One-month Treasury bill rates ended the week at 9 bps, and three-month bills were at 18 bps. Two-year government yields were down 2 bps to 0.90%. Five year T-note yields ended the week 9 bps lower to 1.82%. Ten-year yields dropped 13 bps to 2.87%. Long-bond yields fell 16 bps to 3.56%. The implied yield on 3-month December ’09 Eurodollars increased 6 bps to 1.605%. Benchmark Fannie MBS yields sank 20 bps to 4.25%. The spread between benchmark MBS and 10-year T-notes narrowed 6 to 138 bps. Agency 10-yr debt spreads widened 12 to 74 bps. The 2-year dollar swap spread increased 8 to 77.5 bps; the 10-year dollar swap spread declined 6 to 25.5bps, and the 30-year swap spread declined 7.25 to negative 31.75 bps. Corporate bond spreads widened notably. An index of investment grade bond spreads widened 35 to 280 bps, and an index of junk spreads widened 38 to 1,289 bps. GE Capital Credit default swap prices traded above 1,000 bps.
Yet another week of decent corporate debt issuance. Investment grade issuance included Eli Lilly $2.5bn, Coca-Cola $2.25bn, State Street $1.5bn, PG&E $550 million, FLP Group $500 million, Consumers Energy $500 million, Cargill $450 million, Appalachian Power $350 million, Pitney Bowes $300 million, George Washington University $200 million, and Mississippi Power $125 million.
Junk issuers included Nisource $600 million and Plains Exploration $365 million.
March 6 – Bloomberg (Laura Cochrane): “Emerging-market borrowing costs rose, heading for the biggest weekly increase in three months… The extra yield investors demand to own developing nations’ bonds instead of U.S. Treasuries climbed 3 bps to 6.96 percentage points (up 47bps on the week)…”
International debt issues this week included KFW $4.0bn, International Bank of Reconstruction and Development $3.0bn, BP Capital $3.25bn, Barclays Bank $2.35bn, and Swedish Housing Finance $250 million.
U.K. 10-year gilt yields collapsed 56 bps to 3.06%, and German bund yields dropped 19 bps to 2.92%. The German DAX equities index fell 4.6% (down 23.8%). Japanese 10-year "JGB" yields added one basis point to 1.28%. The Nikkei 225 sank 5.2% (down 19%). Emerging markets were mixed to lower. Brazil’s benchmark dollar bond yields rose 12 bps to 6.98%. Brazil’s Bovespa equities index declined 2.8% (down 1.2% y-t-d). The Mexican Bolsa dropped 4.0% (down 23.8% y-t-d). Mexico’s 10-year $ yields surged 28 bps to 6.76%. Russia’s RTS equities index rallied 5.8% (down 8.7%). India’s Sensex equities index dropped 6.4% (down 13.7%). China’s Shanghai Exchange jumped 5.3% (up 20.4%).
Freddie Mac 30-year fixed mortgage rates rose 8 bps to 5.15% (down 88bps y-o-y). Fifteen-year fixed rates gained 4 bps to 4.72% (down 75bps y-o-y). One-year ARMs increased 5 bps to 4.86% (down 8bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates up 8 bps this week to 6.91% (down 8bps y-o-y).
Federal Reserve Credit declined $8.8bn last week to $1.891 TN. Fed Credit expanded $1.018 TN over the past 52 weeks (116%). Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt last week (ended 3/4) jumped $15.7bn to a record $2.596 TN. "Custody holdings" were up $446bn over the past year, or 21%.
Bank Credit declined $16.6bn to $9.766 TN (week of 2/25). Bank Credit expanded $400bn year-over-year, or 4.3%. Bank Credit increased $391bn over the past 25 weeks. For the week, Securities Credit dropped $15.1bn. Loans & Leases slipped $1.6bn to $7.111 TN (52-wk gain of $220bn, or 3.2%). C&I loans fell $5.9bn, with 52-wk growth of 7.4%. Real Estate loans gained $2.7bn (up 5.3% y-o-y). Consumer loans added $2.3bn, while Securities loans declined $1.3bn. Other loans added $0.5bn.
