Not enough Treasuries to go around or to fulfill commitments... One-month Treasury bill rates sank 88 bps this past week to 0.315%, with 3-month yields down 59 bps to 0.61%. Two-year government yields jumped 11 bps to 1.59%. Five-year T-note yields slipped 3 bps to 2.37%, and ten-year yields fell 11 bps to 3.33%. Long-bond yields sank 19 bps to 4.17%. The 2yr/10yr spread ended the week at 174 bps. The implied yield on 3-month December ’08 Eurodollars surged 21 bps to 2.215%. Benchmark Fannie MBS yields sank 34 bps to 5.11%. The spread between benchmark MBS and Treasuries narrowed 21 to 177 bps. The spread on Fannie’s 5% 2017 note narrowed 25 to 69 bps and the spread on Freddie’s 5% 2017 note narrowed 24 to 70 bps. The 10-year dollar swap spread dropped 9.5 to 62. Corporate bond spreads were mostly narrower. An index of investment grade bond spreads narrowed 30 to 190 bps. Meanwhile, an index of junk bond spreads widened 14 to 642 bps (note to federal govt: Wall Street could use a taxpayer-backed "Junkie Mae").
Investment grade issuance included Weatherford International $1.5bn, International Lease Finance $900 million, Bank of New York $750 million, Commonwealth Edison $700 million, Appalachian Power $500 million, Kroger $400 million, and Mid-American Energy $350 million.
I saw no junk or convert issuance this week (although much of so-called "investment"-grade issuance was borderline).
International dollar bond issuance included British Telecom $1.95bn.
German 10-year bund yields rose 2 bps to 3.75%, as the DAX equities index fell 2.0% (down 21.7% y-t-d). Japanese “JGB” yields added one basis point to 1.27%. The Nikkei 225 declined 2.0% (down 18.5% y-t-d and 27.3% y-o-y). Emerging stocks were mostly lower and bonds mostly higher. Brazil’s benchmark dollar bond yields declined 7 bps to 6.27%. Brazil’s Bovespa equities index dropped 4.8% (down 7.7% y-t-d). The Mexican Bolsa fell 1.7% (down 1.6% y-t-d). Mexico’s 10-year $ yields sank 21 bps to 4.90%. Russia’s RTS equities index was hit for 4.8% (down 14.2% y-t-d). India’s Sensex equities index dropped 4.9%, boosting y-t-d losses to 26.1%. China’s Shanghai Exchange fell 4.2% this week, with 2008 losses now at 27.8%.
Freddie Mac 30-year fixed mortgage rates sank 26 bps this week to 5.87%, with rates down 29 bps from a year earlier. Fifteen-year fixed rates dropped 33 bps to 5.27% (down 63 bps y-o-y). One-year adjustable rates added one basis point to 5.15% (down 25 bps y-o-y).
Bank Credit surged another $38.8bn (4-wk gain of $142bn) during the most recent reporting period (3/12) to a record $9.453 TN. Bank Credit has increased $240bn y-t-d, or 12.3% annualized. Bank Credit posted a 34-week surge of $810bn (14.3% annualized) and a 52-week rise of $1.130 TN, or 13.4%. For the week, Securities Credit jumped $63.9bn. Loans & Leases declined $25.1bn to $6.891 TN (34-wk gain of $567bn). C&I loans added $2.0bn, with one-year growth of 21.4%. Real Estate loans declined $2.6bn. Consumer loans gained $3.8bn, while Securities loans declined $8.3bn. Other loans fell $20bn. Examining the liability side, Deposits jumped $47.2bn.
M2 (narrow) “money” supply gained $5.3bn to a record $7.650 TN (week of 3/10). Narrow “money” expanded $187bn over the past 10 weeks, or 13.1% annualized, with a y-o-y rise of $492bn, or 6.9%. For the week, Currency increased $2.0bn, while Demand & Checkable Deposits dropped $33.3bn. Savings Deposits jumped $38.2bn, while Small Denominated Deposits declined $1.9bn. Retail Money Fund assets added $0.3bn.
Total Money Market Fund assets (from Invest Co Inst) rose $14bn last week (11-wk gain $355bn) to a record $3.468 TN. Money Fund assets have posted a 34-week rise of $884bn (52% annualized) and a one-year increase of $1.037 TN (42.7%).
Asset-Backed Securities (ABS) issuance was a slow $3bn or so. Year-to-date total US ABS issuance of $42.6bn (tallied by JPMorgan's Christopher Flanagan) is running only 25% of the level from comparable 2007. Home Equity ABS issuance of $197 million is a fraction of comparable 2007's $91.7bn. Year-to-date CDO issuance of $6bn compares to the year ago $101bn.
Total Commercial Paper dropped $14.3bn to $1.831 TN. CP has declined $393bn over the past 32 weeks. Asset-backed CP declined $4.3bn (32-wk drop of $415bn) to $780bn. Over the past year, total CP has contracted $166bn, or 8.3%, with ABCP down $275bn, or 26%.
Fed Foreign Holdings of Treasury, Agency Debt last week (ended 3/19) surged $17.3bn to a record $2.168 TN. “Custody holdings” were up $112bn y-t-d, or 23.6% annualized, and $293bn year-over-year (15.6%). Federal Reserve Credit jumped $9.6bn to $879bn. Fed Credit has expanded $5.3bn y-t-d, while having increased $27.7bn y-o-y (3.2%).
International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $1.391 TN y-o-y, or 27.5%, to a record $6.444 TN.
