September 19 – Bloomberg (Dakin Campbell): “Treasuries tumbled, sending two- year note yields up the most in 26 years, after Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben S. Bernanke announced plans to help stem a collapse in financial- market confidence.”
One-month Treasury bill rates traded as low as one basis point yesterday before closing the week at 0.69%, down 66 bps Three-month yields collapsed 47 bps to 0.99%. After today's sell off, two-year government yields ended the week down only 4 bps to 2.17%. Five-year T-note yields rose 9 bps this week to 3.04%, and 10-year yields increased 9 bps to 3.81%. Long-bond yields gained 7 bps to 4.38%. The 2yr/10yr spread increased 13 to 163 bps. The implied yield on 3-month December ’09 Eurodollars added 5.5 bps to 3.375%. Benchmark Fannie MBS yields rose 11 bps to 5.40%. The spread between benchmark MBS and 10-year T-notes widened 2 to 159 bps. Agency 10-yr debt spreads were 17 wider to 64 bps. The 10-year dollar swap spread increased 5 to 66.25. Corporate bond spreads moved wildly. An index of investment grade bond spreads ended somewhat wider at 163 bps, and an index of junk bond spreads widened to 636 bps.
I saw only one debt issue this week, a $500 junk borrowing by Sungard Data Systems.
German 10-year bund yields added 2 bps to 4.21%. The German DAX equities index declined 0.7% (down 23.3% y-t-d). Japanese 10-year “JGB” yields fell 5 bps to 1.48%. The Nikkei 225 lost 1.5% (down 22.1% y-t-d). Emerging markets were under heavy selling pressure before rallying with the world today. Brazil’s benchmark dollar bond yields jumped 23 bps to 6.22%. Brazil’s Bovespa equities index rallied 1.3% (down 17% y-t-d). The Mexican Bolsa added 0.6% (down 13% y-t-d). Mexico’s 10-year $ yields surged 34 bps to 5.97%. Russia’s RTS equities index recovered from a crash to end the week down only 3.4% (down 43.4% y-t-d). India’s Sensex equities index was little changed, with y-t-d losses of 30.8%. Today's 10% rally took China’s Shanghai Exchange back to little changed for the week, with 2008 losses at 60.6%.
Freddie Mac 30-year fixed mortgage rates dropped 15 bps to 5.78% (down 56bps y-o-y). Fifteen-year fixed rates sank 19 bps to 5.35% (down 76bps y-o-y), while one-year ARMs declined 18 bps to 5.03% (down 62bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates this week up 8 bps to 7.01% (down one bp y-o-y).
Bank Credit gained $13.4bn to $9.406TN (week of 9/10). Bank Credit has expanded only $193bn y-t-d, or 2.9% annualized. Bank Credit posted a 52-week rise of $476bn, or 5.3%. For the week, Securities Credit jumped $27.7bn. Loans & Leases dropped $14.2bn to $6.913 TN (52-wk gain of $380bn, or 5.8%). C&I loans fell $4.9bn, with y-t-d growth of 6.5%. Real Estate loans declined $8.4bn (up 1.1% y-t-d). Consumer loans added $2.9bn, while Securities loans declined $6.4bn. Other loans added $1.6bn.
M2 (narrow) “money” supply slipped $1.9bn to $7.714 TN (week of 9/8). Narrow “money” has expanded $251bn y-t-d, or 4.9% annualized, with a y-o-y rise of $357bn, or 4.8%. For the week, Currency was about unchanged, while Demand & Checkable Deposits declined $5.2bn. Savings Deposits fell $4.5bn, while Small Denominated Deposits increased $3.9bn. Retail Money Funds also rose $3.9bn.
Total Money Market Fund assets (from Invest Co Inst) sank an astonishing $169bn to $3.413 TN, reducing the y-t-d expansion to $299bn, or 13.5% annualized. Money Fund assets have posted a one-year increase of $587bn (20.8%).
Asset-Backed Securities (ABS) issuance has basically ground to a halt. Year-to-date total US ABS issuance of $129bn (tallied by JPMorgan's Christopher Flanagan) is running at 27% of comparable 2007. Home Equity ABS issuance of $303 million compares with 2007’s $232bn. Year-to-date CDO issuance of $22.6bn compares to the year ago $277.4bn.
Total Commercial Paper outstanding dropped $52.1bn this week to $1.763 TN, with CP down $22.2bn y-t-d. Asset-backed CP declined $18.6bn last week to $772bn, with 2008 now showing a decline of $11.2bn. Over the past year, total CP has contracted $106bn, or 5.7%.