M2 (narrow) "money" supply declined $5.7bn to $8.275 TN (week of 2/23). Narrow "money" has now inflated at an 16.7% rate over the past 23 weeks and $719bn over the past year, or 9.5%. For the week, Currency added $1.2bn, while Demand & Checkable Deposits dropped $14.6bn. Savings Deposits rose $16.9bn, while Small Denominated Deposits slipped $0.9bn. Retail Money Funds fell $8.2bn.
Total Money Market Fund assets (from Invest Co Inst) rose $17.7bn to $3.906 TN, with a 52-wk expansion of $455bn, or 13.2% annualized.
Asset-Backed Securities (ABS) issuance remains about dead. Year-to-date total US ABS issuance of $2.9bn (tallied by JPMorgan's Christopher Flanagan) is a fraction of the $34.8bn for comparable 2008. There has been no home equity ABS issuance in months. Year-to-date CDO issuance totals only $1.2bn.
Total Commercial Paper outstanding sank $44.2bn this past week to a 19-wk low $1.480 TN. CP has declined $201bn y-t-d (69% annualized) and $380bn over the past year (20.4%). Asset-backed CP declined $2.0bn to $722bn, with a 52-wk drop of $95bn (11.6%).
International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $259bn y-o-y, or 4.1%, to $6.661 TN. Reserves have declined $285bn over the past 20 weeks.
Global Credit Market Dislocation Watch:
March 4 – Bloomberg (Dan Levy): “More than 8.3 million U.S. mortgage holders owed more on their loans in the fourth quarter than their property was worth as the recession cut home values by $2.4 trillion last year, First American CoreLogic said. An additional 2.2 million borrowers will be underwater if home prices decline another 5%...Households with negative equity or near it account for a quarter of all mortgage holders.”
March 4 – Wall Street Journal (Liz Rappaport and Jon Hilsenrath): “The U.S. launched a program to finance up to $1 trillion in new lending to consumers and businesses, in an ambitious attempt to jump-start credit for everything from car loans to equipment leases. The Federal Reserve and the Treasury Department hope to revive the moribund market for so-called securitized lending, which until last year was central to providing consumer and business loans. Starting March 17, large investors -- including hedge funds and private-equity firms -- can obtain cheap credit from the Fed and use the money to buy newly issued securities backed by such loans.”
March 3 – Wall Street Journal: “If you missed the first hedge-fund boom, now may be the time to put up your shingle. Looking at the terms of the Federal Reserve’s new Term Asset-Backed Securities Loan Facility, investors using it should be able to generate hefty returns with little risk. The TALF effectively turns the Fed into a generous prime brokerage. The central bank lends money for up to three years to investment firms to buy bonds backed by assets like auto or credit-card loans. The Fed needs to lure investors back into the market for these asset-backed securities, or ABS, where new issuance has almost disappeared.”
March 5 – Wall Street Journal (Michael M. Phillips and Ruth Simon): “The Obama administration announced details of a housing-rescue plan it said would help as many as one in nine homeowners, from low-income Americans struggling to avoid foreclosure to well-off borrowers who owe more than their homes are worth. The announcement came two weeks after President Barack Obama said he would spend $75 billion on the housing component of an emergency economic plan that includes a financial-system bailout and a $787 billion spending-and-tax-cut package."
March 2 – Bloomberg (Scott Lanman and Hugh Son): “American International Group Inc… will get as much as $30 billion in new government capital in a revised bailout after posting a record fourth-quarter loss. The loss widened to $61.7 billion… The government will also exchange its $40 billion in preferred stock for new shares that ‘resemble common equity,’ the Treasury and Federal Reserve said. AIG was paying a 10% dividend on the preferred stock.”
March 4 – Bloomberg (Shannon D. Harrington): “The cost to protect against a default by the finance division of General Electric Co. rose for the fourth day to a record. Traders of contracts protecting against a default by GE Capital Corp. for five years demanded 20% upfront in addition to 5% a year… That means it would cost $2 million initially and $500,000 annually to protect $10 million of the unit’s debt.”
