Sunday, December 14, 2014

09/13/2013 Blinder, Summers and Monetary Policy *

“Next Sunday marks the fifth anniversary of the fateful day that investment bank Lehman Brothers filed for bankruptcy, signaling the start of a frightening financial meltdown. It’s a good time to ponder how the U.S. economy was nearly brought to ruin. But will we? Or are we already forgetting? Consider the stark historical contrast between the 1930s and this decade: Years of financial shenanigans in the 1920s, some illegal but many just immoral, conspired with a variety of other villains to bring on the Great Depression. Congress and President Roosevelt reacted strongly, virtually remaking the dysfunctional U.S. financial system, including establishing the Securities and Exchange Commission to protect investors, the Federal Deposit Insurance Corp. to protect bank depositors, and much else. The financial beast was comparatively tamed for almost 75 years. Years of disgraceful financial shenanigans in the 2000s, some illegal but many just immoral, brought on the Great Recession with virtually no help from any co-conspirators.” Alan Blinder, Princeton University professor and former vice-chairman of the Federal Reserve, Wall Street Journal, September 11, 2013

Next Wednesday the Fed will reveal its much-anticipated “tapering” plans. Japan’s Nikkei news service Friday reported that the Administration “was set to name” Larry Summers to replace the retiring chairman Bernanke. And Sunday marks the five-year anniversary of the failure of Lehman Brothers. Well, it does seem “a good time to ponder how the U.S. economy was nearly brought to ruin” as well as an appropriate juncture to focus again on the role of Monetary Policy.

The above excerpt is from Alan Blinder’s Wednesday WSJ op-ed, “Five Years Later, Financial Lessons Not Learned.” “Far from being tamed, the financial beast has gotten its mojo back—and is winning. The people have forgotten—and are losing. Here are four examples. There are others.” Blinder then laments the lack of reform in “mortgages and securitization,” derivatives, the rating agencies and proprietary trading. “In sum, the Dodd-Frank Act is taking on water fast. What can be done to help Americans remember the horrors that led to its passage?”

With stock prices near all-time highs and home price inflation back on track, who is keen to “remember the horrors”? Why would anyone today be willing to upset the applecart? With Washington fiscal and monetary stimulus having reflated the asset markets, what limited appetite that existed for so-called “financial reform” has virtually disappeared. It would be laughable if it weren’t so maddening. The GSEs still completely dominate mortgage finance, which implies ongoing market distortions. They are basically as big – and as thinly capitalized – as ever. The nation’s goliath banks have grown only more dominant.

With the Fed such a massive buyer of Treasuries, there has been no market discipline imposed upon a spendthrift Washington. A more than doubling of outstanding federal debt in five years (issued at record low market yields) implies broad market distortions and economic maladjustment. At a record (ballpark) $2.4 TN in assets, the historic inflation of hedge fund industry assets runs unabated. This has propelled the number of billionaires, along with skyrocketing prices for art, collectibles and trophy properties. And at $632 TN (from BIS data), the global derivatives marketplace is as unfathomably monstrous as ever. As for the rating agencies, truth be told, they have little impact on the global Credit Bubble.

Mr. Blinder and others would like to believe that we’ve been persevering through a post-Bubble “Great Recession” with parallels to the Great Depression – but with, thankfully, the benefit of wonderfully enlightened policymaking. Former Treasury Secretary Hank Paulson, discussing the 2008 crisis during a Friday morning CNBC appearance, referred to a “massive Credit Bubble that went bust” – “a 100-year flood with excesses building for years and years.”

At risk of sounding “lunatic fringe,” the reality of the matter is we’re suffering these days from a period of mass delusion. U.S. and world GDP have never been greater. Fueled by record securities prices, U.S. household Net Worth stands today at a record level. U.S. total income in rather short order recovered from 2009’s modest decline. Real estate prices around much of the world are at or near record highs. Total outstanding debt – in the U.S. and globally – is at a record high and inflating.

From a systemic standpoint, the notion of “de-leveraging” has been a myth. And for five years now unprecedented global imbalances have worsened. Chinese and EM Credit Bubbles and attendant Bubble economies have inflated to historic proportions. Indeed, there is a fine line between “frightening financial meltdown” and unleashing history’s greatest inflation of global securities prices. The only justification for the “100-year flood” thesis is wishful thinking.

To be sure, the backdrop has virtually nothing in common with the 1930s. As I’ve written previously, if one is searching for parallels, I would look to the 1920’s. In a replay of errors at key junctures during the “Roaring Twenties,” current monetary policymaking would be more appropriately focused on restraining Bubble excess. Instead, it’s the polar opposite approach with ongoing massive experimental inflationary measures.