Fed Foreign Holdings of Treasury, Agency Debt last week (ended 9/17) increased $13.5bn to $2.409 TN. “Custody holdings” were up $352bn y-t-d, or 23.5% annualized, and $421bn y-o-y (21.2%). Federal Reserve Credit surged $43.1bn to a record $931bn. Fed Credit has expanded $57.8bn y-t-d (9.1% annualized) and $78.3bn y-o-y (9.2%).
International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $1.186 TN y-o-y, or 20.6%, to $6.929 TN.
Global Credit Market Dislocation Watch:
September 19 – Bloomberg (Scott Lanman): “The Federal Reserve and Treasury began a series of emergency measures to prop up the mortgage and money markets ahead of congressional action on a broader lifeline for the U.S. financial system. The Treasury plans to double its purchases of mortgage- backed debt to $10 billion and use a $50 billion fund to insure against losses on money-market funds. The Fed plans to extend emergency loans to banks to purchase asset-backed commercial paper from money funds, and to buy short-term debt from Fannie Mae, Freddie Mac and other agencies. Today’s announcements are aimed at combating a record exodus of investors from money-market funds, long considered to be among the safest investments.”
September 19 – MarketNews International: “U.S. Senator Jim Bunning today issued the following statement regarding the Treasury Departments bailout of Wall Street. ‘Instead of celebrating the Fourth of July next year Americans will be celebrating Bastille Day; the free market for all intensive purposes is dead in America. The action proposed today by the Treasury Department will take away the free market and institute socialism in America. The American taxpayer has been misled throughout this economic crisis. The government on all fronts has failed the American people miserably. My great grandchildren will be saddled with the estimated $1 trillion debt left in the wake of this proposal.’”
September 19 – Bloomberg (Rebecca Christie and John Brinsley): “The U.S. government moved to cleanse banks of troubled assets and halt an exodus of investors from money markets in the biggest expansion of federal power over the financial system since the Great Depression. ‘We’re talking hundreds of billions,’ Treasury Secretary Henry Paulson said in a press conference. ‘This needs to be big enough to make a real difference and get to the heart of the problem.’ The Treasury is likely to run the program, which would involve auctions where the government buys devalued assets, said House Financial Services Committee Chairman Barney Frank. The plan is designed as a comprehensive approach after a series of individual rescues failed to stem the crisis.”
September 19 – Bloomberg (Alison Vekshin): “House Financial Services Committee Chairman Barney Frank said Congress within two weeks will pass legislation letting the Treasury take on financial companies’ soured assets to help revive credit markets. ‘I’m pretty sure this will be Treasury being the one that executes it because you don’t have time to create a new agency,’ Frank said… The plan may cost taxpayers ‘ultimately not a great deal,’ because Treasury will buy ‘selectively,’ Frank said.”
September 19 – Bloomberg (Hugh Son, Erik Holm and Craig Torres): “American International Group Inc. averted the worst financial collapse in history by accepting an $85 billion federal loan and giving the government a majority stake. The U.S. reversed its opposition to a bailout of AIG, the nation’s biggest insurer by assets, after private efforts failed and the Federal Reserve concluded that ‘a disorderly failure of AIG could add to already significant levels of financial market fragility,’ according to a Fed statement…”
September 15 – Bloomberg (Yalman Onaran and Christopher Scinta): “Lehman Brothers Holdings Inc., the fourth-largest U.S. investment bank, succumbed to the subprime mortgage crisis it helped create in the biggest bankruptcy filing in history. The 158-year-old firm, which survived railroad bankruptcies of the 1800s, the Great Depression in the 1930s and the collapse of Long-Term Capital Management a decade ago, filed a Chapter 11 petition with U.S. Bankruptcy Court… The collapse of Lehman, which listed more than $613 billion of debt, dwarfs WorldCom Inc.’s insolvency in 2002 and Drexel Burnham Lambert’s failure in 1990.”
September 15 – Bloomberg (Jeff St.Onge): “Lehman Brothers Holdings Inc., the fourth-largest U.S. investment bank, owes its 10 largest unsecured creditors more than $157 billion, including debts to bondholders totaling $155 billion.”
September 16 – Bloomberg (John Glover): “Lehman Brothers Holdings Inc. bondholders may lose more than $111 billion in the collapse of the investment bank, based on contracts used to set a recovery value for the debt, according to Bank of America Corp. analysts. So-called recovery swaps… Lehman’s $146 billion of outstanding senior debt traded at 35% of face value, the analysts wrote, indicating a loss of as much as 65%. Holders of about $18 billion of subordinated notes may recover 4% at the most…”
September 19 – Financial Times (Jennifer Hughes): “Huge numbers of trades in which Lehman Brothers was a counterparty remain unsettled a week after the US bank collapsed and are likely to remain in limbo for some time. On Friday the London Stock Exchange warned there was no certainty that all the trades that dealers undertook with Lehman that were currently in the Crest settlement system and marked as LSE trades were in fact such…. Many dealers have been caught in a limbo because of the sudden nature of Lehman’s collapse. Most trades, even ‘those for immediate delivery’, are settled in two or three days, meaning that most of the deals done by Lehman traders in the last half of its last week are not officially settled.”