March 3 – Dow Jones: “U.S. corporate defaults continued to increase through February, Standard & Poor’s said… as the year-to-date number equaled the total number of defaults in 2007. Nine companies defaulted in February, bringing the year-to-date total to 27... S&P also raised its estimate for the 12-month trailing junk-grade default rate to 5.4% in February, up from 4.66% in January and 1.23% in February 2008.”
The dollar index ended the week 0.6% higher to 88.51 (up 8.9% y-t-d). For the week on the upside, the Swiss franc increased 0.7%, the Taiwanese dollar 0.5%, the Brazilian real 0.5% and the New Zealand dollar 0.5%. On the downside, the South African rand declined 3.1%, the Swedish krona 2.0%, the British pound 1.6%, the South Korean won 1.0%, the Japanese yen 0.8%, and the Canadian dollar 0.8%. The Euro declined 0.2%.
March 4 – Bloomberg (Luo Jun and Zhang Dingmin): “China Investment Corp., the $200 billion sovereign wealth fund, may invest in ‘undervalued’ commodity assets, joining other Chinese companies in taking advantage of a seven-year low in prices. ‘Many commodities are undervalued and are among our considerations for potential investments,’ Executive Vice President Jesse Wang told reporters…”
March 5 – Bloomberg (Helen Yuan): “Chinese steelmakers, the largest buyers of iron ore, want Cia. Vale do Rio Doce, BHP Billiton Ltd. and Rio Tinto Group to cut prices of the material by between 40% and 50% this year, Anshan Iron & Steel Group said.”
Gold slipped 0.4% this week to $939 (up 6% y-t-d), and silver added 1.7% to $13.33 (up 18% y-t-d). April Crude gained $1.04 to $45.80 (up 3% y-t-d). April Gasoline fell 2.6% (up 26% y-t-d), and April Natural Gas dropped 6.3% (down 30% y-t-d). March Copper surged 9.8% (up 20% y-t-d). March Wheat rallied 1.1% (down 16% y-t-d), and Corn gained 0.6% (down 13% y-t-d). The CRB index declined 0.9% (down 8.7% y-t-d). The Goldman Sachs Commodities Index (GSCI) was little changed (down 3.8% y-t-d).
China Reflation Watch:
March 4 – Bloomberg (Li Yanping): “China’s budget spending may more than double over last year’s planned expenditure as the government implements its 4 trillion yuan ($585 billion) stimulus package, data given by a spokesman for the nation’s lawmakers show. The government has earmarked 480.7 billion yuan for defense this year, accounting for 6.3% of total budgetary expenditure, Li Zhaoxing, spokesman for the National People’s Congress…said…”
March 3 – Bloomberg (Jun Luo and Yidi Zhao): “China’s budget deficit this year may be about 3% of gross domestic product, Jia Kang, head of the Insitute of Fiscal Science at the Ministry of Finance said…”
March 3 – Bloomberg (Li Yanping and Nipa Piboontanasawat): “A Chinese manufacturing index climbed for a third month, adding to evidence that a 4 trillion yuan ($585 billion) stimulus package is pushing the world’s third-biggest economy closer to a recovery.”
