Three-month Treasury bill rates sank 35 bps this past week to 1.84%. Two-year government yields fell 39 bps to 1.84%. Five-year T-note yields declined 35 bps to 2.49%, and ten-year yields fell 29 bps to 3.51%. Long-bond yields declined 15 bps to 4.42%. The 2yr/10yr spread ended the week at 187 bps. The implied yield on 3-month December ’08 Eurodollars dropped 35 bps to 2.215%. Benchmark Fannie MBS yields dropped 37 bps to 5.35%, this week modestly out-performing Treasuries. The spread between MBS and Treasuries declined to a still quite wide 183 bps. The spread on Fannie’s 5% 2017 note was 2 wider at 74 bps and the spread on Freddie’s 5% 2017 note one wider at 72 bps. The 10-year dollar swap spread declined 3.7 to 71. Corporate bond spreads were mixed but wide. An index of investment grade bonds spreads was 2 narrower at 151, and an index of junk bonds spreads was 6 narrower at 594 bps.
February 29 – Bloomberg (Bryan Keogh and Gabrielle Coppola): “Hewlett-Packard… led $63.4 billion in bond sales this month as investment-grade debt posted the worst February returns in a decade… Sales fell about a third from a year ago…”
Debt issuance picked up. Investment grade issuance included Citigroup $2.5bn, McDonald's $2.25bn, Computer Sciences $1.7bn, Honeywell $1.5bn, Pacific G&E $1.1bn, Fifth Third Bank $1.0bn, Biogen $1.0bn, Archer Daniels $700 million, Avon Products $500 million, Clorox $500 million, Peco Energy $500 million, Whirlpool $500 million, Hartford Financial $500 million, and UST $300 million.
Junk issuance included Rock-Tenn $200 million.
Convert issuance included National Retail Properties $220 million.
International dollar bond issuance included KFW $3.0bn.
German 10-year bund yields declined 11 bps to 3.89%, while the DAX equities index fell 0.9% (down 16.4% y-t-d). Japanese “JGB” yields sank 9.5 bps to 1.355%. The Nikkei 225 rallied 0.8% (down 11.1% y-t-d and 22.7% y-o-y). Emerging debt and equities markets were wild, with bond prices going into melt-up mode at the end of the week. Brazil’s benchmark dollar bond yields sank 20 bps to 5.62%. Brazil’s Bovespa equities index declined 1.7% (down 0.6% y-t-d). The Mexican Bolsa fell 2.1% (down 2.1% y-t-d). Mexico’s 10-year $ yields sank 24 bps to 5.02%. Russia’s RTS equities index was little changed (down 9.9% y-t-d). India’s Sensex equities index recovered 1.3%, reducing y-t-d declines to 13.4%. China’s Shanghai Exchange slipped 0.5% this week (down 17.4% y-t-d).
Freddie Mac posted 30-year fixed mortgage rates jumped 20 bps this week to 6.24%, with rates up 57 bps in three weeks to the highest level since November (up 6bps y-o-y). Fifteen-year fixed rates rose 8 bps to 5.72% (down 20bps y-o-y). One-year adjustable rates jumped 13 bps to 5.11% (down 38bps y-o-y).
Bank Credit expanded $19.5bn during the most recent data week (2/20) to $9.333 TN. Bank Credit has now posted a 31-week surge of $690bn (13.4% annualized) and a 52-week rise of $956bn, or 11.4%. For the week, Securities Credit fell $15.2bn. Loans & Leases jumped $34.6bn to a record $6.885 TN (31-wk gain of $560bn). C&I loans gained $4.3bn, with one-year growth of 21.4%. Real Estate loans expanded $12.9bn (up 7.3% y-o-y). Consumer loans increased $1.9bn. Securities loans jumped $9.7bn, and Other loans gained $5.9bn. Examining the liability side, Deposits increased $30.7bn.
M2 (narrow) “money” supply increased $12.6bn to a record $7.597 TN (week of 2/18). Narrow “money” expanded $135bn over the past seven weeks, with a y-o-y rise of $484bn, or 6.8%. For the week, Currency added $0.2bn, and Demand & Checkable Deposits increased $3.0bn. Savings Deposits gained $7.6bn, while Small Denominated Deposits declined $2.7bn. Retail Money Fund assets rose $4.5bn.
Total Money Market Fund assets (from Invest Co Inst) jumped $19.8bn last week (8-wk gain $315bn) to a record $3.428 TN. Money Fund assets have posted a 31-week rise of $844bn (55% annualized) and a one-year increase of $1,030bn (43%).
Asset-Backed Securities (ABS) issuance slowed to a paltry $360 million. Year-to-date total US ABS issuance of $31bn (tallied by JPMorgan) is running only 26% of the level from comparable 2007. Home Equity ABS issuance of $197 million compares to $66bn in early 2007. Year-to-date CDO issuance of $2.4bn compares to the year ago $61.4bn.
Total Commercial Paper jumped $23.5bn to $1.841 TN. CP has declined $383bn over the past 29 weeks. Asset-backed CP gained $7.6bn (29-wk drop of $403bn) to $792bn. Over the past year, total CP has contracted $170bn, or 8.5%, with ABCP down $258bn, or 24.6%.
Fed Foreign Holdings of Treasury, Agency Debt last week (ended 2/27) rose $11.2bn to a record $2.141 TN. “Custody holdings” were up $85.0bn y-t-d, or 23.9% annualized, and $308bn year-over-year (16.8%). Federal Reserve Credit was little changed at $866.6bn. Fed Credit has contracted $6.9bn y-t-d, or 4.6% annualized, while having expanded $13.1bn y-o-y (1.5%).