September 19 – Bloomberg (Shamim Adam and Nate Hosoda): “Central banks in Japan and Australia pumped some $113 billion into money markets this week… Central banks injected more than $220 billion globally this week…”
September 18 – Bloomberg (Scott Lanman): “The Federal Reserve lent a record $59.8 billion to securities firms and $28 billion to American International Group Inc. as of yesterday, while daily borrowing by commercial banks increased in the past week to a fourth straight high.”
September 18 – Bloomberg (Liz Capo McCormick): “The Federal Reserve added a record $105 billion in temporary reserves to the banking system as part of its efforts to break a logjam in lending spurred by financial market turmoil.”
September 19 – Bloomberg (Liz Capo McCormick and Jody Shenn): “The Federal Reserve bought $8 billion of short-term federal agency debt under a new emergency program intended to help keep a run on money-market mutual funds from worsening the credit crisis.”
September 15 – Bloomberg (Rebecca Christie and Sandra Hernandez): “The U.S. Treasury has added almost $300 billion in extra borrowing to offset the impact of Federal Reserve programs aimed at helping troubled financial markets and the economy… As Wall Street grappled with the credit crunch and a weaker economy in the past year, the Fed has introduced lending programs to boost banks’ access to funds… That ‘resulted in nearly $300 billion in additional Treasury issuance,’ [said] Karthik Ramanathan, director of the Treasury’s debt management office…”
September 18 – Bloomberg (Pierre Paulden): “The credit crisis that brought down Lehman Brothers Holdings Inc. and Bear Stearns Cos. is pushing corporate borrowing costs to the highest since at least November 2002…The average yield on the most actively traded investment- grade bonds has risen to 7.43% from 5.99% a year ago. High-yield borrowing costs have jumped to 13.6% from 9.17%.”
September 18 – Dow Jones (Anusha Shrivastava): “In a replay of last year’s dramatic crunch in short-term corporate debt markets, the cost of borrowing in the commercial paper market moved sharply higher Tuesday. The asset-backed sector of the commercial paper market has felt the brunt of rising concerns about cash shortages at financial companies such as American International Group. Rates on asset-backed commercial paper spiked Tuesday, with investors demanding a yield of 4% to 8% on paper that matures in one day, up from between 2.15% and 3.5% Monday…”
September 16 – Wall Street Journal (Simona Covel, Kelly K. Spors and Raymund Flandez): “As Wall Street quaked Monday, small and midsize businesses prepared to feel the aftershocks in the form of tighter credit and tougher borrowing standards. The financial crisis is the latest blow to small businesses, which have suffered through a tough year. As consumers pulled back on spending, these companies have faced more-stringent requirements from bankers, higher rates on credit cards and other loans, and the loss of funding sources from real estate, such as home-equity loans. Now, the environment looks grimmer. Small and midsize companies are likely to see tougher requirements from their bankers in coming months. ‘If you’re seeking a new line of credit, [the effect] will be instantaneous,’ says Andrew Zacharakis, professor of entrepreneurship at Babson College…”
September 16 – Bloomberg (Gavin Finch and Kim-Mai Cutler): “Credit markets seized up as the collapse of Lehman Brothers Holdings Inc. and downgrades of American International Group Inc. drove the cost of borrowing in dollars overnight to the highest level since 2001. The London interbank offered rate, or Libor, that financial institutions charge each other for loans soared 3.33 percentage points to 6.44%... The increase was the biggest in its history. The rate was as low as 2.07 percent in June.”
September 18 – Bloomberg (Sandra Hernandez): “Money-market funds are ‘on the cusp’ of an investor run after Reserve Primary became the first such fund in 14 years to expose investors to losses, Paul McCulley, a portfolio manager at Pacific Investment Management Co., told the financial news network CNBC. ‘It’s an incredibly serious issue,’ McCulley said. ‘A tipping point in this crisis would be when you have a run on money markets, and we are right on the cusp of that.’”