March 5 – Bloomberg (Jason Clenfield): “Japanese companies cut spending last quarter at the fastest pace in a decade… Capital spending excluding software fell 18.1% in the three months ended Dec. 31 from a year earlier…”
March 2 – Bloomberg (Toru Fujioka): “Japan’s wage declines accelerated in January as companies pared production… Monthly wages, including overtime and bonuses, fell 1.3% from a year earlier…”
March 2 – Bloomberg (Naoko Fujimura and Tetsuya Komatsu): “Toyota… and Honda… led a drop in the country’s monthly vehicle sales… to the lowest level in 35 years. Sales of cars, trucks and buses, excluding minicars, fell 32% to 218,212 vehicles in February…”
March 3 – Bloomberg (Tetsuya Komatsu and Naoko Fujimura): “Toyota…, forecasting its first loss in 59 years, is seeking loans from the Japanese government as private investors demand up to 50% more in interest for the company’s debt. The company’s financial unit may ask for 200 billion yen ($2bn) in loans, public broadcaster NHK reported…”
March 6 – Wall Street Journal (Abhrajit Gangopadhyay): “India’s deficit is likely to be 6% of gross domestic product in the next financial year… Junior Finance Minister P.K. Bansal said… ‘There is a sense within the government that a 6% fiscal deficit is acceptable, given the current conditions,’ Mr. Bansal told Dow Jones…”
Asia Reflation Watch:
March 2 – Bloomberg (Seyoon Kim): “South Korea’s exports fell for a fourth month in February, the longest run of declines since 2002, on weaker demand from the U.S., Japan and Europe. Overseas shipments decreased 17.1% to $25.8 billion from a year earlier…”
March 3 – Bloomberg (Kyunghee Park and Seonjin Cha): “South Korea’s biggest port is running out of room to store shipping containers… The bigger concern is that the boxes are almost all empty. Container trade at Busan, the world’s fifth-largest port, has fallen about 40% in recent months…”
March 3 – Wall Street Journal (Evan Ramstad): “Shinchang Electrics Co. offered union leaders a proposal that would reduce wages at the auto-parts company by 20% in exchange for no layoffs among its 810 workers this year. Eight days later, the union agreed. The deal is one sign of the unusual way South Korea is grappling with the global economic crisis. Across the country, executives, salaried employees and hourly workers at companies from banks to shipbuilders are joining to slash wages and other costs with the goal of avoiding layoffs. ‘We have to go through this together. We are colleagues and friends,’ says Shim Ho-yong, a seven-year employee who molds ignition components for Shinchang.”
March 3 – Bloomberg (Shinhye Kang and Heejin Koo): “South Korea’s inflation unexpectedly accelerated in February for the first time in seven months because of increased costs for food, furnishings and clothing. The consumer price index rose 4.1%...”
March 2 – Bloomberg (Aloysius Unditu and Arijit Ghosh): “Indonesia’s exports fell the most in more than 22 years in January and inflation slowed the following month, increasing scope for the central bank to reduce its benchmark interest rate this week. Overseas shipments plunged 35.5% to $7.15 billion from a year earlier…”
March 4 – Bloomberg (Ta Bao Long): “Vietnam’s government said it will spend 300 trillion dong ($17 billion) this year to halt a slowdown in economic growth amid the global financial crisis. The amount, almost a quarter of the Southeast Asian nation’s $71 billion economy, will be used to develop infrastructure, spur exports, and fund other social security projects, Prime Minister Nguyen Tan Dung said…”
Latin America Watch:
March 2 – Bloomberg (Eliana Raszewski): “Argentina’s financing options may dry up next year as the global financial crisis erodes tax revenue from commodity exports, Moody’s Investors Service said. ‘Argentina should have more than enough to finance 2009 needs, but if the crisis continues to dampen revenues, 2010 will be much more challenging,” Moody’s analyst Gabriel Torres said…”
Central Banker Watch:
March 5 – Bloomberg (Jennifer Ryan): “The Bank of England reduced the benchmark interest rate to the lowest ever and said it would start purchasing 75 billion pounds ($105 billion) in assets, printing money to fight the recession. The bank’s nine-member panel… cut the rate a half point to 0.5%, the lowest since the bank was founded in 1694… ‘In these highly uncertain times, there are merits to stimulating the economy through a variety of different channels,’ King wrote…”
March 6 – Bloomberg (Brian Swint and Jennifer Ryan): “Bank of England Governor Mervyn King, criticized for his initial response to the credit crisis, is now embarking on one of the biggest risks in British economic history. The central bank yesterday won authority to print as much as 150 billion pounds ($212 billion) and pump it into an economy facing its worst recession since World War II, after cutting interest rates close to zero. With markets clogged and economic activity shriveling, King can’t be sure the gamble will work.”
March 2 – Bloomberg (Craig Torres and Steve Matthews): “The Federal Reserve may need to hand over emergency credit programs to the U.S. Treasury to keep its focus on monetary policy and protect against political interference, Richmond Fed Bank President Jeffrey Lacker said. An accord with the Treasury ‘could stipulate that the emergency lending is transferred to the books of the Treasury after a brief period of time has elapsed,’ Lacker said…”
March 6 – Wall Street Journal (Damian Paletta): “Senate Banking Committee Chairman Christopher Dodd is moving to allow the Federal Deposit Insurance Corp. to temporarily borrow as much as $500 billion from the Treasury Department.”