I’m not a fan of Alan Blinder’s framework, and I am averse to historical revisionism: “The financial beast was comparatively tamed for almost 75 years. Years of disgraceful financial shenanigans in the 2000s, some illegal but many just immoral, brought on the Great Recession with virtually no help from any co-conspirators.”

Seeds for the 2008/09 crisis were being planted many years prior to the “shenanigans in the 2000s.” Vulnerabilities associated with unbridled global Credit, “activist” monetary management and speculative excess go back to Greenspan’s aggressive post-1987 stock market crash reflationary measures. There were the resulting junk bond, M&A and real estate booms and busts that left a deeply impaired U.S. banking system in the early-nineties. There were the (post-reflation) bond market and derivative Bubbles that faltered in 1994. And we cannot forget the spectacular 1990s booms and busts in Mexico, SE Asia, Russia, Brazil and Argentina (to name only a few). The 1998 LTCM collapse exposed egregious leverage and derivative speculations. And then the decade concluded with a wild speculative Bubble in technology stocks and telecom debt. Somehow, in the face of increasingly apparent shortcomings, monetary policy became only more “activist” and experimental.

It’s not credible to look at “2000s” (mortgage finance Bubble) excesses in isolation. “No help from any co-conspirators”? Did not Bernanke’s “government printing press” and “helicopter money” monetary ideologies play prominently in the 2002-2007 doubling of mortgage debt? Clearly, loose “money” and monetary policy “activism” were fundamental to the previous 25-year period of serial booms and busts. And each bust provoked aggressive reflationary measures in the name of warding off the “scourge of deflation.” Every reflationary cycle further emboldened and inflated the “global leveraged speculating community,” a dynamic that ensured the scope of subsequent booms became bigger and more systemic. Has contemporary inflationist monetary policy not already proven itself immoral?

The most important unlearned lesson is that Federal Reserve (and global central bank) monetary inflation and market interventions carry great risks. For 25 years the Fed has repeatedly employed post-Bubble reflationary measures while inflating the greatest Credit Bubble in history. Back in the 1960s, it was said that Alan Greenspan associated the severity of the Great Depression with the Federal Reserve repeatedly placing “Coins in the Fusebox” throughout the Roaring Twenties Bubble period.

The latest talk is that the FOMC may be considering adding a lower bound inflation rate target to its list of factors for setting monetary policy. The experimental Fed last year employed the use of an unemployment rate target. So, the Fed could now perhaps state its intention of sticking with aggressive monetary accommodation so long as either unemployment is above a certain rate or inflation remained below a targeted level. The Fed continues its stroll down a very slippery slope.

The predominant view holds that an inflation rate of between 2% and 3% is constructive for the economy and supportive of financial stability. Virtually everyone - Fed official, economist and layman alike – believes a modest and relatively stable level of inflation greases the economic wheels. Contemporary economic doctrine holds that moderate price inflation helps to ensure that borrowers will retain the capacity to service their (devalued) debt. It is taken as a given that any decline in the price level risks unleashing a horrific downward deflationary debt spiral and economic depression. And I would caution that because just about everyone believes something doesn’t ensure that it’s true.

It’s a myth that the Fed controls the “money supply.” It is simply a myth that there is some system “price level” within the Federal Reserve's control. Traditionally, the Fed would increase or decrease bank reserves, in the process influencing intra-bank loan rates, bank lending and system Credit growth. And, customarily, bank lending accounted for a major portion of system Credit growth. Throughout much of financial history, inflation was a fairly decent indicator of general Credit conditions and related excess. Inflation, for the most part, provided a reasonable indication of the appropriateness of monetary policy, although it notoriously provided false signals during the “Roaring Twenties” and “Japan in the eighties” Bubbles.

In our contemporary age of securitizations, repos, derivatives, GSEs, hedge funds, asset inflation/Bubbles, globalization, “digitalization” and the general proliferation of non-bank finance, focus on an aggregate measure of consumer prices as an indicator of Credit excess, general monetary conditions or the appropriateness of monetary policy is guaranteed to deceive.

Higher “inflation” these days doesn’t help ensure that borrowers will be able to service their debts. And I don’t believe the Fed and central banks can inflate away the massive (marketable securities) debt loads accumulated by governments around the globe. Rather, monetary policies incentivize behavior that ensures only more acute debt problems down the road. All the talk of near “financial meltdown” in 2008 ignores that the issue back then was chiefly a crisis of confidence in private-sector obligations. For the most part, sovereign debt was the target of panic buying. And virtually insatiable demand for Treasuries ensured massive financial, market and economic support from Washington. Especially with its move to $85bn monthly QE, Fed policy has been accommodating just the type of excess that risks a more systemic crisis of confidence.

