For the week, the Dow advanced 0.8% (up 7.9% y-t-d), and the S&P500 gained 1.1% (up 4.7%). The Transports slipped 0.7% (up 1.8%), while the Utilities added 0.2% (up 16.9%). The Morgan Stanley Cyclical index jumped 1.7% (up 12.5%), and the Morgan Stanley Consumer index added 0.3% (up 7.7%). The broader market rallied strongly. The small cap Russell 2000 surged 4.2% (down 0.3%), and the S&P400 Mid-cap index rose 1.7% (up 8.1%). The NASDAQ100 jumped 1.9%, increasing 2007 gains to 20.2%. The Morgan Stanley High Tech index gained 1.5% (up 11.3%), and the Semiconductors recovered 0.5% (down 11.1%). The Street.com Internet Index jumped 2.5% (up 16.4%), and the NASDAQ Telecommunications index rose 3.1% (up 13.4%). The Biotechs gained 1.3% (up 7.5%). The Broker/Dealers increased 1.4% (down 13.5%), and the Banks added 0.4% (down 23%). With Bullion jumping $16.60, the HUI Gold index rose 2.8% (up 17.6%).
Three-month Treasury bill rates rose 7 bps this week to 2.97%. Two-year government yields sank 11 bps to 3.20%. Five-year T-Note yields declined 5 bps to 3.59%, and ten-year yields fell 6 bps to 4.17%. Long-bond yields dropped 8 bps to 4.58%. The 2yr/10yr spread ended the week at 97 bps. The implied yield on 3-month December ’08 Eurodollars dropped 19 bps to 3.57%. Benchmark Fannie MBS yields fell 6 bps to 5.70%, this week trading in line with Treasuries. The spread on Fannie’s 5% 2017 note was little changed at 49, and the spread on Freddie’s 5% 2017 note was also little changed at 49. The 10-year dollar swap spread declined 3 bps to 65.5. Corporate bond spreads were mixed, with the spread on an index of junk bonds ending the week 30 bps wider.
December 19 - Dow Jones (Kellie Geressy): “Investment-grade companies broke new barriers in 2007, issuing a record amount of debt in the bond market despite the year's volatile second half. And although companies with riskier, more speculative credit profiles also got caught in the mid-year credit crunch, they still managed to post robust new issuance figures as well… According to Thomson Financial, $964.9 billion of high-grade debt has been sold in 2007 year-to-date, nudging out 2006’s $936.6 billion… Despite a major selloff in the second half, the high-yield bond market still saw about $135 billion of new supply this year, beating last year’s $131 billion, according to KDP Investment Advisors…”
December 21 – Financial Times (Lina Saigol and James Politi): “The volume of mergers and acquisitions worldwide suffered a dramatic fall in the second half of the year as credit dried up for private equity deals and many chief executives scrapped plans for bold takeovers. Global M&A in the year to date reached $4,740 bn, surpassing last year’s record of $3,910bn. But volume in the second half dropped 26% and September was the lowest month since November 2005, according to Dealogic…”
December 18 – Bloomberg (Fabio Alves): “U.S. corporate defaults probably will quadruple next year after the number of companies that lost their investment-grade credit ratings rose at the fastest pace since 2003. Moody’s… predicts companies will default on 4.7% of their bonds in 2008 as the economy slows, up from 1% this year. Jones Apparel Group Inc., the Bristol, Pennsylvania-based maker of Nine West shoes, mortgage lender Residential Capital LLC and 31 other companies with a combined $52 billion of debt were downgraded to junk by Moody’s this year.”
December 20 – Financial Times (Paul J Davies): “The outlook for European corporate and financial debt will turn distinctly more negative next year with credit ratings downgrades set to outnumber upgrades by two to one, according to S&P. This would be the first time in more than three years that downgrades have outnumbered upgrades. Default rates are also expected to pick up from their record low levels, the agency said, although they should remain below the long-term European junk-rated average of 3.5%.”
Investment grade debt issuers included Citigroup $3.5bn, Morgan Stanley $2.5bn, Lehman Brothers $1.5bn, and Con-Way $425 million.
Junk issuers included Helix Energy Solutions $550 million.
Convertible issuance included ADC Telecom $400 million.
December 18 – Financial Times (Joanna Chung): “A surge in activity by companies in emerging markets has helped to set a new record for capital raised with initial public offerings this year, according to…Ernst & Young… New share issues raised $255bn by the end of November, surpassing the previous record of $246bn set last year.”
German 10-year bund yields were unchanged at 4.30%, while the DAX equities index added 0.7% for the week (up 21.3% y-t-d). Japanese “JGB” yields were little changed at 1.55%. The Nikkei 225 declined 1.7%, boosting 2007 losses to 11.4%. Emerging equities and debt markets were mixed. Brazil’s benchmark dollar bond yields dropped 9 bps to 5.65%. Brazil’s Bovespa equities index added 1.0% (up 41.9% y-t-d). The Mexican Bolsa declined 1.2% (up 12.1% y-t-d). Mexico’s 10-year $ yields rose 8 bps to 5.50%. Russia’s RTS equities index gained 1.2% (up 19.5% y-t-d). India’s Sensex equities index sank 4.7% (up 39% y-t-d). China’s Shanghai Exchange rose 1.9%, increasing y-t-d gains to 90.7%.
Freddie Mac posted 30-year fixed mortgage rates increased 3 bps this week to 6.14% (up 1 bp y-o-y). Fifteen-year fixed rates increased 1 basis point to 5.79% (down 10bps y-o-y). One-year adjustable rates added 1 basis point to 5.51% (up 7bps y-o-y).
Bank Credit dropped $44.2bn during the week (12/12) to $9.163 TN. Bank Credit has posted a 21-week gain of $520 bn (14.9% annualized) and a y-t-d rise of $866bn, a 10.9% pace. For the week, Securities Credit sank $45bn. Loans & Leases added $0.7bn to $6.751 TN (21-wk gain of $426bn). C&I loans declined $9.3bn (2007 growth rate of 20.7%). Real Estate loans fell $9.9bn. Consumer loans added $2.8bn. Securities loans rose $16.6bn, and Other loans added $0.6bn. On the liability side, (previous M3) Large Time Deposits dropped $10.5bn.