International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $1.340 TN y-o-y, or 26.7%, to a record $6.352 TN.
Global Credit Market Dislocation Watch:
February 29 – Bloomberg (Abigail Moses): “Credit markets headed for the worst two months on record amid investor concern that mounting losses on securities linked to home loans will trigger bank failures, according to traders of credit-default swaps. Contracts on the benchmark Markit iTraxx Europe index jumped 14.25 basis points to 127.5… more than double the 50 basis points at the start of the year… The CDX North America Investment Grade index rose the most in one day yesterday, soaring 14.5 to 153.5.”
February 28 – Financial Times: “Investors must be feeling a little like Hercules. Each time they chop off one of the Hydra’s heads threatening the markets, another pops up. Last year investors obsessed over leveraged loans and their ability to destabilise bank balance sheets. The threat of big writedowns evaporated for a while; market dislocations did not. In another example, structured investment vehicles took centre stage. The Treasury even tried to broker a bail-out. The issue eventually fizzled but market instability did not. The same probably applies to the monolines. The obscure bond insurers have become an obsession with investors, with markets moving wildly on news related to a bail-out. But even if their ratings are stabilised, it is unlikely to mark a sudden end to the credit crisis. Two huge forces remain at work: a slumping US real estate market and repricing of credit.”
February 29 – Bloomberg (Abigail Moses): “Financial firms are likely to face at least $600 billion of losses from the financial crisis, UBS AG analysts said… Financial institutions have written down or lost about $160 billion so far.”
February 29 – Bloomberg (Hugh Son): “American International Group Inc. said the head of its financial products unit, Joseph Cassano, is stepping down after the insurer reported $11.1 billion in losses on contracts sold to fixed-income investors. Cassano co-founded the unit in 1987 and built it into a business providing financial guarantees on more than $500 billion of assets at year-end, including $61.4 billion in securities tied to subprime mortgages.”
February 29 – MarketWatch (Alistair Barr): “Hedge funds that trade municipal bonds have been hit by margin calls in recent days and some are having to sell positions to meet those obligations, according to a leading investor in the market… The disruptions have encouraged banks and brokers that lend money to muni hedge funds to pullback and impose more margin calls… ‘The market is in further disarray the last two days as a number of muni hedge funds are being forced to liquidate to meet margin calls,’ Mark McCray, head of muni bonds at Pimco, said. ‘The widening of munis versus Treasurys has been a negative and broker dealers have upped their margin requirements for hedge funds. As such these funds are trying to liquidate into this illiquidity.’”
February 29 – Bloomberg (Jeremy R. Cooke): “U.S. municipal bonds are headed for their worst month in more than four years after collapsing demand for securities with rates set at periodic auctions sent debt costs for state taxpayers and hospitals as high as 20%... State and local government bonds fell 4.17% through yesterday…”
February 28 – Bloomberg (Michael Quint): “Local government officials from New York to Houston who followed the advice of their bankers and issued auction-rate bonds in combination with interest-rate swaps are now getting squeezed by both. States, cities and hospitals across the country expected yields on the debt to move in tandem with benchmark rates when they bought swaps to protect against rising interest costs. Instead, the bonds' rates are up an average 3.1 percentage points since September, while the one-month London interbank offered rate -- what banks charge each other for funds -- has dropped 2.7 points. ‘It’s a universal problem,’ said Debra Sloan, director of capital markets at…Partners Healthcare System Inc., which has interest-rate swaps on $450 million of its $600 million in auction securities. ‘We try to structure them so that over time there is a match.’ The failure of the financial instruments compounds the pain for borrowers stuck paying record-high interest on auction-rate debt billed as a cheap alternative to traditional bonds.”
February 28 – Bloomberg (Michael McDonald and Michael Quint): “U.S. state and local governments are paying more for their variable-rate bonds as disruptions that first appeared in the market for auction-rate securities widen. The benchmark weekly interest rate that tax-exempt issuers pay more than doubled in the past two weeks as investor demand waned on skepticism about the finances of insurers backing the debt. The Wall Street dealers who help to find buyers for so- called variable-rate demand obligations have also refused to hold the debt when they can’t attract investors, mirroring the breakdown of the auction market, investors and issuers said. ‘The variable-rate demand market worked fine as long as everybody was confident that at the end of the day somebody would open their checkbook and buy the bonds,’ said Lance Pan, director of investment research at Capital Advisors Group….”
February 29 – Bloomberg (Shannon D. Harrington): “MBIA Inc. is writing ‘very little’ new bond insurance business as borrowers balk at buying a guarantee from a money-losing company without stable AAA credit ratings.”
February 29 – Bloomberg (Emma Moody): “Ambac Financial Group Inc., seeking to avoid a crippling credit rating downgrade, cut its dividend and will suspend writing guarantees on new asset-backed securities for six months to bolster capital.”
February 28 – Financial Times (James Mackintosh): “One of London’s most successful hedge funds imploded Thursday when Peloton Partners put the assets of its $2bn flagship fund up for sale and froze its remaining fund after geared mortgage bets left it unable to meet lenders’ demands. Rumours of the crisis at Peloton’s ABS fund, named best new fixed-income hedge fund last month, helped drive the high-quality mortgages in which it was invested to all-time lows this week as traders prepared for $9bn of assets to be dumped. The losses are particularly striking because Peloton ABS was one of the big winners from the US subprime crisis, gaining 87% last year after betting against low-quality mortgages. But last month Ron Beller, co-founder, told the Financial Times that the firm had begun investing in ‘good-quality assets that are trading at deeply discounted prices’ – including a large position in AAA-rated mortgages… ‘It is the classic story of when leverage goes wrong,’ one investor said. ‘But I can’t believe this problem is confined to these guys alone.’”