There’s now more than 20 years of (recent) experience available to illustrate how massive destabilizing growth in Credit and problematic asset Bubbles can coexist with relatively contained inflation in an aggregate measure of consumer prices. As an indicator of financial stability, CPI has already revealed itself as a flawed indicator. At this point, any lower bound inflation target would essentially build upon an array of Fed policy tools, measures and indicators that work in concert to promote financial speculation and Bubbles.

And with the Fed prepared to ever gingerly begin pulling back on QE, there is newfound focus on the efficacy of “forward guidance.” The Fed is determined to avoid the 1994 scenario whereby a 25 bps rate boost incited a problematic spike in yields all along the yield curve. The thinking today is that assurances of a low Fed funds rate target for the foreseeable future will work to anchor longer-term market yields. There has even been Federal Reserve research concluding that QE purchases haven’t had a major impact on market yields.

Well, I would counter that QE has had enormous market impact. U.S. stocks have returned about 30% since the Fed began ballooning its balance sheet this past November. Junk bond issuance is poised for a record year, with likely the strongest expansion of business borrowings since 2007. Housing prices have jumped double-digits, as overheated conditions reemerge across many markets. Globally, a strong inflationary bias has propelled asset prices generally.

Returning back to “forward guidance,” I expect the market to take little comfort from the promise of ongoing near-zero short-term rates. Generally, faith in a persistently low “fed funds” target would place a ceiling on long-term market yields. And, indeed, this dynamic has been in play for years now, in the process fostering major financial leveraging and other speculative excess. And especially after the past year’s broad-based risk market excesses, what really worries the markets these days is a bout of problematic “risk off” de-risking/de-leveraging. The markets are comfortable with, and fully leveraged for, a Fed that won’t be hiking rates anytime soon. Major questions remain, however, as to the availability of a sufficient marketplace liquidity backstop in the event of market turmoil.

I have argued that the “leveraged speculating community” – and securities markets more generally - have been bolstered (and hopelessly distorted) from 20 years of Washington liquidity backstops. The GSE's played prominent roles in accommodating bouts of speculative deleveraging starting back in 1994. In 2006, after revelations of accounting fraud had reined in Fannie and Freddie balance sheet growth, I posited that any serious bout of de-risking/de-leveraging would likely require a massive expansion of Fed holdings. Today, with the Fed’s balance sheet on the way to $4.0 TN – even in the face of ongoing market risk embracement and speculative leveraging – I’m contemplating Fed holdings in the, say, $6.0 TN range in the event our central bank chooses to accommodate a serious bout of speculative deleveraging.

How confident is the marketplace that the Fed would be willing to embark on yet another major escalation of QE? There’s been ample confidence that chairman Bernanke was willing to do whatever it takes. After all, he did recently state the Fed, even after embarking on “tapering,” would “push back” against any market tightening of financial conditions. And the markets seem to be comfortable that Janet Yellen would have no qualms aggressively expanding the Fed’s balance sheet as needed to bolster employment and the general economy. Larry Summers? Well, he has already curmudgeonly stated his view that QE has limited benefits.

And, really, how cozy should we assume Mr. Summers would be to market speculation and myriad shenanigans? One would not expect him to fixate on arcane academic models and Bernanke’s monetary theories. I would tend to view Summers as a Keynesian inflationist – but no monetary nut-case. At this point, he’s more the real-world pragmatist than gun-slinging academic theorist. It’s been almost 15 years since the LTCM fiasco and the (joining Greenspan and Rubin on the cover of Time magazine’s) “committee to save the world.” I think Summers understands the game along with associated risks.

I’ve been assuming that, in preparation for storm clouds gathering on the horizon, the President would seek the services of a street-savvy, seasoned crisis-fighter like Larry Summers. If he is indeed the Administration’s choice, I expect the markets to be somewhat on edge. Will Summers convey that the Fed is willing to backstop the markets, much as his predecessor was so comfortable doing? “Helicopter Larry?” I don’t think so. But it would make for interesting confirmation hearings.




For the Week:

The S&P500 jumped 2.0% (up 18.4% y-t-d), and the Dow surged 3.0% (up 17.3%). The broader market was strong. The S&P 400 MidCaps rose 2.6% (up 20.5%), and the small cap Russell 2000 increased 2.4% (up 24.1%). The Morgan Stanley Consumer index rose 2.7% (up 23.1%), and the Utilities increased 0.6% (up 4.4%). The Banks added 0.8% (up 24.2%), and the Broker/Dealers advanced 1.8% (up 47.0%). The Morgan Stanley Cyclicals were up 3.7% (up 24.8%), and the Transports gained 2.4% (up 22.9%). The Nasdaq100 gained 1.4% (up 19.4%), and the Morgan Stanley High Tech index surged 2.5% to a 13-year high (up 19.3%). The Semiconductors jumped 2.8% (up 27.1%). The InteractiveWeek Internet index gained 2.2% (up 26.9%). The Biotechs added another 2.3% (up 42.7%). With bullion down $65, the HUI gold index was hit for 8.6% (down 47.8%).