M2 (narrow) “money” supply increased $17bn to $7.457 TN (week of 12/10). Narrow “money” has expanded $413bn y-t-d, or 6.1% annualized. For the week, Currency added $0.5bn, while Demand & Checkable Deposits dipped $2.6bn. Savings Deposits rose $14.3bn, and Small Denominated Deposits increased $1.5bn. Retail Money Fund assets rose $3.1bn.
Total Money Market Fund Assets (from Invest. Co Inst) slipped $6.1bn last week to $3.116 TN. Money Fund Assets have posted a 21-week surge of $533bn (51% annualized) and a y-t-d increase of $734bn (31.4% annualized)..
Total Commercial Paper sank a remarkable $54.7bn to $1.784 TN. CP is now down $439bn over the past 19 weeks. Asset-backed CP dropped $27.5bn (19-wk drop of $432bn) last week to $764bn. Year-to-date, total CP has contracted $190bn, or 9.8%, with ABCP down $291bn.
Fed Foreign Holdings of Treasury, Agency Debt last week (ended 12/19) jumped $7.6bn to a record $2.048 TN. “Custody holdings” were up $296bn y-t-d (17.2% annualized). Federal Reserve Credit expanded $7.2bn last week to $871bn. Fed Credit has increased $18.7bn y-t-d (2.2%).
International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $1.250 TN y-t-d (26.5% annualized) to $6.061 TN.
December 20 – Bloomberg (Maria Levitov): “Russia’s foreign currency and gold reserves, the world’s third largest, rose… by $6.2 billion to $467.4 billion in the week ended Dec. 14…”
Credit Market Dislocation Watch:
December 18 – Financial Times (Ralph Atkins, Dave Shellock and Gillian Tett): “Short-term market interest rates in the eurozone plunged at their fastest rate for more than a decade on Tuesday after the European Central Bank stunned investors by pumping a record €348.6bn worth of funds into the markets. The size of the injection – which was intended to calm the markets over the critical year-end period – was twice as big as the ECB had indicated would have been needed in normal circumstances. The bank said some 390 private sector banks in the eurozone had requested funds, which have been offered for two weeks at 4.21 per cent, well below the previous prevailing market rate. ‘The sheer magnitude of the operation caught the market off guard,’ said Win Thin, Brown Brothers Harriman’s senior currency strategist…”
December 18 – Bloomberg (John Fraher): “Bank of England Governor Mervyn King said the coordinated effort by central banks last week to ease a credit squeeze was aimed at persuading financial institutions they would do whatever is necessary to protect the world economy. The actions ‘demonstrate that central banks are working together to try to forestall any prospective sharp tightening of credit conditions that might lead to a downturn in the world economy,’ said King in testimony to lawmakers… Still, ‘a painful adjustment faces the global banking sector over the next few months,’ King said.”
December 19 – Financial Times (Ralph Atkins): “The massive amount of liquidity pumped into financial markets by the European Central Bank appeared yesterday finally to have exceeded demand - but Jean-Claude Trichet, its president, insisted that there had been ‘no bail-outs’. Demand in an auction of three-month money by the ECB yesterday fell short of the €50bn ($72bn, £36bn) that the central bank was prepared to offer… At the same time, the Frankfurt-based institution was able to mop-up €133.6bn of overnight money. The latest moves suggested that the series of measures announced by the ECB in recent weeks had eased banks' fears about the year-end, when financial institutions are under severe pressure to show strong liquidity on their books.”
December 21 – Financial Times (Aline van Duyn): “The crisis of confidence surrounding the creditworthiness of bond insurers deepened yesterday after MBIA revealed larger-than-expected exposure to complex bonds linked to faulty mortgages. Shares in MBIA, which guarantees payments on almost $700bn of debt, fell 26 per cent to close below $20 after the details came to light on the insurer’s website… Fitch…added pressure by warning it could cut MBIA’s triple-A rating unless it raised $1bn in capital in the next four to six weeks.”
December 21 – Financial Times (Aline van Duyn): “With their credit ratings affirmed at triple-A this week, it seemed the world’s biggest bond insurers were at last reaching a period of relative calm which could allow them to get on with boosting their capital positions and building some cushioning for the future. Instead, the lull lasted only a day. MBIA…triggered a near panic after it revealed higher-than-anticipated exposure to some of the riskiest types of structured debt linked to mortgages… For MBIA, this could make its round of capital raising more difficult… David Veno, director at S&P, said: ‘This could have some hindrance on its ability to raise capital. It is all a question of perception.’ Even if the capital raising is successful – and some analysts expect banks and others exposed to some of the hundreds of billions of dollars of bonds backed by insurers to step in if need be – the present crisis could have a longer-term effect on this sector of the market.”
December 21 – Financial Times: “MBIA gets top prize for understatement. When an insurer delicately refers to ‘supplementing’ its list of collateralised debt obligation exposures, that can only be bad news. It is. It turns out that MBIA has an $8bn exposure to CDOs of CDOs (or so called "CDOs-squared"). This is a critical nugget of information, to which the market had an allergic reaction… CDOs-squared are scary because they compound the leverage and complexity of original CDOs, already in the dog house. MBIA can claim that the collateral in the ‘inner’ CDOs is overwhelmingly AAA and AA. Nobody is listening. Markets have had enough of supposedly armour-plated securities tanking…. If MBIA’s capital position is not strengthened sufficiently, the rating agencies could have another go at reviewing the credit rating. A downgrade would hit all the securities MBIA insures, including the vast municipal market.”
December 21 – Financial Times (Ben White): “Trouble at Bear Stearns intensified yesterday when the investment bank reported a quarterly loss - the first in its 84-year history as a public company - that was nearly four times what analysts had forecast. Bear surprised investors with a $1.9bn writedown on its holdings of mortgage assets in its fourth-quarter results, a far larger decline than it forecast only a month ago.”
