Three-month Treasury bill rates fell an additional 8 bps this week to 3.15%. Two-year government yields dropped 8 bps to 3.0%. Five-year T-Note yields were down 2 bps to 3.39%, and ten-year yields fell 6 bps to 3.94%. Long-bond yields declined 4.5 bps to 4.38%. The 2yr/10yr spread ended the week at 94 bps. The implied yield on 3-month December ’08 Eurodollars sank 15 bps to 3.435%. Benchmark Fannie Mae MBS yields collapsed 26 bps to 5.39%, this week remarkably outperforming Treasuries. The spread on Fannie’s 5% 2017 note narrowed 14 to 60, and the spread on Freddie’s 5% 2017 note narrowed 13 to 60. The 10-year dollar swap declined 10.9 bps to 65.4. Corporate bond spreads were mixed to narrower, although the spread on an index of junk bonds ended the week 14 bps wider.
Investment grade debt issuers included GE $4.0bn, Bank of America $3.5bn, CIT Group $2.0bn, Encana $1.5bn, Virginia E&P $1.05bn, Pepsico $1.0bn, Nordstrom $1.0bn, Nucor $1.0bn, Dupont $750 million, Kellogg $750 million, Disney $750 million, Aetna $700 million, Rockwell Auto $500 million, Anheuser Busch $500 million, M&T Bank $400 million, Harris Corp $400 million, Dominion Resources $350 million, Textron $350 million, Southwestern Electric Power $300 million, New York State E&G $200 million and Georgia Power $100 million.
Junk issuers included Texas Competitive Electric Holdings $3.75bn, Constellation $500 million, and Alliance Imaging $150 million.
Foreign dollar bond issuance included Barclays $1.25bn and Marks & Spencer $800 million.
November 29 – Bloomberg (Lester Pimentel): “Emerging-market bonds fell…as soaring international bank lending rates pared demand for higher-yielding assets. The cost of borrowing euros for a month rose by a record amount and loans in dollars climbed the most in more than a decade as financial institutions grapple with losses from subprime mortgage investments.”
German 10-year bund yields jumped 12 bps to 4.12%, while the DAX equities index rose 3.4% for the week (up 19.3% y-t-d). Japanese “JGB” yields gained 5.5 bps to 1.47%. The Nikkei 225 rallied 5.3%, reducing 2007 losses to 9.0%. Emerging debt and equities markets rallied sharply. Brazil’s benchmark dollar bond yields sank a notable 29 bps to 5.63%. Brazil’s Bovespa equities index jumped 3.3% (up 41.6% y-t-d). The Mexican Bolsa rallied 3.7% (up 12.6% y-t-d). Mexico’s 10-year $ yields fell 6 bps to 5.39%. Russia’s RTS equities index advanced 3.2% (up 15.5% y-t-d). India’s Sensex equities index gained 2.7% (up 40.5% y-t-d). China’s Shanghai Exchange fell 3.2%, reducing y-t-d gains to 82% and 52-week gains to 132%.
Freddie Mac posted 30-year fixed mortgage rates dropped 10 bps this week to 6.10% (down 4bps y-o-y), the low since January 2006. Fifteen-year fixed rates fell 10 bps to 5.73% (down 14bps y-o-y). One-year adjustable rates added one basis point to 5.43% (down 3bps y-o-y).
Bank Credit surged $73.1bn during the week (11/21) to a record $9.219 TN. Bank Credit has posted an 18-week gain of $575bn (19.2% annualized) and a y-t-d rise of $922bn, a 12.3% pace. For the week, Securities Credit jumped $39.9bn. Loans & Leases rose $33.2bn to $6.731 TN (18-wk gain of $406bn). C&I loans surged $21.9bn (2007 growth rate 21.8%). Real Estate loans gained $13bn. Consumer loans added $2.3bn. Securities loans declined $16.4bn, while Other loans increased $12.4bn. On the liability side, (previous M3) Large Time Deposits fell $23bn.
M2 (narrow) “money” supply rose $17.3bn to $7.420 TN (week of 11/19). Narrow “money” has expanded $377bn y-t-d, or 5.9% annualized, and $449bn, or 6.4%, over the past year. For the week, Currency dipped $1.0bn, and Demand & Checkable Deposits sank $23.2bn. Savings Deposits surged $32.2bn, and Small Denominated Deposits added $0.1bn. Retail Money Fund assets rose $9.2bn.
Total Money Market Fund Assets (from Invest. Co Inst) jumped $26.3bn last week to a record $3.073 TN. Money Fund Assets have now posted an unprecedented 18-week surge of $489bn (58% annualized) and a y-t-d increase of $691bn (31.4% annualized). Money fund assets have ballooned $744bn, or 31.9%, over the past year.
Total Commercial Paper gained $12.7bn to $1.854 TN. CP is now down $369bn over the past 16 weeks. Asset-backed CP declined $8.0bn (16-wk drop of $333bn) last week to $841bn. Year-to-date, total CP has contracted $120bn, with ABCP down $243bn. Over the past year, Total CP has declined $74bn, or 3.8%.
Asset-Backed Securities (ABS) issuance increased somewhat this week to a still slow $3.5bn. Year-to-date total US ABS issuance of $513bn (tallied by JPMorgan) is running 38% behind comparable 2006. At $219bn, y-t-d Home Equity ABS sales are off 58% from last year’s pace. Year-to-date US CDO issuance of $290 billion is now 16% below comparable 2006.
