One-month Treasury bill rates dropped 13 bps this week to 1.27%, and 3-month yields fell14 bps to 1.465%. Meanwhile, two-year government yields rose 6 bps to 2.65%. Five-year T-note yields jumped 14 bps to 3.42%, and 10-year yields increased 13.5 bps to 4.095%. Long-bond yields increased 12 bps to 4.66%. The 2yr/10yr spread increased 8 to 144 bps. The implied yield on 3-month December ’09 Eurodollars surged 29.5 bps to 4.19%. Benchmark Fannie MBS yields surged a remarkable 31 bps to 6.15%. The spread between benchmark MBS and 10-year Treasuries widened 18 to 206. The spread on Fannie’s 5% 2017 note widened 4 bps to 73 bps, and the spread on Freddie’s 5% 2017 note widened 4 bps to 73 bps. The 10-year dollar swap spread increased 8 to 76. Corporate bond spreads were mixed. An index of investment grade bond spreads narrowed 3 to 145 bps, and an index of junk bond spreads narrowed 8 to 549 bps.
Investment grade issuance this week included Walgreen $1.3bn, Pacificorp $800 million, and Entergy $300 million.
Junk bond funds reported $70.6bn of outflows this week. Junk issuers included Intelsat $1.25bn, CRH America $650 million, Ticketmaster $300 milion, PPL Energy Supply $300 million, and HSN $240 million.
Convert issuers this week included Sino-Forest $300 million and Trina Solar $120 million.
International dollar bond issuance included Ukrsibbank $250 million.
German 10-year bund yields surged 14 bps to 4.57%. The German DAX equities index rallied 3.7% (down 20.9% y-t-d). Japanese 10-year “JGB” yields slipped 4 bps to 1.565%. The Nikkei 225 declined 1.8% (down 16.4% y-t-d and 28.9% y-o-y). Emerging markets were mixed. Brazil’s benchmark dollar bond yields rose 7 bps to 5.95%. Brazil’s Bovespa equities index slipped 0.3% (down 6.1% y-t-d). The Mexican Bolsa gained 2.0% (down 4.6% y-t-d). Mexico’s 10-year $ yields added one basis point to 5.52%. Russia’s RTS equities index fell 1.5% (down 6.8% y-t-d). India’s Sensex equities index gained 1.2%, with y-t-d losses of 32.8%. China’s Shanghai Exchange index dropped 2.7%, boosting 2008 losses to 47.2%.
Freddie Mac 30-year fixed mortgage rates dropped 9 bps to 6.26% (down 47bps y-o-y). Fifteen-year fixed rates fell 13 bps to 5.78% (down 60bps y-o-y), and one-year adjustable rates declined 7 bps to 5.10% (down 62bps y-o-y).
Bank Credit increased $16.9bn to $9.394 TN (week of 7/9). Bank Credit has expanded $181bn y-t-d, or 3.7% annualized. Bank Credit posted a 52-week rise of $775bn, or 9.0%. For the week, Securities Credit rose $14.7bn. Loans & Leases increased $2.2bn to $6.888 TN (52-wk gain of $574bn, or 9.1%). C&I loans added $2.0bn, with one-year growth of 18.1%. Real Estate loans dropped $11.5bn (up 1.1% y-t-d). Consumer loans fell $2.5bn, while Securities loans gained $9.8bn. Other loans were little changed.
M2 (narrow) “money” supply jumped $24.5bn to $7.699 TN (week of 7/7). Narrow “money” has expanded $236bn y-t-d, or 6.1% annualized, with a y-o-y rise of $442bn, or 6.1%. For the week, Currency increased $2.5bn, while Demand & Checkable Deposits dropped $8.2bn. Savings Deposits jumped $22.6bn, and Small Denominated Deposits added $3.2bn. Retail Money Funds increased $4.5bn.
Total Money Market Fund assets (from Invest Co Inst) declined $7.4bn to $3.498 TN, with a y-t-d increase of $385bn, or 23% annualized. Money Fund assets have posted a one-year increase of $925bn (36%).
Asset-Backed Securities (ABS) issuance this week was stable at a slow $2.3bn. Year-to-date total US ABS issuance of $112bn (tallied by JPMorgan's Christopher Flanagan) is running at 27% of comparable 2007. Home Equity ABS issuance of $303 million compares with 2007’s $206bn. Year-to-date CDO issuance of $14.7bn compares to the year ago $241bn.
Total Commercial Paper outstanding dropped $9.1bn this week to $1.750 TN, with a y-t-d decline of $36bn. Asset-backed CP fell $5.5bn last week to $745bn, increasing 2008's fall to $27.5bn. Over the past year, total CP has contracted $445bn, or 20.3%, with ABCP down $433bn, or 36.7%.
Fed Foreign Holdings of Treasury, Agency Debt last week (ended 7/16) decreased $2.1bn to $2.348 TN. “Custody holdings” were up $292bn y-t-d, or 25.4% annualized, and $352bn year-over-year (17.6%). Federal Reserve Credit increased $0.5bn to $888.4bn. Fed Credit has increased $14.9bn y-t-d (3.1% annualized) and $34.6bn y-o-y (4.0%).
International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $1.376TN y-o-y, or 24.6%, to a record $6.977 TN.
Global Credit Market Dislocation Watch:
July 18 – Bloomberg (Jody Shenn): “Yields on agency mortgage securities relative to U.S. Treasuries rose to a four-month high on concern that financial companies including Fannie Mae and Freddie Mac may need to sell the debt or buy less of it. The difference between yields on Fannie Mae’s current- coupon, 30-year fixed-rate mortgage bonds and 10-year government notes widened 5 bps to 206 bps… Freddie Mac is considering selling assets carried below their value to maintain acceptable capital ratios, it said today in a filing with the U.S. Securities and Exchange Commission.”