February 29 – Bloomberg (Pierre Paulden and Caroline Salas): “Peloton Partners LLP, the London- based hedge fund manager being forced to liquidate a $1.8 billion asset-backed fund, said it’s a victim of Wall Street's reduced lending. ‘Credit providers have been severely tightening terms without regard to the creditworthiness or track record of individual firms, which has compounded our difficulties and made it impossible to meet margin calls,’ Peloton co-founders Ron Beller and Geoff Grant said in a letter yesterday to clients.”
February 29 – The Wall Street Journal (Carrick Mollenkamp, Gregory Zuckerman and Cassell Bryan-Low): “In a move reflective of how banks are moving quickly to deal with troubled borrowers, lenders have seized assets held by troubled London hedge fund Peloton Partners LLP… The moves by the banks come as they try and recoup some of the money they loaned the fund.”
February 28 – Bloomberg (Jody Shenn): “Securities backed by Alt-A mortgages and other home loans to borrowers with better-than-subprime credit tumbled this month, causing investment funds to unwind or meet margin calls and signaling larger losses for Wall Street… Valuations for AAA rated securities backed by Alt-A loans, deemed between prime and subprime in terms of expected defaults, slumped 10% to 15% this month, partly because it's so difficult to trade or find prices for them, Thornburg Mortgage… said… ‘There really hasn’t been an orderly two-sided market in 2008,’ Arthur Frank, a mortgage-bond analyst…at Deutsche Bank AG, said…”
February 27 – Bloomberg (Neil Unmack): “Investors could be forced to wind down as much as $150 billion of collateralized debt obligations if rating companies adopt proposals made by Fitch Ratings on the way the securities are graded, according Royal Bank of Scotland Group Plc. Fitch is considering changing its criteria for CDOs backed by company debt to reflect higher risks of default and lower recovery rates.”
February 26 – Dow Jones (Mark Brown): “Two years after the so-called ‘correlation crisis’ hit trading in credit derivatives, bankers fear that a second crisis is brewing as correlation hits fresh highs. Correlation describes the likely pattern of defaults that some credit market participants anticipate. High correlation means markets are expecting a broad-based or ‘systemic’ deterioration in credit conditions. When correlation is low, credit risk is ‘idiosyncratic,’ meaning default risk is seen as focused on specific companies or sectors. Correlation is driven up or down by investors who trade different slices, or tranches, of credit default swap indexes.”
February 28 – Financial Times (Michael Mackenzie): “Banks working on injecting up to $3bn into Ambac, the bond insurer, in the hope of staving off ratings downgrades and preventing the need for writedowns, might face further losses indirectly related to bond insurers, analysts have warned. The latest source of concern is variable interest entities (VIEs), another three-letter acronym that now holds toxic properties… VIE is an accounting term that covers a multitude of activities in almost any kind of special purpose vehicle - from conduits and structured investment vehicles (SIVs) to individual CDOs themselves… Accounting for VIEs has been increasingly in the spotlight since US banks began to reveal more details about their exposure to various vehicles, such as the asset-backed commercial paper conduits used to fund investment in mortgage-backed bonds and other structured debt.”
February 28 – Financial Times: “According to Dealogic, total leveraged buy-out volume so far in 2008 is down two-thirds year-on-year, at $34bn. Just one of last year’s mega-deals would dwarf that number. When leveraged loan volumes last collapsed, after 2000, they took three years to recover.”
February 27 – Bloomberg (Neil Unmack and Shannon D. Harrington): “Sigma Finance Corp., the investment company run by London-based asset manager Gordian Knot Ltd., may have its Aaa ratings on $27 billion of debt cut by Moody’s… A drop in holdings of more than 3 cents on the dollar since late July and ‘continued inability to issue senior debt’ have helped increase the risk that the company won’t be able to repay investors, Moody’s said… ‘Asset prices have continued their unprecedented decline,’ Moody’s analysts…said…”
February 23 – The Oregonian (Jeff Manning): “Local cities, ports, hospital chains and colleges face significantly higher interest payments on some of their outstanding debt, another impact of the national mortgage bust that continues to bruise the U.S. economy. The city of Portland, the Port of Portland, Oregon Health & Science University, Reed and Lewis & Clark colleges and PeaceHealth, the hospital chain…combined hold a total of more than $1 billion in outstanding debt on so-called auction rate bonds… ‘Investors have just lost confidence in the whole market,’ said Ed McFarlane, Reed's treasurer.”
February 27 – Bloomberg (Adam L. Cataldo): “The Pennsylvania Higher Education Assistance Agency will stop making loans next month because of increasing interest costs paid on auction-rate bonds. The agency services and buys existing obligations and makes about $500 million in new loans annually, said chief financial officer Tim Guenther. Officials, who made 140,000 student loans in the 12 months through June 30, said they will halt making new ones on March 7. ‘The decision was taken because with the auction rates resetting where they are, bringing on new loans is a guaranteed loss at this time,’ Guenther said. ‘Basically, since Feb. 13 every auction has failed.’”
February 27 – Financial Times (Joanna Chung): “Yields on bonds issued by eurozone governments are diverging more widely than at any time since the 1999 creation of the euro, a stark sign that the global credit crisis is infecting sentiment in traditionally safe European sovereign debt markets. The development is being fuelled by investors who have been shunning bonds considered more risky and instead buying those of Germany - the region's largest and most liquid market. The result is that governments whose bonds trade in smaller, less-liquid markets have to pay higher risk premiums to sell their bonds than they did before, threatening to push up the cost of borrowing for some governments.”