One- and three-month Treasury bill rates ended the week at one basis point. Two-year government yields declined 2 bps to 0.43%. Five-year T-note yields ended the week down 6 bps to 1.70%. Ten-year yields dropped 5 bps to 2.89%. Long bond yields fell 3 bps to 3.84%. Benchmark Fannie MBS yields fell 6 bps to 3.65%. The spread between benchmark MBS and 10-year Treasury yields narrowed one to 76 bps. The implied yield on December 2014 eurodollar futures fell 6 bps to 0.725%. The two-year dollar swap spread was little changed at 16 bps, while the 10-year swap spread declined one to 17 bps. Corporate bond spreads narrowed. An index of investment grade bond risk declined 5 to 77 bps. An index of junk bond risk fell 26 to 373 bps. An index of emerging market (EM) debt risk dropped 8 to 340 bps.

Debt issuance set an all-time weekly record. Investment grade issuers included Verizon $49bn, Citigroup $2.4bn, Oneok Partners $1.25bn, Reynolds American $1.1bn, Public Service E & G $600 million, Providence Health & Service $575 million, International Game Technology $500 million, Weyerhaeuser $500 million, Dayton Power & Light $445 million, Corporate Office Properties $250 million, and North Shore Long Island $250 million.

Junk bond funds saw inflows of $632 million (from Lipper). Junk issuers this week included Activision Blizzard $2.25bn, Whiting Petroleum $1.9bn, Oasis Petroleum $1.0bn, Diamondback Energy $450 million, Ancestry.com $300 million and Hovnanian Enterprises $170 million.

Convertible debt issuers included Clean Energy Fuels $220 million, Alon USA Energy $130 million and GSV Capital $60 million.

International dollar debt issuers included Russia $6.0bn, KFW $3.0bn, Caisse D'Amort Dette $2.5bn, South Africa $2.0bn, Ecopetrol $2.5bn, Perusahaan Penerbit $1.5bn, FMS Wertmanagement $1.5bn, Kommunivest $2.0bn, Sumitomo Mitsui Trust & Bank $1.0bn, Korea Development Bank $750 million, PTT Exploration & Product $500 million, Export-Import Bank of Korea $1.0bn, NXP $500 million, Inkia Energy $450 million, Petroleos Mexicanos $400 million, and Australia & New Zealand Bank $105 million.

Ten-year Portuguese yields jumped another 28 bps to a nine-month high 7.26% (up 51bps y-t-d). Italian 10-yr yields rose 8 bps to a 12-week high 4.57% (7bps). Spain's 10-year yields declined 3 bps to 4.49% (down 78bps). German bund yields added 3 bps to 1.98% (up 66bps). French yields slipped a basis point to 2.53% (up 53bps). The French to German 10-year bond spread narrowed 4 to 55 bps. Greek 10-year note yields declined 12 bps to 10.09% (down 38bps). U.K. 10-year gilt yields dipped 2 bps to 2.91% (up 109bps).

Japan's Nikkei equities index ended the week up 3.9% (up 38.6% y-t-d). Japanese 10-year "JGB" yields fell 5 bps to 0.72% (down 6bps). The German DAX equities index jumped 2.8% for the week (up 11.8%). Spain's IBEX 35 equities index was up 3.3% (up 9.5%). Italy's FTSE MIB gained 2.9% (up 7.8%). For the most part, emerging markets extended their rallies. Brazil's Bovespa index was little changed (down 11.7%), while Mexico's Bolsa jumped 3.0% (down 5.9%). South Korea's Kospi index rose 2.0% (down 0.1%). India’s Sensex equities index gained 2.4% (up 1.6%). China’s Shanghai Exchange surged 4.5% (down 1.5%).

Freddie Mac 30-year fixed mortgage rates were unchanged at 4.57% (up 102bps y-o-y). Fifteen-year fixed rates were unchanged at 3.59% (up 74bps). One-year ARM rates were down 4 bps to 2.67% (up 6bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up 5 bps to 4.84% (up 66bps).

Federal Reserve Credit expanded $8.9bn to a record $3.616 TN. Over the past year, Fed Credit was up $810bn, or 29%.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $565bn y-o-y, or 5.3%, to $11.174 TN. Over two years, reserves were $946bn higher, for 9% growth.