Fed Foreign Holdings of Treasury, Agency Debt last week (ended 11/28) increased $5.7bn to $2.031 TN. “Custody holdings” were up $279bn y-t-d (17.3% annualized) and $320bn during the past year, or 18.7%. Federal Reserve Credit expanded $1.5bn last week to $869.6bn. Fed Credit has increased $17.4bn y-t-d and $25.6bn over the past year (3.0%).
International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $1.178 TN y-t-d (27% annualized) and $1.231 TN year-over-year (26%) to a record $5.989TN.
Credit Market Dislocation Watch:
November 30 – Bloomberg (Alison Vekshin and Craig Torres): “U.S. Treasury Secretary Henry Paulson is negotiating an agreement with banks to stem a surge in foreclosures by fixing interest rates on loans to subprime borrowers, according to people familiar with a meeting he led yesterday. Paulson…presided over a one-hour gathering at the Treasury Department…with federal regulators, bankers and lobbyists. Citigroup Inc., Wells Fargo & Co. and Washington Mutual Inc. executives attended, said a person present…”
November 28 – Financial Times (Stacy-Marie Ishmael): “Capital market issuance in the US fell in the third quarter, hit by the ongoing upheaval in the credit world, but municipal and investment grade corporate bond issuance remained strong. A total of $1,330bn in securities was issued in the third quarter of 2007, compared with $1,920bn in the second and $1,510bn in the same quarter a year earlier…the Securities Industry and Financial Markets Association [data] showed.”
November 26 – Financial Times (Gillian Tett, Jennifer Hughes and Krishna Guha): “Investors fear the financial system is moving into new credit turmoil, which could create further losses for financial institutions - and potentially hurt sentiment in the ‘real’ economy. Credit markets are trading at levels which imply that investors assume that the US is heading for a recession, bank analysts and economists have warned. ‘Recession is getting priced in,’ said Jan Loeys, economist at JPMorgan, adding that markets went into ‘virtual panic mode’ last week. ‘Pressure is building for central banks to become a lot more active and vocal [this] week if they want to avert a collapse in credit markets.’… Peter Sutherland, chairman of both Goldman Sachs International and BP, joined those voicing concern. ‘The US economy is in a mess… There is a whole big issue...which has not fully played out in regard to providing credit and liquidity to institutions, so I think it is a dangerous period for the world. I think we are going to go through next year, certainly the first half of next year, with considerable traumas.’”
November 28 – Financial Times (Michael Mackenzie and Saskia Scholtes): “Investor flight from anything bearing the taint of the US subprime mortgage crisis has pushed financial companies debt to its weakest versus US Treasuries in more than five years. Energy, utilities and telecommunications companies, conversely, have seen their lower-rated BBB bonds attract haven buying. This divergence is a stark indicator of one root cause of the current credit crunch: the unwinding of leverage on the part of investors. The paper rated AA that is common to most financial companies was popular in many complex credit structures using leverage. ‘The AA to BBB [performance] pattern suggests that the fear is a massive liquidation trade that causes spread widening, rather than weak balance sheets that cause default risk,’ said Michael Cloherty, strategist at Banc of America… Structured investment vehicles (SIVs) – one significant type of leveraged investor – are off-balance sheet vehicles that hold long-term assets such as mortgage debt and corporate bonds… These were huge buyers of financial company debt, which made up on average more than 40% of their holdings.”
November 29 – Financial Times (David Oakley): “The cost of borrowing in the corporate bond markets rose to five-year highs yesterday as issuance for a November slumped to a record low. Ben Bennett, credit strategist at Lehman Brothers, said: ‘The markets are dead. It’s down to a mixture of investors being reluctant to buy new deals and issuers reluctant to lock in at prices that are some of the worst or widest for years. ‘The general market appetite for any credit activity has taken a bit of a battering. People's appetite for going long has been reduced greatly. No one wants to be doing big trades now. The market has in general given up over the last two weeks.’ According to figures from Lehman, the spread or risk premium for financial and corporate bonds over safe government paper rose to the highest level yesterday in the dollar denominated market since January 2003… Dealogic…said global bond issuance in the US and Europe for November was at its lowest level since 2001. Non-government bond issuance in the US is $106bn so far this month compared with $327bn in November last year, while in Europe it is $124bn compared with $247bn in November last year.”
November 27– Dow Jones (Romy Varghese and Anusha Shrivastava): “Investment-grade investors have gone into hiding, bringing the U.S. market for highly rated debt to a virtual standstill. Risk premiums are wider in the secondary market and primary issuance has dwindled to a trickle. Rattled by worries about the outlook for the economy, the credit markets and the health of the financial system, investors appear to have mostly closed up shop for the year. Trading is ‘extremely illiquid,’ said Wayne Schmidt, senior portfolio manager at AXA Investment Management. So much so, it’s worse than August, the height of the summer credit crunch, he said. New issuance has sputtered out…”
November 27– Bloomberg (Jody Shenn): “Losses on collateralized debt obligations at the world’s biggest banks may double to $77 billion, JPMorgan Chase & Co. analysts predict. Losses marketwide on CDOs linked to U.S. mortgages will reach about $260 billion…JPMorgan analysts, led by Christopher Flanagan said… ‘One of the benefits of securitization is the offloading and global distribution of risk… Ironically, this is now a capital markets hazard, since no one is sure where subprime losses lurk.’”
November 30 – Bloomberg (Shannon D. Harrington): “Moody’s Investors Service said $64.9 billion of debt sold by Citigroup Inc.'s structured investment vehicles was cut or placed on review for a downgrade as part of a review of $130 billion of SIV debt.”