July 13 – Wall Street Journal (Michael Corkery and James R. Hagerty): “At the heart of the near-panic rocking Fannie Mae and Freddie Mac is a vicious cycle gripping the U.S. housing market. It starts with the oversupply of homes, which is causing prices to plummet. Falling prices are leading to more foreclosures, as homeowners have difficulty refinancing their mortgages or selling their houses. Banks are reluctant to lend freely at a time when home values keep sinking and defaults keep rising. That is crimping housing demand further and leading to more price drops and defaults. This phenomenon… began with subprime borrowers but has gone well beyond the small segment of borrowers with poor credit. It is now spreading to the much-larger market of prime borrowers, which forms the bread and butter of Fannie’s and Freddie’s mortgage assets.”
July 18 – Financial Times (Chris Flood): “Gold’s appeal as a safe haven for investors has again been rising amid widespread fears that the stability of the global financial system is exhibiting renewed strains… On Friday there was a record one-day increase in holdings in gold exchange traded funds as Fannie Mae and Freddie Mac, linchpins of the US mortgage market, threatened to collapse and IndyMac Bank imploded – the third-largest financial institution to fail in the US.”
July 16 – Bloomberg (Josh P. Hamilton): “MGIC Investment Corp., PMI Group Inc. and competing U.S. mortgage insurers reeling from record claims may have to absorb even higher loss rates from bad home loans, Fitch Ratings said. About 70% of the industry’s policies cover loans issued from 2005 through 2007 when mortgage and insurance underwriting standards were lax, leading to progressively higher default rates, Fitch said. Mortgage insurers pay lenders when borrowers default and foreclosure fails to recoup costs. ‘The mortgage insurance industry’s troubles are not over and may, in fact, get worse,’ Fitch said… The industry ‘underestimated both the scope and severity of the decline in residential mortgage markets that became increasingly acute in 2007.’”
July 18 – Financial Times (Paul J Davies): “Almost a year into the widespread financial deleveraging sparked by the credit and liquidity crisis, the markets for bonds backed by mortgages and other debt are yet to see an invasion of bargain hunters. Even for the safest, supposedly bomb-proof, triple A rated bonds backed by the least risky home loans have not seen a sustained revival in fortunes. In fact, a recovery in April and May for some such deals has proved short-lived. This is not what many analysts and investors expected. The worst of the forced selling is thought to have been over by the end of the first quarter. And the height of fears about systemic risk and a potential collapse of large parts of the financial system were supposed to have passed with the rescue of Bear Stearns in March. However, across the board in markets for asset-backed securities, it is increasingly fundamental credit risk that is now coming to the fore.”
July 17 – Bloomberg (Josh P. Hamilton and Daniel Taub): “IndyMac Bancorp Inc.’s collapse may spur withdrawals from banks ranging from First BanCorp in Puerto Rico to Los Angeles-based Nara Bancorp Inc. as customers trim accounts below the $100,000 limit on deposit insurance, according to Sandler O’Neill… ‘IndyMac’s failure has people worried about others,’ Mark Fitzgibbon, a principal at Sandler O’Neill, said… The result could be a liquidity squeeze at banks that rely on ‘jumbo’ deposits, Fitzgibbon said.”
July 18 – Bloomberg (Vernon Wessels): “The Federal Deposit Insurance Corp. set new rules for U.S. banks that lets regulators take charge of paying off depositors in a move to prevent spillover in the event of a large failure. The rules, which apply to 159 banks with at least $2 billion in U.S. deposits and either $20 billion in assets or 250,000 account holders, start Aug. 18, the... regulator said... Banks have 18 months to comply. The change will help pay off insured deposits as soon as possible and help ‘maintain public confidence in the banking industry,’ the regulator said. It will also ‘mitigate the spillover effects of a failure, such as risks to the payments system, problems stemming from depositor illiquidity and a substantial reduction in credit availability.’”
July 15 – Wall Street Journal (Joanna Slater): “A long history of bank bailouts around the world provides some models for what could unfold in the U.S. as the government becomes more directly involved in fixing a damaged financial system. This history shows it is almost always a painful process… Since the 1990s, countries like Japan, Sweden, South Korea and Thailand have all experienced banking crises. The U.S. had its own financial upheaval during the savings-and-loan debacle in the 1980s. Each of these predicaments required dramatic moves, including bank closures and nationalizations, efforts to buy bad assets, plus injections of capital by governments that the market wouldn’t provide. Often, depositors and creditors of ailing financial institutions get protection and shareholders get the worst deal of all. The U.S. government has tiptoed toward some of these measures with its handling of the Fannie Mae and Freddie Mac crisis.”
July 18 – Dow Jones (Marshall Eckblad): “Federal banking regulators are girding for a new challenge to the nation's beleaguered banking system: rising inflation. Banks already face a historic collapse of the nation's housing markets, and a resulting wave of consumers defaulting on their mortgage, car and credit-card loans. Now, a prolonged spike in food and fuel prices threatens to push short-term interest rates higher, and squeeze operating income for banks. Higher short-term rates stemming from inflation are ‘the next issue’for banks, said Sheila Bair, chairman of the Federal Deposit Insurance Corp…. ‘We are focused on that and encourage banks to’ do the same, she said.”