M2 (narrow) "money" supply rose $11.8bn to a record $10.790 TN. "Narrow money" expanded 7.1% ($717bn) over the past year. For the week, Currency slipped $0.4bn. Total Checkable Deposits gained $12.3bn, while Savings Deposits dipped $0.4bn. Small Time Deposits declined $2.5bn. Retail Money Funds gained $2.8bn.

Money market fund assets jumped $20bn to $2.659 TN. Money Fund assets were up $81bn from a year ago, or 3.1%.

Total Commercial Paper outstanding jumped $20bn to a 10-week high $1.035 TN. CP has declined $31bn y-t-d, while increasing $20bn, or 1.9%, over the past year.

Currency and 'Currency War' Watch:

The U.S. dollar index slipped 0.8% to 81.42 (up 2.1% y-t-d). For the week on the upside, the Norwegian krone increased 2.5%, the New Zealand dollar 1.6%, the British pound 1.6%, the Brazilian real 1.2%, the Swedish krona 1.1%, the Mexican peso 1.0%, the Danish krone 0.9%, the Swiss franc 0.9%, the euro 0.9%, the South African rand 0.9%, the Australian dollar 0.7%, the South Korean won 0.6%, the Canadian dollar 0.5%, the Singapore dollar 0.4% and the Taiwanese dollar 0.3%. For the week on the downside, the Japanese yen declined 0.3%.

Commodities Watch:

The CRB index declined 0.8% this week (down 1.4% y-t-d). The Goldman Sachs Commodities Index dropped 2.2% (up 0.5%). Spot Gold fell 4.7% to $1,326 (down 21%). Silver sank 9.1% to $21.72 (down 28%). October Crude dropped $2.32 to $108.21 (up 18%). October Gasoline sank 2.9% (little changed), while October Natural Gas rallied 4.2% (up 10%). December Copper fell 1.8% (down 12%). December Wheat declined 1.0% (down 18%), and December Corn fell 2.0% (down 34%).

U.S. Fixed Income Bubble Watch:

September 13 – Bloomberg (Sarika Gangar and Veronica Navarro Espinosa): “Verizon Communications Inc. and Ecopetrol SA are leading the busiest week ever for dollar- denominated bond sales… Corporate borrowers have issued $80.1 billion of debt this week, surpassing the previous record of $60.4 billion set in March 2012… Verizon’s unprecedented $49 billion offering followed a $2.5 billion sale by Colombian oil producer Ecopetrol and $2.42 billion of subordinated debt from Citigroup Inc. that removes the last vestiges of its government bailout during the financial crisis.”

September 10 – Bloomberg (Matt Robinson): “Bonds of telecommunications companies are losing twice as much as the rest of the corporate- debt market as Verizon Communications Inc. prepares to issue as much as $50 billion to take full control of its wireless unit. Dollar-denominated bonds of 27 telecommunications issuers with investment-grade ratings have lost an average 2.1% this month, the most of any industry group…”

September 9 – Bloomberg (Brian Chappatta): “The smallest amount of municipal-bond issuance in Michigan in 10 years is threatening to derail the state’s economic comeback, showing how Governor Rick Snyder underestimated the fallout from Detroit’s bankruptcy. Bond sales dwindled to $71.5 million in August… At least three Michigan localities -- Genesee and Saginaw counties and Battle Creek -- postponed a combined $131 million of issuance last month after Detroit’s July 18 Chapter 9 filing…”

September 9 – Bloomberg (James Nash): “California’s largest toll-road agency, whose revenue has trailed projections for six years, is nearing the biggest default in the $3.7 trillion municipal market since Detroit’s record bankruptcy. The Foothill-Eastern Transportation Corridor Agency, which operates 39 miles (63 kilometers) of toll highways in Orange County, risks default on $2.4 billion in debt, a consultant to California Treasurer Bill Lockyer’s Debt and Investment Advisory Commission said in July… The agency asked late in in 2012 to extend maturities and tolls by 13 years, a proposal the state Transportation Department has yet to accept. With benchmark municipal yields setting a two-year high this month, the window to complete the refinancing may be closing.”

September 13 – Bloomberg (Laura Marcinek and Michelle Kaske): “Popular Inc., Puerto Rico’s biggest bank, extended a three-day slide after the island’s economy shrank and yields on the government’s debt rose past 10%...The shares have declined 15% since their two-year high on Aug. 20. Chief Executive Officer Richard Carrion has sought to rid Popular of bad loans after a $935 million U.S. bailout in 2008. The local economy contracted 5% this year through July, the most since February 2010… Puerto Rico’s bonds rank one step above junk, and yields have soared amid doubt about the government’s ability to carry more debt… Popular’s bailout debt is the largest still outstanding in the Troubled Asset Relief Program’s capital purchase fund… It’s almost three times more than the second-largest debtor, Puerto Rico’s First BanCorp, which owes $254 million.”