November 26– Bloomberg (Neil Unmack and Sebastian Boyd): “HSBC Holdings Plc, Europe’s largest bank, will add $45 billion of assets to its balance sheet by consolidating two structured investment vehicles it manages. Investors in the SIVs will be able to exchange their holdings for debt issued by a new company, backed by loans from HSBC… HSBC’s decision reduces the worldwide assets in SIVs as U.S. lenders led by Bank of America Corp. seek to persuade competitors to help finance an $80 billion bailout of the companies. HSBC’s Cullinan Finance Ltd. and Asscher Finance Ltd. have more than $34 billion of senior debt, making it the second-largest bank sponsor of SIVs after Citigroup Inc.”
November 27 – Financial Times (Stacy-Marie Ishmael and Saskia Scholtes): “Specialist bond insurers are facing mounting pressure to improve their financial standing and avoid losing their top credit ratings because of the subprime mortgage crisis. But while much investor attention has been focused on risks at the two biggest companies in the industry, MBIA and Ambac, analysts say the bond insurers most at risk are the smaller, less established players such as ACA, FGIC and Security Capital Assurance…. The cost of insuring FGIC against default was more than 700 bps yesterday, according to Markit, about in line with the cost of protecting General Motors, which is rated high yield.”
November 29 – Washington Post (David Cho): “The widening credit crunch is making it harder for cities and school systems to get money for buildings, ballparks and other vital projects from the $2.5 trillion market for municipal bonds, a sector of Wall Street that rarely sees trouble. That is leaving them with a tough choice: either put off the projects, or pay higher interest rates on their bonds… Faced with the prospect of paying higher interest rates this month, Chicago canceled a $960 million bond. Miami-Date pulled a $540 million offering for its airport… Several finance directors said it is unusual for turbulence to hit municipal bonds, a tax-exempt investment that has long been considered safe. ‘There’s some unique and maybe even unprecedented dynamics that have been occurring because of the credit crunch,’ said Lasana Mack, the District’s treasurer. For the past several years, cities and towns have been able to borrow money by issuing bonds that pay historically low interest rates. That era of easy money is ending for many municipalities, mostly because of spiraling losses in the mortgage industry that have been driving up borrowing costs.”
November 27– Bloomberg (Michael B. Marois): “The worst U.S. housing recession in 16 years will drive down property values by $1.2 trillion next year and slash tax revenue by more than $6.6 billion, according to a report by the U.S. Conference of Mayors. California… will suffer a $630.6 billion decrease in property values that will cut property tax revenue to local governments by almost $3 billion, the study found. The New York City region will see the greatest slowdown in the output of goods and services because of the mortgage crisis, according to the report… ‘The real estate crisis of 2007 and 2008 will go down in the record books,’ according to the report… The wave of foreclosures that has rippled across the U.S. has already battered some of our largest financial institutions, created ghost towns of once vibrant neighborhoods -- and it’s not over yet.’”
November 28 – Bloomberg (David Evans): “Florida local governments and school districts pulled $8 billion out of a state-run investment pool, or 30% of its assets, after learning that the money-market fund contained more than $700 million of defaulted debt. Orange County…removed its entire $370 million from the pool on Nov. 16, two days after the head of the agency that manages the state’s short-term investments disclosed the defaulted debt in a report delivered to Governor Charlie Crist. ‘Our primary goal is to protect our funds,’ said Jim Moye, Orange County’s chief deputy comptroller… ‘Knowing other people were pulling out, and that word was spreading, we looked at the potential for a run on the pool,’ said Orange County’s Moye… Should the withdrawals continue, Florida’s pool may have to consider filing for bankruptcy protection, says John Coffee, a securities law professor at Columbia Law School... Coffee predicts the pool will likely file lawsuits to recover losses. ‘I’d expect the pool is going to sue the people who sold them the commercial paper, saying the risks were hidden,’ he said… The Florida pool, which was the largest of its kind in the U.S. at $27 billion before the recent spate of withdrawals, has invested $2 billion in SIVs and other subprime-tainted debt…”
November 29 – Bloomberg (David Evans): “Florida officials voted to suspend withdrawals from an investment fund for schools and local governments after redemptions sparked by downgrades of debt held in the portfolio reduced assets by 44%. The Local Government Investment Pool had $3.5 billion of withdrawals today alone, putting assets at $15 billion, said Coleman Stipanovich, executive director of the State Board of Administration, which manages the fund along with other short-term investments and the state’s $137 billion pension fund. ‘If we don’t do something quickly, we’re not going to have an investment pool,’ Stipanovich said… The fund was the largest of its kind, managing $27 billion before this month's withdrawals… ‘We need to protect what is there in the interim,’ said Governor Charlie Crist… The fund has invested $2 billion in structured investment vehicles and other subprime-tainted debt... About 20% of the pool is in asset-backed commercial paper, Stipanovich said… ‘There is no liquidity out there, there are no bids’ for those securities, he said.”
November 30 – Bloomberg (David Evans): “School districts, counties and cities across Florida sought to raise cash after being denied access to their deposits in a $15 billion state-run investment fund. The Jefferson County school district was forced to take out a short-term loan to cover payroll for the 220 teachers and other employees in the system after $2.7 million it held in the pool was frozen yesterday. At least five other districts also obtained last-minute loans… ‘The unthinkable and the unimaginable have just happened here in Florida,’ said Hal Wilson, chief financial officer of the Jefferson County school district…”
November 29 – Financial Times (Michael Mackenzie): “The baton of tension in the money market will pass to one-month paper today as the countdown to year-end funding pressures enters its final four weeks… In the present situation, traders report a distinct reluctance among banks to lend beyond a one-week period and say conditions are approaching the levels of stress seen back in September when the credit squeeze initially flared. ‘People are waiting for the day of reckoning,’ said George Goncalves, analyst at Morgan Stanley… Money markets are already enduring a protracted period of stress, thanks to the credit squeeze. This is being exacerbated by the traditional pressures associated with the closing of the fiscal year for many financial institutions. This is when banks garner cash in order to meet dividend, tax and interest payments and provide for bonuses. ‘Year end is usually a nervous time and this is being magnified by the present strains and stress in the system,’ said John Wraith, head of UK rates strategy at RBS.”