July 18 – Bloomberg (Lenka Ponikelska): “Receivers for Cheyne Finance Plc, the first of the structured investment vehicles to auction assets after collapsing last year, accepted bids at 43.9% of face value. Deloitte & Touche LLP asked banks to bid for $2.29 billion, or 30.9%, of the SIV’s debt holdings this week. The auctioned holdings include asset-backed securities and collateralized debt obligations, according to Moody’s…”
July 14 – Bloomberg (Bradley Keoun): “At an investor presentation in May, Citigroup Inc. Chief Executive Officer Vikram Pandit said shrinking the bank’s $2.2 trillion balance sheet, the biggest in the U.S., was a cornerstone of his turnaround plan. Nowhere mentioned in the accompanying 66-page handout were the additional $1.1 trillion of assets that… Citigroup keeps off its books: trusts to sell mortgage-backed securities, financing vehicles to issue short-term debt and collateralized debt obligations, or CDOs, to repackage bonds… ‘If you start adding up all the potential exposures, it’s a huge number,’ said Sam Golden, a former ombudsman for the U.S. Office of the Comptroller of the Currency… ‘The banks will say that it was disclosed. Investors are saying, `Yeah, but it was cryptic. We really didn’t know what you were telling us.’”
July 18 – Financial Times (Daniel Pimlott): “Merrill Lynch has pulled out of talks to locate its headquarters at the new World Trade Center after suffering billions of dollars of writedowns. Merrill had been expected to take one of three buildings in development by Larry Silverstein at the World Trade Center. The decision to hold off on building offices – at a likely cost of as much as $3bn – is the second time in less than a year that the troubled investment bank has vetoed new headquarters.”
July 17 – Bloomberg (Erik Holm): “Record tornado damages, the weakening economy and a drop in premiums may reduce insurers’ earnings by 30%, the steepest second-quarter decline since 2002… Losses from catastrophes, including the most tornadoes in the U.S. since at least 1950, were about $5.5 billion. At the same time, investment returns and opportunities to sell residential and corporate coverage declined as the economy slowed and home sales dropped. ‘We’re going to see amazingly bad numbers from the property insurers in the second quarter,’ said Meyer Shields, an analyst at Stifel Nicolaus… ‘There are lots and lots of losses out there.’”
July 14 – Bloomberg (Mark Herlihy): “More than three quarters of U.K. chief financial officers said credit has become ‘hard to obtain’ as a result of turmoil in financial markets, according to a survey by Deloitte and Touche LLP. The survey found that 77% of CFOs said credit was hard to obtain, compared with 63% in March and 48% in September, Deloitte said… Some 89% of respondents rated credit as ‘costly,’ compared with 72% in March and 59% last September. Conditions are likely to get ‘worse,’ Deloitte said.”
July 18 – Bloomberg (Svenja O’Donnell): “U.K. mortgage lending fell 32% in June from a year earlier, the Council of Mortgage Lenders said. Gross lending against property declined to 23.8 billion pounds ($47.44bn)… Lending fell 3% from May.”
Global Inflation Turmoil Watch:
July 18 – Bloomberg (Li Yanping and Zhang Dingmin): “China tightened scrutiny of foreign direct investment to prevent ‘fake’ ventures that the government said are acting as channels for speculative capital and endangering the world’s fastest-growing major economy. Sham joint ventures and shell companies are among the conduits… ‘Hot money’ from investors attracted by a strengthening currency and interest rates at a decade high threatens to stoke inflation and destabilize the financial system in the event of sudden outflows.”
July 18 – Bloomberg (Drew Benson and Lester Pimentel): “Chilean central bank President Jose de Gregorio may have to abandon his plan to boost exports by weakening the peso after inflation accelerated to the fastest pace in 14 years. The peso has become the world’s worst performing currency, tumbling 11.8% in the three months since de Gregorio told traders at Banco Central de Chile to buy $50 million a day. Annual inflation soared to 9.5% in June, the highest since 1994… ‘They have a very serious inflation problem,’ said Igor Arsenin, an emerging-markets strategist at Credit Suisse… ‘The next step for them is to scrap those dollar purchases.’”
The dollar index added 0.1% to 71.19. For the week on the upside, the Mexican peso increased 1.2%, the South African rand 0.9%, the Brazilian real 0.5%, the Taiwanese dollar 0.3%, and the British pound 0.2%. On the downside, the South Korean won declined 1.0%, the Japanese yen 0.8%, the Swiss franc 0.7%, the New Zealand dollar 0.4%, and the Euro 0.4%.
July 15 – Bloomberg (Scott Reyburn): “Diamonds, like art, are a commodity that is gaining attention as an alternative investment. Increases in the price of the rarest colorless and colored diamonds are attracting wealthy investors and structured funds as stock markets and real-estate values decline. The price of 5-carat gems with the potential to be sold at $1 million or more has risen 76.5% in the year to May 2008, according to… the Web site of the International Diamond and Jewelry Exchange… Five years ago, dealers were paying $70,000 per carat for colorless diamonds of 10 carats and more… ‘Now we’re paying over $200,000 per carat…’”
Gold declined 0.9% to $955 and Silver fell 3.3% to $18.20. August Crude sank $16.34 to $128.74. August Gasoline sank 11.5% (up 27.8% y-t-d), and August Natural Gas dropped 10.2% (up 42.9% y-t-d). September Copper declined 1.9%. September Wheat fell 3.2% and August Corn sank 11.8%. The CRB index was hit for 7.4% (up 19.1% y-t-d). The Goldman Sachs Commodities Index (GSCI) sank 9.5% (up 30.5% y-t-d and 55% y-o-y).
