3.1% this week to a 3-month high $928 (up 5.2% y-t-d), and silver 5.9% to $12.64 (up 11.9% y-t-d). March Crude sank $4.87 to $41.60 (down 6.7% y-t-d). March Gasoline jumped 6.7% (up 18.9% y-t-d), while March Natural Gas declined 2.4 % (down 22% y-t-d). March Copper slipped 1.8% (up 2.5% y-t-d). March Wheat dropped 2.5% (down 7% y-t-d), and Corn fell 2.9% (down 6.9% y-t-d). The CRB index lost 2.4% (down 4.0% y-t-d). The Goldman Sachs Commodities Index (GSCI) dropped 4.1% (down 3.7% y-t-d).
China Watch:
January 28 – Financial Times (Gillian Tett and Andrew Edgecliffe-Johnson): “Wen Jiabao, the Chinese premier, on Wednesday struck a defiant pose in a keynote speech in Davos, insisting that China was already putting in place a sweeping package of measures to support its economy to ward off the threats posed by the global financial crisis. He also argued that western countries had been dangerously negligent in their own policies towards their financial institutions – and argued that this failure of banking management, couple with a culture of ‘low savings and high consumption’, was the key reason for the current global financial crisis.”
January 26 – Bloomberg (Dune Lawrence): “China will have difficulty balancing its budget this year as the government’s economic stimulus plan leads to higher spending and lower tax revenue, Finance Minister Xie Xuren said. China faces ‘very severe’ international and domestic economic conditions and officials must make sure they spend funds efficiently, Xie said…”
Japan Watch:
January 30 – Bloomberg (Jason Clenfield and Toru Fujioka): “Japan headed for its worst postwar recession as factory production slumped an unprecedented 9.6%, NEC Corp. said it will cut more than 20,000 workers and Hitachi Ltd. forecast a record loss.”
January 26 – Bloomberg (Makiko Kitamura): “Toyota Motor Corp. and other Japanese carmakers are eliminating almost 25,000 jobs this fiscal year as they cut production because of a plunge in global vehicle demand, Jiji Press said…”
January 29 – Bloomberg (Toru Fujioka): “Japan’s retail sales posted the largest decline in almost four years as households pared spending and became more concerned about job security. Sales fell 2.7% in December from a year earlier…”
India Watch:
January 29 – Bloomberg (Kartik Goyal): “Indian exporters have shed as many as 1 million jobs, more than 15 times a December estimate, amid the most protracted decline in overseas sales in a decade, the commerce ministry said.”
Asia Bubble Watch:
January 27 – Bloomberg (Francisco Alcuaz Jr.): “Philippine imports fell the most in 10 years in November as manufacturers reduced purchases amid slowing demand at home and abroad. Overseas purchases tumbled 31.5% from a year earlier to $3.48 billion…”
Latin America Watch:
January 27 – Bloomberg (Jens Erik Gould and Hugh Collins): “Mexico’s central bank said the economy will contract this year as the global financial crisis reduces demand for exports and slows consumer spending. Gross domestic product may shrink 0.8% to 1.8 percent in 2009 after growing 1.5% last year…”
Central Banker Watch:
January 29 – Bloomberg (Tracy Withers): “New Zealand reduced its interest rate by 1.5 percentage points to a record low, saying there’s room for further cuts to steer the economy out of a deepening recession. Reserve Bank of New Zealand Governor Alan Bollard trimmed the official cash rate to 3.5%...”
Unbalanced Global Economy Watch:
January 30 – Bloomberg (Theophilos Argitis): “Canada’s economy contracted in November by the most since the 2003 power outage, led by slumping production in the manufacturing and construction industries. Gross domestic product fell 0.7 percent, its second straight decline and the biggest drop since August 2003 when northeastern North America was hit by a power blackout…”
January 26 – Bloomberg (Chris Fournier and Doug Alexander): “Canada may sell up to a record C$100 billion ($82 billion) in debt this year, a 30% increase from 2008, to fund fiscal stimulus measures as the federal deficit climbs, according to estimates by three economists. The amount would be almost five times what the nation raised a decade ago… Canada posted 11 straight surpluses to this year.”