Global Credit Market Dislocation Watch:
March 17 – Financial Times (Gillian Tett): “In recent years, bankers have succumbed to the idea that the credit world was all about numbers and complex computer models. These days, however, this assumption looks ever more of a falsehood. For as anyone with a classical education knows, credit takes its root from the Latin word credere (“to trust”) And as the current credit turmoil now mutates into ever-more virulent forms, it is faith – or, rather, the lack of it – that has turned a subprime squall into a what is arguably the worst financial crisis in seven decades. Make no mistake: what we are witnessing right now is not just a collapse of faith in one single institution (namely Bear Stearns) or even an asset class (those dodgy subprime mortgage bonds). Instead, it stems from a loss of trust in the whole style of modern finance, with all its complex slicing and dicing of risk into ever-more opaque forms. And this trend is not just damaging the credibility of banks, but the aura of omnipotence that has enveloped institutions such as the US Federal Reserve in recent years.”
March 20 – Bloomberg (Scott Lanman): “The Federal Reserve expanded collateral eligible for its auction of Treasuries to include bundled mortgage debt and securities linked to commercial- property loans. The New York Fed bank, which is conducting the $200 billion Term Securities Lending Facility program, set the amount of the first auction on March 27 at $75 billion. The new collateral list will be applied in the first weekly auction instead of the second, as originally intended. Central-bank officials are increasing efforts to ease logjams in credit markets that are exacerbating the economic slowdown by making it harder for companies and consumers to get loans. Under the program, first announced on March 11, the Fed will accept debt that's more difficult to borrow against than Treasury notes, the world's most liquid securities. ‘Everyone’s waiting for help at financing some of these more difficult mortgages,’ said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi…”
March 20 – Bloomberg (Liz Capo McCormick): “Surging demand for U.S. Treasuries is causing failures to deliver or receive government debt in the $6.3 trillion a day market for borrowing and lending to climb to the highest level in almost four years. Failures, an indication of scarcity, surged to $1.795 trillion in the week ended March 5, the highest since May 2004… Investors seeking the safety of government debt amid the loss of confidence in credit markets pushed rates on three-month bills today to 0.387%, the lowest level since 1954… ‘It shows you the kind of anxieties that are going on and the keen demand for Treasuries,’ said Tony Crescenzi, chief bond market strategist at Miller Tabak… ‘The rise in fails tells us about the inability of dealers to obtain Treasury collateral.’”
March 20 – Dow Jones (Emily Barrett): “Money markets were pushed to their limit Thursday in panicky trade that recalls the worst moments of last summer's liquidity crisis. Investors poured into the safest corners of the government bond markets, for fear of more bad news from the financial sector upsetting markets shuttered for the Easter long weekend, and sheltering from tumbling commodity prices and sharp fluctuations in currencies. The rush took yields on short-term Treasury bills to lows not seen in 50 years, and borrowing costs spiked higher in defiance of central banks' efforts to flood the system with super-safe collateral and additional cash. ‘Liquidity in the bill market is nil,’ noted one trader… ‘The Street has ceased making offerings for cash and as such we cannot either.’”
March 19 – Bloomberg (Sandra Hernandez): “Treasuries rose and three-month bill rates plunged to the lowest level in almost 50 years on speculation credit market losses will widen, prompting investors to seek the relative safety of government debt. Bonds gained on concern the investment firm run by ex-Long- Term Capital Management LP chief John Meriwether is facing losses and Thornburg Mortgage Inc. may go bankrupt… ‘It’s a capital preservation trade,’ said Michael Cloherty, an interest-rate strategist at Banc of America… ‘The rationale is, ‘I’ll buy a bill, I know that when the thing matures I’ll get 100 cents on the dollar.’”
March 19 – Dow Jones (Matthew Cowley): “JPMorgan Chase may have stepped in to save Bear Stearns, but that hasn’t stopped investors from worrying about counterparty risks. The weekend maneuver by JPMorgan and the Federal Reserve seems to be more about preserving Bear Stearn’s trades, rather than its business. That’s why the firm’s shareholders are being wiped out, but its mechanics will continue to operate under the auspices of its acquirer, JPMorgan Chase. Default by a counterparty is one of the major threats pervading crucial parts of the international financial system today; it's helped spread fear far beyond the origins of this crisis in the U.S. subprime market. The extent to which the Fed wants to avoid even testing a possible default by a major counterparty is indicative in the speed with which Bear's rescue plan was put together.”
March 20 – Bloomberg (Andrew Frye): “Thornburg Mortgage Inc., the ‘jumbo’ mortgage specialist struggling to meet margin calls, delayed the pricing of its $1 billion convertible securities offering until March 24. ‘We are continuing to work with interested, large investors’ who are carrying out due diligence on the sale…a spokeswoman…said… Thornburg may declare bankruptcy if it can’t raise $948 million by next week, the company said… ‘It’s going to be a weekend of contemplation for anyone waiting to pull the trigger on that deal,’ said analyst Jason Arnold at RBC Capital Markets… ‘People lost a lot of money on the previous deal.’”
March 21 – Wall Street Journal (David Enrich, Liz Rappaport and Liam Pleven): “Main Street is about to feel another tremor from Wall Street. CIT Group Inc. said Thursday that its normal sources of funding have dried up because of the credit crisis, forcing the… company to draw down its entire $7.3 billion line of backup credit. That could mean trouble for commercial borrowers, since CIT will shrink its lending operations and sell assets in order to conserve cash. ‘We recognize that, given the current market environment, we need to run a smaller company,’ said Jeffrey Peek, CIT's chief executive. While it isn’t a bank, CIT is a major lender that specializes in providing financing to companies of all sizes that often can’t get all the capital they want from traditional banks. With customers in more than 30 industries and 50 countries, CIT had managed assets of $83.2bn as of Dec. 31… Since CIT can’t fund its operations with bank deposits, it typically relies on a combination of financing including short-term borrowing known as commercial paper as well as asset backed markets and the corporate bond market.”