U.S. Bubble Economy Watch:

September 13 – Bloomberg (Thomas Black): “Randy Webb sees scant evidence of a U.S. manufacturing rebound in the Ohio plant where he’s fixed aircraft electronics for 25 years. Honeywell International Inc. is closing the shop in 2014 as it expands such work overseas. Webb is among 80 employees poised to lose their jobs in Strongsville, Ohio…, near where General Electric Co. will shut a lighting factory in favor of production in Hungary. Delphi Automotive Plc is sending parts assembly to Mexico from Flint, Michigan, and Eaton Corp. will make extra- large hydraulic cylinders in the Netherlands, not Alabama. ‘Manufacturing is clearly on the downswing,’ said Webb… ‘Everybody I know is jumping to the service industry or taking some other kind of job. The U.S. industrial comeback, an idea embraced by President Barack Obama and some economists as 12 years of factory-job losses gave way to three annual gains, is now sputtering. Even with nonfarm payrolls up 1.1% in 2013 to 136.1 million, manufacturing has stagnated at less than 12 million. Factories added more than 500,000 positions after falling in February 2010 to the lowest since 1941.”

September 9 – Bloomberg (David J. Lynch and Alan Bjerga): “A Depression-era program intended to save the nation’s farmers from ruin has grown into a 21st-century crutch enabling affluent growers and financial institutions to thrive at U.S. taxpayer expense. Federal crop insurance encourages farmers to gamble on risky plantings in a program that has been marred by fraud and that illustrates why government spending is so difficult to control. And the cost is increasing. The U.S. Department of Agriculture last year spent about $14 billion insuring farmers against the loss of crop or income, almost seven times more than in fiscal 2000… The arrangement is a good deal for everyone but taxpayers. The government pays 18 approved insurance companies to run the program, pays farmers to buy coverage and pays the bills if losses exceed predetermined limits. With a showdown over the nation’s finances -- and a possible government shutdown -- looming this fall, the growing insurance tab is a bipartisan target.”

September 11 – Bloomberg (Victoria Stilwell): “Mortgage applications in the U.S. plunged last week to the lowest level in almost five years as rising borrowing costs led to a slump in home refinancing… Refinancing dropped 20.2%, with the measure reaching its weakest reading since June 2009. The gauge of purchases slid for a second week, decreasing by 2.7%, the most in a month.”

September 11 – Bloomberg (Prashant Gopal, Heather Perlberg and Dakin Campbell): “JPMorgan Chase & Co., the nation’s largest bank by assets, is easing mortgage lending standards in housing markets hard hit by the crash where prices are surging. The bank lowered some down payment requirements in Florida, Nevada, Arizona and Michigan because they will ‘no longer be considered distressed states’… The second-largest U.S. mortgage lender also loosened underwriting requirements for a refinancing program for Federal Housing Administration borrowers.”

Global Bubble Watch:

September 13 – Bloomberg (Kasia Klimasinska): “The Federal Reserve’s exit from quantitative easing will increase market volatility, said former U.S. Treasury Secretary Henry Paulson, who also praised Fed Chairman Ben S. Bernanke for navigating the economic recovery from the 2008 financial crisis… ‘There is bound to be volatility,’ Paulson said… ‘When you have a big, ugly, messy problem, there is never going to be a perfect, elegant solution.’”

September 9 – Bloomberg (Wes Goodman and Candice Zachariahs): “Investors suffering the worst losses in Treasuries since at least 1978 can add dollar sales by emerging-market central banks to their list of challenges. Speculation that the Federal Reserve, the biggest buyer of Treasuries, will reduce its purchases sent U.S. debt down 4.1% this year and boosted the dollar against developing- nation currencies for four straight months, matching the longest streak since 2001… India, Brazil, Russia and Indonesia have intervened in foreign-exchange markets, and dollar sales mean liquidating Treasuries… While the $48 billion drop in foreign central bank holdings at the Fed since a record in June is less than half of the $113 billion in withdrawals from U.S. bond funds in the past three months, they mark a change in trend. Foreign ownership of Treasuries fell 0.6% in the first half of 2013, poised for the first full-year decline in data going back to 2000 and a departure from the 10% annual gains seen since 2006. ‘There is a lack of buyers in the Treasury market,’ Ali Jalai, a Singapore-based trader at Scotiabank… said… ‘Selling by central banks to back up their currencies exacerbates the situation.’”