November 26 – Financial Times (Jennifer Hughes): “Auditors will apply tough standards to banks’ assessments of their holdings, according to a draft paper being put together by the biggest auditing firms that aims to bring about a common approach to valuation. The paper, seen by the Financial Times, is also designed to allay fears that the ongoing market turmoil will lead banks and their auditors to different conclusions about how they value holdings and what is a fair price. The issue is increasingly urgent with financial year-ends approaching since only full-year financial statements are fully audited…. The paper is being drawn up by the ‘Big Four’ - PwC, KPMG, Deloitte and Ernst & Young - together with BDO International and Grant Thornton… In a sign of the seriousness of the situation, this is the first time the six have sat down and formally compared their internal practices in such a way.”
November 28 – Financial Times (Ben White): “Sixteen years ago, the largest bank in the US was on the ropes, its balance sheet crippled by bad debts, especially on commercial real estate and Latin American loans. Citicorp, as it was then known, turned to a top client in the Middle East for help, securing a $600m investment from Prince Alwaleed bin Talal of Saudi Arabia for convertible shares paying a cumulative annual dividend of 11%. Now Citigroup, its balance sheet threatened by bad residential real estate loans and related securities, has once again turned to a top client in the Middle East. This time it is receiving a $7.5bn cash infusion from the investment arm of the Abu Dhabi government for convertible stock yielding 11%.”
The dollar index rallied 1.5% to 76.18. For the week on the upside, the Brazilian real increased 2.9%, the South African rand 2.6%, the New Zealand dollar 1.8%, the Australian dollar 1.6%, and the Mexican peso 0.9%. On the downside, the Japanese yen declined 3.4%, the Swiss franc 3.1%, the Swedish krona 2.5%, the Norwegian krone 2.4%, the Danish krone 1.6%, and the Euro 1.6%.
November 29 – Financial Times (Javier Blas): “Policymakers already concerned about the relentless rise in global food inflation are facing more bad news in the shape of soaring soyabean prices. Soyabean prices have risen to their highest level in 34 years, boosted by strong Chinese demand and fears that current prices are not high enough to swing acreage from corn to soyabeans in the US… The price-jump threatens to resonate through the supply chain, boosting meat and poultry prices because soyabean is used largely for animal feed, analysts warned. The surge in soyabean costs - coupled with price increases in other feedstock, such as wheat and corn - could prompt some farmers to abandon production of pork, beef and lamb amid mounting losses, paving the way for higher meat prices in the future. Food inflation is already a big concern for policymakers in developed and developing countries… Soyabeans are, together with corn, rice and wheat one of the world’s key crops. About 80% of the harvest is processed into soyameal and cakes for livestock feeding, while the other 20% is converted into oil for human consumption (and more recently also to feed the biodiesel industry).”
For the week, Gold fell 4.9% to $784, and Silver sank 5.1% to $14.17. March Copper rallied 5.1%. January Crude sank $9.47 to $88.71. January Gasoline dropped 9.5%, and January Natural Gas fell 8.9%. December Wheat jumped 4.9%. For the week, the CRB index dropped 4.1% (up 10.6% y-t-d). The Goldman Sachs Commodities Index (GSCI) sank 6.4%, reducing 2007 gains to 33.2%.
November 30 – Bloomberg (Lily Nonomiya): “Japan's housing starts fell for a fourth month in October as stricter rules for obtaining building permits remain a burden on economic growth. Starts tumbled 35% from a year earlier…”
November 30 – Bloomberg (Zhang Shidong and Chua Kong Ho): “Chinese stocks fell, sending a key index to its steepest monthly slump in at least 12 years… PetroChina Co., the world’s biggest company, and China Shenhua Energy Co., the nation’s largest coal producer, led the decline. PetroChina tumbled 35% from a Nov. 5 high and Shenhua sank 32% from its Oct. 15 record close.”
November 29 – Financial Times: “The tide has turned on overseas Chinese initial public offerings, one of the last outposts of irrational euphoria open to foreigners. In the past week, two IPOs have tanked on their debut on the Hong Kong stock exchange: the latest, Sinotruk, slid 16% on Wednesday, the worst first-day performance seen in the territory this year. Coming at the end of a year marked by excesses - until November 20, such IPOs were returning an average one-day pop of 30%, according to Dealogic - the latest arrivals herald a marked shift in sentiment.”
November 27– Bloomberg (Winnie Zhu): “China Three Gorges Project Corp. had invested 115.3 billion yuan ($15.6 billion) in the world’s biggest hydroelectric venture by September… The project has 19 hydropower units in operation, with generation capacity of 13,300 megawatts, Wang Xiaofeng, director of the Three Gorges Dam office…said… The dam is scheduled to have 26 units in place by the end of next year.”
November 30 – Bloomberg (Cherian Thomas): “India’s economy grew at the slowest pace since the final quarter of 2006, signaling the central bank may soon end three years of interest-rate increases. Asia’s third-largest economy expanded 8.9% in the three months to Sept. 30 from a year earlier, after a 9.3% increase in the previous quarter…”
Unbalanced Global Economy Watch:
November 28 – Bloomberg (Gabi Thesing): “Money-supply growth in the euro region accelerated more than economists forecast in October, to the fastest pace in more than 28 years, adding to the European Central Bank’s inflation concerns. M3 money supply… grew 12.3% from a year earlier, after gaining 11.3% in September… That’s the highest rate since July 1979.”