March 19 – Bloomberg (Shannon D. Harrington): “CIT Group Inc., the largest independent commercial finance company in the U.S., may need to tap $7.3 billion in unsecured bank lines because its access to traditional debt markets has become ‘materially constrained,’ Fitch Ratings said…”
March 19 – Bloomberg (Jody Shenn): “Merrill Lynch & Co. sued XL Capital Assurance Inc. to force the bond insurer to honor $3.1 billion of guarantees on collateralized debt obligations as the securities firm attempts to avoid more writedowns of mortgage-backed debt. ‘We filed suit to make clear that XL Capital Assurance Inc. is required to meet its contractual obligations,’ Mark Herr, a spokesman for…Merrill, said… ‘Apparently in light of the current dramatic downturn and deterioration in the credit markets, defendants are having ‘sellers’ remorse,’ Merrill said…”
March 19 – Dow Jones (Laura Mandaro): “Instead of waiting for the U.S. government to fix the nearly defunct market for auction-rate securities, counties, states and health authorities seeking to raise money are increasingly turning to money-market funds to get cash. As a result, the once little-known market for auction-rate securities, propelled into the headlines by turmoil in financial markets, is witnessing a mass flight of municipal debt to other sources of funding… The auction-rate market ‘is broken, it’s dead, it’s going away,’ said Joe Lynagh, portfolio manager for five municipal money-market funds at T. Rowe Price Group…”
March 19 – Dow Jones (Min Zeng): “There is no sigh of relief in short-term funding markets Wednesday as concerns over the credit-market crunch and rising cash demand ahead of the quarter-end pushed up borrowing costs in the U.S. and Europe. After a brief euphoria Tuesday following the Federal Reserve’s interest-rate cut and better-than-expected broker earnings, jitter returned to markets overnight amid worries about hedge fund troubles and concerns over the health of the U.K. banking system. Credit concerns, coupled with surging cash demand among companies to protect their balance sheets leading into the quarter end and the Easter Holiday Friday, pushed term London interbank offered rates in dollar, euro and pound higher.”
March 19 – Bloomberg (Katherine Burton and Saijel Kishan): “JWM Partners LLC, the investment firm run by ex-Long-Term Capital Management LP chief John Meriwether, lost 24% in its $1 billion fixed-income hedge fund this year through March 14… Meriwether’s Relative Value Opportunity fund was hurt as bond managers such as Peloton Partners LLP and Carlyle Capital Corp. were forced to sell securities to meet margin calls…”
March 19 – Dow Jones (Margot Patrick): “Sharp moves in Japanese bonds this month have wiped more than $725 million off a $2.9 billion fixed-income hedge fund run by Endeavour Capital LLP, heightening concerns about how hedge funds are faring in increasingly volatile interest-rate markets. Endeavour Capital Chief Executive Paul Matthews said the Endeavour Fund lost money as the spread between shorter- and longer-dated Japanese government bond yields rose… ‘The move we’ve seen is far more than anything that happened in the past in these instruments,’ Matthews told Dow Jones… ‘It’s one thing to have the market move against you but the lack of liquidity, to not be able to get out of government bonds, is very unusual,’ he added. London-based Endeavour closed out nearly all of its Japanese bond positions over the past several days, and has reduced its use of borrowed money on government bond trades to 12.5 times investor capital from around 18 times.”
March 20 – Dow Jones (Alistair Barr): “Hedge funds moving from Bear Stearns Cos. to rival prime brokers may be facing tougher borrowing requirements as investment banks cut back on the amount of money they are willing to lend to some managers in the $2 trillion business.”
March 19 – Bloomberg (Yalman Onaran and Christine Harper): “Goldman Sachs Group Inc. and Morgan Stanley, the two biggest U.S. securities firms, said they've used a lending facility created by the Federal Reserve to ease concerns that Wall Street faced a cash shortage. ‘We have tested the window because we want to remove the stigma from the window,’ Morgan Stanley CFO Colm Kelleher said… ‘It’s meant to be there for normal business. It’s not meant to be there as a last-recourse thing.’”
March 20 – Dow Jones (Lavonne Kuykendall and Chad Bray): “Bond insurers have reassured investors for months that ironclad protections they built into insurance policies for derivatives gave them unique controls over the complex securities they guaranteed. Now those contract clauses may help in an unexpected way: by giving bond insurers a way out of some of the most exposed deals. Bond insurer Security Capital Assurance says that Merrill Lynch & Co. signed seven credit default swap contracts with Security Capital subsidiary XL Capital Assurance Inc. that gave the bond insurer ultimate control of underlying collateralized debt obligations totaling $3.1 billion in face value. Merrill then violated the agreement, SCA says, by making side deals giving the same control to rival insurer MBIA Inc. The issue plays into what bond insurers have long called one of the strengths of the financial guarantees they write on investment bank securities: the powers they can exercise when something goes wrong.”
March 20 – Reuters: “Security Capital Assurance said… it had severed seven credit guarantee contracts with a Merrill Lynch unit because Merrill had given important rights promised to it under the contracts to at least one other party. Merrill Lynch is suing the XL Capital Assurance unit of Security Capital to force the insurer to make good on the agreements. Security Capital said XL Capital was promised control rights on the $3.1 billion of portfolios it had guaranteed for Merrill Lynch International, but Merrill Lynch had given those same rights to one or more third parties. ‘The decision to terminate the Merrill Lynch International contracts was not made lightly,’ Security Capital said. By terminating the contracts, Security Capital is hoping to get out from under an obligation that could cost it hundreds of millions of dollars. But ending the contracts could force Merrill Lynch to write down billions of dollars of exposure.”
March 20 – Bloomberg (Oliver Suess): “IKB Deutsche Industriebank AG, the first German casualty of the collapse of the U.S. subprime- mortgage market, forecast a wider loss and said it will need a fourth government bailout. IKB fell to the lowest in at least 11 years… KfW Group, the state-owned development bank that controls IKB, will inject another 450 million euros to shore up the lender.”