December 18 – Bloomberg (Jody Shenn): “More than $174 billion of collateralized debt obligations tied to U.S. mortgages were under review for downgrades by Moody's Investors Service at the start of this month, according to the ratings company, suggesting the subprime crisis may deepen. Moody’s downgraded $50.9 billion of CDOs made up of structured-finance securities in November, or about 9.4% of the total… Standard & Poor’s…has so far downgraded or placed under review $57 billion of the debt.”
December 17 – Bloomberg (Neil Unmack): “Sales of U.S. collateralized debt obligations, securities that pool bonds and loans, will fall by about 50% next year as defaults increase, Lehman Brothers Holdings Inc. analysts said. Collateralized loan obligations, CDOs based on loans, will decline 55 to 60% from this year’s estimated $81 billion of sales… Sales of CDOs that bundle credit-default swaps will decrease by about 40 to 50% from $53 billion in 2007.”
December 21 - Bloomberg (Elizabeth Hester and Shannon D. Harrington): "Citigroup Inc., Bank of America Corp., and JPMorgan Chase & Co. abandoned a U.S. Treasury-sponsored plan to buy assets from cash-strapped structured investment vehicles. The 'SuperSiv' fund brokered by Treasury Secretary Henry Paulson, slated to be about $80 billion when it was announced in October, 'is not needed at this time,' the banks said..."
December 20 – Financial Times: “John Mack wants investors to know he feels their pain. But forget the bonus Mr. Mack will forgo. The Morgan Stanley boss is lucky to hang on to his job after the bank disclosed a total writedown of $9.4bn for the quarter and its first ever loss… As for the writedown, it is jaw-dropping, even by subprime standards. A dozen or so traders laid on a position to offset the cost of shorting subprime. Had things worked out, the short could have netted the bank at most about $2bn. Instead, it cost the bank more than $7bn, as the traders’ correct hunch was overwhelmed by a deteriorating long position in top-rated collateralised debt obligation securities. How could that have happened?”
December 21 – Financial Times (Saskia Scholtes): “Hedge funds are scrutinising their levels of exposure to bank defaults, in a telling reversal of conventional risk management concerns. While bank exposure to the hedge funds they trade with has been in sharp focus since the 1998 collapse of Long Term Capital Management, a run of record-breaking losses and bailouts in banking has hedge funds re-examining how much they can be hurt by a bank collapse… In this environment, some hedge funds have found they are more exposed to the risk of bank failure because they agreed to trading terms that did not require banks to post collateral against certain derivatives trades, said Lauren Tiegland-Hunt, managing partner at law firm Tiegland-Hunt. ‘When the credit crunch took hold, many firms were surprised to discover they had entered ‘one-way’ collateral agreements that not only left money on the table, but also left them exposed to increased counter-party credit risk,’ she said. ‘In the current era of falling credit ratings and banks announcing huge...writedowns, this kind of risk is a real and pressing concern.’”
December 21 – The Wall Street Journal (Susan Pulliam and Kara Scannell): “Regulatory investigations into mortgage-securities pricing are examining whether financial firms should have told the public earlier about the declining value of such securities and how they priced them on their books, people close to the matter say. The regulators, led by the Securities and Exchange Commission, also are delving into whether Wall Street firms placed higher values on their own securities than those they placed on customer holdings, the people say. ‘As in most investigations, the issue comes down to what did people know and when did they know it,’ said Mark Schonfeld, director of the SEC’s New York office.”
December 21 – Bloomberg (Martin Z. Braun): “Florida Governor Charlie Crist called for outside lawyers to review the activities of an investment pool whose local government investors withdrew half of their deposits after learning the fund held downgraded and defaulted debt tied to subprime mortgages.”
December 18 – Financial Times (Jane Croft and Chris Giles): “Nationalisation moved a step closer for Northern Rock yesterday after the Treasury extended further guarantees to the stricken bank. Two months ago the government said it would provide cast iron guarantees to all Northern Rock’s retail savers and for wholesale deposits and borrowings. Yesterday’s additional guarantee means the government is mired even deeper in the Northern Rock crisis. The taxpayer is, in effect, backing exotic instruments at Northern Rock such as covered bonds - an ultra-safe type of bond - and derivatives that are not backed by mortgage collateral.”
December 20 – Bloomberg (Sebastian Boyd and Gregory Viscusi): “Credit Agricole SA, France’s second-biggest bank by assets, will write down the value of holdings by 2.5 billion euros ($3.6 billion) before tax as the U.S. subprime crash roils debt markets. The bank decided to take the writedowns after S&P yesterday cut its rating on bond insurer ACA Financial Guaranty Corp. to junk…”
December 18 – Bloomberg (Jenny Strasburg and Christine Harper): “Goldman Sachs Group Inc. said clients pulled about $3 billion from quantitative hedge funds including Global Alpha in the fiscal fourth quarter and withdrawals will increase over the next three months. ‘We are OK with those funds being smaller, especially Global Alpha, because the funds have gotten too big,’ Chief Financial Officer David Viniar said… Global Alpha, which started 2007 with more than $10 billion, declined 37% through November…”
December 19 – Bloomberg (Shannon D. Harrington): “A so-called structured investment vehicle-lite managed by a unit of Ellington Management Group LLC failed to pay interest due on three classes of notes, according to S&P. Ratings on the A-2, B-1 and B-2 notes sold by Duke Funding High Grade II-S/EGAM I Ltd.’s were cut to D…”
December 17 – Financial Times (Peter Smith): “The residents of Tumbarumba, an outback town in the foothills of the Snowy Mountains, have little contact with the exotic world of structured debt. But at one point this year their local council had invested close to 70% of its investment portfolio in collateralised debt obligations. Tumbarumba is not alone. Dozens of Australian councils, charities and a public hospital operator invested heavily in high-risk CDOs actively marketed by Grange Securities, a fixed income specialist owned by Lehman Brothers… Similar pain afflicts communities across the world, from Norway to the US, as a result of direct and indirect exposure to exotic and complex debt instruments that failed to price risk accurately in the run-up to the credit meltdown.”
Currency Watch:
The dollar index rallied 0.4% to 77.72. For the week on the upside, the Brazilian real gained 1.5%, the Canadian dollar 1.4%, the Australian dollar 1.2%, the New Zealand dollar 1.2% and the Singapore dollar 0.5%. On the downside, the British pound declined 1.8%, the South African rand 1.5%, the Japanese yen 1.0%, and the Swiss franc 0.5%.