July 14 – Bloomberg (Nipa Piboontanasawat and Li Yanping): “China’s foreign-exchange reserves climbed… to a record $1.81 trillion at the end of June… Currency holdings rose 35.7% from a year earlier… Chinese regulators are adding controls this month to limit ‘hot money’ inflows from investors betting the yuan will keep appreciating after 25 straight monthly gains. The trade surplus, foreign direct investment and speculative capital have flooded the world’s fourth-biggest economy with cash…”
July 17 – MarketNews International: “China’s enterprise commodity price index, which measures prices at the wholesale level, rose 9.5% year-on-year in June…”
July 17 – Bloomberg (Kevin Hamlin and Li Yanping): “China’s economy grew at the slowest pace since 2005 in the second quarter… Gross domestic product rose 10.1% from a year earlier, down from 10.6% in the first quarter, as exports weakened and the government curbed lending.”
July 18 – Bloomberg (Wang Ying and Winnie Zhu): “China, the world’s second-biggest energy consumer, may face a worse-than-expected power shortfall when demand peaks in summer, the nation’s largest electricity distributor said.”
July 18 – Bloomberg (Tian Ying): “China’s stockpile of unsold new vehicles rose about 50% in the six months ended June, hitting a four-year high, as automakers expanded production and sales growth slowed. The backlog reached 170,000 vehicles… First-half sales totaled 5.18 million.”
July 13 – Wall Street Journal (Tomoyuki Tachikawa): “Japan’s consumer sentiment worsened to its lowest level ever in June… signaling that growing inflationary pressures world-wide will likely further hurt Asia’s biggest economy… Consumer spending accounts for 55% of Japan's gross domestic product.”
July 18 – Bloomberg (Anil Varma): “Money supply in India grew 20.5% in the two weeks ended July 4 from a year earlier…”
Asia Bubble Watch:
July 15 – Bloomberg (Seyoon Kim): “South Korea’s import prices surged by the most in more than 10 years because of rising oil costs. Prices of imported goods surged 49% in June after a 44.6% gain in May, the Bank of Korea said… From a month earlier, prices climbed 2.7%, the central bank said.”
July 17 – Bloomberg (Shamim Adam and Karl Lester M. Yap): “The Philippine central bank raised its benchmark interest rate by the most since 2000 and forecast inflation will exceed last month's 14-year high on record oil and food prices. Bangko Sentral ng Pilipinas increased the rate it pays banks for overnight deposits by 0.5 percentage point to 5.75%...”
Latin America Watch:
July 18 – Bloomberg (Jens Erik Gould): “Mexico’s central bank raised its benchmark interest rate for the second straight month to curb the highest inflation rate in more than three years. The bank’s five-member board… raised the key lending rate by a quarter percentage point to 8%...”
Unbalanced Global Economy Watch:
July 15 – Wall Street Journal Europe (Elga Bartsch and Joachim Fels): “The main driver behind rising global inflation pressures is well understood: a very lax global monetary policy stance, particularly in the U.S. and in many emerging-market countries. This has fueled higher food and energy prices, and other prices are likely to follow -- especially as most central banks around the world are unlikely to tighten policy sharply anytime soon. So it is not surprising that inflation is rising everywhere. What does appear puzzling is that, at 4%, euro-area inflation is at about the same level as that in the U.S. and has actually risen by a greater amount over the past year. That’s despite a significant appreciation of the euro against the dollar during the same period…”
July 15 – Bloomberg (Jennifer Ryan and Brian Swint): “U.K. inflation accelerated to the fastest pace in at least 11 years and the housing slump worsened, making it harder for the Bank of England to stave off a recession by cutting interest rates. Consumer prices climbed 3.8% from a year earlier…Property- price declines stayed close to the most widespread in 30 years and transactions dropped, a separate report showed.”
July 16 – Bloomberg (Svenja O’Donnell): “U.K. unemployment jumped the most in June since the aftermath of the last recession in 1992 as the economic slowdown forced companies to cut jobs and stop hiring. Claims for jobless benefits climbed for a fifth month, increasing 15,500 from May…”
July 18 – Bloomberg (Svenja O’Donnell): “U.K. money supply increased at the quickest pace since 1988 in June, five times as fast as economists forecast… M4, the broadest gauge of money supply in Britain… rose 2% from May… From a year earlier, it rose 11.5%...”
July 18 – Bloomberg (Mark Deen and Gonzalo Vina): “The U.K. budget deficit ballooned to the widest since records started in 1946… The shortfall was 24.4 billion pounds ($49bn) in the three months through June… Last month, the deficit expanded to 9.2 billion pounds…”
July 18 – Bloomberg (Ian Guider): “Ireland’s unemployment rate may rise to 7% in 2009 as more companies fire workers in response to a slumping economy, the country’s job training agency said. ‘There are already signs that some of the external problems facing the economy are having a direct impact on the labor market,’ said Brian McCormick, FAS senior economist…”
July 16 – Bloomberg (Fergal O’Brien): “Inflation in Europe accelerated to the fastest in more than 16 years in June, led by a 53% surge in the cost of heating oil. The inflation rate in the euro area rose from 3.7% in May, the European Union statistics office… said.”
July 16 – Bloomberg (Cecile Gutscher and John Glover): “If there is any doubt European shoppers are following their U.S. counterparts into a recession, look no further than … Chain stores… are the worst performers among the region’s 140 billion euros ($220 billion) of leveraged-buyout loans, according to Markit Group Ltd. and S&P data… ‘We’re going into a consumer-led slowdown, which is just now starting to show its signs,’ said… Pilar Gomez- Bravo, who is in charge of credit funds for Europe at Lehman Brothers Asset Management.”