March 20 – Bloomberg (John Glover): “The cost of protecting the bonds of Kaupthing Bank hf, Landsbanki Islands hf and Glitnir Banki hf against default soared to records this week amid concern Iceland’s three largest banks may be unable to fund themselves. Credit-default swaps on Kaupthing, Iceland’s biggest bank, rose 22 bps to 855… The cost of the contracts is about seven times more than the average for banks in Europe…
March 19 – International Herald Tribune (Sandra Hernandez): “The Australian property investor Rubicon Japan Trust warned…that it would not be able to meet an expected margin call… Joining a growing list of Australian companies facing margin calls as nervous banks call in their loans amid a deepening credit crisis, Rubicon said it might be unable to pay its debts if it cannot reach an agreement on the margin call of 30 million Australian dollars, or $28 million, with National Australia Bank, or NAB.”
The dollar index rallied 1.5%, ending the week at 72.71. For the week on the upside, the South Korean won increased 1.9%, the Taiwanese dollar 1.1%, and the Mexican peso 0.4%. On the downside, the Norwegian krone declined 2.6%, the Canadian dollar 2.5%, the Swiss franc 2.5%, the Japanese yen 2.2%, the Australian dollar 2.1% and the Euro 1.9%.
March 19 – AFP (Sandra Hernandez): “Sky-rocketing food prices in Egypt since the start of the year are being matched by a rumbling wave of popular discontent and unprecedented strikes and demonstrations. Textile workers, teachers, doctors and accountants have all threatened strikes under the united banner of ‘Stop The Expensive Life,’ while doctors went ahead last week with a one-hour work stoppage for better pay and conditions…”
Gold sank 9.2% to $910 and Silver collapsed 18.4% to $16.85. May Copper dropped 6.6%. May Crude declined $7.15 to $101.59. April Gasoline fell 3.3%, and April Natural Gas sank 8.0%. May Wheat dropped 17.1%. The CRB index sank 8.3% (up 6.4% y-t-d). The Goldman Sachs Commodities Index (GSCI) dropped 7.2% (up 8.4% y-t-d and 47.2% y-o-y).
March 20 – Market News International: “Chinese foreign exchange reserves hit $1.6471 trillion at the end of February, rising $57.3 billion over the month… The increase compares with January’s record $61.6 billion addition to reserves and marks the second highest monthly increase on record.”
March 20 – Bloomberg (Nipa Piboontanasawat and Theresa Tang): “Hong Kong’s inflation accelerated to the fastest pace in more than a decade as snowstorms in China pushed up the cost of food imported from the mainland. Consumer prices rose 6.3% in February from a year earlier…”
March 18 – Financial Times (Richard McGregor): “China is ‘deeply worried’ about the state of the US and global economies and about the impact from the continuing weakness of the dollar against other currencies, Wen Jiabao, the country’s premier, said… Chinese policymakers are grappling with conflicting pressures, trying to control inflation, which has hit 12-year highs, without slowing the economy too much when they need to create millions of new jobs a year.”
March 19 – Bloomberg (Nipa Piboontanasawat): “Hong Kong’s unemployment rate unexpectedly fell to the lowest in a decade… The… jobless rate for the three months ended Feb. 29 was 3.3%…”
March 21 – Bloomberg (Toru Fujioka): “Japanese households’ assets fell for the first time in five years as the nation’s benchmark stock index fell, eroding consumer wealth and reducing the prospects for their spending to support economic growth.”
Asia Bubble Watch:
March 18 – Financial Times (Javier Blas): “Rice prices surged to a fresh 34-year high on Tuesday as the Philippines awarded a tender for the staple at an average price of $708 a tonne, up almost 50% from the price it paid in late January. The sharp rise reflects a market suffering from tightening supply after key producers India and Vietnam this month both imposed further restrictions on rice exports… The jump in rice prices would exacerbate rising inflation in Asia and risks triggering social unrest, analysts said. The Philippines, one of the world’s biggest rice importers, is particularly exposed.”
Unbalanced Global Economy Watch:
March 20 – Bloomberg (Kari Lundgren): “Mortgage lending in the U.K. fell to 24 billion pounds ($47.6bn) in February, a 7% drop from the previous month…”
March 20 – Bloomberg (Helene Fouquet): “The French statistics office cut its forecast for economic growth and predicted accelerating inflation, reflecting a global slowdown and surge in commodity prices.”
March 19 – Bloomberg (Flavia Krause-Jackson and Flavia Rotondi): “Italy’s economy will expand at the slowest pace in five years as ‘external shocks’ such as record oil prices and the euro’s strength against the dollar hurt consumers and businesses, the Isae research institute said.”
Central Banker Watch:
March 20 – Bloomberg (Scott Lanman): “The Federal Reserve bypassed its own emergency-lending policies to let securities firms borrow at the same interest rate as commercial banks as the central bank sought last weekend to stave off a financial-market meltdown. Guidelines revised in 2002 say the Fed should charge non- banks more than the highest rate that commercial banks pay. Instead, Chairman Ben S. Bernanke and his colleagues, in emergency votes on March 16, invoked broader authority in the Federal Reserve Act to give Wall Street dealers the same rate as banks, a Fed staff official said on condition of anonymity. Backstopping securities firms, coupled with last week’s action to keep Bear Stearns Cos. afloat before its sale to JPMorgan Chase & Co., represent the central bank’s first lifelines to institutions other than banks since the Great Depression.”
March 20 – UPI: “Former U.S. Federal Reserve Chairman Alan Greenspan defended his interest rate policy, but said he should have monitored banks more closely. ‘I don’t know a of a single example of when interest rate policy has been successful in suppressing gains in asset prices,’ he said. Greenspan said low interest rates during his years as chairman were due to global economic forces. The current economic crisis came after a period of ‘disinflationary forces’ and a long period of ‘underpricing of risk,’ Greenspan told The Washington Post…”
March 19 – Bloomberg (Carol Massar and Eric Martin): “U.S. stocks, which surged the most in five years yesterday, will likely continue their rally this year because the ‘out of control’ Federal Reserve is cutting interest rates to save investment banks from collapse, investor Jim Rogers said. The Fed’s support is ‘why we’re having a big rally, but that’s not going to solve the problem,’ Rogers…said… ‘The system is terribly corroded.’ …What are they going to do when the stock market is down 40% or 50%? They’re not going to have any bullets left. They’re not going to be able to solve the problems at that point.’”
