A gallant effort to resurrect the bull market was hit this week by myriad problems economic, financial, and geopolitical. For the week, the Dow dipped 2% and the S&P500 declined 3%. The Morgan Stanley Cyclical and Morgan Stanley Consumer indices declined 2%. The broader market also gave up some gains, as the small cap Russell 2000 and S&P400 Mid-Cap indices shed about 2%. Many of this year’s early leaders were this week’s biggest losers. On the back of the drubbing of Microsoft, the NASDAQ100 sank 6%. The Morgan Stanley High Tech index dropped 8%, while the Semiconductors plunged 12%. The Street.com Internet index was hit for 6% and the NASDAQ Telecommunications index 4%. The resilient Biotechs were about unchanged. The financial stocks were mixed. The Securities Broker/Dealer index was down 5%, while the Banks gave up only 1%. Although bullion was up $1.90, the HUI gold index dipped 3%.
The Treasury market was relieved by it all. For the week, two-year Treasury yields dropped nine basis points to 1.68% and five-year yields sank 15 to 2.97%. The 10-year yield declined 11 basis points to 4.01%, while the long-bond saw its yield dip 12 basis points to 5.04%. Agency debt continues to perform well, with the implied yield on agency futures sinking 15 basis points. Mortgage-backs gave back some of their strong relative performance, with benchmark yields generally declining only 6 basis points. The spread on Fannie’s 5 3/8 2011 note narrowed one to 38, while the 10-year dollar swap spread declined 1.5 to a narrow 44. Corporate spreads generally widened marginally. The dollar fell to the lowest level against the euro since October 1999 and to a four-year low against the Swiss franc. Latin American currencies came under significant selling pressure, especially late in the week. The CRB commodity index continued its move higher, adding less than 1% this week.
While clearly impacted by year-end maneuvering, broad money supply (M3) dropped $58.9 billion last week. Demand and Checkable deposits combined for a decline of about $22.4 billion. Savings Deposits increased $8.1 billion. Retail Money Fund deposits were down $2.7 billion, and Institutional Money Fund deposits were down $6.9 billion. Large Denominated Deposits declined $6.9 billion. Repurchase Agreements, the big gainer over the past month, saw a decline of $25.8 billion last week. Bank assets have also been impacted by year-end. Last week, Total Assets increased $46.6 billion after declining $112 billion the previous week. Loans and Leases jumped $49.2 billion after dropping $77.7 billion. Commercial and Industrial loans were up $5.4 billion last week, while Real Estate loans were up $18.7 billion. Corporate and agency debt issuance slowed from last week’s barrage, but ended the week with $35 billion sold. Year-to-date issuance has already reached about $115 billion. Asset-backed issuance remained brisk at $6 billion, with y-t-d issuance at a hot $13.7 billion.
Today’s University of Michigan preliminary survey of January Consumer Confidence was disappointing. With expectations for a slight improvement to 87, confidence was reported at only 83.7 (down from May’s 96.9). And while the index of current conditions was up slightly, Economic Outlook sank 5.6 points to the lowest level since October. It appears that stock market rallies now have noticeably less impact on consumers than in the past. Until proven otherwise, we will read weak consumer confidence readings as evidence of heightened concern with the poor state of household finances. Elsewhere, the Mortgage Bankers Association's weekly Refi Index declined 1.4%, but remains at a historically high level. The Purchase index declined 4.8% for the week, only slightly above the year ago level. There were 29,108 bankruptcies filed last week, up 11% y-o-y.
January 13 – Moody’s: “U.S. asset-backed securities (ABS) issuance reached nearly $400 billion in 2002 and has grown on average 26% annually since 1986, says Moody's Investors Service in its first report looking at the trends and history of ABS issuance since the market's inception. In contrast, corporate bond issuance volume experienced a 9% average annual growth rate during the same period… In 2001, home equity issuance increased by 56%, driven by the low interest rate environment, while CDO issuance dropped by 32%, primarily due to the poor performance of underlying corporate bonds.”
January 13 – Fitch: “Marking an unprecedented decline in corporate credit quality, 2002 produced $109.8 billion in high yield defaults and a new par based record default rate of 16.4%, exceeding 2001's $78.2 billion default volume and 12.9% default rate.”