January 26 – Bloomberg (Jennifer Ryan): “U.K. home loan approvals declined in December as house prices fell, the British Bankers’ Association said. Banks granted 22,051 loans for house purchase, down 47% from a year earlier…”
January 27 – Bloomberg (Andrew Cleary): “U.K. beer sales dropped at an accelerating pace in the fourth quarter as the recession and a duty increase led to 2.2 million fewer pints being drunk each day, according to the British Beer & Pub Association. The quantity of beer sold fell 8.3% from a year earlier in the last three months of 2008…”
January 26 – Bloomberg (Simone Meier): “German exports to China surged 14.3% in the 11 months through November from the same period a year earlier, led by sales of machinery, cars and power generators.”
January 28 – Bloomberg (Emma Ross-Thomas and Ben Sills): “Spain’s economic contraction deepened in the fourth quarter as output shrank by the most in 16 years after the collapse of a construction boom forced consumers to rein in spending. The economy shrank 1.1%...”
January 29 – Bloomberg (Johan Carlstrom): “Swedish household credit grew at its slowest pace in almost six years at the end of last year… Household borrowing grew an annual 9% in December…”
January 26 – Bloomberg (Alex Nicholson): “Russians’ disposable income fell an annual 11.6% in December, Interfax reported, citing an unidentified government official with knowledge of Federal Statistics Service figures. Disposable income grew 2.7% in 2008 compared with a 12.1% pace in 2007…”
January 27 – Bloomberg (Alex Nicholson): “Russia may run a budget deficit this year equivalent to 7.6% of gross domestic product, Vedomosti reported, citing an unidentified government official.”
January 28 – Bloomberg (Helga Kristin Einarsdottir): “Iceland’s inflation rate jumped to 18.6% in January, the highest in 19 years, after last year’s slump in the krona pushed import prices higher. Inflation accelerated from 18.1% in December…”
Bursting Bubble Economy Watch:
January 27 – Bloomberg (Bob Willis): “Home prices in 20 U.S. cities declined 18.2% in November from a year earlier, the fastest drop on record, as foreclosures climbed and sales sank.”
January 27 – Wall Street Journal (Jane Zhang): “At least 25 states have enacted or proposed cuts in health-insurance programs for the poor, potentially leaving millions of patients with reduced levels of care or no coverage at all. The cuts come as states are making painful moves to close record budget deficits while facing increased demand for services.”
January 27 – Bloomberg (Lindsay Fortado and Linda Sandler): “Lawyers at Kirkland & Ellis LLP, home to former Whitewater prosecutor Ken Starr, are asking as much as $1,110 an hour for bankruptcy work even as creditors recover less of their loans from restructurings. Kirkland requested a top rate equal to $18.50 per minute for advising Tronox Inc. in its bankruptcy… Chicago-based Sidley Austin LLP and New York’s Skadden, Arps, Slate, Meagher & Flom LLP also requested hourly rates exceeding $1,000 in the last two months….as lenders’ recoveries are forecast by ratings company Moody’s… to drop 22% in the recession.”
MBS/ABS/CDO/CP/Money Funds and Derivatives Watch:
January 27 – Wall Street Journal (Nick Timiraos): “Rising defaults by affluent homeowners are raising the specter of another cloud over banks and investors… About 6.9% of prime ‘jumbo’ loans were at least 90 days delinquent in December, according to LPS Applied Analytics… The rate was up sharply from 2.6% a year earlier. In comparison, delinquencies of non-jumbo prime loans… climbed to 2.1% from 0.8% in December 2007… Moody’s has downgraded more than 75% of all prime jumbo loans originated in 2006 and 2007 that carried the top rating of triple-A. From 2002 to 2006, banks originated an average of $557 billion a year in jumbo loans, according to Inside Mortgage Finance… About 40% of the total was sold to investors as securities.”