Bursting Bubble Economy Watch:
March 21 – Washington Post (Neil Irwin and Alejandro Lazo): “Inflation is walloping Americans with low and moderate incomes as the prices of staples have soared far faster than those of luxuries. The goods and services Americans consumed in February were 4% more expensive than they were a year earlier. But there is a big divide in how much prices are climbing between the basic items people need to live and get to work… An analysis of government data by The Washington Post found that prices have risen 9.2% since 2006 for the groceries, gasoline, health care and other basics that a middle-income American family has little choice but to consume. That would cost such a family, which made $45,000 on average in 2006, an extra $972 per year…”
March 18 – San Francisco Chronicle (Tom Abate): “The investment banking crisis on Wall Street is already drying up the flow of capital to Silicon Valley, and while money should find new ways to reach local startups, a cash drought of unknown duration and severity is under way. That’s the synthesis of interviews with a half-dozen sources, each of whom have what valley people call ‘skin in the game’ - personal financial stakes in the startup economy that depend on Wall Street firms like Bear Stearns to keep the whole system working… In the startup economy, the lakes are the venture capital funds that raise money to create startups, which then go public or get sold to a bigger firm. Confidence takes the place of evaporation to keep the cycle going. At the moment, however, confidence has all but evaporated. ‘There’s so much fear and doubt out there,’ said Sam Colella, a founding partner of Versant Ventures, which invests in biotech and health care startups.”
March 18 – Bloomberg (Bill Koenig): “U.S. sales of new vehicles will slide below 15 million this year to their lowest level since 1994 because of a slowing economy and declining consumer confidence, J.D. Power & Associates said.”
March 21 - Los Angeles Times (Mike Boehm): “Some of Southern California’s major cultural institutions are bleeding because of the sub-prime mortgage crisis, with combined losses of more than $3 million -- and mounting -- since February, when their seemingly safe and innocuous construction bonds turned into fiscal leeches. Among those scrambling to escape interest payments that have more than doubled are the Los Angeles County Museum of Art, the Orange County Performing Artscenter, the Natural History Museum of Los Angeles County and the Colburn School. The soaring rates -- which are hitting an array of nonprofits as well as municipalities and government agencies -- reflect doubts about insurance companies that issued policies guaranteeing so-called auction-rate bonds.”
March 20 – Bloomberg (Daniel Taub and Dan Levy): “Sacramento may eliminate up to 600 jobs in the city’s first staff reductions in half a century, and the police and fire departments in the California capital may have their budgets cut by 20%. The culprit is the collapse of the U.S. housing market. California, the birthplace of the subprime mortgage industry, is paying the highest price of any state as the housing meltdown persists… ‘The depth and magnitude of what’s happening in the real estate market is really, really grim,’ said Russell Fehr, Sacramento’s finance director… California… accounting for almost one-seventh of gross domestic product, will lose $25 billion in personal income by the end of 2008 and property values will fall by $630.7 billion, according to forecasts from economist Jerry Nickelsburg at UCLA… and the U.S. Conference of Mayors… Almost half of the 25 biggest U.S. subprime lenders were based in the state… and almost a quarter of the country’s outstanding subprime loans were issued there… Prices that more than doubled in California from 2000 to 2005 fueled demand for nontraditional mortgages that allowed people to purchase homes, said Peter Navarro, a professor at the University of California… ‘The high home prices here made it very difficult to get into houses unless you started doing really funky things,’ Navarro said. The number of houses and condominiums sold in California plummeted 30% in January from a year earlier… California had 481,392 foreclosure filings on properties last year…”
MBS/ABS/CDO/CP/Money Funds and Derivatives Watch:
March 20 – Bloomberg (Daniel Taub): “U.S. home prices may decline as much as 20% by the end of 2008 from their peak in 2006 as the housing slump worsens, Standard & Poor’s said. There is a ‘growing economic consensus that U.S. home price declines will be larger than previously forecast and that the slump in the U.S. housing market will last longer than previously anticipated,’ the… company said…”
Real Estate Bubble Watch:
March 15 – Barron’s (Jacqueline Doherty): “Brace yourselves, homeowners. the current weakness in U.S. home prices could persist for years, especially if you count the toll exacted by inflation. For all the wishful thinking in the housing industry, home prices can be remarkably stubborn. Just look at what happened in the ‘80s and ‘90s. The inflation-adjusted average price of an existing home peaked in 1979, didn't bottom out until 1984 and didn’t return to the 1979 level until 1995. In other words, real home prices went nowhere for 16 years.”
March 19 – Bloomberg (Jeremy R. Cooke): “The outlook on Florida’s $13 billion of general obligation bonds was cut to negative from stable by Moody’s…, as the economic slowdown and housing recession depress state revenue estimates.”
March 20 – Bloomberg (Michael B. Marois): “Local governments across the U.S. are learning an expensive lesson from the auction-rate bond market: When Wall Street bankers offer a financing deal that seems too good to be true, it may just be. Sewer officials for California’s Sacramento County sold $250 million of auction-rate securities in November 2004 so they could pay annualized interest as low as 1.35%... Borrowing for 34 years at a rate that reset every seven days seemed the best of both worlds -- until it soared to 12% last month. ‘I’m going to pay a little bit more attention to the dark side of the deal’ now, said Marcia Maurer, CFO of the county’s sewer district… ‘When bond attorneys talk about the worst-case scenario, people are going to be a lot more ready to believe that the worst-case scenario really can happen.’”