Currency Watch:
February 28 – Financial Times (Javier Blas, Robert Cookson and Sarah O’Connor): “It was D-day for the dollar yesterday – ‘D’, as in downward, devalued and dumped. The greenback sank to all-time low versus a basket of currencies, and broke through the psychological $1.50 level against the euro, as Ben Bernanke suggested that he would continue to cut interest rates to prop up the US economy. The emphasis on growth rather than inflation by the chairman of the US Federal Reserve prompted investors to seek refuge in real assets such as gold and crude oil as a hedge against future inflation… Ashraf Laidi, of CMC Markets in New York, said: ‘The record lows in the US dollar and the record highs in gold and oil mark a key tipping point in currency markets.’ He added that, rather than subscribing to the notion that the Fed’s aggressive rate cuts were a positive for the US economy and hence for the dollar, the greenback was ‘being damaged across the board on the notion that the ultra low interest rates at the expense of escalating inflation is the only way forward.’”
February 28 – Bloomberg (Chris Young and Lilian Karunungan): “The Australian dollar rose to its highest level in almost 24 years on speculation the nation’s interest-rate advantage over the U.S. will keep widening.”
The prospect of more desperate Fed rate cuts hit the dollar index for 2.4%, ending the week at 73.71. For the week on the upside, the Swiss franc gained 4.7%, the Japanese yen 4.2%, the Danish krone 2.5%, the Euro 2.4%, the Norwegian krone 1.9%, and the Swedish krona 1.8%. It is worth noting that the two big gainers were the low yielding "carry trade" currencies. On the downside, the South African rand fell 2% and the New Zealand dollar 1.6%.
Commodities Watch:
February 26 – Bloomberg (Marianne Stigset): “The price of pasta in Italy, the world’s biggest consumer of the food, is set to soar as wheat climbs to records, the chief executive officer of the nation’s largest flour miller said. ‘Agflation in products such as pasta needs to correspond to the underlying commodity and the price of durum wheat has more than tripled in the past couple of months,'' Antonio Costato said… ‘The price of pasta has been increased by 10%. That’s only the beginning.’”
February 26 – Bloomberg (Hugo Miller): “Norilsk, the world’s biggest producer of nickel, is building its own shipping fleet to capitalize on the melting of the polar ice caps… The thawing sea ‘has enormous economic implications, and commerce is going to push this ecological zone to the limit,’ says Rear Admiral Timothy McGee, head of the U.S. Navy’s Meteorology and Oceanography Command.”
Gold jumped 3.1% to a record $974 and Silver a whopping 9.7% to $19.92. May Copper added 1.4%. April Crude surged $2.90 to a record $101.71. April Gasoline dipped 0.3%, while April Natural Gas gained 1.7%. March Wheat rose 2.2%. The CRB index surged 3.5% to a new record (up 15% y-t-d). The Goldman Sachs Commodities Index (GSCI) gained 2.9%, also to a new record (up 11.4% y-t-d and 52.6% y-o-y).
China Watch:
February 28 – Bloomberg (Zhang Dingmin): “China’s economic growth will slow to 10.5% in the first quarter on weaker overseas sales and after the worst snowstorms in 50 years disrupted consumer spending and investment, the State Information Center said.”
February 28 – Financial Times (Jamil Anderlini): “Chinese banks will announce record profits for 2007 in coming weeks in contrast with their global counterparts… But 2008 will be much more challenging as a global slowdown spills over into China and the government attempts to cool the economy and head off rising inflation. Some of the country’s biggest banks…have already said their earnings rose by more than 60% year-on-year in 2007 and analysts say net profits for the industry grew by a similar amount.”
February 26 – Bloomberg (Xiao Yu): “The average wholesale price of steel products in China, the world's largest user of the metal, climbed 26.1% in January from a year earlier, the nation’s central bank said…”
February 26 – Bloomberg (Chia-Peck Wong): “The value of new mortgages granted in Hong Kong more than doubled last month to the highest in a decade as falling interest rates and accelerating inflation fueled demand for loans.”
February 29 – Bloomberg (Chia-Peck Wong): “Hong Kong lending rose 20% in January as the city’s economic growth and low interest rates fueled demand.”
Asia Bubble Watch:
February 26 – Bloomberg (James Peng): “Taiwan’s export orders rose more than forecast in January and industrial production expanded at the fastest pace in three months on increased demand from China and the Middle East. Orders, indicative of shipments over the coming one to three months, advanced 16.89% from a year earlier…”
February 25 – Bloomberg (Shamim Adam): “Singapore’s inflation accelerated in January at the fastest pace since 1982, increasing pressure on the central bank to allow its currency to appreciate further. The consumer price index jumped 6.6% from a year earlier, after gaining 4.4% in December…”
February 27 – Bloomberg (Stephanie Phang): “Malaysia’s economy expanded at the fastest pace in more than three years last quarter as higher commodity prices and government spending spurred domestic demand, pushing 2007 growth above government forecasts. Southeast Asia’s third-largest economy grew 7.3%...”
February 27 – Reuters: “Vietnam estimated its consumer price index for February rose 15.67% from a year earlier, the strongest increase in more than 12 years, underlining the global and domestic price pressures affecting the economy. High prices of food, fuel and housing are giving Vietnam’s Communist Party government one of its biggest challenges as it pursues faster economic growth and market reforms.”
India Watch:
February 29 – Bloomberg (Kartik Goyal): “India’s economy grew at the slowest pace since 2005 last quarter as interest rates near a six-year high curbed consumer spending. Asia’s third-largest economy expanded 8.4%...”