January 16 – Standard & Poor’s: “Against a backdrop of lagging consumer confidence, rising unemployment, and concerns about a stalling economic recovery, the U.S. ABS sector ended 2002 much as it began, with a flurry of downgrade activity… Moreover, last year’s record 688 ABS downgrades exceeds the 637 life-to-date ABS downgrades that occurred between 1985 and 2001 inclusively. Indeed, fourth-quarter 2002 continued the downward trend exhibited during the entire year: there were 176 lowered ratings during the quarter, affecting 133 transactions across more than seven asset classes.”
January 16 – Dow Jones (Tom Barkley): “The ‘bleak’ outlook for the U.S. airline industry portends another difficult year for the aircraft leasing environment, Fitch Ratings said Thursday. In a conference call, the rating agency warned of another likely round of downgrades for aircraft-backed structured finance deals and depressed plane values over the next several years. ‘The operating environment for U.S. majors continues to be quite discouraging, with persistent weakness in business travel demand, low passenger yields and very slow recovery in passenger unit revenues throughout the country,’ said Fitch airline analyst Bill Warlick, who said there are few signs of a robust recovery for 2003… Meanwhile, aircraft values have fallen between 10% and 50% this year, depending on the type and liquidity of the aircraft, and they aren’t likely to recover until 2005 at best, warned structured finance analyst Donald Powell. Along with bankrupt airlines cutting their fleets, other airlines are also grounding inefficient aircraft, as well. About 1,800 planes are now parked in the desert, and Fitch estimates that only 500 to 600 of those will return to service. Powell anticipates ‘highly discounted distressed sales’ this year, which could depress aircraft values another 20%, bringing values down between 30% and
70% from their pre-Sept. 11 levels.” (If Only…the Fed could inflate aircraft values…)
January 15 – Bloomberg: “Bankruptcy filings by the Ottawa Senators and Buffalo Sabres may drag other National Hockey League teams into financial trouble as lenders consider whether to cut team values and force them to pay back part of their debt, bankers said. J.P. Morgan Chase & Co. and SG Cowen Securities Corp. are among the firms that have written clauses into loans they’ve arranged or made to hockey teams allowing the lenders to demand clubs reduce debt if the values of other franchises fall. Such ‘price-floor covenants’ typically limit debt to half of a team’s value. Under current economic conditions, many of the league’s teams would have a hard time coming up with the money to reduce debt, and that could lead to more bankruptcies, said Sal Galatioto, head of Lehman Brothers Inc.’s sports finance unit. ‘For the league, this is scary,’ Galatioto said. ‘It's going to be harder and more expensive for NHL teams to get credit, and that could put marginal teams in distress.’” (If Only…the Fed could inflate NHL franchise values…)
January 13 – Bloomberg: “Standard & Poor’s said it lowered ratings on almost twice the amount of public debt that it raised last year because of weak economic conditions, increasing costs for governments, and poor stock performance. S&P lowered the credit rating last year on $61.6 billion of debt from five U.S. states and one commonwealth: California, Colorado, Kentucky, New Jersey, Wisconsin and Puerto Rico… The credit rating company last year lowered its outlook to ‘negative,’ meaning a downgrade is likely if trends continue, on eight states: Arizona, Connecticut, Kansas, Maine, Ohio, Oregon, Tennessee and Washington. Indiana had its outlook lowered to ‘negative’ in 2001, and maintains a negative outlook. Three states, Illinois, Massachusetts and Rhode Island, had their outlooks reduced to ‘stable’ from ‘positive’ last year. ‘States are coming into 2003 in the most negative posture we’ve seen,’ said S&P analyst Alex Fraser…”
January 16 – Bloomberg: “Illinois faces a $4.8-billion budget deficit, giving the state the fifth-largest deficit in the U.S., Governor Roy Blagojevich said, calling for the state to change spending and revenue policies. Illinois, the U.S.’s fifth-largest state, is expected to have a $1.2 billion deficit in its 2003 fiscal year and a $3.6 billion deficit in its 2004 fiscal year… Illinois faces the ‘worst budget crisis’ it has ever known, Blagojevich said. Illinois would follow New Jersey with a $5 billion deficit, according to rankings by the American Legislative Exchange Council. Illinois originally ranked ninth with an estimated $2.25 billion deficit when the rankings were released last week.”