Commodities Watch:
December 17 – Financial Times (Javier Blas, Chris Giles, and Hal Weitzman): “Global food prices will come under further pressure today as benchmark prices for cereals at much higher levels kick in, making it almost inevitable that a second wave of food price inflation will hit the world's leading economies. In Chicago wheat and rice prices for delivery in March 2008 have jumped to an all-time record, soyabean prices are at a 34-year high and corn prices at an 11-year peak. Knock-on price rises are set to hit consumers in coming months, raising inflationary pressure and constraining the ability of central banks to mitigate the slowdown in their economies.”
For the week, Gold jumped 2.1% to $811, while Silver gained 3.6% to $14.49. March Copper surged 4.8%. February Crude gained $2.02 to $93.57. January Gasoline added 1.7%, and January Natural Gas rose 2.8%. December Wheat declined 3.1%. For the week, the CRB index gained 1.6% (up 15.3% y-t-d). The Goldman Sachs Commodities Index (GSCI) added 1.1%, increasing 2007 gains of 38.5%.
China Watch:
December 20 – Bloomberg (Nipa Piboontanasawat and Li Yanping): “China raised interest rates for a sixth time this year to cool decade-high inflation in the world’s fastest-growing major economy. The benchmark one-year lending rate will increase to 7.47%, a nine-year high, from 7.29%…”
December 20 – Market News International (Joe Richter): “Chinese economic growth faces a host of challenges in the new year including dollar weakness and the ongoing subprime crisis in the US credit markets, an official with the country’s planning agency said… Guo Lanfeng, deputy director of the National Economy Department…also told a forum here that the economy faces risks from domestic factors… Guo highlighted dollar depreciation and the subprime crisis as risk factors. ‘We have been studying the US subprime crisis for half a year. We can’t see clearly what’s going to happen to US GDP growth... but one thing that’s certain is that subprime hasn’t finished making its impact felt and the US economy is generally on a downwards track.’ He said that ‘you can’t overstate how much emphasis to place on dollar depreciation,’ noting the impact on global financial markets and raw materials prices. But Guo also said that China should ignore the concerns of others in managing its exchange rate, noting that the Chinese unit’s proper name is ‘people’s currency.’”
December 18 – Bloomberg (Belinda Cao and Li Yanping): “China is studying extra lending curbs to prevent overheating in the world's fastest-growing major economy, according to a central bank official. The People’s Bank of China is considering requiring a larger proportion of new deposits to be set aside as reserves, said a central bank official who declined to be named because he’s not authorized to speak publicly. It’s also studying larger reserve requirements for bigger banks with faster loan growth, he said.”
December 18 – Bloomberg (Luo Jun): “China should cap expansion of loans by commercial banks at between 14% and 14.5% in 2008, the Shanghai Securities News reported… Chinese banks’ outstanding loans stood at 26.1 trillion yuan in the first 11 months of the year, 17% higher than the same period in 2006…”
December 17 – Bloomberg (Winnie Zhu): “China, the world’s second-largest energy consumer, increased diesel imports to the highest in almost three years as the government ordered refiners to avoid fuel shortages. Purchases of the fuel from overseas climbed to 200,000 metric tons in November, the highest since Jan. 2005, while exports declined to 30,000 tons, the lowest since July, customs data released in Beijing today show. In the first 11 months, diesel imports jumped 55% to 800,000 tons and exports fell 14.5% to 640,000 tons.”
December 20 – Bloomberg (Li Yanping and Zhang Dingmin): “Chinese households’ concern about inflation is at the highest level since a central bank survey began… Of 20,000 urban households, 48% said prices are too high, according to the quarterly survey… About 65% expect prices to rise in 2008, also the largest number yet. The central bank began collecting the survey in 1999.”
December 20 – Bloomberg (Nipa Piboontanasawat and Wendy Leung): “Hong Kong’s inflation rose at the fastest pace in nine years as food from China became more costly and lower borrowing costs drove up property prices and rents. Consumer prices rose 3.4% in November from a year Earlier…”
Japan Watch:
December 20 – Bloomberg (Megumi Yamanaka and Shigeru Sato): “Imports of crude oil by Japan, the world’s largest consumer after the U.S. and China, rose for the second month in November, up 15.6% from a year earlier.”
December 20 – Financial Times: “It’s official: Japan’s economic recovery is running out of steam. A spate of consumer and business surveys said as much; several private sector economists are flagging the possibility of recession. The government has slashed its estimates. It expects the economy to grow 1.3% in the year to March, down from earlier forecasts of 2.1%. The numbers…highlight the extent of the gloom in the world’s second biggest economy. Even with a lower base, the next fiscal year’s economic growth is forecast to be 2%... New rules have extended the [homebuilding] approval process, with insufficient staff adding to the bottlenecks. The government reckons the private housing element of gross domestic product will drop 12.7% this year…”
December 20 – Bloomberg (Kathleen Chu): “The condominium supply in Tokyo and the surrounding area will fall to the lowest since 1993 this year and may decline further in 2008 as stricter rules for obtaining building permits has slowed housing starts, the Real Estate Economic Research Institute said.”
Unbalanced Global Economy Watch:
December 17 – Bloomberg (Rich Miller): “The world economy is facing the risk of both recession and faster inflation. Global growth this quarter and next may be the slowest in four years, while inflation might be the fastest in a decade, say economists at JPMorgan Chase & Co… ‘What lies ahead is a period of stagflation -- slow or no growth combined with rising inflation -- in the advanced economies,’ says Joachim Fels, co-chief global economist at Morgan Stanley…”
December 20 – Bloomberg (Andreas Scholz and Simone Meier): “Bert Ruerup, head of German Chancellor Angela Merkel’s council of economic advisers, said the European Central Bank is adding ‘way too much liquidity’ to money markets to try and push down credit costs at year-end. Central banks are ‘fueling moral hazard through the permanent availability of liquidity… It shows that the ECB governing council is under pressure and nervous. Banks are absorbing liquidity like vacuum cleaners.’”