Unbalanced Global Economy Watch:
March 6 – Bloomberg (Adam Haigh): “Profits in the U.K. will plunge more than during the Great Depression… Earnings will fall 60 percent from peak to trough, London- based equity strategists Graham Secker and Charlotte Swing wrote…”
March 4 – Bloomberg (Fergal O’Brien): “Irish jobless claims rose to a seasonally adjusted 352,800 in February, the country’s statistics office said on its Web site today. The unemployment rate was 10.4%.”
March 3 – Bloomberg (Andrew MacAskill): “Northern Rock Plc, the first U.K. lender nationalized during the credit crunch, said new residential lending plunged 90% last year… The company registered a quadrupling of bad loan impairments, which more than tripled to 894 million pounds from 239.7 million ponds a year earlier.”
March 5 – Bloomberg (Emma Ross-Thomas): “Spain’s industrial production fell by 20% in January, matching a record drop the month before, after automakers cut jobs and output in the deepening recession.”
March 5 – Bloomberg (Alex Nicholson): “Russia’s inflation rate rose to a four-month high in February as the weaker ruble drove up the price of imports. The rate jumped to 13.9%...”
March 4 – Bloomberg (Victoria Batchelor): “Australian sales of new cars and light trucks slumped 21.9% in February from a year earlier as slowing economic growth and faltering confidence reduced demand.”
Bursting Bubble Economy Watch:
March 6 – Bloomberg (Bob Willis): “The U.S. unemployment rate jumped in February to 8.1 percent, the highest level in more than a quarter century, a surge likely to send more Americans into bankruptcy and force further cutbacks in consumer spending. Employers eliminated 651,000 jobs, the third straight month that losses surpassed 600,000 -- the first time that’s happened since the data began in 1939…”
March 5 – Bloomberg (Matt Townsend): “Interior designer J.C. Trabanco began applying for sales jobs after his Wall Street clients stopped calling last year. ‘It’s humbling,’ Trabanco said… The 50-year-old, who said he used to earn more than $100,000 a year, only briefly considered leaving when he realized he was among the oldest people in line for a chance at a job that may pay as little as $9 an hour. “You can’t be proud,’ he said. As Macy’s Inc. eliminates 7,000 positions, Sears Holdings Corp. shuts 24 stores and furniture merchants slash payrolls by 11%, retail jobs are disappearing at a faster rate in this recession than in any other since the U.S. government began keeping track in 1939.”
March 4 – Bloomberg (Bill Rochelle and Bob Willis): “Bankruptcy filings in the U.S. surged 37% in February from a year earlier… Total filings for individuals and companies rose to more than 103,000, according to… Automated Access to Court Electronic Records… Commercial filings rose to 6,303, up 47% from the same month a year earlier, the group said.”
March 3 – Wall Street Journal (Alex P. Kellogg and Matthew Dolan): “U.S. auto sales plunged yet again in February, falling 41% to 688,000 vehicles, according to Autodata Corp… General Motors Corp.’s sales fell 53% from February 2008 to 126,170… while Ford Motor Co.’s dropped 48% to 99,050… Toyota Motor Corp.’s sales slid 40% to 109,583, Honda Motor Co.’s fell 38% to 71,575 and Nissan Motor Co.’s dropped 37% to 54,249.”
March 5 – Bloomberg (Mary Jane Credeur): “United Airlines and American Airlines led the six biggest U.S. carriers to a combined 11% drop in passenger traffic last month as the worsening recession spurred businesses and consumers to curb spending.”
March 3 – Bloomberg (David Evans): “Public pension funds across the U.S. are hiding the size of a crisis that’s been looming for years. Retirement plans play accounting games with numbers, giving the illusion that the funds are healthy. The paper alchemy gives governors and legislators the easy choice to contribute too little or nothing to the funds, year after year. The misleading numbers posted by retirement fund administrators help mask this reality: Public pensions in the U.S. had total liabilities of $2.9 trillion as of Dec. 16, according to the Center for Retirement Research at Boston College. Their total assets are about 30 % less than that, at $2 trillion.”