July 18 – Bloomberg (Bernd Bergmann): “German producer prices rose at the fastest pace in 26 years in June, adding to pressure on the European Central Bank to keep interest rates high even as economic growth slows. Prices for goods from newsprint to plastics increased 6.7% from a year earlier, the most since March 1982, after rising an annual 6% in May…”
July 18 – Bloomberg (Charles Penty): “Spain’s stock of mortgage loans rose an annualized 10% in May, the slowest growth in at least 15 years, as the country’s real estate boom ended. Mortgage growth in May halved from 20.5% a year earlier…”
July 15 – Bloomberg (Sharon Smyth and Ben Sills): “Home prices in Spain fell for the first time in almost 10 years in the second quarter after higher borrowing costs and restrictions on mortgage lending eased demand. The average price of new and used houses and apartments declined 0.1% from the previous quarter… Prices rose 2.4% from a year earlier… ‘This is happening much faster than expected and much faster than is desirable,’ said Jose Carlos Diez, chief economist at Intermoney SA.”
July 14 – Bloomberg (Elizabeth Konstantinova): “Bulgaria’s inflation accelerated to a decade-high in June as higher transport and tobacco prices outweighed a seasonal drop in food costs. The inflation rate rose to 15.3%, the second-highest in the European Union after Latvia, from 15% in May.”
July 17 – Bloomberg (Farhan Sharif): “Pakistan investors stormed out of the Karachi Stock Exchange, smashed windows and cursed regulators after the benchmark index fell for a 15th day, the worst losing streak in at least 18 years. ‘I have lost my life savings in the last 15 days and no one in the government or regulators came to help us,’ said Imran Inayat, 45, a protester and a former banker who retired early and said he lost 300,000 rupees ($4,175) on the market. Police surrounded the exchange after hundreds of investors stoned the building and shouted anti-government slogans.”
July 15 – Bloomberg (Tracy Withers): “New Zealand’s consumer prices rose at the fastest pace in 18 years in the second quarter, fanned by fuel and food costs, adding to signs the economy is facing stagflation as it slips into recession. The consumer prices index rose 1.6% from the first quarter…”
Bursting Bubble Economy Watch:
July 16 – Bloomberg (Bob Ivry): “The U.S. housing crisis may accomplish what years of parental hectoring couldn’t: Turn Americans from spenders into savers. Spending will fall because homeowners can no longer use rising real estate values to borrow cash -- $837.5 billion in 2006, according to a report by former Federal Reserve Chairman Alan Greenspan and senior Fed economist James Kennedy. With mortgage lenders requiring down payments of 20%, the average household, which puts away less than 1% of after- tax pay, will have to save 10% for 10 years to buy a home.”
July 16 – Bloomberg (Shobhana Chandra and Timothy R. Homan): “U.S. consumer prices surged 5% in the past year, the biggest jump since 1991, just as households struggled with falling home values and the credit crunch. Spiraling expenses for food and fuel spurred the increase in June…”
July 16 – Bloomberg (Timothy R. Homan): “Misery hasn’t had this much company in more than 15 years. The jump in consumer prices reported today by the Labor Department means the so-called Misery Index, the sum of the unemployment and inflation rates, is the highest since… January 1993… The figures underscore Federal Reserve Chairman Ben S. Bernanke’s comment to lawmakers yesterday that U.S. households are under ‘tremendous pressure.’ ‘You add that to what’s going on with home prices and that’s just a huge stress on consumers,’ said Robert Dye, senior economist at PNC Financial Services…”
July 16 – Time (Bill Saporito): “You would expect Americans, in a period of falling home prices, a wobbly stock market and an ongoing war, to be less than satisfied with the direction of the country. It’s natural. But Americans are not simply dissatisfied. They are very unhappy. O.K., deeply, pessimistically unhappy. Un–American Dreamy unhappy: 85% of respondents in an exclusive TIME/Rockefeller Foundation poll believe that the country is on the wrong track. It’s an unprecedented downer from an optimistic nation, and depending on whom you talk to, the numbers simply get worse.”
July 14 – Bloomberg (Chris Dolmetsch): “Amtrak, the U.S. national passenger railroad, raised fares on 13 routes in the Midwest and Northeast by 5%, a spokeswoman said… The fares went up this month because of agreements with labor unions reached this year and the rising cost of fuel on routes served by diesel locomotives…”
Central Banker Watch:
July 15 – Bloomberg (Craig Torres and Scott Lanman): “Federal Reserve Chairman Ben S. Bernanke abandoned his June assessment that the threat of an economic downturn had diminished, telling lawmakers that growth and inflation risks are increasing. There are ‘significant downside risks to the outlook for growth,’ and ‘upside risks to the inflation outlook have intensified,’ Bernanke said… Bernanke’s shift reflects renewed turmoil in markets that forced the Treasury and Fed to mount a rescue of Fannie Mae and Freddie Mac this week. He said that stabilizing financial markets remains ‘a top priority’…”
July 17 – Washington Post (Neil Irwin): “The sprawling financial and economic crisis is leading to expansion of the Federal Reserve’s role, increasingly turning the central bank into a sort of all-purpose guarantor of the financial system. In the past few months, Fed Chairman Ben S. Bernanke has burst through long-standing boundaries on what the Fed does. Bernanke’s actions… have repeatedly pulled the world from the brink of financial catastrophe and have won praise from Wall Street and Capitol Hill… ‘The Federal Reserve has re-created itself,’ said Vincent Reignhart, a senior staffer at the Fed until last summer… ‘And if you do more things, you set yourself up to have to choose among them and trade off. What happens when concern for housing finance conflicts with the need to pursue price stability?’”