December 20 – Financial Times (Ralph Atkins): “German business confidence tumbled this month to its lowest for almost two years… The Ifo institute’s ‘business climate’ index for the eurozone’s largest economy dropped unexpectedly sharply from 104.2 to 103.0 in November - the weakest since January 2006. ‘The economic cycle is -losing dynamism,’ said Hans-Werner Sinn, the… institute’s president. But the decline reflected greater pessimism about the current situation rather than declining expectations for the future.”
December 20 – Bloomberg (Svenja O’Donnell): “U.K. money supply growth slowed in November to the lowest since August 2005… M4…rose 11.1% from a year earlier, compared with 11.8% in October…”
December 20 – Bloomberg (Tasneem Brogger): “Icelandic wage growth accelerated to 8.3% in November, suggesting record-high interest rates are having a limited impact on pay.”
December 21 – Bloomberg (Maria Levitov): “Russia’s inflation rate rose to a two-year high in November as fruit, vegetables and other food prices surged. The rate rose to 11.5%... ‘Inflation is a serious problem,’ Economy Minister Elvira Nabiullina said… Consumer prices will probably increase an annual 12% this year… [he] said.”
December 21 – Bloomberg (Alex Nicholson): “The cost of goods leaving Russian factories and mines rose at the fastest annual pace in almost three years in November because of record global energy prices. Producer prices in the world’s biggest energy exporter rose 22.2%, up from 14.2% in October and 8.6% in September…”
December 20 – Bloomberg (Tracy Withers): “New Zealand’s economy grew at the slowest pace in a year in the third quarter as record-high interest rates curbed consumer spending and a rising currency crimped exports. Gross domestic product increased 0.5% from the second quarter…”
December 19 – Bloomberg (Nasreen Seria): “South African inflation accelerated to an annual 7.9% in November, the highest in more than four years, adding to pressure on the central bank to raise interest rates further.”
Bubble Economy Watch:
December 20 – Bloomberg (Joe Richter): “Manufacturing in the Philadelphia region contracted in December to the lowest level since April 2003, adding to evidence that a weakening economy is making companies more reluctant to spend.”
Central Banker Watch:
December 21 – Bloomberg (Liz Capo McCormick): “The Federal Reserve will conduct emergency auctions of loans as ‘long as necessary’ every two weeks as part of a global attempt by central bankers to restore faith in the money markets.”
December 20 – The Wall Street Journal (Nina Koeppen): “European Central Bank President Jean-Claude Trichet warned yesterday that inflation remains a threat, dismissing calls for the ECB to cut interest rates to help overcome the credit crisis. ‘We have to do our job, and our job is to deliver price stability,’ Mr. Trichet told the European Parliament’s committee for economic and monetary affairs. Mr. Trichet said the ECB stands ready to counter inflation risks with interest-rate increases if higher prices for fuel and food result in excessive wage and industrial price spikes. ‘Don’t be surprised if we remain alert and we tell . . . all price setters we wouldn’t hesitate to do whatever would be necessary to avoid those second-round effects,’ he said. Some warning signs are already surfacing. Germany’s public-sector union yesterday called for an 8% pay raise for its 1.3 million employees, as workers in both the public and private sectors have started demanding higher wages ahead of a coming round of salary negotiations in Europe’s largest economy.”
December 18 – Bloomberg (Svenja O’Donnell and Jennifer Ryan): “Bank of England Governor Mervyn King comments on the global credit squeeze… ‘The reason for the rise in spreads was not due to a shortage of cash. The large banks are now awash with cash. The issue is not whether they have enough cash. The issue is whether they’re willing to lend. In recent weeks, what has become evident is that banks are concerned about the capital position of other banks. They do not know where the losses from an array of investments in financial instruments will come to rest. Banks themselves are worried that the impact of their reluctance to lend will lead to a sharper downturn in the United States. That concern is a serious one. Central banks are clearly aware of these problems and will take steps.’”
GSE Watch:
Fannie and Freddie’s combined Books of Business (guaranteed MBS and retained mortgages) ballooned an additional $52.7bn during November, or 13.1% annualized, to $4.895 TN. For comparison, their Books of Business increased $23.0bn during November 2006 and $27.6bn during November 2005. Year-to-date, Fannie and Freddie’s Books of Business have increased a record $541bn, or 13.5% (2006 BofB growth of $352bn and 2005 growth of $166bn). Their retained portfolios have declined $5.0bn y-t-d to $1.423 TN, while the guaranteed MBS exposure has inflated $546bn to $3.472bn.
MBS/ABS/CDO/CP/Money Funds and Derivatives Watch:
December 21 – Financial Times (Paul J Davies): “The volatility in credit markets appears set to claim fresh victims after Moody’s yesterday put a number of complex and highly leveraged products, known as CPDOs, on review for downgrade… CPDOs (constant proportion debt obligations) are essentially highly leveraged bets on a large portfolio of corporate debt exposures, which carry ultra-safe ratings while promising high returns. They are usually created by selling protection on the main European and US indices of investment grade credit default swaps, which provide a kind of insurance against non-payment of corporate debt. The bets made through CPDOs are leveraged by 15 times on average…”
December 19 – Bloomberg (Bradley Keoun): “Citigroup Inc…dismissed about 30 employees in its structured-credit group after record mortgage-related losses… The cuts reduced the division by almost a third, a week after newly appointed Chief Executive Officer Vikram Pandit pledged a ‘front-to-back’ cost review…”
December 18: “Moody’s…downgrades of US structured finance (SF) CDO securities in November totaled US$50.9 billion across 952 tranches of 267 deals… The November downgrades represent roughly 9.4% of the original principal balance of Moody's-rated US SF CDOs outstanding on November 30.”
December 19 – Bloomberg (Dan Levy): “U.S. home foreclosures rose 68% in November from a year earlier as adjustable-rate mortgages left subprime borrowers unable to meet higher payments, according to data compiled by RealtyTrac Inc. There were 201,950 foreclosure filings in November, including default notices, auction letters and bank repossessions, down 10% from October’s total, RealtyTrac reported… California, Florida and Ohio had the most filings and Nevada had the highest foreclosure rate.”