March 5 – Bloomberg (Gillian Wee): “U.S. college and university endowments lost an average of 24.1% in the last six months of 2008, more than in any year since the returns have been tracked… Endowments had their worst full year in 1974, when they reported an average loss of 11%.”
March 3 – Bloomberg (Sree Vidya Bhaktavatsalam): “The value of college-savings plans fell 21% last year, a loss of $23.4 billion… Assets in the savings accounts, called 529 plans, declined to $88.5 billion from $111.9 billion at the end of 2007…”
MBS/ABS/CDO/CP/Money Funds and Derivatives Watch:
March 6 – Bloomberg (Christine Harper): “Myron Scholes, the Nobel prize- winning economist who helped invent a model for pricing options, said regulators need to ‘blow up or burn’ over-the-counter derivative trading markets to help solve the financial crisis. The markets have stopped functioning and are failing to provide pricing signals, Scholes, 67, said… The “solution is really to blow up or burn the OTC market, the CDSs and swaps and structured products, and let us start over,” he said…”
March 5 – Bloomberg (Dawn Kopecki): “Fannie Mae and Freddie Mac are being used by the Obama administration to help dig the U.S. out of an economic ‘hole,’ yet that public policy role won’t affect the mortgage-finance companies’ future, House Financial Services Committee Chairman Barney Frank said.”
Real Estate Bust Watch:
March 3 - UPI: “The percentage of U.S. homeowners 60 days behind on their mortgages increased 16% in the fourth quarter of 2008, TransUnion.com said… The loan delinquency rate jumped to a national average 4.58%, up sharply from the third quarter’s 3.96% and dramatically higher than the fourth quarter of 2007, when the delinquency rate was 2.99%.”
March 5 – Bloomberg (William Selway): “Arizona Governor Jan Brewer is seeking to raise taxes and slash government spending to meet a $3 billion deficit in the coming fiscal year caused by the slumping economy. ‘We cannot afford the size of government we now have, and even a slowly recovering economy won’t fix the problem…’”
March 6 – San Francisco Chronicle (Tom Abate): “Unemployment rates in the Bay Area jumped into record territory in January, reaching 9.4% in the San Jose area, 9.2% in the East Bay and 7.5% in San Francisco and its vicinity.”
March 2 – Bloomberg (Helen Yuan): “The Carlyle Group may lose 500,000 yuan ($73,068) per house on the sale of 100 villas in Shanghai, China Business News said… Carlyle has paid $120 million, or 9.5 million yuan each, for the villas…”
A Washington-Induced Bubble:
March 5 – Bloomberg (Dawn Kopecki): “The ‘phenomenon of securitization’ must be curtailed by lawmakers to prohibit banks and mortgage lenders from shifting all the risk on loans they originate and sell to investors, U.S. House Financial Services Committee Chairman Barney Frank said. ‘I will be pushing for legislation that will make it illegal for anybody to securitize 100% of anything,’ Frank… told reporters… Securitization is a ‘large part’ of the problem in the housing market, he said.”
March 5 – Bloomberg (Scott Lanman and Craig Torres): “Federal Reserve Vice Chairman Donald Kohn came under fire from Democratic and Republican senators for rescuing American International Group Inc. without providing cost estimates or enough openness, risking public confidence in government. Federal aid to AIG ‘appears to be a bottomless pit,’ said Mark Warner… Regulators ‘are asking for an open-ended check and’ are ‘not going to get’ it, said Senator Robert Menendez… ‘The people want to know what you have done with this money,’ said Senator Richard Shelby… The $163 billion AIG rescue… may worsen prospects for congressional approval of more spending on bank rescues beyond the $700 billion Troubled Asset Relief Program, lawmakers said…”
Our Washington policymakers have too belatedly recognized the perils associated with unregulated Credit and speculative finance. They now come down hard on our Federal Reserve and Treasury Department officials, quickly losing sight of the Mountains of Blame to be spread around. Let us not forget that Congress repealed the Depression era Glass-Steagall Act back in 1999. And it is fair to remind leaders from both parties and both Houses that they are directly culpable for the spectacular rise and unfolding fall of the Government-Sponsored Enterprises (GSEs). I get no sense that a coherent understanding of the Credit Bubble is manifesting in Washington.