September 16 – Bloomberg (Betty Liu and Elizabeth Stanton): “U.S. financial markets are facing the worst crisis since 1932 and require ‘an enormous overhaul’ of regulations, said Roger Altman, the former deputy Treasury secretary in the Clinton administration who founded investment bank Evercore Partners. ‘The outlook is very poor,’ Altman said… ‘This is the worst financial market environment it seems to me since 1932.’”
September 19 – Bloomberg (Jeff Plungis): “Ongoing turmoil in financial markets may test the strength of the Securities Investor Protection Corp., the securities industry’s consumer safety net. Brokerage customers have emerged largely intact as two of Wall Street's five largest brokerages have failed. The… SIPC, a nonprofit corporation funded by Wall Street to ensure the safety of customers’ accounts, hasn’t been tested on a bankruptcy on the scale of a Morgan Stanley or Goldman Sachs Group Inc… Unlike the Federal Deposit Insurance Corp…, the securities corporation doesn’t have a direct line to the U.S. Treasury. The SIPC maintains about $1 billion in reserves…”
September 18 – Bloomberg (Rich Miller): “The rapid-fire rescues of financial firms may end up tarnishing America’s free-market reputation as the moves expose defects in the U.S. economy, undermining its standing with foreign buyers of the dollar and U.S. Treasury securities. The government’s actions might add hundreds of billions to a budget deficit already expected to hit a record next year. The salvage operations, which include Tuesday’s takeover of American International Group Inc., also raise questions about the U.S. commitment to a free-market economy that, until recently, was the envy of the world. America’s credit ‘profile is now weaker because contingent risks have become actual risks to the U.S. government,’ said John Chambers, managing director of sovereign ratings at Standard & Poor’s…”
September 18 – Wall Street Journal (Jon Hilsenrath, Serena Ng and Damian Paletta): “The financial crisis that began 13 months ago has entered a new, far more serious phase. Lingering hopes that the damage could be contained to a handful of financial institutions that made bad bets on mortgages have evaporated. New fault lines are emerging beyond the original problem -- troubled subprime mortgages -- in areas like credit-default swaps, the credit insurance contracts sold by American International Group Inc. and others firms… Each episode seems to bring intervention by the government that is more extensive and expensive than the previous one, and carries greater risk of unintended consequences.”
September 18 – Dow Jones (Matthias Rieker): “The dominance of commercial banks over the capital market business will lead to a fundamental re-adjustment of risk: Leverage will leave the capital markets in the United States overall. Those bankers willing to take risk would demand to be paid for it. This change to a calmer Wall Street - albeit one with slower growing profits - could encourage a more stable economy. What exactly the impact of the shrinking leverage is going to have on the financial system, ranging from the innovation of capital markets products to trading and underwriting and leveraged lending, is uncertain. Most likely - and some say, ideally - there will be a little less of everything”
September 19 – Bloomberg (Christine Richard): “MBIA Inc. and Ambac Financial Group Inc. fell after Moody’s… said it’s considering cutting the two bond insurers' financial-strength ratings by several grades.”
September 19 – Bloomberg (Linda Shen): “The American Bankers Association objected to the U.S. Treasury’s plan to insure money-market mutual funds, saying it may compromise the ability of banks to attract and keep deposits.”
September 16 – Bloomberg (Robert Schmidt): “FBI Director Robert Mueller told lawmakers that his agency won’t hesitate to pursue top financial executives as it investigates the subprime mortgage meltdown. The Federal Bureau of Investigation is now probing 24 large companies for possibly misstating their assets, up from 21 in July, Mueller told the U.S. House Judiciary Committee in Washington. ‘The FBI will pursue these cases as far up the corporate chain as necessary to ensure those responsible receive the justice they deserve,’ he said. The FBI has come under pressure to hold companies responsible as the loan crisis has rocked Wall Street and led to the biggest housing slump since the Great Depression.”
September 18 – Bloomberg (Alexis Xydias and Mark Gilbert): “Falling currency reserves will stall emerging-market growth and turn assets linked to developing economies into ‘toxic waste,’ according to Albert Edwards, global strategist at Societe Generale… ‘All things connected with emerging markets will become toxic waste,’ Edwards wrote… ‘The emerging-market liquidity squeeze will intensify ferociously and, much to the shock of most commentators, recessions will unfold in the emerging-market universe.’”
September 19 – New York Times (Andrew E. Kramer): “The Russian government will inject up to $20 billion into domestic stocks in an effort to halt the free fall of the Russian stock markets, President Dmitri A. Medvedev said…, in the most direct effort yet to use oil profits to ease a deepening stock market crisis here. The two main Russian stock exchanges remained closed Thursday after authorities halted trading Wednesday afternoon. By that time, they had each lost about 57% since their peaks in May…”
September 18 – Bloomberg (Denis Maternovsky): “Russian bonds dropped to the lowest in four years after the government poured $44 billion into its three largest banks to stem its worst financial crisis since the nation defaulted in 1998."