Real Estate Bust Watch:
January 26 – Bloomberg (Dan Levy): “Home prices fell in 34 U.S. states in 2008 as it became harder to get a mortgage and foreclosures hammered property values, First American CoreLogic said. Prices for single-family detached houses fell a record 10.6% nationally, the biggest annual decline in data that goes back to 1976…First American said…”
January 27 – Wall Street Journal (Amy Hoak): “These days, a bigger home isn’t always a better one: Recent research suggests that homes being built today are getting smaller. The average size of homes started in the third quarter of 2008 was 2,438 square feet, down from 2,629 square feet in the second quarter, according to the U.S. Census Bureau. Similarly, the median size of homes started in the third quarter was 2,090, down from 2,291.”
January 28 – Bloomberg (Hui-yong Yu): “U.S. real estate investment trusts may pay more of their dividends in 2009 in stock rather than cash to save $10 billion a year in the credit crisis. ‘Seventy companies out of 100 are likely to do this,’ said Dean Frankel, who manages $1.3 billion of REIT shares at Urdang Securities… ‘It’s about liquidity and concerns over debt. Every dollar they have, the better.’”
Speculator Watch:
January 29 – Bloomberg (Edward Evans and Simon Clark): “Leveraged buyout firms that use debt to pay for takeovers are likely to be at the back of the line for loans as governments bail out banks and bolster lending oversight. ‘LBO loans have clearly got to be at the back of any government’s priorities,’ said Jon Moulton, founder of… private equity firm Alchemy Partners LLP. ‘If there’s a limited supply of credit, it must be better from society’s point of view for it to go toward supporting existing businesses rather than financing changes of ownership.’”
January 27 – Bloomberg (Gillian Wee): “North American college endowments lost an average of 22.5% on investments from July to November and the declines probably will get bigger after returns on private equity and real estate are calculated. The funds shed $94.5 billion in asset value in the five months ended Nov. 30, according to a study released…by Commonfund and the National Association of College and University Business Officers.”
Muni Watch:
January 29 – Bloomberg (Jeremy R. Cooke): “U.S. state and local government bonds are headed for their best monthly returns in eight years, rebounding from a rout in early December when tax-exempt yields soared to record highs relative to Treasuries. Tax-exempt bonds have gained 3.62% so far in January, according to Bank of America Merrill Lynch’s Municipal Master Index…”
California Watch:
January 29 – AFP: “The giant calculator outside Gov. Arnold Schwarzenegger’s office adds almost 500 dollars each second as California’s budget deficit balloons inexorably toward $40 billion. The California governor’s ‘deficit clock’ calculator is a graphic reminder of what the State Legislative Analyst’s Office calls ‘the fiscal crisis that has put our state on the edge of disaster.’ …state Controller John Chiang has warned the state could run out of cash as early as next week, saying payments might be deferred from Feb. 1. Chiang already has imposed a delay on tax refunds and has threatened to stop paying some bills… Moody’s… has warned of a possible downgrade in the California’s credit rating - which would make it more difficult and expensive for the state to borrow.”
New York Watch:
January 28 – Bloomberg (Henry Goldman): “Cash bonuses paid to New York City employees of Wall Street firms declined 44% last year amid record losses in the securities industry, [said] state Comptroller Thomas DiNapoli… Financial firms disbursed $18.4 billion in 2008 compared with $32.9 billion the previous year, DiNapoli’s office calculated…”
January 27 – Bloomberg (Peter S. Green): “Home prices in the Hamptons, New York’s oceanside resort favored by financiers and celebrities, fell 14% in the fourth quarter… The median price in Long Island’s Hamptons and the North Fork slid to $690,000 from $800,000 a year earlier… The number of sales dropped 41% and the inventory of properties rose 19%. ‘The market is in stagnation,’ said Paul Brennan, regional director for the Hamptons at Elliman. ‘If you sell in this market, it’s usually one of the three D’s: death, divorce or debt.’”