January 15 – Bloomberg: “New York State might defer paying some bills until the next fiscal year should legislators fail to authorize selling bonds backed by money from the tobacco-suit settlement in time to close a gap of as much as $2.5 billion in this year’s budget, the budget division said. In addition, a December cash flow report by the state comptroller’s office said tax and other general fund receipts declined 15.6 percent in the first nine months of the fiscal year, compared with the previous year. The numbers ‘are extremely troubling, and raise questions of how the state will address tremendous budget gaps’…”
January 13 – Bloomberg: “Texas’ budget shortfall, driven by falling sales tax receipts, will be $9.9 billion by September 2005, nearly double projections and $495 for every resident of the country’s second most-populous state. Texas faces a $1.8 billion deficit in its current fiscal year, which ends Sept. 30, and an $8.1 billion deficit in the 2004-2005 fiscal year, Texas Comptroller Carole Keeton Strayhorn said… The deficit widened from $5.1 billion as sales, franchise and automobile taxes declined. ‘The aspects of our economy that feed the sales tax, by far, our most important source of revenue, have declined,’ Strayhorn said… Texas’ revenue fell 9.54 percent as franchise, sales and automobile taxes paid by businesses and sales taxes and other revenue declined in the quarter ended Dec. 31…”
January 17 – Bloomberg: “Arizona Governor Janet Napolitano wants to borrow against state lottery revenue, state-owned buildings and a land trust fund as part of a plan to close a $1 billion budget deficit without raising taxes.”
January 17 – Bloomberg: “The Texas Teacher Retirement System faces a $3.3 billion unfunded liability, according to the Web site of Pensions & Investments magazine, citing a report by the state auditor. The $67 billion fund, nation’s seventh-largest pension system, went from fully funded to under funded in 2002, because of market declines the last two years that led to net investment losses of $16.2 billion…” (If Only…the Fed could inflate equities back to Bubble peaks…)
January 16 – Bloomberg: “California paying the biggest interest premium ever for a U.S. tobacco bond to sell a record $3 billion in debt may signal that other states will need to boost yields to attract buyers. The Golden State Tobacco Securitization Corp. sold the bonds yesterday to yield a top 7 percent, or 220 basis points more than the 4.8 percent for top-rated state debt… Yields on tax-exempt tobacco bonds began rising last year as a surge of sales put some investors near limits for holding the debt. Dozens of states and municipalities have sold $17.5 billion in bonds backed by a 1998 settlement with big cigarette makers in the U.S., such as Philip Morris Cos. California plans another $2 billion tobacco bond sale in April. Other states, including New York and Oregon, may add as much as $10 billion more. A 7 percent tax-free yield translates into a taxable equivalent return of 12.57 percent for a California resident in the top federal and state income tax brackets.” (If Only…the Fed could inflate state revenues…without impacting consumer prices.)
The Consumer Price Index (CPI) saw its y-o-y change rise to 2.4% in December, up from November’s 2.2%. The y-o-y change for the index was at 1.5% in September and 1.1% for June. Yet, last month y-o-y Transportation costs were up 3.8%, Medical Care 5%, and Housing 2.4%. The Producer Price Index (PPI) was up 1.2% year-over-year, the highest rate since September 2001. Keep in mind that the y-o-y change in the PPI was a negative 2.70% in January and was at negative 1.90% as recently as September 2002. Importantly (especially for an economy that is currently importing on a monthly basis 70% more goods than it is exporting), the Import Price Index saw its y-o-y increase jump to 4.2%, the highest rate since November 2000. The y-o-y Import price change had been negative for 19 months before turning positive only three months previously in September. Looking back one year (December 2001), we see that year-over-year Import Prices were actually down 8.9%. In stark contrast, December 2002 Import Prices by category saw Petroleum up 57.9% y-o-y, Industrial Prices up 22% y-o-y, Foods, Beverages up 6.2% y-o-y, Capital Goods down 2.5% y-o-y, and Consumer Goods down 0.7% y-o-y. For comparison, December 2001 y-o-y price changes by import category had Petroleum down 38.5%, Industrial Supplies down 23.9%, Foods, Beverages down 4.9%, Capital Goods down 2.6%, and Consumer Goods down 0.8%. What a difference a year makes, and we fully expect that the death of King Dollar marks a historic inflection point with regard to relative prices for so many things, real and financial.