February 29 – Bloomberg (Anoop Agrawal): “Money supply growth in India accelerated to 21.5% in the two weeks ended Feb. 15 from a year earlier…”
Unbalanced Global Economy Watch:
February 27 – Bloomberg (Simone Meier): “Money-supply growth in the 15-nation euro region slowed less than economists forecast in January, limiting the European Central Bank’s scope to cut interest rates. M3 money supply… rose 11.5% from a year earlier, after gaining 11.6% in December…”
February 28 – Financial Times (Jonathan Guthrie): “As Britain’s economy slows, the gloom felt by its middle class has led to the acquisition of a new label: the coping class. The term, invented by an Irish politician, has been enthusiastically adopted by the media who deploy it as a display of empathy with their readers and listeners. Recent news suggests that middle-class Britons are right to feel financially squeezed.”
February 24 – Bloomberg (Heather Smith): “French supermarket food prices rose faster than raw material costs, Le Parisien said today, citing a study by the Institut National de la Consommation that will be published tomorrow. The…consumer group found the biggest price jumps were for baby milk, pasta, ham and yogurt, which climbed between 40% and 48% in a six-week period…”
February 28 – Bloomberg (Helene Fouquet): “Consumer confidence in France fell to a record low in February as the fastest inflation in 12 years squeezed purchasing power.”
February 25 – Bloomberg (Ben Sills): “Producer prices in Spain accelerated in January to the fastest pace in 20 months… The price of goods leaving Spain’s factories, farms and mines rose 6.6 percent from the year-earlier period after a 5.9 % increase in December…”
February 29 – Bloomberg (Robin Wigglesworth): “Norway’s domestic credit growth was little changed at 14.3% in January as the impact of the biggest wage gains in six years was offset by seven interest rate increases last year.”
February 27 – Bloomberg (Robin Wigglesworth): “Norway’s jobless rate fell to the lowest since at least 1989 in the three months through January after the fastest economic growth in 26 years boosted demand for workers. The seasonally adjusted rate fell to 2.4%...”
February 26 – Bloomberg (Tasneem Brogger): “Iceland’s inflation rate…accelerated to 6.8% from 5.8% in January…”
Central Banker Watch:
February 26 – Bloomberg (Craig Torres): “Federal Reserve Vice Chairman Donald Kohn said turmoil in credit markets and the possibility of even slower economic growth pose a ‘greater threat’ than inflation. ‘I do not expect the recent elevated inflation rates to persist,’ Kohn said… ‘The adverse dynamics of the financial markets and the economy have presented the greater threat to economic welfare in the United States.’”
February 26 – Bloomberg (Svenja O’Donnell): “The Federal Reserve has ‘rock solid’ credibility on inflation and has kept a lid on consumers’ price expectations, U.S. Treasury official Phillip Swagel said. ‘Expectations remain contained,’ Swagel said… ‘The Fed have really worked within the dual mandate’ and ‘the Fed’s credibility on inflation is really strong, it’s rock solid,’ he said.”
February 27 – Bloomberg (Gabi Thesing): “German import prices, an early indicator of inflation pressure in the economy, rose the most in 16 months in January, led by surging energy costs. The price of imported goods gained 5.2% from a year earlier…”
February 27 – Dow Jones: “The market ‘clearly underestimates’ euro-zone inflation risks, Axel Weber, a member of the European Central Bank's governing council, said Wednesday. ‘Interest rate expectations for the euro zone don't reflect the monetary policy assessment of a central bank that is committed to price stability,’ Weber told politicians…”
Bursting Bubble Economy Watch:
February 26 – Bloomberg (Aliza Marcus): “Medical spending by employers, insurers, individuals and the government will outpace economic growth in the U.S. by about 2 percentage points a year, consuming $1 of every $5 spent by 2017, a study found. Health-care costs made up 16% of the economy last year, costing about $2.2 trillion, according to…economists for the…Medicare program…”
February 26 – Bloomberg (Michelle Fay Cortez): “American men, favoring Botox injections and liposuction, underwent 17% more cosmetic procedures in 2007 to more than 1 million treatments, according to the American Society for Aesthetic Plastic Surgery… Botox, the biggest product from… Allergan Inc., generated $1.21 billion in sales last year, a 23% gain…”
GSE Watch:
February 28 – Bloomberg (Junko Fujita): “Fannie Mae, the largest source of money for U.S. home loans, may have its bank financial strength rating cut by Moody’s… because of a record $3.55 billion fourth-quarter loss. The loss ‘represents a significant deterioration of surplus regulatory capital’ from $3.9 billion in December, Moody’s said… Fannie Mae is likely to have ‘sizable losses’ in the first half of 2008 and may have a net loss for the year.”
February 28 – Financial Times (Saskia Scholtes and Francesco Guerrera): “Fannie Mae and Freddie Mac, the US government-sponsored mortgage financiers, were given a green light to expand their loan portfolios yesterday amid mounting evidence that the US housing slump is deepening. The move by the companies' regulator came after Fannie reported a $3.6bn fourth-quarter loss and triggered wild swings in US financial markets as investors debated whether Fannie and Freddie were in a strong enough position to help the housing sector significantly.”