September 11 – Bloomberg (Katherine Burton): “Stanley Druckenmiller, who boasts one of the hedge-fund industry’s best long-term track records of the past three decades, said it would be a ‘big deal’ for financial markets if the Federal Reserve were to completely end its asset purchases over the next 12 months. ‘How in the world does anyone think when the actual exit happens that prices are not going to respond?’ Druckenmiller said… ‘The mere hint that maybe in three months, if the economy is good, we might go from $85 billion a month to buying $65 billion a month caused that kind of havoc and risk around the world,’ he said, referring to the selloff in bond markets and emerging markets in the past months… ‘I really don’t care whether we go to $70 billion or $65 billion in September,’ Druckenmiller said. ‘But if you tell me quantitative easing is going to be removed over nine or 12 months, that is a big deal.’ The purchases have subsidized all asset prices, he said, and completely stopping them would mean ‘the market will go down.’”

Global Economy Watch:

September 13 – Bloomberg (Andrew Mayeda and Greg Quinn): “The ratio of Canadian household debt to disposable income rose to a record in the second quarter… Credit-market debt such as mortgages rose to 163.4% of disposable income, compared with a revised 162.1% in the prior three-month period… Mortgage borrowing rose 1.7% to C$1.11 trillion ($1.08 trillion).”

September 13 – Bloomberg (Nichola Saminather): “Home prices in Sydney could rise by as much as 10% over the next 12 months, driven in part by unprecedented levels of Chinese demand, according to McGrath Estate Agents. As much as 80% of homes in parts of Sydney are being sold to Chinese buyers, John McGrath, chief executive officer of the company that recorded A$7 billion ($6.5bn) of property sales in the year to June 30, said… Record-low interest rates and the biggest influx of investors in almost a decade are also fueling prices. ‘The Chinese market is extremely strong, the strongest I’ve seen a new entrant into the market,’ McGrath said. ‘Record low interest rates, the ability to fix such rates for a long period of time is very attractive.’”

Bursting EM Bubble Watch:

September 9 – Bloomberg (Gabrielle Coppola): “Itau BBA, Brazil’s biggest underwriter of corporate bonds, predicted in March the nation’s struggling infrastructure debt market would expand 10-fold this year to 5 billion reais ($2.2bn). So far this year, just three deals worth 2.2 billion reais have been completed… The pickup in issuance earlier this year ground to a halt as the real plunged the most among major currencies, reducing the appeal of the securities to foreign investors the government sought to attract… ‘The instability of the currency is a very important factor for foreign investors to allocate their investments domestically,’ Luiz Macahyba, a former official at Brazil’s capital markets association…, said… ‘And now, government debt has gone back to competing with private bonds’ as the infrastructure notes’ tax-exempt status is now shared by sovereign debt.”

September 12 – Bloomberg (Fion Li): “Dim Sum bonds are extending the slowest summer sales in three years as the advantage of borrowing offshore diminishes along with reduced yuan appreciation expectations. Issuances excluding certificates of deposit slumped to 1.9 billion yuan ($310 million) in July and August, compared with 22 billion yuan and 24 billion yuan in the same periods of 2012 and 2011… Dim Sum borrowing costs are surging amid slower yuan gains as Premier Li Keqiang targets a reduced pace of economic growth and eases restrictions on investing in local bond markets. The average Dim Sum sovereign yield was 46 bps lower than the similar rate in Shanghai on Sept. 10, compared with a record 275 bps discount in June 2011…”

China Bubble Watch:

September 11 – Bloomberg: “China’s broadest measure of new credit almost doubled in August from the previous month in a sign leaders are committed to meeting economic goals even at the cost of adding financial risks. Aggregate financing was 1.57 trillion yuan ($257bn)…, topping the 950 billion yuan median estimate of 10 analysts surveyed by Bloomberg… New yuan loans from banks accounted for about 45% of the total, down from July’s 87%, as non- traditional credit played a bigger role… The data also mark a resurgence in shadow banking that poses risks for the financial system after a record credit boom in the first quarter.”

September 10 – Bloomberg: “China’s home sales transaction value fell for a second month in August from the previous month, as rising prices strained buyers’ finances. The value of homes sold dropped to 514.6 billion yuan ($84bn) last month from 516.5 billion yuan in July… Housing sales from January to August were up 35.7% to 3.85 trillion yuan from the same period a year earlier… Home prices posted their biggest gains in August since December, according to SouFun Holdings Ltd., China’s biggest real estate website owner…”

September 10 – Bloomberg: “China’s broadest measure of new credit was more than forecast in August as money-supply growth quickened… M2, the broadest gauge of money supply, rose 14.7% from a year earlier, compared with the 14.6% median estimate of analysts and 14.5% in July. New yuan loans were 711.3 billion yuan… That represented a 45% share of aggregate financing after about 87% in July, which was the highest in almost two years following a government crackdown at shadow banking aimed at limiting risks in the financial system.”