Mortgage Finance Bust Watch:
December 19 – The Australian (Anthony Klan): “The most senior executives at Centro Properties Group - which is facing collapse after suffering a $6 billion meltdown this week - were given 10-year interest-free loans by the company to buy $44 million worth of shares. However, seven of the company's top executives, including Centro's chief executive, Andrew Scott, chief operating officer, Graham Terry, and chief financial officer, Romano Nenna, may never have to pay the money back because of a legal clause in the generous share agreements that says the money does not need to be repaid if the share price collapses.”
December 18 – Bloomberg (Patricia Kuo): “The risk of Australian property trusts defaulting on their debt rose to a record after Centro Properties Group, the owner of 700 U.S. shopping malls, said it has difficulty refinancing debt.”
Real Estate Bubbles Watch:
December 19 – Bloomberg (Saijel Kishan): “Jim Rogers, author of ‘Investment Biker,’ sold his New York townhouse for $1 million more than the asking price, according to Leslie J. Garfield & Co… Rogers, 65, sold the Riverside Drive property for $16 million on Dec. 17, a record for a single-family townhouse in New York’s upper westside…”
Muni Watch:
December 19 – Bloomberg (Michael Quint and Jeremy R. Cooke): “Wall Street’s three-year love affair with debt sold by U.S. states and cities is over. Municipal bonds, whose returns trounced Treasuries and corporate debt from 2004 to 2006, are headed for their worst year since 1999, according to Merrill Lynch & Co. indexes. They may remain laggards after securities firms reduced their holdings at the fastest pace in at least 12 years during the third quarter, data compiled by the Federal Reserve show.”
December 18 – The Wall Street Journal (Amy Merrick): “Falling home values and rising property taxes in many parts of the country are generating the loudest complaints about property levies since the 1970s, forcing state and local officials to address the outcry even as the housing-market slump eats into many sources of their revenue… In California, thousands of homeowners are having their assessments reduced under a decades-old state law, and lower tax revenue due to the weaker housing market is likely to force an emergency budget session. Falling real-estate prices and turmoil in the mortgage market are expected to reduce property values for U.S. homeowners by a total of $1.2 trillion next year, according to Global Insight Inc… Unless tax rates are changed, California could lose $2.96 billion in property taxes over several years because of the housing bust, the firm predicted. New York could lose $686 million; Florida, $589 million.”
December 18 – Bloomberg (Henry Goldman): “New York Mayor Michael Bloomberg said a slowing U.S. economy will reduce Wall Street profits and real estate sales, creating ‘worrisome’ city tax shortfalls… ‘The test of our character as well as our policies is how we handle any long-term downturn headed our way,’ Bloomberg said. The mayor said that while he is optimistic about long-term prospects because of the city’s fundamental economic strengths, ‘We are going to have some very tough times.’ In October, the mayor ordered budget cuts of 2.5% for the remainder of the fiscal year and 5% for the next year, which begins July 1. He sought to reduce the 2009 budget gap that had grown to $2.73 billion from $1.55 billion in June. The mayor said ‘unfunded mandates’ for public employee pensions and benefits and Medicaid had increased by $8.2 billion in the six years he’s been mayor, costing the city 47 cents out of every dollar in the city’s $59.4 billion budget.”
December 20 – Bloomberg (Christopher Condon): “Nuveen Investments Inc.’s John Miller, the No. 2 ranked municipal bond-fund manager of the past five years, may post his first annual loss because he kept almost half his assets in unrated securities as prices sank. Miller invested 48% of the $5.1 billion Nuveen High Yield Municipal Bond Fund in non-rated bonds that finance projects such as schools, hospitals and water-treatment plant… The strategy backfired this year when investors fled all but the highest-rated government bonds as subprime mortgage losses mounted.”
Financial Sphere Bubble Watch:
December 21 - Bloomberg (Christine Harper): "Goldman Sachs Group Inc... awarded Chief Executive Officer loyd Blankfein a record $67.9 million bonus in 2007 as mortgage losses drove his counterparts at Morgan Stanley and Bear Stearns os. to forgo year-end payouts."
December 18 – Bloomberg (Christine Harper): “Goldman Sachs Group Inc.’s 2007 bonus pool rose 23% to a record $12.1 billion as Wall Street’s biggest securities firm made revenue and profit history for a fourth consecutive year. Total compensation, including salaries, benefits and bonuses, climbed to $20.2 billion from $16.5 billion last year… Bonuses, which typically account for about 60% of pay, increased from $9.88 billion in 2006.”
December 18 – Bloomberg (Ambereen Choudhury and Zachary R. Mider): “Even Goldman Sachs…is prepared for a decline in mergers and acquisitions income next year… The value of transactions may fall 20% from a record $3.9 trillion this year, executives at JPMorgan Chase & Co., Lehman Brothers Holdings Inc. and Bank of America Corp. estimate.”
California Watch:
December 18 – Bloomberg (Dan Levy): “Southern California home prices fell a record 10% in November from a year earlier and sales declined the most in at least 20 years as tighter mortgage standards reduced the number of home buyers, DataQuick…said. A total of 13,173 new and existing houses and condominiums were sold in six southern California counties in November, down 43% from a year ago and up 2% from October. The median home price dropped to $435,000 from last November, the largest monthly decline since DataQuick began keeping records in 1988… Southern California home sales financed with so-called jumbo loans, those that exceed $417,000, tumbled 69% in November from a year earlier, DataQuick said… Purchases using jumbo loans accounted for 22% of Southern California home sales in November, down from 40% in the first seven months of the year… The median home price in Los Angeles County fell for the second consecutive month, dropping 3.5% in November from a year earlier to $499,000… Sales fell 46%... The San Diego County median home price dropped 9.7% to $440,000… San Diego prices peaked in November 2005 at $517,000… The Orange County median home price dropped 6.5% in November to $582,750…and sales decreased 45%... Orange County prices peaked in June at $645,000… The biggest Southern California sales decline was in San Bernardino County, which dropped 48.1%... The County’s median fell 13% to $330,000.”