Mortgage Finance Bust Watch:
February 26 – Bloomberg (Sharon L. Lynch): “Bank seizures of U.S. homes almost doubled in January as property owners failed to make higher payments on adjustable-rate mortgages. Repossessions rose 90% to 45,327 last month from the same period a year ago, according to RealtyTrac Inc… ‘The most troubling thing is that we are seeing more and more of these properties actually going all the way through the process and going back to the banks,’ Rick Sharga, executive vice president of…RealtyTrac, said… The rate of foreclosure filings in Nevada continued to lead the nation, with 6,087 properties in default or having been repossessed… California had the highest total number of default and foreclosures with 57,158 properties facing possible seizure last month. That was more than double the year-earlier figure and was up 7% from December. Florida had the second-highest number of homes in default or foreclosure with 30,178 in January, more than double the figure for the prior year…”
February 26 – Dow Jones: “Countrywide Financial flip-flopped on whether it will continue making loans to buy high-rise condominiums, reversing a decision telling brokers that certain mortgages would no longer be available, brokers said.”
MBS/ABS/CDO/CP/Money Funds and Derivatives Watch:
February 29 – Bloomberg (Jody Shenn): “Standard & Poor's said it may cut ratings on $12.9 billion of securities backed by Alt-A mortgages because of a ``persistent rise'' in delinquencies on the loans… The ratings action is S&P’s largest so far on Alt-A bonds, whose prices fell to new lows this month… The default rate on such mortgages quadrupled in November from a year earlier, according to Friedman Billings Ramsey Group Inc.... About $950 billion of Alt-A securities are outstanding, compared with about $650 billion of subprime securities, according to Deutsche Bank AG analyst Arthur Frank… Last year, S&P downgraded more than 400 Alt-A securities created in 2005, about 1,000 from 2006, and roughly 900 from 2007, including repeat actions on the same bonds. Alt-A securities issuance plunged to $5.4 billion in January, compared with about $249 billion for all of last year and $365 billion in 2006…”
Real Estate Bubble Watch:
February 26 – The Wall Street Journal (Kelly Evans, Serena Ng and Ruth Simon): “The decline in U.S. home prices accelerated in the fourth quarter… The S&P/Case-Shiller national home-price index for the fourth quarter fell 8.9% from a year earlier, the largest drop in its 20 years of data. And the Office of Federal Housing Enterprise Oversight’s index -- which tracks only homes purchased with mortgages guaranteed by home-loan giants Fannie Mae or Freddie Mac -- was down 0.3%, the first year-to-year decline in the measure’s 16 years.”
February 29 – Bloomberg (Brian Louis and Dan Levy): “When Quinn Cuthbertson looks around his new neighborhood in El Dorado Hills, California, he sees rows of empty homes and barren hillsides. A promised new school and a clubhouse haven’t materialized. Cuthbertson paid $460,000 for a four-bedroom house in this northern California town… Nearby, 87 of 98 Toll Brothers Inc. home sites are undeveloped. Almost 200,000 newly constructed single-family homes are sitting empty in the U.S., the most since Commerce Department statistics began in 1973.”
February 25 – Bloomberg (Jody Shenn): “U.S. commercial property prices may drop by 15% to 20% over the next few years, reversing increases seen in the past two years, according to Moody’s…”
February 27 – Bloomberg (Daniel Taub): “Prices for U.S. apartment buildings are being cut as investors looking for a quick rise in appreciation leave the market and lenders make it more difficult to borrow, said Reis Inc., a real estate research firm. The average price for apartment buildings dropped by almost $5,000 to about $105,000 per unit between the third quarter of last year and the fourth quarter…”
Muni Watch:
February 26 – Bloomberg (Terrence Dopp): “New Jersey Governor Jon Corzine proposed a $33 billion budget that would reduce spending by cutting at least 3,000 jobs, eliminating three state departments and scaling back property-tax rebates. The budget for the year beginning July 1 would be $500 million below the current $33.5 billion…”
February 26 – Bloomberg (William Selway): “Jefferson County, Alabama, had the credit rating on $3.2 billion of sewer system bonds cut to near junk status by Standard & Poor’s after its borrowing costs soared because of the insurance backing the debt. The county paid $6 million extra in interest in the last four months on the variable-rate bonds…”
California Watch:
February 25 – California Association of Realtors (C.A.R): “Home sales decreased 29.8% in January in California compared with the same period a year ago, while the median price of an existing home fell 21.9%... ‘This most recent decrease in the median price is yet another result of the liquidity crunch, which has choked off sales in recent months for nearly half of California’s housing market,’ said C.A.R. President William E. Brown…. C.A.R.’s Unsold Inventory Index for existing, single-family detached homes in January 2008 was 16.8 months, compared with 7.6 months for the same period a year ago.”
February 26 – Bloomberg (Michael B. Marois and William Selway): “Vallejo, California, is moving toward becoming the largest city in the state to file for bankruptcy as it confronts ballooning labor costs and declining tax revenue. City manager Joseph Tanner is recommending that the city council approve filing for Chapter 9 bankruptcy protection when it convenes on Feb. 28…”
Fiscal Watch:
February 26 – Bloomberg (James Tyson and William Selway): “U.S. governors including New Jersey’s Jon Corzine and New York’s Eliot Spitzer may ask Congress to help reverse rising municipal debt costs stemming from the subprime mortgage market’s collapse, Washington Governor Christine Gregoire said. Gregoire, Corzine and Spitzer joined other governors Feb. 24 in forming a group that will ‘produce something that gets us out of the problem, but most importantly produce something for Congress’ to deter a future borrowing squeeze, Gregoire…said…”
Speculator Watch:
February 28 – The Wall Street Journal (Cassell Bryan-Low and Gregory Zuckerman): “London-based hedge fund Richmond Capital LLP has stumbled this year, losing about half its money in January alone… That makes Richmond, launched by Luca Bechis, an experienced trader with a track record of posting strong gains, among the biggest losers in a year that is already proving challenging for a number of funds. January was one of the worst months for hedge funds in recent years… The fund had $524 million in assets as of December 2007… Richmond follows a so-called long-short strategy, which involves buying a portfolio of stocks, while also betting that other stocks will fall… Managers of long-short funds, which often struggle during volatile markets, had a particularly tough time among hedge funds in January, with the group down more than 4% for the month…”
February 29 – Bloomberg (Edward Evans): “KKR Private Equity Investors LP, Kohlberg Kravis Roberts & Co.’s publicly traded buyout fund, cut the value of its stakes in chipmaker NXP BV and six other companies amid a drop in the value of bonds sold to finance LBOs... Falling bond and loan prices are jeopardizing returns for private equity firms after they gorged on a record $1.4 trillion of takeovers in 2006 and 2007.”