Inflationism: The Bane of Capitalism:
I’ve never liked (or used) the terminology “shadow banking system.” And while there have been notable highs and lows throughout the hundreds of years of industry history, when done well banking is a legitimate – as well as invaluable – business. Banking is always a critical facet of Capitalism. The effective pricing and distribution of finance throughout an economy are fundamental to the long-term success of Capitalistic systems.
For years now, I’ve referred to our expansive mechanism of non-bank Credit creation as “Wall Street finance,” and the proliferation of players operating in this space the “leveraged speculating community.” Unfettered Credit creation, endemic asset inflation, speculative excess and an unmatched concentration of financial wealth and power was the thrust of this historic Bubble. In stark contrast to sound banking, Wall Street finance was a destructive force imperiling our Capitalistic system through the distortion of market pricing, spending patterns and resource allocation. Unsound non-traditional finance fostered both a Bubble and Financial Mania of Historic Proportions.
I have been a somewhat reluctant supporter of recent policymaking. Fearing systemic collapse, it’s been my view that there has been no real alternative other than our government taking a major role in our post-Bubble financial and economic lives. I have also tried to limit criticism of our present team of policymakers, with the view that the great policy mistakes were made during the Bubble years. Post-Bubble policy mishaps are inevitable – and today’s backdrop explains why our “regulators” made catastrophic errors in accommodating the long Wall Street boom.
I find it somewhat puzzling that our Federal Reserve Chairman is not held more accountable for his flawed theories and critical role in accommodating precarious late-cycle financial excesses. James Lockhart, chairman of the Office of Federal Housing Enterprise Oversight that morphed into the Federal Housing Finance Agency, today enjoys a similar Teflon coating. But, candidly, I have to admit to being bewildered that my “analytical nemeses” over at Pimco have seemingly never been held in higher regard. I’m just waiting for the announcement that Mr. McCulley will be joining the Fed. He’s worked hard for it.
Over the years, Pimco and others have consistently trumpeted policy views that they label “Keynesian.” I've tried to offer counter arguments – and referred to their flawed framework as “Inflationism.” Pimco, after all, was the leading public voice espousing massive fiscal and monetary stimulus to ward off the horrible evil of “deflation” after the bursting of the tech Bubble. It apparently didn’t matter that mortgage debt was at the time expanding at double-digit rates, or that a strong inflationary bias was taking hold in our nation’s housing markets, or that “Wall Street finance” was clearly on course for runaway excess.
Not unexpectedly, employing so-called “Keynesian” stimulus to sustain an unwieldy Credit boom ended with disastrous results. The idea may have been for the system to compensate for financial stress and lost output attendant with the bursting of the technology Bubble, but the much greater effect was to stimulate already overheated financial mechanisms and asset markets. The end result was spiking the punchbowl right when the party was getting out of hand – ensuring terminal late-stage excesses wreaked absolute bloody havoc on system stability. And, you know, back then the “Inflationists” conveniently avoided discussing the myriad downside risks to artificially stimulating the Credit system. Apparently, it was a moot point because the risks associated with “deflation” were so much greater. They were completely wrong on this.
So, fast forward to January 2009. There you go again - Mr. McCulley and Mr. Gross are right out there (the kings of all media) espousing Inflationism (a.k.a. “Keynesianism”). I’m the first to admit that circumstances today are altogether different than 2002. For one, and in contrast to 2002, the Credit and economic systems are today actually in a post-Bubble environment. And most regrettably - and specifically because of the extreme excesses that emanated from an artificially extended boom – unprecedented government support has been necessary to thwart system implosion. The collapse of Wall Street finance and myriad asset Bubbles has significantly broadened the scope of asset price declines, attendant debt problems and economic disruption. No doubt about any of that. Yet at the same time, and as it was in 2002, I find it regrettable that pundits paint deflation risks as so catastrophic as to not even discuss the risks associated with a full-fledged bout of Inflationism.