If Only…the Fed could inject sufficient money into the system to inflate Capital Goods prices, while not inflating oil and import prices...
The November trade deficit surged to a much worse-than-expected and record $40.1 billion. And while the unloading of ships after October’s 10-day dock strike was a factor, the story here is an out-of-control trade situation, a maladjusted economy, and a faltering dollar. For the month, Goods Imports of $102.3 billion (up 14% y-o-y) were 76% above Goods Exports of $58 billion (up 3% y-o-y). Let’s take a look at December Goods Imports by category, keeping in mind that imports are surging because of both volume and price increases. Industrial Supplies were up 22.6% y-o-y, with Crude Oil up 51.6%. Consumer Goods were up 17.5%, with Pharmaceuticals up 17.5% and Apparel up 21.2%. Automotive was up 10.6% and Food & Beverage was up 10.3%. Capital Goods imports were up 6.9% y-o-y, with Telecom Equipment up 31.3%. Moreover, December data from the Ports of Los Angeles and Long Beach offer little encouragement. December year-over-year inbound containers were up 16% versus November’s 10.1%. During the month, a combined 475,048 inbound containers were unloaded, with 275,086 (58%) departing empty. The number of outbound empty containers was up 32% y-o-y.
“SLM Corporation, commonly know as Sallie Mae, today reported fourth-quarter and year-end 2002 earnings and performance results that include an 18-percent annual increase in…loan originations, resulting in a calendar year 2002 total of $11.9 billion.”
Fannie had quite a December. “Total Business Volume (total mortgage and MBS purchases) rose to $113.8 billion, the highest on record.” The previous record of $95.6 billion was set during November. Fannie’s Book of Business (retained mortgage portfolio plus guaranteed MBS held in the marketplace) expanded $40.5 billion during the month, a 31% annualized rate, to $1.82 Trillion. Fannie’s retained mortgage portfolio expanded $20 billion during December, a 59% annualized rate.
During the fourth quarter, Fannie’s Total Book of Business surged a record $78.44 billion, an annualized growth rate of 18%. Fannie’s Total Assets jumped a striking (and record) $49.5 billion, an annualized rate of 24%. For comparison, Total Assets increased $38 billion during the first three quarters of 2002. Also worth noting, the aggressive “reliquefication” efforts back in the fourth quarter of 1998 saw a record $30 billion asset growth. For 2002, Fannie’s Total Book of Business increased $256.2 billion, or 16%. To put this number into perspective, 1998 was the first year TOTAL U.S. home mortgage borrowings surpassed $250 billion. Fannie’s Total Business Volume (purchases) was up 38% last year to $849 billion. The company repurchased 15.4 million shares during 2002, up from 2001’s 6.0 million. During the past five years, Fannie’s Total Book of Business increased $925 billion (103%). Total Assets expanded $496 billion, or 127%.
Interesting comments from a Fannie Mae executive during Wednesday’s conference call: “It’s important to note that we serve a role in the financial markets of reducing systemic risk by absorbing some of the flows that you see coming through the marketplace. I think we’ve done that fairly effectively. I think that we do absorb some risk for our shareholders. We’ve tended to manage it effectively. We’ve tended to earn a good income from it over time, and still remain at a very, very low risk position. I think it’s an important role, not just for our shareholders. I think it’s an important role from a public policy standpoint. I think we done that again this year.”