December 20 – San Francisco Chronicle: “The Bay Area’s housing market remained in a bit of deep freeze in November, when sluggish demand kept sales at a two-decade low for the third straight month. Prices continued to hold up best in the region’s core markets, while some outlying areas posted more double-digit annual declines… A total of 5,127 new and resale houses and condos sold in the Bay Area in November. That was down 6.5% from 5,486 in October, and down 36.2% from 8,042 in November 2006, DataQuick…reported… Last month was the slowest November in DataQuick's statistics, which go back to 1988…”
December 21 – Bloomberg (William Selway): “California Governor Arnold Schwarzenegger said he will invoke emergency powers to force lawmakers into a special session to wrestle with a $3.3 billion shortfall in the state’s budget this year. The gap for the current year, ending in June, emerged as the housing market slump curbed tax revenue, wildfires in Southern California increased expenses, and the state was forced to set aside more money for teachers’ pensions… Over the next two fiscal years, the state is forecast to take in $14 billion less than it has committed for programs because spending growth is outpacing revenue.”
December 21 – Sacramento Bee (Andy Furillo): “In what may be the largest early release of inmates in U.S. history, Gov. Arnold Schwarzenegger’s administration is proposing to open the prison gates next year for some 22,000 low-risk offenders.
According to details of a budget proposal made available to The Bee, the administration will ask the Legislature to authorize the release of certain non-serious, nonviolent, non-sex offenders who are in the final 20 months of their terms. The proposal would cut the prison population by 22,159 inmates and save the cash-strapped state an estimated $256 million in the fiscal year that begins July 1 and more than $780 million through June 30, 2010.”
December 21 – Los Angeles Times (Sharon Bernstein and Paloma Esquivel): “California’s population continued to grow modestly in the last fiscal year despite a significant exodus of residents to other states, according to a state report… The annual study by the Department of Finance showed that 89,000 more people moved out of California than moved here from elsewhere in the United States. California’s population did grow in fiscal 2007 -- but the growth rested on births and the arrival of more than 200,000 immigrants from other countries. The shift dovetails with the state’s weakening economy and is most likely related, said Howard Roth, chief economist for the Department of Finance. Those who left, Roth said, were fleeing an economy in which just 5,800 jobs per month were created -- down from more than 20,000 per month the previous year. Jobs were lost in housing, finance, construction and other sectors, and key indicators like the number of automobiles sold were also down, he said… ‘If you’re someone in finance and you haven’t already been laid off . . . or if you’ve lost your job here and maybe your house, maybe you’re thinking that there are better prospects out there in other states,’ he said.”
Speculator Watch:
December 21 – Bloomberg (Jenny Strasburg and Jason Kelly): “Blue Wave, the hedge fund started by private-equity firm Carlyle Group in March, fell 6% last month, hurt by losses on structured credit investments backed by fixed-income assets.”
Wall Street-Backed Finance:
It was not a good week for Wall Street finance. Bear Stearns reported its first loss in its 84 year history. “Market conditions during the company’s fourth quarter continued to be very challenging as the global credit crisis that began in July continued to adversely impact global fixed income markets… On November 14th, we announced we would take a $1.2bn write-down on our mortgage securities inventories as a result of continuing deterioration in market conditions through the end of October. During the month of November, market conditions continued to deteriorate, which resulted in additional write-downs – bringing total mortgage related losses to $1.9bn.”
Yet Bear’s total writedown was rather puny in comparison to Morgan Stanley’s bombshell. “During the fourth quarter, the firm recognized a total of $9.4 billion in mortgage related writedowns as a result of the continued deterioration and lack of liquidity in the market for subprime and other mortgage related securities since August 2007. Of this total, $7.8 billion represents writedowns of the firm’s U.S. subprime trading positions…”
Morgan Stanley’s CFO: “As you are aware, over the past year our trading group decided to short the subprime market. The traders were short the lowest tranche of the subprime securities with a notional value of approximately $2.0bn. The traders decided to cover the cost of the negative carry in the short position. To do so they went long approximately $14bn of the super senior AAA or BBB subprime securities we refer to as mezzanine. As the Credit markets declined dramatically, the implied cumulative losses in the subprime market “ate” (unclear) into the value of the super senior AAA tranche we were notionally long. As a result, not withstanding the short position, the implied losses of the notional long generated a major net loss when the position was marked-to-market. The loss was non-linear with the decline of the relevant ABS index, given the long/short structure of this particular trade.”
Analyst question: “I know everyone is dancing around it, but I guess my question would be to help us understand how this could happen – that you could take this large of a loss? I would imagine that you have position limits and risk limits, as such. It behooves me to think that you guys could have one desk that could lose $8 billion?”
CFO: “Look, let’s be clear. One, this trade was recognized and entered into our accounts. Two, it was entered into our risk management system. It is very simple – it’s simple and very painful. So I’m not being glib. When these guys stress-lossed (tested) the scenario on putting on this position, they did not envisage in their stress losses that we could have this degree of defaults, right? It is fair to say that our risk management division did not stress those losses as well. It is as simple as that. There was a big fat tail risk that caught us hard, right? That’s what happened. Now, with hindsight, can you catch these things? We are not unique being long these positions, right? What is unique is that this was a trade that was put on as a proprietary trade and we have learned a very expensive and, by the way, humbling lesson.”
Morgan Stanley’s stock was up 8% for the week, despite reporting the first loss in its 72 year history. Investors were apparently comforted with the news of a $5bn equity infusion from the China Investment Corporation (controlled by the Chinese Finance Ministry).
The marketplace should be petrified with the revelation of an $8bn loss on a single trade that was not “rogue” - nor did it apparently even circumvent risk management processes. Instead, it appears to be a “simple” case of a devastating failure in the models used to structure a highly leveraged “hedged” trade. At the heart of the issue were illiquidity and a collapse in the value of a leveraged position, in a development that is very much systemic in nature. As the CFO stated, the company is “not unique being long these positions.” Morgan Stanley is quite fortunate that they do retain a strong global franchise in what remains a period of extraordinary Global Credit Bubble excess. They still enjoy the capacity to plug part of the hole in their equity base.