I think it’s nuts to advise our policymakers to target asset prices. I think it’s nuts to focus policy on stoking a quick economic recovery. I think its nuts to even ponder the resurrection of the “shadow banks.” I disagree with the notion of trying to support prices in the debt securitization marketplace. Wall Street finance – all the sophisticated securities, the trillion of derivatives, myriad forms of Credit insurance, all the leveraged speculation, and all the nonsense – is bust and its not coming back as a force for directing finance to – and inflating prices of – the asset markets. There is no quick fix here.
The financial sector is a black hole right now. With myriad assets Bubbles having burst, there is an enormous amount of debt today insufficiently backed by asset values. At the same time, there is a tremendous amount of debt backed by households, businesses, municipalities and our federal government. In terminology I have used in the past, the Credit Bubble has left both the Financial Sphere and the Economic Sphere grossly inflated. Total system debt has been severely impaired.
There are enormous risks today associated with systemic reflation. For one, the scope of problem – the various sectors that could obviously benefit from artificial government stimulus – is almost unfathomable. There is very real risk at this point that policymaking is about to set course for bankrupting the country. The pundits are out there suggesting trillion dollar economic stimulus; trillions for the banks; hundreds of billions to support the securitization markets; and hundreds of billions more for households, businesses, and municipalities. There is a current need for “Trillions” and future needs for “Trillions” more. Once the Trillions start to flow there will be no easy way to end them.
Policymakers and pundits are in dire need of a framework where some type of “stimulus” cost/benefit analysis is at least attempted. I find the Pimco inflation laundry list without a discussion of costs and risks hard to swallow. At this point, focus on the securitization marketplace is a classic example of “throwing good ‘money’ after bad.” And with mortgage borrowing costs today at historic lows, I don’t believe housing markets should be policymakers' major focus going forward. In short, a focus on rejuvenating asset markets is the wrong course. Housing prices will be in retreat until they find a floor supported by local incomes.
Unfortunately, the protracted Credit boom severely distorted incomes (along with asset prices). With the goal of avoiding national bankruptcy, I suggest that policymakers focus on incomes as opposed to both asset markets and incomes. And the key is promoting sound long-term investment in real economic wealth creation. “Money” created today to artificially inflate asset prices and incomes will simply require more inflationary fuel next year and the year after. The focus instead needs to be on real investment in real things that produce real wealth. Haven’t we seen enough of the Illusion of Financial Wealth? Have we not seen enough to understand that Inflation is the Road to Ruin? Will we allow the Treasury market to go the way of private-label MBS?
I certainly don’t like the idea of the government setting investment policy. Let’s face it: it’s repulsive to have Washington dictating the allocation of financial and real resources. But the reality of the situation is that the Bubble’s aftermath has left unworkable financial and economic structures. On the financial side, the focus should be on recapitalizing the banking system and reducing the banks’ unmanageable burden of bad assets. With the overriding goal of not bankrupting the country, the broader securitization markets should be left to their own devices. On the real economy side, stimulus should be directed toward funding businesses, capital investment and national infrastructure projects. The focus should be on stabilizing the economy as it transitions away from a “services”/asset-based economic model. “Money” should be directed toward jobs rather than home and asset prices.
The entire notion of the government and Fed manipulating market prices should have been discredited by now. Granted, in past crisis the Greenspan Fed was too successful at manipulating the cost of finance and dictating the behavior (expanding leveraging and risk-taking) of the speculating community. It may have worked miraculously more than a few times, but that entire “Monetary Process” has now collapsed. To be sure, we will not come out of today’s mess by inflating financial claims. Various forms of financial Keynesianism will do no more than create phantom recovery and the need for only greater inflation not far down the road.
Extraordinary government interventions were necessary to stabilize the financial system. But attempts to stimulate quick economic recovery and the rejuvenation of asset prices come with great risks. There is no resurrecting the old boom. The focus should instead be on supporting the financial and economic systems toward a path of much less dependency on Credit growth and the asset markets.