September 10 – Bloomberg: “Chinese local government financing vehicles’ reliance on land sales and rising land prices to repay debt creates ‘problems,’ People’s Bank of China Governor Zhou Xiaochuan wrote… LGFVs are similar to municipal bonds in more mature markets, with both relying on future income to fund repayments, Zhou said… The difference is that Chinese financing platforms rely on land sales and not tax revenue for income, he wrote. ‘As China rapidly evolves, some local governments want to accelerate their urbanization and require a huge amount of investment,’ Zhou wrote. ‘Yet, government finances are limited, what can they do? So they consider using future income to bridge the current funding gap instead.’ Zhou’s comments come before the results of China’s first full audit in more than two years of its local government debt, which the National Audit Office said in 2011 totaled 10.7 trillion yuan ($1.75 trillion). A lack of transparency in LGFVs prompted Fitch Ratings Ltd. to cut China’s long-term local- currency debt rating in April. China ordered the review in July.”

September 10 – Bloomberg (Kyoungwha Kim): “Banks are leading losses in China’s bond market this quarter as investors brace for a record $175 billion in debt due in 2014 and Standard & Poor’s warns that bad loans will escalate. Notes issued by financial companies including China Construction Bank Corp. have lost 2.7% since the end of June, the most among the sectors tracked by Bank of America Merrill Lynch’s China Broad Market Index… China’s banks have 1.07 trillion ($175bn) of bonds maturing in 2014, up from 970 billion yuan this year, according to Citigroup Inc…. Troubled borrowers are struggling to refinance maturing debt as a measure of total financing in the economy slumped for the fourth straight month in July, the longest losing streak in 11 years, and economic growth slumped to its slowest in 23 years.”

September 9 – Bloomberg: “China’s exports increased more than estimated in August and inflation stayed below a government target, helping Premier Li Keqiang sustain a rebound in the world’s second-largest economy from a two-quarter slowdown. Overseas shipments rose 7.2% from a year earlier, the General Administration of Customs said… That exceeded the 5.5% median…”

Latin America Watch:

September 13 – Bloomberg (Blake Schmidt): “Brazil is creating an insurance fund in a bid to keep 250 billion reais ($110bn) in infrastructure projects from suffering the same fate as a bullet train that was shelved after a third failed auction. The fund of up to 11 billion reais will insure part of the railroad, port and highway projects needed to end bottlenecks for commodity exporters and commuters, as well as for tourists during next year’s World Cup. Standard & Poor’s said luring investors for the concessions is essential to reviving economic growth and avoiding a sovereign downgrade as investment lingers at 21% of gross domestic product, the least among the largest developing nations… Policy makers are working to attract private lenders as S&P says loans by state-owned banks such as BNDES are imperiling Brazil’s creditworthiness.”

Europe Crisis Watch:


September 9 – Bloomberg (Francesca Cinelli): “Italy banks’ gross non-performing loans rose 22.2% in July from year earlier, Bank of Italy says… Loans to private sector fell 3.3% y-o-y in July: BOI”

September 9 – Bloomberg (Angeline Benoit): “Patricia Carral Cunningham says the economic recovery may come too late for her business even after she kept up sales to weather Spain’s six-year slump. ‘I’ve put up all my personal assets as guarantees and now there’s no way I can get another credit line,’ according to Carral, 50, who says her Madrid-based construction company Soldray S.L.’s 20 years of experience helped it survive the end of a real-estate boom in 2007. While Spanish manufacturing and services expanded in August for the first time in more than two years, falling bank lending threatens small companies in a country where only 2% of businesses employ more than 20 people… ‘Spanish companies are most often small family-run operations,’ said Nathalie Gianese, director of studies at Informa D&B… ‘Between the slump in revenue and their limited means, these small firms are disadvantaged at a time when banks are seeking to reduce risk as much as possible.’ The number of companies seeking protection from creditors increased by 26% through August compared with the same period a year earlier…”

September 13 – Bloomberg (Angeline Benoit and Esteban Duarte): “Spain’s public debt rose above Prime Minister Mariano Rajoy’s year-end goal last quarter as the nation struggled to emerge from its second recession since 2008. Borrowings by the euro area’s fourth-largest economy at the end of June rose to 92.2% of gross domestic product, or 943 billion euros ($1.3 trillion)… That compares with 923 billion euros, or 90.1% of GDP, at the end of March, and the government’s goal of 91.4% by the end of the year. Spain’s debt load has more than doubled since 2008, when the end of a real-estate boom triggered an economic slump that is now in its sixth year.”