November 28 – Market News International: “Growth of eurozone M3 money supply soared to a record high in November and, along with a renewed climb of growth in loans to the private sector, will cause some discomfort at the ECB, which is already concerned about mounting risks to price stability. But while the outcome -- which saw the key 3-month moving average of M3 growth rise to a new high of 11.7% -- was unexpectedly high, the ECB has also acknowledged that the monetary data may be distorted by the financial market strains related to the U.S. subprime mortgage woes."
November 28 – Bloomberg (Gabi Thesing): “Inflation in the euro area may accelerate to a six-year high of 3% this month, increasing pressure on the European Central Bank to raise interest rates, economists said after prices jumped in Germany… ‘Faster than expected inflation is a major headache for the ECB,’ said Stephane Deo, chief European economist at UBS AG… ‘If inflation expectations get dislodged, the ECB will face a credibility crisis and it will have to raise rates.’”
November 30 – Bloomberg (Fergal O’Brien): “European inflation accelerated in November to the fastest in more than six years, adding pressure on the European Central Bank to raise interest rates even as economic expansion cools. The inflation rate in the 13-nation euro area rose to 3% this month from 2.6% in October…”
November 29 – Market News International: “UK mortgage approvals slumped in October, underscoring the rapid cooling in the housing market… Mortgage approvals fell to 88,000 in October from 100,000 in September, the lowest outturn since Feb 2005.”
November 29 – Bloomberg (Fergal O’Brien): “Irish housing starts fell 51% in October from a year earlier as property demand cooled and builders cut back on projects… In the 10 months through October, starts were down 33% from a year earlier.”
November 30 – Bloomberg (Joshua Gallu): “Switzerland’s inflation rate rose to the highest level in more than six years in November… Consumer prices gained 1.8% from a year earlier, compared with a rate of 1.3% in the previous month…”
November 26– Bloomberg (Ben Sills): “Producer prices in Spain accelerated in October for a second month in three… The price of goods leaving Spain's factories, farms and mines rose 4.7% from the year earlier period after a 3.4% increase in September…”
November 29 – Bloomberg (Robin Wigglesworth): “Norway’s statistics agency raised its forecast for economic growth this year for a second time, predicting the mainland economy will expand at the fastest pace since 1985. The mainland economy…will grow 5.7%...”
Bubble Economy Watch:
November 29 – EconoPlay.com (Gary Rosenberger): “New vehicle sales were adrift in November – and fell sharply in regions where housing was hardest hit – with no amount of factory incentives able to get the market rolling… The dominant issues were collateral damage from the housing market and a growing population of credit-challenged consumers… ‘I’ve never seen it this slow. GM has the big Red Tag sale going on right now, but it hasn’t moved the needle for us. I don’t think they could give away cars, it’s so bad,’ said Dennis Fitzpatrick of Fitzpatrick Chevrolet Buick Hummer in Concord, California… ‘I’m looking at everybody’s numbers, and they’re not good. The housing market is in the tank. There are foreclosures all over the place. Ancillary businesses like mine are affected. I have never seen so many credit-challenged people coming in to my dealership.’ He sees people with 450 to 500 FICO scores who would never qualify for the zero-percent financing incentives that drew them in the first place. ‘Every single deal is a struggle to get bought by the finance companies,’ he said. ‘They’re coming in upside down on their home mortgages. They have no money to put down. Their credit sheets are horrible. They’re broke.’”
Central Banker Watch:
November 30 – Dow Jones (Brian Blackstone): “Federal Reserve Bank of St. Louis President William Poole Friday said any concerns that rate reductions might be interpreted as bailing out investors and spurring risky behavior wouldn’t prevent him from cutting rates aggressively if he thought it was warranted. ‘I wouldn’t want people in the markets to believe that I, at any rate, would be so concerned about the moral hazard argument that I wouldn't possibly advocate a 25-basis-point or a 50-basis-point cut (in the federal-funds rate) or whatever might be on the table," Poole told reporters…”
November 27 – Financial Times (Michael Mackenzie and Saskia Scholtes): “Four months after the credit squeeze first gripped US money markets, traders are losing confidence that the New York Federal Reserve is able to get the market for so-called Fed funds under control again. Yesterday, the New York Fed said it would conduct the first of a series of term repurchase agreements designed to help prevent the funds rate from rising sharply above its target around the end of the year. The effective Fed funds rate has oscillated round the target rate, or the interest rate set by the Federal Reserve's Open Market Committee. The Fed’s lack of success in controlling the funds rate has maintained stress in the interbank lending market as banks face balance sheet constraints near the end of their financial year. ‘The fact that funds rate expectations have become unanchored is itself a source of instability,’ said Lou Crandall, economist at…Wrightson ICAP.”
November 28 – Financial Times (Ralph Atkins and Krishna Guha): “Soaring eurozone inflation is threatening fresh difficulties for the European Central Bank as it fights to calm tensions in financial markets that are casting a shadow over economic growth in the 13-country region. Energy and food prices pushed inflation in Germany this month to the highest level since at least 1995, leading economists to forecast the annual eurozone figure…would reach 3% or above for the first time in more than six years. That would pose a serious challenge to the ECB, which pledges to keep inflation ‘below but close’ to 2%. The Federal Reserve faces a similar dilemma in the US, where consumer price inflation hit an annual rate of 3.5% last month, and could approach 4% in the coming months, in spite of sharply slowing growth… Moreover, unlike the ECB, the Fed has to worry about the effects of currency weakness on prices.”