The market was rocked Thursday by the revelation of an additional $8bn “CDO-squared” (CDOs of CDOs) exposure at troubled MBIA. The stock’s 25% pounding confirmed that MBIA has reached the point where there’s scant room for error. And while the Credit insurers (“financial guarantors”) are (massively) exposed to Devastating Model Failure similar to that which has hammered Morgan Stanley, Bear Stearns, Merrill Lynch and scores of others, they today lack the fundamental “franchise value” that would be enticing to investors from China, the Middle East or elsewhere.
The financial guarantors suffer today from a confluence of terminal forces. First of all, current and future Credit Insurer losses are unknowable. And it’s not that loss estimates are difficult to reasonably quantify – it’s much more a case of requiring a series of assumptions with respect to the Credit cycle, market environment and economic performance on top of a bunch of guesses as to how various interrelated risk exposures will react to myriad possible scenarios. Such an exercise would require sophisticated models based on various other models, when we know full well today that even basic securities valuation modeling has broken down. Moreover, it is likely that prospects for writing profitable new business will be dismal for years to come. The market has lost trust in the insurance. At this point only a massive and highly-complex multi-government-orchestrated industry bailout would avert a collapse.
Morgan Stanley’s CFO stated that the company was caught hard by “big fat tail risk.” I don’t believe it was a case of “tail risk” at all. Devastating illiquidity and market losses were inevitable, only the timing was unclear. Broker/Dealer assets ballooned 140% in just four and one-half years to $3.2 TN. During this same period, the asset-backed securities market (including “private-label” MBS) inflated 120% to almost $4.3 TN. Myriad sophisticated structures, financial guarantees, liquidity agreements, and leveraging strategies were implemented to perpetuate the greatest financial Bubble in history. As with all great schemes of leveraged speculation, the minute the music stops collapse ensues. Underlying Acute Fragility is exposed with the inevitable reversal of speculative and leverage-based market liquidity.
To keep the music playing required increasingly egregious excesses – ever greater quantities of increasingly risky loans, structures and leveraging. The Credit Insurers came to play a critical role in perpetuating the Bubble. They could not resist the allure of easy “profits” insuring Wall Street’s creative “structured Credit products,” while at the same time aggressively expanding their traditional guarantee business at the top of a Historic Credit Cycle. The Credit insurers destroyed themselves.
December 20 – Bloomberg (Shannon D. Harrington and Christine Richard): “MBIA Inc. fell the most since 1987 in New York trading after the world's biggest bond insurer disclosed that it guarantees $8.1 billion of collateralized debt obligations that investors say have a greater chance of losses. ‘We are shocked management withheld this information for as long as it did,’ Ken Zerbe, an analyst with Morgan Stanley…wrote… ‘MBIA simply did not disclose arguably the riskiest parts of its CDO portfolio to investors.’”
December 21 – Bloomberg (Shannon D. Harrington): “The perceived risk of MBIA Inc. and Ambac Financial Group Inc. defaulting on their bonds rose for a second day after Fitch Ratings said it may cut its rankings on the world’s two largest bond insurers. Credit-default swaps tied to…Ambac, the second-biggest bond insurer, climbed 15 basis points to 598 basis points and contracts tied to MBIA, its larger rival, rose 17 basis points to 590 basis points, a signal of eroding investor confidence.”
December 21 – Bloomberg (Christine Richard): “Credit ratings for Ambac Financial Group Inc. were placed under review for a possible downgrade by Fitch Ratings, which said the world’s second-largest bond insurer needs to raise $1 billion of capital. Fitch cited the…company’s guarantees on about $32.2 billion of collateralized debt obligations with varying degrees of exposure to subprime mortgage assets… The once unquestioned strength of AAA rated bond insurers is being reassessed on concern by Fitch, Moody’s Investors Service and Standard & Poor’s that the companies don’t have enough capital to cover losses stemming from downgrades on securities they guarantee. Fitch gave Ambac, MBIA Inc. and FGIC Corp. four to six weeks to raise at least $1 billion or lose their top ratings.”
December 21 – Bloomberg (Jeremy R. Cooke): “U.S. municipal bonds guaranteed by Ambac Assurance Corp. were placed under review for a possible cut from AAA by Fitch Ratings, which said it may downgrade the insurer because of its backing of subprime-mortgage debt. The ‘rating watch negative’ affects almost 138,000 municipal bonds backed by the financial guarantor, Fitch said… Four of the seven AAA rated companies that insure U.S. state and local government debt are now under review for a downgrade from Fitch. Standard & Poor’s and Moody’s… also are looking into whether the insurers have enough capital to warrant top grades…”
December 21 – Bloomberg (Darrell Preston): “State and local borrowers are discovering that buying municipal bond insurance from MBIA Inc. and Ambac Financial Group Inc. is a waste of money… Wisconsin, California, New York City and about 300 other municipal issuers sold bonds without buying insurance in recent weeks, avoiding premiums that are as high as half a percentage point of the bond issue…”
Wednesday S&P downgraded ACA Financial Guarantee from “A” to “CCC.” The insurance on about $69bn of “structured Credit products” is now essentially worthless, including $26bn or so of CDO guarantees. This is one further blow to the imploding CDO marketplace and a potential tipping point for Credit insurance more generally. To this point, the market has been content to assume that the larger financial guarantors were “too big to fail” – which implies too important in the marketplace to have their debt downgraded. But Fitch today placed Ambac’s ratings on watch for possible downgrade. By the pricing of their Credit default swaps, Ambac and MBIA this summer lost their “AAA” stature and are now quickly losing market confidence in their long-term viability.
We expect further significant and imminent weakness in “structured Credit products” – certainly in the illiquid markets for CDOs and Credit default swaps (CDS). Keep in mind that the economy is only now succumbing to recessionary forces, and we’ve yet to experience the failure of a major financial institution in the U.S. There will be many, and it’s worth noting that Rescap’s CDS prices surged again this week. It’s amazing to watch the massive central bank liquidity injections inflate the value of government and quasi-government backed securities, while having minimal impact on the imploding market for Wall Street-backed securities. It’s impossible to rectify the damage from the bursting Bubble, and there’s today literally trillions of increasingly impaired Wall Street securities overhanging the debt markets.