February 27 – Bloomberg (Edward Evans): “Private equity firms are preparing to bypass Wall Street and directly approach sovereign wealth funds in the Middle East and Asia to provide loans for leveraged buyouts, British financier Guy Hands said… ‘Private equity firms will start to go direct,’ Hands told the 1,600 conference delegates. ‘It’s about cutting out those fees which are enormous and getting that certainty of execution.’”
February 28 – Financial Times (James Mackintosh): “Investors cooled towards new hedge funds last year, with cash put into European launches falling for the first time since the 2001 bear market. The number of new launches dropped to 370 from 420, according to Eurohedge magazine… The $33bn raised was 11% lower than the $37bn of the year before.”
Crude Liquidity Watch:
February 24 – Bloomberg (Matthew Brown and Tarek Al-Issawi): “Saudi Arabia’s inflation accelerated to a record 7% in January as the cost of rents and food soared, increasing pressure on the kingdom to revalue its currency with the weak dollar. Rents jumped an annual 16.7% in January, while food and beverage prices increased 7.9%, the Ministry of Economy and Planning said…”
February 24 – Bloomberg (Ladane Nasseri): “Iran’s high inflation is among the government’s most serious concerns, Sarmayeh reported, citing the country’s central bank governor. ‘When the country’s objectives are based on an inflation rate of 8%, reaching 20%, for which the country is unprepared, is worrisome,’ … citing central bank Governor Tahmasb Mazaheri.”
February 25 – Bloomberg (Tarek Al-Issawi): “Inflation in the United Arab Emirates is forcing many employees to consider quitting their jobs and moving abroad, Gulf News reported, citing a survey. The survey showed that 37% of those polled said they are thinking of leaving the country because of rising costs…”
No LTCM:
February 29 – Economist: “After hubris comes nemesis. On January 24th more than 1,000 leading figures in the European hedge-fund industry gathered for a dinner at the swanky Grosvenor House hotel on London’s Park Lane to witness the EuroHedge awards for 2007. Out of the 20 awards, two—credit fund of the year and new fund of the year (for non-equity strategies)—were awarded to Peloton Partners, a credit manager set up by ex-Goldman Sachs employees in 2005.”
I’ll go out on a limb and suggest that this week provided another critical juncture for the unfolding Credit and Economic Crisis. Peloton Partners, commencing the year with about $3bn under management, is run by smart, seasoned investment managers. One of the fund’s founding managers was previously a co-head of macro proprietary trading at Goldman. They recognized and profited handsomely from last year’s subprime collapse, with their flagship “ABS” fund ending 2007 up 87%. By recent industry standards, their strategy was not particularly risky. To capitalize on the dislocated Credit market and depressed prices, the fund increased leveraged exposure to “AAA” securities. It was reported that a week ago Friday the fund had posted losses for the month of about 8%. A few days later Peloton funds was in full crisis, forced to halt redemptions and seek liquidation. This evening the Wall Street Journal reported that some of its Wall Street lenders had moved to seize assets. Investors will suffer huge losses on “AAA”-rated securities bought at a discount.
The co-founders stated in a letter yesterday to investors: “Credit providers have been severely tightening terms without regard to the creditworthiness or track record of individual firms, which has compounded our difficulties and made it impossible to meet margin calls.” They are clearly not the only funds pounded abruptly by sinking asset values, illiquid markets, and increasingly distressed lenders. In the case of Peloton, leverage of four to five times was used commonly, with sinking prices on $9bn of assets quickly burning through equity. It’s convenient to blame an implosion on the margin clerk, although in this highly unstable environment playing with leverage is playing with fire.
Also yesterday, Thornburg Mortgage – seasoned leveraged “AAA” MBS players that last year had aggressively retrenched, cut holdings to $37bn from $53bn, and had seemingly weathered the subprime storm – reported that they were once again hit with margin calls and forced liquidations on a portion of their mortgage holdings. The root of the problem was a 10% to 15% drop THIS MONTH in the values of “Alt-A” mortgages. With an estimated $950bn of “Alt-A” mortgages in the marketplace, such a dramatic price decline pelted scores of investors/speculators in these mortgages, mortgage-related CDOs, and myriad derivative instruments. Leveraged players, such as Peloton, were crushed. Forced liquidations and a rush to hedge in the derivatives market exacerbated the spiral. The troubled major banks and Wall Street firms have significant direct exposures in this area, as well as huge indirect risk on such collateral used by their leveraged clients. The impaired lender community today has no alternative than to manage risk very diligently, which means an aggressive approach to margin requirements and forced liquidations has become part of the new (Post-Bubble) marketplace reality. The “smart guys,” that had jumped in over the past months to capitalize on market tumult, have been humbled, chastened, and in some cases bludgeoned. Many are coming to recognize that the market backdrop has fundamentally changed.