November 29 – Bloomberg (James Tyson): “Freddie Mac…sold $6 billion of non-convertible preferred stock to bolster capital amid a deepening housing slump. The stock will pay an 8.375% fixed dividend for five years and then shift to 7.875% or to 416 basis points above the three-month London interbank offered rate…”
November 28 - California Association of Realtors (C.A.R): "Home sales decreased 40.2% in October in California compared with the same period a year ago, while the median price of an existing home fell 9.9%... 'Financing issues have dogged entry-level buyers since early 2007, but they spilled over into the middle and upper-tier markets in the last few months,' said C.A.R. President William E. Brown. 'The decline in sales at the upper end of the market contributed to a significant decline in the statewide median price as even well-qualified borrowers had difficulty securing financing.'”
California's statewide median price was down $33,720 to $497,110, putting the two-month decline at a remarkable $91,860. The month's supply of home inventories was down slightly from September to 16.3 months, this compares, however, to the year ago 6.4 months.
MBS/ABS/CDO/CP/Money Funds and Derivatives Watch:
November 28– Bloomberg (Jody Shenn): “Fraud by subprime mortgage borrowers in recent years played a significant role in the unexpectedly high number of defaults, Fitch Ratings said, citing loan documents. Fitch’s review of documents for 45 loans that were packaged into bonds last year and defaulted within six months found two-thirds contained occupancy fraud, in which borrowers falsely claimed they planned to live in properties. ‘Almost every file’ indicated some type of fraud or misstatement of the borrower’s financial condition that was missed or encouraged by lenders, Fitch said… ‘While we realize this was a very limited sample, Fitch believes that the findings are indicative of the types and magnitude’ of the issues, wrote Glenn Costello, Diane Pendley and Mary Kelsch, analysts at the…firm.”
November 27– Bloomberg (Jody Shenn): “Defaults on subprime mortgages rose last month, as the U.S. real estate slump made it harder to sell homes or refinance loans, according to data on the debt underlying benchmark ABX derivatives. About 23.4% of loan balances from 20 subprime bonds created in the first half of 2006 were at least 60 days late, in foreclosure, subject to borrower bankruptcy or were already turned into seized property, up 1.76 percentage points from September…”
November 30 – Bloomberg (Mark Rohner and Sharon L. Crenson): “One third of adjustable-rate subprime home loans in the U.S. were delinquent as of August, according to a study by the Federal Reserve Bank of New York.”
November 26– The Wall Street Journal (Ruth Simon): “The subprime mortgage crisis is poised to get much worse. Next year, interest rates are set to rise -- or ‘reset’ -- on $362 billion worth of adjustable-rate subprime mortgages, according to…Bank of America… While many accounts portray resetting rates as the big factor behind the surge in home-loan defaults and foreclosures this year, that isn’t quite the case. Many of the subprime mortgages that have driven up the default rate went bad in their first year or so, well before their interest rate had a chance to go higher. Some of these mortgages went to speculators who planned to flip their houses, others to borrowers who had stretched too far to make their payments, and still others had some element of fraud. Now the real crest of the reset wave is coming, and that promises more pain for borrowers, lenders and Wall Street.”
November 28 – Bloomberg (John Glover and Jody Shenn): “In the bond market, commercial property investors are about as creditworthy as U.S. homeowners with subprime mortgages. ‘Commercial real estate is a full-blown bubble that feels very much at a bursting point,’ said Christian Stracke, an analyst…at CreditSights Inc… ‘There’s a fairly toxic mix of factors at work.’ The cost of derivatives protecting investors from defaults on the highest-rated bonds backed by properties more than doubled in the past month, according to Markit Group Ltd. Prices suggest traders anticipate defaults rising to the highest level since the Great Depression, according to analysts at RBS Greenwich Capital… The seven-year rally in offices and retail properties ended in September when prices fell an average of 1.2%, according to Moody’s… More losses are likely because banks are holding $54 billion of commercial mortgages they can’t sell, data compiled by …Citigroup Inc. show.”
Mortgage Finance Bust Watch:
November 27– The Wall Street Journal (James R. Hagerty): “Sen. Charles Schumer…urged regulators to examine potential risks posed by a sharp increase in lending by the Federal Home Loan Bank of Atlanta to Countrywide Financial Corp… In a letter sent Monday to Ronald Rosenfeld, chairman of the Federal Housing Finance Board, which regulates the 12 regional home loan banks, Sen. Schumer said: ‘I am concerned that the loans being pledged by Countrywide to secure these advances (borrowings) may pose a risk to the safety and soundness of the FHLB system as a whole.’ He called for a review of the Atlanta bank’s policies for evaluating collateral and of the loans pledged by Countrywide to secure its advances. The home loan banks, created by Congress in 1932 to prop up failing banks and provide money for housing, have taken on a larger-than-usual role over the past few months in providing funds for mortgage lending. They have stepped up their secured loans, or ‘advances,’ to mortgage lenders to fill a void created in August… Countrywide has replaced that funding mainly by tapping the Atlanta bank, where its borrowings totaled $51.1 billion as of Sept. 30, up 77% from three months earlier…”
November 29 – Bloomberg (Steven Church): “New Century Financial Corp., the biggest subprime lender in bankruptcy, faces $34.9 billion in claims from its creditors… The defunct mortgage company asked U.S. Bankruptcy Court Judge Kevin Carey…for more time to devise a plan to pay the claims… Sorting out the claims ‘has been an intense and time-consuming process,’ the company said in court papers…”
Real Estate Bubbles Watch:
Combined October Existing and New Home Sales were down 21% from a year earlier, and almost a third lower than October 2005. Existing Home Sales were down 20.7% from a year ago and New Home Sales 23.5%. New Home Sales were fully 46% below the level from October 2005. Existing Average (mean) Prices were down 4.4% y-o-y to $254,600. New Home Average Prices were down 0.3% y-o-y to $305,800. Year-to-date, Existing Home Sales were running 11.2% below 2006's level and New Homes 23.7% below.