September 15 – Bloomberg (Christopher Swann): “About one-third of the world’s biggest government-run investment funds are considering plans to overhaul their operations, according to a survey by an International Monetary Fund…”
Currency Watch:
September 18 – Dow Jones: “The next cause for concern in the battered U.S. economy is whether there will be buyers abroad for the nation’s billions in debt, New York Mayor Michael Bloomberg warned… In a speech at Georgetown University in Washington, the billionaire political leader said the tumult in financial markets is being felt worldwide and it’s unclear who will continue to buy U.S. Treasury bills.”
It was another wild ride in currency markets. The dollar index dropped 1.6% to 77.68. For the week on the upside, the New Zealand dollar increased 4.5%, the Australian dollar 3.4%, the Swedish krona 2.3%, the Canadian dollar 2.3%, the South African rand 2.0%, the British pound 1.7%, and the Euro 1.6%. For the week on the downside, the South Korean won declined 2.7%, the Japanese yen 2.6%, the Brazilian real 0.8%, the Taiwanese dollar 0.4%, and the Singapore dollar 0.3%.
Commodities Watch:
September 18 – Bloomberg (Stewart Bailey and Millie Munshi): “While TV camera crews staked out American International Group Inc.’s Wall Street headquarters following its takeover by the U.S. government, Jules Karp was quietly trading gold coins in ‘unbelievable’ numbers from his basement dealership across the street. Karp… has traded physical gold, including one-ounce Canadian Maple Leafs, American Eagles and South African Krugerrands, since 1974. Demand has ‘hit a crescendo,’ he said… while an assistant prepared the special packages used to send gold coins to a growing list of mail-order customers.”
The merits of precious metals became a little clearer this week. Gold recovered 14.1% to $874 and Silver 15.6% to $12.475. October Crude rallied $3.67 to $104.55. October Gasoline dropped 6.1% (up 5% y-t-d), while October Natural Gas added 2.2% (up 0.6% y-t-d). December Copper slipped 0.5%. December Wheat was little changed, while December Corn fell 3.7%. The CRB index ended the week about unchanged (up 0.2% y-t-d). The Goldman Sachs Commodities Index (GSCI) was almost exactly unchanged (up 5% y-t-d and 17.6% y-o-y).
China Watch:
September 18 – Market News International: “China’s tax revenue growth slowed sharply in August to the lowest level seen so far this year on the back of a slowing economy… The government’s take from stamp duties on share transactions also plunged in the face of a slumping stock market. Revenues rose just 11% year-on-year to 355.1 billion yuan last month compared with the 30.2% spike in revenues seen during the first seven months of this year…”
Japan Watch:
September 18 – Bloomberg (Kathleen Chu): “Land prices in Japan fell by 1.2% in the twelve months through the end of June, with the rate of decline accelerating for the first time in five years as lenders tightened credit after the U.S. subprime market collapse.”
Asia Bubble Watch:
September 19 – Bloomberg (Seyoon Kim): “South Korea said it plans to build 5 million homes over the next 10 years to meet demand for property and bolster economic growth.”
Unbalanced Global Economy Watch:
September 18 – Bloomberg (Tariq Panja): “Manchester United’s shirts read AIG. They might as well say U.S.A. The U.S. government’s $85 billion takeover of American International Group Inc. gave it control of United’s shirt sponsorship, one of the most visible in sports after the team won two of soccer’s biggest club championships last season. The English Premier League is becoming a scoreboard for the global credit crisis. Newcastle players wear the logo of Northern Rock Plc, a U.K. mortgage-lender that was nationalized in February; West Ham lost XL Leisure Group Plc last week when the tour operator grounded all its flights because it ran out of money… ‘There’s not that much money sloshing about,’ said Nigel Currie, director of sports marketing at… Rapport. ‘Football clubs are not immune from the credit crunch. They are absolutely in the same boat as everybody else.’”
September 18 – Bloomberg (Jennifer Ryan): “The U.K. budget deficit widened more than economists expected in August as the deepening slump eroded tax receipts, putting Prime Minister Gordon Brown at risk of breaking his own borrowing rules. The 10.4 billion-pound ($18.5bn) shortfall was up from 8 billion pounds a year earlier and the largest August deficit since records began in 1993…”
September 18 – Bloomberg (Brian Swint): “U.K. money supply increased twice as much as economists forecast last month, Bank of England data show. M4… rose 1.4% from July… From a year earlier, it rose 11.5%.”