March 18 – Bloomberg (Michael Quint): “New York Governor David Paterson proposed $800 million of spending cuts in next year’s budget, anticipating a weaker economy and less tax revenue than previously estimated. The state faces a $4.6 billion budget gap for the year beginning April 1… ‘New York is facing a fiscal challenge that we have not seen since the dark days following Sept. 11, and our state budget must reflect that reality,’ Paterson said…”
March 19 – Bloomberg (Adam L. Cataldo): “New Jersey’s unfunded pension liability increased 14% to at least $28.3 billion as of June 30, from $24.8 billion a year earlier… The increase is smaller than the 31% increase a year ago, when the liability grew from $18.9 billion as of June 2005.”
March 19 – Dow Jones (John Shipman): “The hedge-fund party may be over in Asia, Deal Journal says. After years in which the number and assets of Asia-focused hedge funds have steadily risen, prime brokers and hedge fund managers say they expect a larger number of managers to fold up the tent this year - not so much because they are decimated by subprime debt losses, as are some in the US and Europe, but because declining equity returns mean the hedge-fund managers themselves won't be making much money.”
March 19 – Bloomberg (Sree Vidya Bhaktavatsalam): “Hedge funds opened last year at the slowest pace since 2001 as investors flocked to established managers, according to a report published today by Hedge Fund Research Inc. The net number of new funds industrywide slumped 26% to 589, after 1,152 were started and 563 funds were liquidated…”
Crude Liquidity Watch:
March 20 – The Wall Street Journal (Chip Cummins): “Protests and violent skirmishes over rising prices are hitting parts of the Middle East, a region already beset by strife but otherwise enjoying an unprecedented, oil-fueled economic boom. Hundreds of workers demanding higher wages to counter soaring food costs rioted at an industrial park in this Persian Gulf emirate Tuesday. They burned and battered dozens of cars and buses at a U.S.-owned contracting company, then ransacked and set ablaze parts of the company's offices. It was the worst reported protest in the oil-rich and booming U.A.E. since thousands of workers rioted and struck at construction sites in the neighboring emirate of Dubai this past fall.”
March 19 – Bloomberg (Sean Evers and Will McSheehy): “Gulf banks, flush with capital from an oil-fueled economic boom, are pushing international lenders out of the Middle East’s project-finance market, Merrill Lynch & Co.’s head of regional investment banking said. ‘For the first time, borrowers in this market are not required to go to international banks,’ Jeffrey Culpepper said… ‘We have here right now probably the lowest cost of capital in the world.’ ...Gulf states including Saudi Arabia and the United Arab Emirates plan to spend a combined $1.1 trillion to develop their economies, Qatar Finance Minister Yousuf Hussain Kamal said… Economies in the Middle East will expand 9.2% this year as oil revenue spurs spending on airports, power plants and business parks, Morgan Stanley has forecast.”
March 21 – Washington Post: “To Understand Wednesday’s decision by federal regulators to let Fannie Mae and Freddie Mac set aside less cash to protect against losses, imagine a family that keeps its precious antique silver in a strongbox on a high shelf, beyond easy reach. The regulators have essentially authorized Fannie and Freddie to pawn some of their family silver. Currently, the two firms, known as government-sponsored enterprises, or GSEs, have combined reserves of $82 billion. This includes an extra amount that the regulator, the Office of Federal Housing Enterprise Oversight (OFHEO), required them to hold while they got their books in order after accounting scandals. Now it is reducing that extra cushion by $5.8 billion. The newly freed-up money will leverage the purchase and securitization of up to $200 billion in home loans. The point, however, is not to save Fannie and Freddie themselves but to use the two firms, which buy mortgages and resell bunches of them to investors in the form of bonds, to ease the difficulties of borrowers more generally. It’s as if our hypothetical family pawned its silver to help the neighbors out of a financial jam… This is risky. If all goes well, freeing up the GSEs will buoy mortgage lending, thus slowing or reversing the slide in housing prices… But if housing continues to tank, and the GSEs rack up new multibillion-dollar losses on top of those they have already incurred in recent months, they will have that much less in reserve to fall back on. The GSEs enjoy an implicit federal guarantee, but reducing their capital for a purpose such as this, at a time such as this, goes a fair way toward making that bailout promise an explicit one.”
I found OFHEO director James Lockhart’s interview late Wednesday afternoon on CNBC worthy of documentation:
CNBC’s Maria Bartiromo: “Some have been arguing that the blowup in Bear Stearns caused the Administration to reconsider policy responses to this crisis. The deal announced today is basically telling them that that is a fact – that it really was Bear Stearns that pushed the government’s hand. Is that true – was it Bear?”
OFHEO Director James Lockhart: “Not really. We’ve been talking about this for a long time. I’ve been talking for many months about the need for these two companies to raise additional capital. And I’ve talked for over the last year that once they got remediated and fixed their books and got them on a timely basis, we would start looking at removing that 30% excess capital charge we had on.”
Bartiromo: “It seems to have taken a long time. A lot of people – from hedge fund companies to certainly the lenders – have wanted the restrictions eased for some time. What was the biggest barrier and what went away over the last several weeks in order to push your hand?”
Lockhart: “I think the key thing was three weeks ago they did actually produce their ‘07 financial accounts on a timely basis. And we’ve gone through all the consent agreement issues and they’re virtually finished on them as well. We thought it really was the appropriate time. They now have the proper systems and controls - proper risk management. And we think it really is a time they can help the mortgage market in a big way.”
Bartiromo: “We’re talking about a big number, too. Some $200bn in the market. What’s the best case scenario, sir – what would you like to see - what specific mortgages do you want these two guys to buy?”