Compounding systemic stress, this week also saw significant forced liquidations in the municipal bond market. This has been a hot area for sophisticated leveraged trading and derivatives strategies. Today, one can add this huge market to the List of Bubbles Burst. It is difficult to know the scope of the unfolding liquidation and resulting inventory of muni bonds overhanging the marketplace. It is easy analysis, however, to suggest that liquidity for this key market will be scarce for some time. The ramifications for municipal finances, state and local borrowings, and overall economic activity are disconcerting.
In many respects, systemic stress from de-leveraging is more intense today than even during the LTCM fiasco. Many have been eagerly anticipating a LTCM-style Federal Reserve-orchestrated “reliquefication.” It’s not forthcoming. I will again remind readers to think in terms of this being the first Post-Credit Bubble “reflation” attempt. The Fed’s influence on risk asset prices has been dramatically diminished. Unlike LTCM (or 2002 for that matter), it is simply no longer a case of the Fed lowering the cost of funds for the leveraged players and in the process enticing them to increase holdings of mortgages, MBS, junk bonds, stocks and derivatives (all on leverage). There are these days much greater financial and economic forces at work.
This week the California Association of Realtors reported that January home sales were down almost 30% from a year ago, with median prices sinking 21.9% y-o-y. Median prices dropped $46,010 during the month, putting the decline from June’s high at an astounding $163,900. These “averages” are being skewed by the lack of mortgage Credit – hence transactions – at the upper end. Inventory is up to almost 17 months supply and will likely growing rapidly as thousands of foreclosed properties hit the market in the coming months. Keep in mind that the California downturn is relatively recent – running about a year behind Florida, for example. Increasing recognition of the dimensions of the unfolding real estate collapse in California (and elsewhere) certainly is a major factor for the sinking valuations of “Alt-A,” “jumbo” and MBS generally in the markets. And the resulting further tightening of lending standards by the mortgage companies, banks, GSEs, and mortgage insurers will only exacerbate the unfolding real estate bust.
This is No LTCM. The current financial and economic backdrop is altogether different. Speculators that would typically seek to capitalize on depressed securities prices now confront enormous uncertainties. How bad will things get in California, Florida, and elsewhere? How many will walk away from underwater mortgages – for starter homes and million dollar-plus California bungalows? How badly will the U.S. “services” economy be hit by housing and financial woes? How bad are the unfolding Credit problems in state and local finance? Will pinched consumers also turn their backs on Credit card, auto and student loans? How long will the seizing up of the securitization markets last? How will corporate Credits hold up in the event of prolonged Credit restraint and economic tumult? What are the ramifications if the “monolines,” GSEs, private-label MBS/ABS, the Credit derivatives marketplace, and Wall Street “structured finance” (more generally) don’t recover? None of these pertinent questions were even remotely contemplated or relevant in 1998.
The problem today remains a highly leveraged Credit system now confronting massive – and unquantifiable - Credit losses. And Moody’s and S&P can continue to claim that the major “monolines” are “AAA” – while the GSEs can pretend they are adequately capitalized. But the marketplace is not buying it. Sinking securities valuations are not a “technical” market issue that will be resolved when the margin calls are satisfied. Indeed, the Credit crisis and the economic downturn are gaining significant momentum.
Throughout the system, risk models have broken down. They will now be functionally inoperable for some time to come. At the heart of the now unfolding systemic de-leveraging are some newfound realities. Leveraging, as Peloton Partners realized this week, has become a perilous endeavor. The markets have become hopelessly illiquid, providing no escape route for even the perceived safest securities. Worse yet, the greatest leverage has accumulated in the perceived safest securities – creating atypical de-leveraging risk and Acute Systemic Fragility. Credit costs are now spiraling higher, and it is today impossible to accurately forecast either the timing or scope of losses for securities from subprime to munis to agency debt and MBS. Meanwhile, Wall Street and the securities lending community are reeling and will over time impose only tighter standards (less leverage and more collateral).
Importantly, the nature of systemic liquidity and Credit risks has become a major risk factor working against leveraged speculating. Or, said differently, the Bubble in leveraged speculation has burst. Today’s reality is one of a Credit system severely impaired, with the ABS, junk, and CDO markets basically closed for business. Now the huge muni and investment-grade bond markets are badly faltering. This week also saw the Swiss franc and the Japanese yen as the best performing currencies, gaining 4.7% and 4.2% respectively. For those borrowing in these low-yielding currencies to finance leveraged speculations in higher-yielding U.S. (and other) securities, there is now also recognition of acute currency risk. The stage is set for a panic out of the crowded leveraged trades.
This is No LTCM. And a very strong case can be made that Fed rates cuts have destabilized the Credit system. While the argument that Fed rate cuts worsen an already problematic inflation problem certainly has merit, there is a greater risk that goes unrecognized. During the Greenspan tenure, the Fed was keen to use the leveraged speculating community as its Key Monetary Reflationary Mechanism. This, over time, became an instrumental facet of the Credit Bubble; the Bubble in Wall Street finance; and the U.S. Bubble Economy.
Recent Fed desperate efforts to sustain both the Bubble in leveraged speculation and the deeply mal-adjusted U.S. economy are futile. As for the leveraged speculating community, it would be better for the long-term health of the system to let the bust run its course. Today’s reflationary efforts are clearly fueling further wild and destabilizing global speculation and excess, with major – and increasingly obvious - negative consequences here at home. As for the U.S. Bubble economy, throwing additional Credit at the Current Unsustainable (“services-based”) Economic Structure only ensures greater future Credit losses and financial sector upheaval, along with more problematic economic dislocation. Importantly, the Fed (Kohn and Bernanke) made another major mistake this week downplaying inflation and dollar risk – focusing instead on economic risk. Ironically, the Fed is today impotent with respect to the economy. It had best start paying attention to the stability of the currency markets, where it could have some impact.