September 16 – Bloomberg (Brian Swint): “U.K. inflation accelerated to the fastest pace in at least 11 years last month, putting pressure on the Bank of England to refrain from cutting interest rates as the economy slides toward a recession. Consumer prices rose 4.7% in August from a year earlier…”
September 16 – Wall Street Journal (Alex Frangos, Darren Lazarus and Conor Dougherty): “The blast furnace known as the finance industry that has stoked the economies of New York and London for decades is rapidly cooling. Both cities have relied heavily on the securities industry for jobs, taxes and a prosperity that has lifted restaurants, stores, auto sales, fashion, entertainment and a wide range of other businesses. The future of that largess is in doubt a year into the credit crunch, with the bankruptcy filing of Lehman… and the sale of Merrill… adding to the thousands of jobs already lost -- and the likelihood that more will come.”
September 16 – Bloomberg (Laurence Frost): “European car sales tumbled 16% last month, the fourth straight decline, as higher fuel prices and slowing economies hurt demand for models from General Motors Corp. and Toyota Motor Corp.”
September 15 – Bloomberg (Kati Pohjanpalo): “Finnish inflation unexpectedly accelerated to 4.7% in August, the fastest pace in more than 17 years, led by higher food prices. The rate increased from 4.4% in July…”
September 18 – Bloomberg (Firat Kayakiran and Ali Berat Meric): “Turkey’s energy-markets regulator today approved a 9.1% increase in residential electricity prices to take effect in October.”
Bursting Bubble Economy Watch:
September 18 – Bloomberg (Alan Purkiss): “The U.S. government will probably have to spend between $1 trillion and $2 trillion, or five to 10 times as much as it has so far, to halt the spreading contagion of the financial crisis, said Kenneth Rogoff, an economics professor at Harvard and a former chief economist at the International Monetary Fund.”
September 18 – Bloomberg (Alan Ohnsman and Mike Ramsey): “U.S. auto sales were hobbled in the first half as gasoline prices jumped to record highs. Now, a financial crisis… has toughened new-vehicle loan terms… ‘The panic over fuel prices this year brought the quickest shift from trucks and SUVs to cars I’ve ever seen,’ said Dave Zuchowski, vice president of sales for Hyundai… ‘The new story is access to credit. That will impact us more in the second half.’”
MBS/ABS/CDO/CP/Money Funds and Derivatives Watch:
September 18 – Bloomberg (Neil Unmack): “Standard & Poor’s may cut the credit ratings on 381 European asset-backed bonds linked to Lehman Brothers Holdings Inc., the collapsed U.S. investment bank. The notes relied on Lehman as a counterparty for hedges against swings in currencies and interest rates, or pooled assets created by the… bank, S&P said…”
GSE Watch:
September 19 – Bloomberg (Dawn Kopecki): “The U.S. Treasury will use Fannie Mae and Freddie Mac, the two largest mortgage-finance companies, to pump money into the home loan market by ‘immediately’ increasing their purchases of mortgage bonds. The Federal Housing Finance Agency, which seized control of the companies this month, directed them to start increasing their purchases of loans and mortgage-backed securities as part of Treasury’s plan to absorb illiquid and underperforming assets from financial companies…”
September 19 – Bloomberg (Dawn Kopecki): “Fannie Mae, the mortgage-finance company taken over by the U.S. government this month, said bankrupt securities firm Lehman Brothers Holdings Inc. owes it ‘very substantial sums.’ The exact amounts ‘change on a nearly daily basis,’ Fannie said in a filing… Lehman was one of the company’s frequent business partners in servicing home loans and the mortgage bonds Fannie and fellow government-sponsored enterprise Freddie Mac guarantee.”
Speculator Watch:
September 18 – Bloomberg (Saijel Kishan): “Hedge-fund liquidations worldwide rose about 16% in the first half of the year amid turmoil in the financial markets, according to Hedge Fund Research Inc. About 350 funds shut down compared with 303 in the first six months of last year… An estimated 700 funds may go out of business by the end of 2008, an increase of 24% from last year…”
September 16 – Dow Jones (Marietta Cauchi): “Hedge funds’ main concern following the collapse of Lehman Brothers Holdings Inc. is their exposure to unsettled trades, experts say. Following its bankruptcy filing overnight Sunday, Lehman’s prime brokerage business is no longer trading, leaving hedge fund clients in the lurch. Like other prime brokers, Lehman offered a smorgasbord of services to hedge funds - most importantly securities and money lending, as well as settling and clearing. ‘There is a great deal of confusion in the market over the counterparty risk attached to dealing with Lehman,’ one hedge fund adviser said.”