Lockhart: “Well, I think they should be a player in many segments of the market. I think certainly, as (Fannie CEO) Dan Mudd just said, the conventional mortgage market has really weathered this storm pretty well because Fannie and Freddie have been there for the last year. But they could do more there. They’re just getting into the ‘jumbo” market next month, and certainly they’ll need capital to do that. And there’s a lot more that could be done in the subprime – refinancing some of these people into safer mortgages. And, also, just loan modifications. So there are a lot of ways that this capital can be used to improve the mortgage market.”
Bartiromo: “Are you expecting the capital at all to be earmarked for some of the passthrough CMOs – I mean the really troublesome securities that really did in Thornburg or Carlyle Capital or Bear Stearns, among others?”
Lockhart: “Carlyle Capital was actually holding Fannie and Freddie’s securities and the spreads widened dramatically – which they’ve probably come back this week. But I think they will be looking at buying their own mortgage-backed securities. They may look at some other mortgage-backed securities as well. I think we need to increase the trading. And as both of them said this morning, they need to be a bid in the marketplace to buy those securities.”
Bartiromo: “And just the idea that they are a bid in the marketplace to buy those securities obviously was really celebrated in terms of investors and the idea that now there is a buyer there. How long do you expect this process to take? And how long do you think it will take to actually get this moving – liquidity back into the market and a feeling of stability?
Lockhart: “Well, it may take awhile. The mortgage market is one issue, but there are some other markets out there as well. I think this is going to be a major step forward. As you said, they can do $200bn in purchases immediately. And to the extent they’re guaranteeing mortgage-backed securities - that could almost get into the trillions. We’re looking at that they would have the capacity – between what we did today and the significant capital raising that they committed to – they could do over $2 trillion in business this year if the market needs that money.”
As long-time readers are all too familiar, I have been a persistent critic of the GSEs. These behemoths of historic Credit excess – instigators of the Mortgage Finance and housing Bubbles – liquidity backstops for the ballooning leveraged speculating community – and instrumental agents for an unparalleled misallocation of financial and economic resources – are proving themselves The Freddie Krueger of Systemic Distortions and Policy Failures.
It would be an outright crime if thinly-capitalized Fannie and Freddie were allowed to increase their Books of Business (mortgages retained on their balance sheets and MBS guaranteed in the marketplace) by $2 Trillion this year – “if the market needs that money.” I was shocked when Mr. Lockhart imparted that they were now in a position to accomplish such a feat. It is certainly a terrible idea to put Fannie and Freddie guarantees on millions of new mortgages created from restructuring loans of troubled borrowers. This would amount to nothing less than a despicable transfer of massive prospective Credit losses directly to the American taxpayer (current owners of this paper should not be bailed out).
I have fully expected the GSEs, at some point, to be taken over by the federal government. It may have been orchestrated subtly, but I can only presume that such a historic endeavor was accepted this week as the only means of averting financial dislocation. And for their regulator to suggest that the GSEs today have any handle whatsoever over their unfolding “risk management” challenge is wishful thinking - at best.
As far as I’m concerned, much of the U.S. mortgage market was this week essentially Nationalized. I’ll take the dramatic narrowing in agency debt and MBS spreads as support for this view. Additional support arrived from comments from Mr. Lockhart, Mr. Paulson, and actions by the Federal Reserve. Having lived contently for years with the markets’ interpretation of the (grey-area) “implied” government backing of the GSEs, our policymakers are surely today satisfied with the inferred market acceptance of mortgage industry Nationalization. To be sure, the Fed’s Splashy “Sunday Night Special” bailout of Bear Stearns is rather trivial in both its implications and consequences when compared to Thursday’s Quiet Coup.
I have my own hunches about The Rise and Inevitable Fall of the GSEs. I’ve always assumed that the Greenspan Fed was pleased (relieved?) to watch Fannie and Freddie morph in the early nineties from conservative mortgage insurance providers to aggressive bank-like lending institutions and market operators. GSE Credit creation (and timely market interventions) worked greatly to alleviate the forceful economic headwinds created by an impaired banking system. I also (admittedly, rather cynically) pictured President Clinton, Treasury Secretary (and former Goldman Chairman) Robert Rubin, and Budget Director (and former Fannie vice chairman and so-to-be CEO) Franklin Raines behind the closed doors of the Oval Office plotting the exploitation of the GSEs, Wall Street finance, system mortgage Credit, and housing inflation for the orchestration a politically expedient economic boom. After beginning the nineties with assets of $454bn, the GSEs ended the decade with balance sheets that had swelled more than three-fold to $1.723 TN.
In the latter years of the nineties, global financial crisis coupled with political foible – not to mention Wall Street’s rapidly growing power and influence - granted the GSEs carte blanche. And then there was the market hysteria surrounding Y-2K, followed by the bursting of the technology Bubble, the terrible terrorist attacks, and then the 2002 corporate bond dislocation. By the time accounting irregularities surfaced in 2004, GSE assets had almost reached $3.0 TN.
I also have a hunch with regard to Greenspan’s now infamous prodding of households into adjustable-rate mortgages. I think he recognized clearly the degree to which the impaired GSEs (and their scantily capitalized counterparties) had become acutely vulnerable to a rise in market yields. As the Maestro, his interest-rate policies (market manipulations) orchestrated a massive shift of interest-rate risk from the financial sector to the household sector. In the process, however, recklessly low interest rates spurred unprecedented mortgage lending and speculative excesses that today imperil borrower, lender, leveraged speculator and system stability alike.
Somewhere along line, I think the Fed came to appreciate the extent to which they had relegated monetary (mis-) management to the agencies (and their Wall Street enthusiasts). Meantime, some politicians belatedly came to recognize what an affront the GSEs had become to the pricing and allocation of system Credit, as well as to the functioning of free markets more generally. Especially after the 2004 revelation of massive fraud and gross system inadequacies, a consensus developed in Washington that the GSEs needed both restraint and a powerful regulator (although the legislative details were much too slow to materialize). Apparently, all these justifiable concerns were chucked out the window this week in the name of “system stability”.