July 18 – Bloomberg (Vivien Lou Chen): “The Federal Reserve shouldn’t wait until financial and housing markets stabilize to raise interest rates, central bank policy maker Gary Stern said. ‘We can’t wait until we clearly observe the financial markets at normal, the economy growing robustly, and so on and so forth, before we reverse course,’ Stern, president of the Federal Reserve Bank of Minneapolis, said… ‘Our actions will affect the economy in the future, not at the moment.’ The comments by Stern… reinforced traders’ forecasts for a rate increase by year-end.”
July 17 – Bloomberg (Simone Meier): “The European Parliament may call on the European Central Bank to revise its inflation goal as food and energy costs soar, according to a draft report. The ECB’s aim to keep inflation just below 2% ‘should be examined in the context of a new age of globalization characterized by rising energy and food prices,’ said the non- binding report… ‘The ECB should move toward a full inflation target regime where a shift to a range of targets might be more meaningful than a point target inflation rate.’”
Burst Mortgage Finance Bubble Watch:
July 14 – Bloomberg (Jody Shenn): “More than two of every five subprime borrowers whose mortgages were reworked in the first half of 2007 are defaulting anyway, Moody’s… said. Among subprime adjustable-rate mortgages modified in the first half of last year, 42% were at least 90 days late on March 31… Modifying loans granted to consumers with poor credit records has gained favor as record numbers fail to keep up with payments and home prices tumble… Modification rates for subprime ARMs rose to 9.8% of all loans whose initial ‘teaser’ rate periods have expired since the beginning of 2007, up from the 3.5% recorded in a December survey…”
July 18 – Bloomberg (Bill Rochelle): “Lake at Las Vegas Joint Venture LLC, the master developer of the Lake Las Vegas Resort 17 miles from the Las Vegas Strip, filed for Chapter 11 protection yesterday in Las Vegas with affiliates, saying assets are more than $500 million and debt exceeds $1 billion.”
Real Estate Bust Watch:
July 17 – Bloomberg (Daniel Taub): “Apartment rents in the Western U.S. rose 2.5% in the second quarter from a year earlier, slower than the rate of inflation, as unemployment increased and occupancies fell in most areas, according to research company RealFacts. The average monthly rent in 15 U.S. states, most of which are in the West, climbed 0.6% from the first quarter to $999…”
July 16 – Washington Post (Anita Huslin): “In the four years since he stepped down as Fannie Mae’s chief executive under the shadow of a $6.3 billion accounting scandal, Franklin D. Raines has been quietly constructing a new life for himself. He has shaved eight points off his golf handicap, taken a corner office in Steve Case’s D.C. conglomeration of finance, entertainment and health-care companies and more recently, taken calls from Barack Obama’s presidential campaign seeking his advice on mortgage and housing policy matters. And he’s privately smoldered over the events of the past week, when Fannie Mae and Freddie Mac were portrayed as being on the brink of disaster… In his first interview in two years, Raines remained insistent that the mortgage finance giant’s problems are not rooted in the company but stem from a time when the Bush administration and the Fed insisted the government-sponsored enterprise carried no explicit federal backing.”
July 16 – Wall Street Journal (John D. McKinnon and James R. Hagerty): “For years, Washington officialdom enabled Fannie Mae and Freddie Mac, the congressionally chartered mortgage companies, to grow until they dominated the U.S. market. Now lawmakers are confronting the result: a crisis of confidence in the two companies that raises questions about whether they can make it through the deep downturn that has struck the real-estate market. And nobody wants to get stuck with the blame. If there’s one decision that is being second-guessed, it’s the 1992 legislation that created the companies’ regulator, the Office of Federal Housing Enterprise Oversight, or Ofheo. In the 1992 debate, Ofheo came away with fairly weak powers, and capital requirements for the companies were set very low… Lobbyists from the companies are said to have strongly influenced the 1992 legislation…”
July 18 – Wall Street Journal (Michael R. Crittenden and Sarah Lueck): “House Democrats negotiating a rescue of Fannie Mae and Freddie Mac said they wouldn’t exempt the proposal from the annual debt limit, a move designed to quell lawmakers’ concerns that the Treasury’s financial aid could be unlimited. Rep. Barney Frank said any help for the two mortgage-finance giants would be counted against the federal debt limit, which Congress must vote to increase. Congress has voted five times during the Bush presidency to increase the limit…which currently stands at $9.815 trillion. Total public debt subject to the limit as of July 15 is $9.440 trillion, within $375 billion of the limit. Some lawmakers have worried the rescue plan would expose taxpayers to trillions of dollars in losses.”
July 14 – Bloomberg (Carol Massar and Eric Martin): “The U.S. Treasury Department’s plan to shore up Fannie Mae and Freddie Mac is an ‘unmitigated disaster’ and the largest U.S. mortgage lenders are ‘basically insolvent,’ according to investor Jim Rogers. Taxpayers will be saddled with debt if Congress approves U.S. Treasury Secretary Henry Paulson’s request for the authority to buy unlimited stakes in and lend to Fannie Mae and Freddie Mac, Rogers said…”
July 18 – Wall Street Journal (Deborah Solomon): “The government’s rescue plan for Fannie Mae and Freddie Mac is the latest move by the Bush administration that transfers risk from the private sector to taxpayers, a phenomenon that poses potentially enormous financial risks if the economy worsens. From the bailout of Bear Stearns Cos. to a guarantee of student loans, the federal government has either injected public money into the private sector or promised to make capital available if needed. While taxpayers are not yet bearing the brunt of these moves, they could still wind up on the hook… ‘The potential for things to go wrong is big and so the potential to step in and take a lot of the cost is really high,’ said Deborah Lucas, a finance professor at… Kellogg School of Management and former chief economist for the Congressional Budget Office.”