Fiscal Watch:
September 19 – Bloomberg (Sandra Hernandez): “The U.S. may have to borrow an extra $700 billion to $1 trillion to fund the biggest rescue of the financial system since the Great Depression, according to Barclays Capital Inc.’s Michael Pond.”
Muni Watch:
September 19 – Bloomberg (Jeremy R. Cooke): “Borrowing by U.S. states and local governments stalled this week as officials delayed most planned offerings amid an unprecedented rise in benchmark yields.”
September 19 – Bloomberg (Jeremy R. Cooke): “U.S. state and local government debt grew at the slowest pace in almost five years during the second quarter, as the auction-rate bond collapse in February forced borrowers to focus on refinancing deals.”
September 18 – Bloomberg (Jeremy R. Cooke): “U.S. municipal bonds plummeted, driving up benchmark yields by the most in more than four years, on concern soaring short-term interest rates may be forcing investors to liquidate holdings financed through borrowing. Average weekly variable rates shot above 5%, the highest in eight years, as bond dealers sought to entice investors and hoard capital after Lehman… declared bankruptcy.”
California Watch:
September 18 – Bloomberg (Dan Levy): “San Francisco Bay Area home prices fell a record 32% in August from a year earlier as sales declined and buyers struggled to get mortgages. The median price tumbled to $447,000, the lowest since January 2004… DataQuick said…”
Crude Liquidity Watch:
September 18 – Bloomberg (Glen Carey): “United Arab Emirates real-estate developers… declined on concern borrowing costs will rise in a market that has seen property prices double over the last two years… ‘The cost of borrowing money is going up substantially,’ Ali Khan, head of equity trading at Arqaam Capital Ltd. in Dubai, said… ‘It is simply not possible that the U.A.E. can be cocooned from the U.S. credit problems.’”
September 16 – Bloomberg (Matthew Brown): “Qatari inflation accelerated to a record 16.6% in the second quarter as the cost of food and housing soared.”
Misdirected Credit Runs Unabated:
When I titled last week’s piece “Too Big to Suffer a Loss” I had no real inkling of what the past week would have in store. Actually, I had presumed that the Treasury and Fed wouldn’t allow Lehman to fail. Lehman Brothers, after all, was one of the major players in the precarious daisy chain of Wall Street risk intermediation. A failure by any key player in this realm would immediately have this historic Credit Crisis jumping the firebreak from the rugged terrain of mortgages and “risk assets” into the hallowed land of perceived safe and liquid contemporary “money.” The consequences of such a lurid escalation were potentially so catastrophic that I believed Hank Paulson and Ben Bernanke were prepared to use the overwhelming force of fleets of aerial supertankers to ensure our “money” tinderbox was not set ablaze.
It now appears they didn’t appreciate the ramifications for Lehman going under – how this would quickly ignite a run on the core of our monetary system. It wasn’t long, however, before the horror of watching the entire system going up in flames prompted a mad scramble to conjure the equivalent of monetary firefighting "Shock and Awe". What an incredible week.
Yesterday the administration presented Congress a $700 billion plan to stem the Credit and, increasingly, economic crises. Wall Street and the Banking system have been rapidly burning through their entire “capital” buffer, as the risk intermediation community suffers enormous and unending losses. The bursting of the Credit Bubble is proving catastrophic for many that intermediated the risk between Trillions of risky loan assets funded by the issuance of Trillions of perceived safe and liquid money-like liabilities. For awhile, the global sovereign wealth funds, speculators, and some investors were content to step up and lead a recapitalization process. As time passed, however, this was increasingly recognized as a classic case of “throwing good ‘money’ after bad.”
As losses escalated and sources of additional “capital” dried up, focus quickly turned to escalating losses being suffered by some gigantic and highly leveraged players (i.e. Lehman, Merrill, and AIG). At least in the case of Lehman, a run on their money market liabilities (especially “repos”) had commenced. Bankruptcy by Lehman – with the extreme market uncertainty associated with unprecedented losses to bondholders, creditors and counterparties – immediately froze the Credit default swap marketplace. Dislocation in the CDS market was a deathblow for AIG and many hedge funds.
The Lehman Contagion quickly incited panic throughout the money fund complex, to-this-point a bulletproof sector that had, after a year of enormous growth, become an even more vital pillar to the sacred domain of contemporary “money.” Exposure to Lehman forced the Primary Reserve Fund, a venerable money market operation, to mark down its portfolio 3%. Primary Reserve saw 60% of its fund (almost $40bn) redeemed in just two days, as trading in even the lost “liquid” short-term money market instruments seized up. A modern day electronic “run” on contemporary “money” had commenced; the system had reached the brink of collapse.