After first reaching $2.0 TN in 1999, Fannie and Freddie’s Combined Books of Business surpassed $5.0 TN in January. This “Book” increased $638bn, or 16%, last year, in what will surely be the greatest transfer yet of risky mortgage Credit to the GSEs (only to be greatly outdone in 2008). Interestingly, OFHEO, Washington politicians, and Wall Street analysts are keen to play a dangerous game pretending that there is limited risk in guaranteeing MBS (as opposed to the obvious risk associated with mortgages retained on their balance sheet). The absurdity of Mr. Lockhart stating that the GSEs will be in a position to take on an additional $2.0 TN of mortgage risk this year is simply incomprehensible. Keep in mind that the GSEs are on the hook for the “timely payment of principle and interest” on more than $5 TN of American mortgages – and counting… Such obligations will, in the Post-Bubble Era, prove untenable.
I remember when my old “analytical nemesis” Paul McCulley would refer to himself as a “populist” (I still prefer my “inflationist” characterization). Well, where are our “populist” statesmen today? The “average American” is getting slammed by rapid inflation in the prices for fuel, food, healthcare, education and other basis necessities. He was duped into various dangerous mortgage products to purchase homes with, in many cases, grossly inflated market values. Millions are in the process of losing virtually everything. He was also duped into various risky investment products, while the bursting of Bubble markets will leave him dreadfully unprepared for retirement. Now, he is seeing the returns from his savings crushed by the melee to bailout Wall Street “money changers” and speculators. Over the coming months, millions will lose their jobs with the inevitable adjustment and realignment to cope with post-Bubble realities. And now, apparently, the American taxpayer is to sit back and watch his contingent liabilities balloon (even further) with the Nationalization of the U.S. mortgage market.
I understand perfectly the motivation Wall Street, the Administration and the Fed have in blindly throwing the “kitchen sink” at this unfolding Crisis. These are indeed scary times bereft of solutions. I am certainly familiar with the view that bailing out Wall Street and the speculators is medicine necessary to stabilize the system. But not only is this approach both inequitable and unethical on moral grounds, it is my view that such endeavors will prove only further destabilizing for the system overall.
Many are this weekend undoubtedly relieved by the market's strong rally. The Fed and Administration finally are said to have discovered the right antidote – crisis resolved – buy financial stocks! I will caution, however, that U.S. and global markets this week had “dislocation” written all over them. First of all, there is the issue of a problematic dislocation in the massive “repo” market to resolve. We all should hope and pray that this is not the next “contemporary” financing market buckling under the forces of contagion. And to see commodities break down while financial stocks go into spectacular melt-up mode forebodes only greater losses for leveraged speculators in the troubled “market neutral” and “quant” arenas. The short financials and long commodities “pairs trade” was quickly added to the list of favorite trades gone sour. And those (and there were many) using March options (especially financial sector derivatives) to hedge market risk saw this strategy go up in flames as well. Speculators that were long international markets against shorts in the U.S. were similarly crushed. And speculators hedging with short positions in agency, agency MBS, and many other fixed-income derivative indices quickly found themselves on the wrong side of hasty developments.
Surely, policymakers were keen to mete out some punishment on the increasingly destabilizing “systemic risk trade” (shorting stocks, bonds, Credit derivative indices, buying bearish derivative products, etc.), but the upshot was only further destabilization. News that the GSEs were Back in the Game in a Big Way added to an already highly unsettled situation for myriad sophisticated trading strategies. But before getting too excited about the spectacular short-squeeze, keep in mind that shorting has become an instrumental facet of leveraged speculator trading strategies – and, really, “contemporary finance” more broadly speaking. And the disintegration of an ever increasing number of hedge fund and Wall Street strategies, as I’ve written previously, remains at the Heart of Deepening Monetary Disorder.
Not surprisingly, the Fed could not risk a Bear Stearns failure - not with all of its derivative, “repo” and counterparty exposures. It really was not a difficult fix. Yet the rapidly lengthening line of vulnerable non-bank lenders (Thornburg, CIT Group, and Rescap come immediately to mind) and hedge funds will pose a greater challenge. There are some very substantial balance sheets at risk and significantly more “de-leveraging” in the offing - and the big banks will have no appetite.
The S&P500 is down a modest 7% from the much changed financial and economic world of one year ago. While having little impact on the Unfolding Credit Crisis (or home prices), policymakers have thus far largely succeeded in sustaining inflated U.S. stock prices. But, in reality, the profound deterioration in the U.S. and global Credit backdrop has greatly altered prospects for the vast majority of companies, industries, and the U.S. and global economies more generally. Despite any number of policy actions and all the good intentions imaginable, there is absolutely no way that the U.S financial system will now be capable of sustaining either the (pre-bust) quantity of Credit or the uniform flow of finance that levitated Bubble Economy asset prices, household incomes, corporate cash-flows, “investment” spending or consumption. Huge sections of the Credit infrastructures (notably throughout Wall Street-backed finance) are inoperable and disCredited. Prominent Monetary Processes have been broken and the resulting Flow of Finance radically revamped.
Prospective Credit and financial flows will prove insufficient for scores of companies, as well as for state and local governments and various entities all along the economic food chain. Enormous numbers of business downsizings and failures – many by companies that thrived during the Bubble Era – will lead to huge losses of jobs and incomes (many at the “upper end” where the greatest excesses transpired). I simply see no way around it – Nationalization of U.S. mortgages notwithstanding. It is fundamental to my analytical framework that efforts to subvert the Unavoidable Adjustment Process only extend the misallocation of finance and real resources, while adding greatly to the future burden of the financial institutions today aggressively intermediating very risky pre-adjustment Credit (certainly including the banking system and GSEs). And I certainly don’t believe this week’s rally in the dollar should be viewed as a vote of confidence for the direction of U.S. policymaking. Nationalization will prove a further blow to already fragile confidence.