July 18 – Los Angeles Times (Marc Lifsher): “California’s unemployment rate crept up to 6.9% in June, a tenth of a percentage point higher than the month before and the highest in nearly five years… The latest figure ties California with Mississippi for the third-highest jobless rate among the states, the U.S. Bureau of Labor Statistics said.”
July 14 – Bloomberg (Michael B. Marois): “U.S. states, already reeling from the slumping housing market and turbulent financial markets, will likely increase borrowing to meet budget demands next year, S&P said. The… company said discretionary resources that states often rely upon to fund capital projects have mostly evaporated, causing them to meet needs with bonds in fiscal 2009. Many states have increased short-term borrowing for cash-flow purposes, S&P said. States will have to fill gaps of more than $30 billion to balance budgets for 2009 in response to reduced tax receipt expectations because of weak economic growth… Deficits are forecast in at least 23 states for the 2009 budget year. ‘For the next year, state budgets are likely to be strained because…’ S&P credit analyst Robin Prunty said. ‘This could ultimately lead to significantly higher debt issuance to meet budget requirements, a trend seen in prior downturns… Connecticut pays 12.6% of its general fund to debt service, the most of all U.S. states. New York expends 6.5%, compared with New Jersey’s 7.4%.”
July 17 – Bloomberg (Michael Quint): “New York state’s tax revenue in the three months ended June 30 was $195 million less than projected because of lower business tax collections largely due to the New York City financial sector, Comptroller Thomas DiNapoli said. Business taxes fell $273 million from last year, mostly because of a 54% decline in taxes from banks.”
July 18 – Bloomberg (Adam L. Cataldo): “New York Mayor Michael Bloomberg said the city hasn’t yet felt the full effects of the economic slowdown, a day after the state reported a drop in projected tax revenue. ‘We’re doing better than the rest of the country, but it is going to get to us, it is starting to get to us… Anybody that thinks it is not going to hit us is wrong.’”
July 16 – Associated Press: “Housing data show the median price of a home in California plummeted 31.5 percent in June compared with the same month last year. DataQuick… says… the statewide median home price last month was $328,000. The statewide median home price peaked in May 2007 at $484,000. The decline is being driven by tightening mortgage markets and a growing willingness by sellers to accept less for their homes… About 41.9% of the resold homes in June were foreclosed properties.”
July 17 – Los Angeles Times (Peter Y. Hong): “Southern California’s housing market continues to be racked by falling prices and declining sales volume… The median home-sales price was $355,000 in June, down 29.3% from a year ago. Home values are now on par with what they were in early 2004… Los Angeles economist Christopher Thornberg, principal of Beacon Economics, said home prices remain out of sync with what buyers can afford to pay. Thornberg said prices must fall to 40% below the peak to match incomes.”
July 16 – Bloomberg (Daniel Taub): “House and condominium sales in Southern California fell 14% last month to the lowest level for a June in two decades as buyers struggled to get loans and prices declined, DataQuick… With little capital available, ‘even some of the well-qualified households aren’t getting home loans’ in Southern California, said DataQuick analyst John Karevoll… ‘What I find remarkable here is that the numbers have stayed as low as they have. When we’re looking at numbers this low, we’re looking at an awful lot of activity that just isn’t happening.’”
July 17 – San Francisco Chronicle (Carolyn Said): “Double-digit drops in median home prices hit every Bay Area county in June, even the ones that had seemed Teflon-coated. Across the nine counties, the median price paid for resale homes, new homes and condos in June plunged 27.1% from a year ago to $485,000, dipping below the half-million-dollar mark for the first time in four years, DataQuick… reported… Among resold homes, bank-repossessed foreclosures… accounted for 28.7% of all existing-home sales, up from just 3.5% in June 2007… ‘This is pretty grim; double digits across the board,’ said Christopher Thornberg, principal… Beacon Economics. ‘It was eminently predictable if you had a realistic view of the world. I heard a lot of people say the Bay Area was never going to see prices fall, San Francisco was untouchable; in San Mateo, it was impossible; San Jose, not with all the tech money, blah, blah, blah. But prices at the peak relative to people's incomes never made any sense.’”
Crude Liquidity Watch:
July 14 – Bloomberg (Daniel Kruger): “Petroleum-exporting nations from Saudi Arabia to Russia are not only charging Americans record high prices for fuel, they are also poised to become the biggest creditor to the U.S. government. Holdings of Treasuries by oil producers and institutions such as U.K. banks that are proxies for Middle East nations rose 44% this year to $510.8 billion through April, four times faster than the rest of the world, according to the Treasury Department… At the current pace, they’ll surpass Japan, which holds $592.2 billion, as the largest owner this month. While the investment of so-called petrodollars into government debt is helping to temper a rise in borrowing costs as the U.S. finances a record budget deficit, it highlights America’s dependence on foreign money.”
July 18 – Bloomberg (Fergal O’Brien): “Europe’s energy trade deficit soared 42% in the four months through April as crude-oil prices jumped to a record. The euro region’s deficit on energy products widened to 99.7 billion euros ($158bn) from 70.4 billion euros a year earlier, the European Union statistics office…said… Energy-product imports increased 41%.”