To stabilize the system at such a point required nothing less than unprecedented measures. The Treasury and Federal Reserve would have to become major “buyers of last resort” – both the providers of massive marketplace liquidity and the underwriter of massive Credit losses. With the monetary system breaking down, the federal government saw no alternative than to fill the void left by the impaired risk intermediators. Or, from a more theoretical perspective, our government would have to guarantee the “Moneyness of Credit” – assume the spiraling losses between the Trillions of risky system loans and the Trillions issued of perceived safe and liquid “money.” No systemic federal guarantee, no more “Moneyness” – and an immediate end to the last bastions of Credit growth that have been sustaining the U.S. Bubble Economy.
So what’s the problem with the government stepping up to guarantee “Moneyness”? How can it be inflationary, when Credit growth has slowed so dramatically, assets prices have come under such pressure, and confidence in the system has been so shaken? Well, I continue to believe that some overriding issues are today lost in the discussion; lost in all the pontificating; lost in the frenzy of panicked policymaking.
I am not surprised that our policymakers nationalized Fannie and Freddie. It was predictable that the Treasury and Fed were forced into wholesale bailouts and unprecedented liquidity operations. That Washington had to step up and guarantee money fund deposits is not all too surprising. Ditto with the upwards of $1 Trillion of Congressional authorizations, with policymakers bumbling through various measures in hopes of stabilizing the system. Over the years, we’ve been pretty cognizant of the extreme nature of excesses; the extent of system vulnerability; and the expensive bill that would come due with the arrival of the bust. But I want to be especially clear on one thing: I am shocked and incredibly alarmed that all these measures became necessary at such an early stage of financial and economic adjustment. After all, the Dow remains above 11,000 and GDP expanded 3.3% last quarter.
And this gets right to the heart of the matter – where the analytical rubber meets the road. A massive inflation of government obligations; a major government intrusion into all matters financial and economic; and an unprecedented circumvention of free market forces have been unleashed – but to what end? I believe it is a grave predicament that such a rampage of radical policymaking has been unleashed in order to maintain inflated asset markets and to sustain a Bubble Economy. Normally, such desperate measures would be employed only after a crash and in the midst of a major economic downturn – not in efforts specifically to forestall the unwind. Not only will such measures not work, I believe they will only exacerbate today’s already extreme Global Monetary Disorder. They will definitely worsen the inevitable financial and economic dislocation.
I have over the past several years repeatedly taken issue with the revisionist view that had the Fed recapitalized the banking system after the ’29 stock market crash the Great Depression would have been avoided. Some have suggested that $4bn from the Fed back then would have replenished lost banking system capital and stemmed economic collapse. But I believe passionately that this is deeply flawed and dangerous analysis. An injection of a relatively small $4bn would have mattered little. What might have worked – albeit only temporarily – would have been the creation of many tens of billions of new Credit required to arrest asset and debt market deflation and refuel the Bubble Economy. Importantly, however, at that point only continuous and massive Credit injections would have kept the system from commencing its inevitable lurch into a downward financial and economic spiral.
Importantly, market, asset and economic Bubbles are voracious Credit gluttons. I would argue that the system today continues to operate at grossly inflated – Bubble - levels. The upshot of years of Credit excess are grossly distorted asset prices, household incomes, corporate cash flows and spending, government receipts and expenditures, system investment and economy-wide spending and, especially, imports. So to generally stabilize today’s maladjusted system will, as we are now witnessing, require massive government intervention. Enormous government-supported Credit growth will be necessary this year, next year, and the years after that. To be sure, a protracted and historic cycle of Misdirected Credit Runs Unabated.
Today’s efforts to sustain the Bubble Economy create an untenable situation. Washington is now in the process of spending Trillions to bolster a failed financial structure, while focusing support on troubled mortgages, housing, and household spending. Regrettably, this is a classic case of throwing good ‘money’ after bad. Not yet understood by our policymakers, literally Trillions of new Credit will at some point be necessary to finance an epic restructuring of the U.S. economic system. Our economy will have no choice but to adjust to less household spending, major changes in the pattern of spending (i.e. less “upscale” and services), fewer imports, more exports, and less energy consumption. Moreover, our economy must adjust and adapt to being much less dependent on finance and Credit growth – which will require our “output” to be much more product-based as opposed to “services”-based. We’ll be forced to trade goods for goods.
The current direction of Bubble-sustaining policymaking goes the wrong direction in almost all aspects. At some point, the markets will recognize this Bubble Predicament, setting the stage for a very problematic crisis of confidence for the dollar and our federal debt markets