November 28 – Financial Times (Krishna Guha): “US house prices fell at their fastest rate in more than two decades during the third quarter, according to a measure of house prices released yesterday and widely followed by investors… The S&P/Case-Shiller index suggests that house prices nationwide fell 1.7% in the three months to October from the second quarter and were down 4.5% year on year. Prices in 20 big cities were down on average by 4.9% year on year.”
November 29 – Market News International (Margaret Chadbourn): “Signaling the housing market is sinking further, the Office of Federal Housing Enterprise Oversight… said that U.S. home prices dropped 0.4% from the second to third quarters of 2007, marking the first time in 13 years the index experienced a quarterly decline.”
November 27: Florida Association of Realtors: “Disruptions in the mortgage market and tightening credit continued to impact Florida’s housing sector in October. Statewide, sales of existing single-family homes totaled 9,165 last month while 12,846 homes sold in October 2006 for a decrease of 29% in the year-to-year comparison… Florida’s median sales price for existing single-family homes last month was $222,100; a year ago, it was $242,700 for an 8% decrease… Sales of existing condominiums in Florida also decreased last month, with a total of 2,819 condos sold statewide compared to 3,508 in October 2006 for a 20% decline…”
November 30 – Bloomberg (Alan Mirabella): “Manhattan apartment prices and sales are starting to slip, a signal the national housing decline is moving to New York City, the Wall Street Journal reported. The median price of a Manhattan apartment fell 3.4% in the third quarter from the second quarter, the newspaper said, citing…RadarLogic Inc.”
Financial Sphere Bubble Watch:
November 28 – Financial Times (Ben White): “US bank earnings plunged nearly 25% in the third quarter, falling below $30bn for the first time since 2003 as the sagging US housing market hit profits… Net income for banks in the period fell to $28.7bn, down $9.4bn from last year driven by a steep increase in provisions for loan losses and a drop in non-interest income, according to the FDIC. Loan loss provisions rose $9.2bn, or 122%, to $16.6bn compared to the same period a year earlier… The $16.6bn in provisions is the most made since the second quarter of 1987 and the second highest ever. Nearly half of all US banks reported annual earnings declines, largely as the result of the weakening US housing market… The data from the FDIC also strongly indicated that US consumers are having increasing difficulty keeping up with payments on a range of loans. The amount of delinquent loans grew for the sixth quarter in a row, rising by $16bn, or 24%.”
November 26 – Financial Times: “Where does it hurt the most? US banks seem to have taken the brunt of the pain from subprime so far. Since the start of September, US bank stocks have performed more than twice as badly as European peers. They also seem to have been braver about taking the pain. Of the subprime exposure of about $400bn announced to date globally, US banks account for about $222bn, while European banks have stated exposure of about $164bn, according to estimates by Goldman Sachs.”
November 28– Bloomberg (Jody Shenn): “Securities firms and banks sold ‘too many lottery tickets’ tied to U.S. mortgages and failed to look closely enough at their growing risks, the head of the Securities and Exchange Commission's market regulation division said today. Financial companies had ‘a significant risk management failure’ on so-called super senior classes of collateralized debt obligations made up of asset-backed bonds, Erik R. Sirri said… The CDO classes were ‘a perfect structure to lull even sophisticated traders and risk managers into a state approaching complacency,’ Sirri said.”
Crude Liquidity Watch:
November 25– Bloomberg (Will McSheehy): “Investors in Persian Gulf states including Saudi Arabia and the United Arab Emirates are spending $2.4 trillion on local construction projects as oil earnings boost economic growth, a study found. The $120 billion King Abdullah Economic City project in Saudi Arabia is the region’s biggest, followed by the $86 billion Silk City project in Kuwait and the $60 billion Dubailand leisure park in the U.A.E., Dubai-based research company Proleads said… Gulf developers including Emaar Properties PJSC and Qatari Diar have a combined 2,837 projects underway and are drawing up plans for 680 more, the statement said.”
November 26– Bloomberg (Glen Carey and Matthew Brown): “The United Arab Emirates, the second-largest Arab economy, warned retailers against unwarranted price rises after announcing a 70% salary boost for government employees. Suppliers and traders should ‘avoid all forms of exploitation and monopoly leading to an unjustified increase in prices,’ the Economy Ministry said… The U.A.E. announced Nov. 20 that it will raise the wages of federal government employees by 70% starting in January.”
November 25– Bloomberg (Matthew Brown): “Oman’s annualized M2 money supply growth, an indicator of future inflation, increased to 30% in September from 28% in August, the central bank said… Money supply growth reached a record 32% in Oman in June. Inflation in the sultanate rose to a record 7.1% in September as the cost of food and rent increased.”
November 29 – Bloomberg (Matthew Brown): “Bahrain’s annual M3 money supply growth…accelerated to a 10-year high in October. The indicator rose an annual 33%...”