When did playing central banker become part of the GSE mission? What are the systemic consequences for repeatedly putting “coins in the fuse box”? Whether their executives appreciate it or not, the reality of this endemic Bubble situation is that Fannie’s “very, very low risk position” is but a figment of imaginations; it will disappear as soon as their extraordinary growth slows. But at least the issue of the GSEs as central bank-style buyers of (first and) last resort is now out of the closet. This week, in a speech before the Exchequer Club in Washington, DC, Armando Falcon, (Director of The Office of Federal Housing Enterprise Oversight - OFHEO), made the following comment: “The Enterprises also provide liquidity and stability to the mortgage market by purchasing mortgage securities during periods of significant market turmoil. For example, in the Fall of 1998…”
OFHEO, with supposed responsibility for government-sponsored enterprise (GSE) regulatory oversight, has an impossible job. The GSEs are today much too big to fail; much too big to even slow down; and, hence, too big to regulate. Nonetheless, Mr. Falcon this week addressed many issues confronting the GSEs and made some cogent points. He recognized the “challenging” task ahead for the GSEs in their efforts to obtain sufficient derivative protection in the marketplace to hedge ballooning interest-rate exposure. However, it is our view that, as the GSE’s have come to dominate the markets, hedging operations have become little more than a ruse. And the deeper we get into the Great Mortgage Finance Bubble, the more heavily GSE risk is weighted to Credit losses rather than interest rates. In their (thus far) unfettered capacity to create money and Credit, the GSEs do exercise considerable influence over interest rates. However, this manipulation over many years has created an inflationary Bubble with unprecedented risk to sinking housing prices and Credit losses. Today, it is fair to posit that things have become so distorted that the GSEs have huge Credit exposure to even stable home prices. But there is no market for hedging systemic Mortgage Credit Risk.
Mr. Falcon also addressed another issue near and dear to our hearts: “The most significant benefit Fannie Mae and Freddie Mac enjoy is what many have described as the implied Federal guarantee.” In this regard, it is worth noting that agency spreads have now narrowed to the lowest level since pre-1998 financial crisis (when the risk profile of these institutions was a small fraction of what it is today).
Importantly, agency spreads collapsed after 9/11. Unprecedented Federal Reserve marketplace intervention rendered it incontrovertible that that the previous “implied” federal backing of the GSEs (and repo market?) had become explicit. This was an historic bestowment of financial power, with absolutely no effort by the Fed to bridle the almighty agencies. Instead, they were adopted as next of kin. This development has had a profound role in inciting the reckless terminal stage of Mortgage Finance Bubble excess, with the consequent lurch to incurable financial and economic fragility. It is simply difficult to comprehend that Fannie and Freddie have come to possess $1.6 Trillion of assets and $3.1 Trillion of total exposure.
As masters of the Great Credit Bubble – with its attendant acutely vulnerable Credit system and economy – the GSEs now have no alternative than desperate (non-productive) money and Credit inflation. This may appear “business as usual,” and is, apparently, good news for Fannie and Freddie shareholders. The system, however, is a huge loser. Many will continue painting GSE operations in a positive light, but it should be increasingly clear that these institutions have and continue to be the most responsible for our degraded currency. Being quasi-governmental lending institutions was always problematic. Having the Fed and Wall Street transform them to the status of quasi-central banks – with the incredible shift of power such status infers - is a true abomination. We live, after all, in a democracy, and neither the public nor our representatives legislated to establish a parallel GSE central bank. There should be explicit constitutional safeguards against such dangerous financial overreach and abuse of power.
We have discussed (ad nauseam) how the Fed, GSEs and Wall Street “structured finance” came to have mastered systemic liquidity creation. We now know that Fannie expanded its balance sheet by $50 billion during the fourth quarter, playing no small role in the newfound liquidity in the corporate bond market. Yet this week it appears that the marketplace came to appreciate that, unlike times in the past, it has serious issues to contend with beyond systemic liquidity. Indeed, years of Credit excess nurtured by (“coins in the fuse box”) liquidity operations have come home to roost with an unfolding serious dollar problem. U.S. savings are being devalued, as well as foreign savings held in dollar assets. Global financial markets have commenced a significant and uncertain transition, with potentially destabilizing financial flows and derivative issues. Those derivative players that have profited handsomely from writing (King) dollar protection will now be forced to earn (and dynamically trade for) their keep.