I could on a weekly basis come with dire predictions, but there’s more than enough of this type of reading available these days. I’ll stay focused on (contemporaneously) analyzing this historic Credit Bubble from every angle, with The Objective of Contributing to Lessons Learned. And I believe quite strongly that gleaning The Key Lessons from Major Bubbles is incredibly more challenging than one would ever imagine – that confusion, flawed analysis, ideologies and The Overwhelming Forces of Historical Revisionism create imposing obstacles to understanding. One can point to the 80 years or so of writings examining the Roaring Twenties and the Great Depression (what Chairman Bernanke refers to as the “Holy Grail of Economics”) to support this view.
There is no doubt the securitization and CDS (Credit default swap) markets were key facets of the Credit boom and are today at the heart of the devastating bust. Financial “innovation” always plays a critical role in major Bubbles – and this process of experimentation and innovation is consistently evolutionary in nature. While it is in many ways reasonable to cast blame upon these markets and their operators, Lessons Learned requires an understanding as to how these markets came to play such decisive roles. What critical features of the financial landscape contributed to the marketplace’s enthusiasm for these types of instruments? More specifically, how was it that Total Mortgage Credit growth surpassed $1.5 TN annualized during the first-half of 2006? How did asset-backed securities (ABS) issuance balloon to $900bn annualized in late-2006? How was it that Wall Street asset growth surpassed $1.0 TN annualized during the first-half of 2007? How could CDO issuance have possibly reached $1.0 TN in 2007 – and that the CDS market mushroomed to more than $60 Trillion at the very top of the Credit cycle?
The ratings agencies provide such easy and browbeaten scapegoats. They adorned “AAA” ratings on Trillions of MBS, ABS, and CDOs (collateralized debt obligations) during the heyday of the boom – back when home prices were forever rising, incomes were surging, Credit losses were disappearing, and New Era Babble was as unnerving as it was alluring. The rating agencies, Wall Street, Congress and virtually everyone else believed the boom was sustainable. But the radically-altered Post-Bubble backdrop now finds the rating agencies appearing as nincompoops complicit with shady Wall Street operators. Such a post-boom spotlight is predictable. From an analytical perspective, however, focus on the idiocies and malfeasance of the boom is certain to neglect key Bubble nuances.
From a “Moneyness of Credit” perspective, the Wall Street Credit mechanism evolved to the point of creating virtually endless debt instruments perceived by the marketplace as safe and liquid stores of nominal value (contemporary “money”). One cannot overstate the principal role top-rated money-like debt instruments played in fueling the Bubble, although let’s not get carried away and convince ourselves that the rating agencies had much at all to do with market psychology and speculative dynamics. For more culpable villains I suggest Washington look in the mirror. The “moneyness” enjoyed by Wall Street finance was either explicitly or implicitly underwritten within the beltway.
It was said back in the sixties that Alan Greenspan blamed the Great Depression on the Federal Reserve repeatedly placing “Coins in the Fuse Box” – repeated market interventions with the intention of perpetuating the 1920s boom. Going back at least to the 1987 stock market crash, our policymakers cultivated the markets’ view that Washington was right there to nurture and forever protect the “free” market. And the greater the prosperity and the higher asset prices went – the more certain the market became that policymakers would never let it all come crashing down.
The Greenspan Federal Reserve, in particular, nurtured the market perception that Washington was there to backstop marketplace liquidity. Greenspan pegged the cost of finance and essentially promised liquid and continuous markets. Mr. Greenspan became a leading proponent for securitizations, derivatives and “contemporary finance” more generally. “Liquid and continuous” markets were the lifeblood of these momentous Credit system innovations - and Washington seemingly delivered the goods.
Importantly, the GSEs – with their implied government guarantees – became commanding market operators and quasi-central banks, aggressively intervening to stem varying degrees of financial stress in 1994, 1998, 1999, 2000, 2001, 2002, and 2003. Congress was enamored with the virtues of deregulation, while turning a blind eye to the most glaring market distortions and excesses. Both sides of the isle were elated with the newfound capacity for the Federal Reserve and GSEs’ to jam Coins in our system’s “Fusebox.”