July 17 – Washington Post (Faiza Saleh Ambah): “Clouds of yellow dust swirled in the air as tractors moved back and forth, leveling a huge, barren piece of land dotted with billboards announcing the city that will rise from the sand here. Over the next few years, Saudi officials say this stretch of desert will be transformed into a buzzing hub of scientific research and development, with cutting-edge universities, hospitals and housing for more than 130,000 people… The project, called Knowledge Economic City, represents a first serious step by Saudi Arabia toward building a post-petroleum economy. It is one of six major industrial centers planned to rise over the next 15 years. At a cost of more than $100 billion, the sites are expected to provide housing and jobs for the country’s fast-growing population, half of which is younger than 21. These cities-from-scratch are the most ambitious projects to date launched by a kingdom enriched almost entirely by oil…”
Benchmark MBS and the SEC:
This week benchmark Fannie Mae MBS yields jumped 31 bps, to an 11–month high 6.15%. Spreads versus treasuries widened 18 bps to the widest level (206bps) since the height of the crisis in March. Also this week, the SEC took an extraordinary step to tighten the rules for shorting the large financial stocks. These developments are not unrelated.
In JPMorgan Chase’s and Citigroup’s earnings conference calls, both major lenders this week noted deterioration in prime mortgages. This provides additional confirmation that the mortgage crisis is now reaching the bedrock of our nation’s mortgage Credit system. And particularly with the mortgage insurers, the GSEs, and the leveraged speculating community having come under varying degrees of stress, a tightening in “conventional” mortgages will now significantly exacerbate the mortgage/housing/financial/economic crisis.
In years past, I have occasionally used my fictional “town by the river” analogy to demonstrate how the introduction of inexpensive flood insurance and a resulting speculative boom in writing this protection fostered a building boom along the river. The financial (insurance, lending and speculation) and economic (building, asset inflation, and spending) aspects of the boom were interrelated and reinforcing. In my fictional account, the booms were further spurred by a drought that both inflated the profitability of writing risk insurance (attracting throngs of speculative players) and buoyed complacency for those living, building, and spending freely near the water’s edge.
These dynamics set the stage for the inevitable dislocation in the flood insurance market. With the arrival of the first torrential rains, there was a panic as the thinly capitalized “insurers” rushed in a futile attempt to re-insure their risk of potentially catastrophic losses in the event of a flood along what had become a highly over-developed river bank. Few in the insurance market had built reserves, as most speculators simply planned on hedging flood risk in what was, at least during the time of the boom/drought, a highly liquid insurance marketplace. Worse yet, over time the pricing of flood protection had become grossly inadequate with respect to the mounting (“Bubble”) risks that had developed over the life of the financial and economic booms. Any reinsurance available during the crisis was priced prohibitively.
Back in 1990, when I first began working on the short-side, there was an estimated $50bn to $60bn in the hedge fund community. The few of us actually shorting stocks were primarily focused on diligent fundamental company “micro” research and analysis. It was not until some years later that “market neutral” and “quant” strategies took the financial world by storm. And back in the early nineties the OTC (over-the-counter) derivatives industry was just starting to take hold. Today’s Wild West CDS (Credit default swap) marketplace didn’t even exist.
Nowadays, the “leveraged speculating community” is measured in the multi-Trillions; the derivatives market in the hundreds of Trillions. The scope of players and sophisticated strategies utilizing short-selling is unlike anything previously experienced in the markets. And similar to how drought magnified the boom along the river, it was the boom in leveraged speculation and derivatives that played the instrumental role in fueling self-reinforcing Credit expansion and the resulting Credit, asset price and economic Bubbles. But those Bubbles are bursting – the torrential rains are falling and there is today extraordinary and overwhelming impetus to “reinsure” – to offload - the various risks that ballooned over the life of the protracted boom.
Many writing the multitude of types of market insurance incorporate “dynamic hedging” strategies. This means that few hold little in the way of actual “reserves” to pay in the event of major losses. Instead, they rely on “shorting” various securities that, in a declining market, will provide the necessary cash-flow to satisfy any insurance obligations. This all worked wonderfully in theory, and the basic premise of modern day risk hedging capabilities was supported by the nature of highly liquid boom-time financial markets. But “torrential rains” have a way of rapidly and dramatically altering marketplace liquidity. The reality is that entire markets cannot insure themselves again declines. Any attempt by a large swath of the marketplace to hedge exposure will be problematic. Selling will either immediately overwhelm the market or the “put options” accumulated as protection will create acute market vulnerability to self-reinforcing selling pressure and market dislocation.
Today, there is little liquidity in the securitization or corporate bond markets. So, the multi-Trillions of strategies relying on shorting securities for hedging and speculating purposes have gravitated to the relative liquidity of U.S. equities. And, when it comes to hedging against or seeking profits from heightened systemic risk, one can these days see rather clearly how incredible selling pressure can come down hard on the 19 largest U.S. financial institutions. And when one considers the scope of derivative strategies that incorporate “delta hedging” trading dynamics – where the amount of selling/shorting increases as the market declines (systemic risk increases) – one recognizes the possibility of a marketplace dislocation along the lines - but significantly more systemic - than the “portfolio insurance” fiasco that fueled the 1987 stock market crash.
Importantly, this issue of acute systemic risk has taken a turn for the worst with the recent deterioration in the conventional mortgage market. The highly exposed GSEs, mortgage insurers, and leveraged speculators are positioned poorly to withstand a bust in prime mortgages. The fate of the U.S. Bubble economy today rests on the ongoing supply of low-cost "prime" mortgages. Any meaningful tightening in conventional mortgage Credit – including the lack of availability of mortgage insurance, required larger down payments, and/or tougher Credit standards – would have a major impact on Credit Availability for core housing markets throughout the country (many that have thus far held together fairly well). Such a tightening would put significant additional downward pressure on prices, exacerbating already escalating problems for the GSEs, Credit insurers, and speculators.