We should also expect that the battered major international super-banks/financial conglomerates have commenced a program to reduce exposure to dollar assets. And, importantly, the death of King Dollar has opened up an entire Brave New World of commodities, currencies, and other enticing markets for speculators and investors alike. For several years, King Dollar made for a one-way bet. The Fed and GSEs ensured inflated securities prices and a liquid marketplace. There was, then, little reason for global players to look beyond the U.S. Treasury, agency, mortgage-back, and “structured finance” markets.
Most importantly, this unending flow of speculative finance into U.S. securities (Recycling Bubble Dollars) for years buoyed the U.S. dollar, despite rampant and eventually self-defeating Credit excess and ballooning trade deficits. “Eventually” has arrived, and it is today not that bold to posit that the great dollar speculative Bubble is in the process of bursting. This will change EVERYTHING, including the efficacy of previous (bulletproof) liquidity operations.
The over-jubilant marketplace also this week came face to face with the harsh reality that unfolding Consumer Debt Problems were not magically cured by fourth-quarter “reliquefication.” Yes, the beleaguered corporate bond market – that had dislocated and was basically closed for business by early October – has been re-energized. Open up the Credit spigot to a negative cash-flow enterprise previously cut off from additional finance, and the impact can be enormous. But the issues today within consumer finance are much different. Unlike corporates, Credit Availability has not been the issue for consumer finance; the exact opposite. Accordingly, the liquidity onslaught and the drumbeat of “reflation,” so enamoring corporates, are basically non-issues for the over-borrowed consumer. In regard to consumer debt problems, “reliquefication” - and its powerful capacity to rectify Credit Availability issues - is basically moot. (And we don’t see higher oil and import prices benefiting stretched household finances.) The problem is that reckless consumer lending excesses have for too long driven spending, economic “growth,” and jobs creation. The unsound Consumer Debt Bubble is now faltering on its own weight and there is little anyone can do about this. If Only…the Fed could reflate household balance sheets and cure impaired lenders…
The acquisition by HSBC significantly reduced the systemic issues related to Household International. Yet the company still has a $100 billion plus loan portfolio we will monitor for indications as to the health of the U.S. consumer borrower. Looking at fourth-quarter data, things are not all too encouraging. Household’s “two-months-and-over contractual delinquency” jumped 42 basis points to 5.24% (Household saw a 51 basis point increase in December delinquencies, the worst performer of the major Credit card master trusts). By category, Real Estate Secured delinquencies increased 68 basis points during the quarter to 3.94% (up 126 bps y-o-y), Auto Finance 47 basis points to 3.65%, and Personal Non-Credit Card 52 basis points to 9.41%. In dollars, Total Nonperforming Managed Receivables jumped 25% during the year to $4.52 billion.
Over at AmeriCredit, things are quickly going from bad to much worse. The company reported a $27.6 million loss, quite a deterioration from the previous quarter’s $70 million profit. Combined delinquencies and foreclosures rose to 14.7% of managed receivables, up from the third quarter’s 12.2%. Total dollars delinquent actually rose about 24% during the quarter, while Total Charge-offs jumped 15% to $236.6 million. Year-over-year, charge-offs were up 82%. The fact that the company continues to lend aggressively and grow receivables makes the rapid Credit deterioration all the more alarming. Year-over-year, managed receivables were up 36% to $16.2 billion. Receivable growth has slowed, however, with the past quarter’s 2.9% (11.6% annualized) down sharply from the previous quarter’s 6.7% (26.8% annualized). Slowing growth is today's kiss of death for subprimie lending.
For those of us who have watched this company since its early days as a used car dealer in Fort Worth (U-Car-Co), it is rather incredible that near failure in the early nineties was transformed by Wall Street structured finance into a company with managed receivables of over $16 billion. We’ll stick with our view that subprime lending is not a viable business over the entire business cycle, and that the securitization and Credit insurance market have only transformed subprime into a bad business with much larger, systemic consequences. It is worth noting that behemoth Credit insurer MBIA jumped into the fray by providing insurance on a $1.7 billion securitization in October, MBIA’s first deal with AmeriCredit. The Credit insurers (and the holders of their insured bonds) will regret ever conjugating with subprime lending. What could they have been thinking?