Congress steadfastly refused to address the issue of the GSEs’ implicit government backing, thus endorsing the most dangerous distortion to a “free” market pricing mechanism in the history of finance. All along, market confidence that Washington was backstopping system liquidity became more ingrained and problematic. Trillions of “money-like” agency debt and MBS securities were accumulated, with operators (and GSE “enablers”) cocksure that this market was much too big to stumble. The GSEs eventually did falter and were hamstrung by their accounting issues. By that time, however, the inflationary bias within mortgage finance and housing had become so powerful that the boom in Wall Street “private-label” mortgages/MBS easily supplanted GSE-related Credit creation.
This Credit boom – along with the GSE’s (and Fed’s) capacity for intervening to stem market liquidity crises – played a fundamental role as the market’s evolving perception of “moneyness” branched out to Wall Street's private-label mortgages and ABS more generally. Or, said another way: “No GSEs, then no uninterrupted Credit expansion; no rampant housing inflation and current account deficits; no massive global pool of speculative finance; no endless demand for perceived safe and liquidity mortgage securities of all stripes; and no evolving mortgage/housing/ABS/CDS Bubble.” There is plenty of blame to share with New York, London and elsewhere, but a strong case can be made that this was, at its core, A Washington-Induced Credit Bubble.
The securitization and CDS markets are the financial crisis’ current focal point. The markets’ misperception of liquid and continuous markets – that was instrumental in fueling the explosion of debt issuance and Credit insurance – has come home to roost in a very bad way. The securitization market’s basic premise was that the Creditworthiness of Trillions of Credit instruments would be supported by the capacity of borrowers to forever refinance and/or increase debt loads (Minskian “Ponzi Finance”). The basic premise of the CDS market was twofold: One, that contemporary securitization markets (backstopped by Washington) would provide borrowers endless quantities of inexpensive finance. And, second, that liquid securities markets would provide an effective means of (“dynamically”) hedging Credit exposures sold into the (“wild west”) CDS marketplace.
Today, those on the wrong side of the CDS market (having written Credit insurance) are getting killed and this dynamic is seemingly taking the entire system down with it. Corporate bond (bear) market liquidity is scarce, while the viability of scores of participants on all sides of the market is very much up in the air. This means that the hundreds of billions of default protection sold against troubled debt issuers (i.e. GMAC, Ford Motor Credit, GE Capital, AIG, etc.) today confront a serious dilemma when it comes to hedging rapidly escalating losses (and unwieldy “books” of derivatives and counter-party exposures). Originally, the writers of this Credit protection would have assumed only a remote possibility that any one of a number of major institutions would default. They also would have expected that, in the event of rising default risk, short positions would be established in the bond market to hedge Credit risk. They wrongly assumed benefits from diversifying Credit risks, the availability of market liquidity, and various forms of “too big to fail.”
Today, those on the wrong side of these trades and dislocated markets confront an environment that their models would have suggested was impossible: A domino collapse of major debt issuers in the face of near illiquidity throughout the corporate bond marketplace. During the boom, market participants would have assumed the opposite of an impotent Washington rummaging market wreckage for villains.
I’ll surmise that the CDS market is now in complete dislocation. I’ll also assume the sellers of CDS (and various Credit insurance) have resorted to shorting equities (individual stocks, ETFs and futures) in a desperate attempt to hedge escalating losses. This has likely placed additional pressure on sickly equities markets – and it goes without saying that it is especially damaging to market confidence when the stocks of our nation’s (and the world’s) major borrowers and financial institutions are all locked together in a death spiral. This dynamic has surely led to another round of forced de-leveraging. And, importantly, this type of market dynamic incites an acute case of “animal spirits.” While perhaps not as gigantic as before, the global pool of speculative finance (that accumulated over the boom) remains a force to be reckoned with. The dynamic of panic liquidations, de-leveraging and market operators seeking to profit from systemic dislocation creates a problematic deluge of selling.