November 29 – Financial Times (James Mackintosh): “Hedge funds aiming to profit from activism and corporate events have been hit hard this month as a raft of deals fell through and markets plummeted. The so-called event-driven sector, which includes many of the best-known activist hedge funds, is bearing the brunt of a downturn in hedge fund performance this month, the worst for the industry since the credit squeeze hit home in August… According to investors several funds turned in double-digit drops in the first three weeks of this month, hurt by losses as private equity groups walked away from agreed takeovers and by the renewed impact of concern over credit… By September the main stock markets had turned in their worst performances since the bear market of 2001-2002. ‘It is bloody awful,’ said one prime broker. ‘The dispersion between the best and the worst this month is something we have never seen before.’”
November 27– Bloomberg (Jenny Strasburg): “Carlyle Group’s Blue Wave hedge fund has lost 9.3% since being started in March by the Washington-based firm to expand beyond buyouts. The fund…fell 9.5% in October after beginning the month with $690 million in assets…”
Between June 30, 2004 and June 29, 2006, the Federal Reserve raised rates from 1% to 5.25%. During this period of significant Fed “tightening”, “money” became progressively looser. More accurately, Credit and Financial Conditions loosened in the face of rising short-term interest rates. Today, the Fed is in the midst of another of its aggressive loosening cycles. Credit Conditions are today tight, and there is the distinct possibility that they will remain taut or possibly tighten further.
The Fed receives too much Credit for the “efficacy” of past easing cycles. Going all the way back to the then extraordinary rate slashing from the early-nineties (23 straight cuts!), it was actually the burgeoning power of Wall Street Finance providing the brut force behind Fed “reliquefications” and “reflations.” The evolving securitization markets and government-sponsored enterprises were the key mechanisms driving system Credit expansion when the banking system was severely impaired back in 1991/92. By 1993, the blossoming leveraged speculating community had become a major force, taking highly leveraged positions in U.S. (and Mexican!) debt securities, in the process significantly augmenting system Credit Availability and Marketplace Liquidity. By the time of the “Asian Contagion” and then Russian/LTCM crisis, leveraged speculation throughout the (global) debt markets had become a prevailing source of system Credit and liquidity creation.
Having first nurtured “Wall Street finance” to buck the banking system "headwinds" early in the nineties, by the end of the decade Fed accommodation had fashioned the most powerful “reflationary” tool in the history of central banking. Simply tinker with rates or signal lower prospective market yields and the enterprising speculators would quickly lever up on risky debt instruments on demand. Never had it been so easy for a central bank to incite “animal spirits” and stimulate Credit and liquidity. The hedge funds, Wall Street firms and, increasingly over time, myriad global financial players forged both the Maestro’s “genius,” the American economic “miracle”, and synchronized global asset and economic booms. In any case, the leveraged speculating community has been the force behind U.S. Bubble Economy Dynamics including $800bn Current Account Deficits, negative savings rates, destabilizing asset Bubbles, and so-called economic “resiliency.”
I’ll be quite surprised if this easing cycle lives up to market expectations. Most importantly, Wall Street Finance self-destructed over the past few years. Trust will not be returning anytime soon to “structured Credit products”, meaning the securitization and derivatives markets are for quite some time impotent to play their usual “reflationary” role. This has been a momentous development, one certainly compounded by the role our major financial institutions came to play in structured finance and their resulting problematic Credit and market exposures.
It is also worth noting that 10-year Treasury yields are today below 4%. This compares to the 6% or so when the economy headed toward recession in 2000 and the 8% or so yields when the economy succumbed to tightened Credit conditions back in 1991. There is simply not much room for further “easing” of most market yields today. The Wall Street firms and the hedge funds are already dangerously distended after several years of reckless speculation. Wall Street is today in extraordinarily poor position to expand and bolster system Credit. More likely, there is today years worth of overhang of risk securities that will eventually be liquidated by impaired leveraged players.
The unfolding Credit Crisis has necessitated the sequel “Committee to Save the World Part Two.” Especially after the Credit system took a turn for the worst last week, I can understand Secretary Paulson’s urgency to have institutions renegotiate mortgage terms with troubled borrowers. But not only are we too far into the mortgage bust for such efforts to pay much in the way of dividends, I am skeptical that our securitization markets have the necessary infrastructure and legal structure to equitably adjust mortgage terms on millions of loans. And it is becoming increasingly clear that a large segment of troubled loans today involved some degree of fraud at origination. Besides, there is simply not much time to sort through all the various details. Examining the startling almost $92,000 two-month drop in California median prices, it's apparent that momentum generated by the The Great Housing Bust is not to be impeded by a program to check subprime mortgage resets.
Such efforts, however, obviously have major impacts on the markets. I can’t imagine more challenging market conditions or ones more fascinating to try to analyze. It was quite a “squeeze” this week in stocks, Credit instruments, currencies and commodities. The way I see it, there is today a great and destabilizing dichotomy. On the one hand, the Credit crisis and severe impairment of key sectors in the Credit system ensure major liquidity constraints, faltering asset markets, and an arduous economic adjustment period. On the other hand, years of egregious Credit Inflation have created an incredibly bloated financial apparatus (domestically and internationally) determined to disregard new realities.
This “system”, importantly, is especially indisposed to succumbing to boom-turned-bust dynamics. Or, stated another way, our Wall Street dominated financial apparatus is keen on “Inflate or Die” dynamics and has no intention of relinquishing the tremendous power it has gathered over the years. This is understandable, although it certainly creates a very serious problem when it comes to the stock market refusing to adjust to rapidly deteriorating underlying fundamentals. And if market dynamics preclude an orderly stock market revaluation, expect it to come at some point violently and with great hardship. This is one aspect of the great costs associated with the Fed moving aggressively again to “reflate.” It won’t work, its further subverts the market process, and only worsens an already perilous situation.