From AmeriCredit’s CEO: “We’re seeing continued weakness in recovery values on repossessed vehicles and in the overall economy, causing increases in both loss severity and frequency.” If Only... the Fed could create sufficient money to “reflate” the value of used automobiles…
And if AmeriCredit’s numbers are dreadful, they are absolutely horrendous at Metris. December charge-offs actually jumped 264 basis points during the month to a rate of 21.25%. Charge-offs were up an amazing 469 basis points in two months. But, then again, this is what subprime lenders should today expect when they hit the wall and lose the capacity to extend additional loans (raise maximum lending limits) to their bad Credits.
And while continued aggressive lending is postponing the day of reckoning, the Capital One train wreck remains firmly on course. Fourth Quarter Net Charge-Offs surged 30.6% from the previous quarter to $896 million, as the charge-off rate increased from 4.96% to 6.21%. Similar to AmeriCredit, the degree of deterioration in the face of strong receivable growth is disturbing. Total Managed Receivables expanded 5% (20% annualized) during the quarter to $59.7 billion, with y-o-y growth of 32%. Yet charge-offs were up 73% y-o-y, with estimated dollars delinquent up almost 50%. The buoyant securitization market has been a lifesaver for sustaining needed lending growth. Total assets increased by less than $500 million (all financed by deposits!) during the fourth quarter, up only 1% quarter-over-quarter (y-o-y 33%). Capital One is today running frantically but barely staying ahead of a gritty pack of loan losses. It appears to us that Credit Problems hasn’t even broken a sweat.
After a week of perusing through dismal consumer Credit data and witnessing some key lenders’ seeming acceleration toward the proverbial wall, we are increasingly confident that the worst is yet to come for “Structured Finance.” And we just can’t shake our discomfort with the major Credit insurers’ exposure to subprime, CDOs, and various festering areas. There is also the issue of the alarmingly high yields states are beginning to pay to sell some types of bonds. Recognizing that municipalities will be very heavy issuers of debt for as far as the eye can see – and that the increasingly vulnerable Credit insurers are instrumental players in this arena – and the murky scenario of systemic issues inflicting muni finance becomes a little more coherent. It is going to be an interesting year.
As informed Barron’s readers appreciated again this past week, Marc Faber runs circles around his Roundtable counterparts. The depth of his knowledge and insight, as well as his fierce devotion to critical, independent thinking, is something us regular readers of his exceptional newsletter have come to take for granted. A few months back I wrote that the extraordinary environment confronting us had rendered his always valuable Gloom, Boom & Doom Report “invaluable.” Well, we have now become only more fortunate, as he shares his wealth of knowledge on markets, history, cycles, economics and humanity in his recently published book, Tomorrow’s Gold – Asia’s Age of Discovery. It’s a wonderful read that I strongly recommend. And especially as we witness the passing of King Dollar and the consequent historic transition to a reshaped, uncertain environment, to call Dr. Faber’s book “timely” is a gross understatement. His brilliant interplay of history, theory and critical issues of contemporary finance and economics creates a strikingly pertinent book. And as someone who puts his thoughts in writing on a regular basis, I must confess to being quite envious of his impressive mastery of the subject matter, not to mention his appealing writing style.
I could have pages of pertinent extractions, but I will entice you with just a brief one:
“Can the recession and the deflationary trend be corrected by massive reflation? According to Ropke, the fact, ‘that the credit expansion of the boom leads to overinvestment, provides at the same time a proof that the capital formation induced by credit creation, and the extension of production that it sets going, leads to a painful reaction expressing itself in the crisis and the depression.” This reaction can indeed be postponed by ‘a further increase of the credit supply but only at the price of a corresponding aggravation of the ultimate reaction. An ‘eternal boom’ is therefore out of the question.”
Or perhaps a selection of chapter titles may prove more seductive: A world of change; Major future investment themes; A caution about high-return investment expectations; Business cycles – Alive and well!; New eras, manias and bubbles; The economics of Inflation; The rise and fall of centres of prosperity; etc. Anyway, it’s a heck of a good book. And to think that so much valuable knowledge and insight can be had for about $30. What a gift! A big “Hats Off” and special thanks to our good friend Marc Faber! If Only…there were more of his kind around…
January 13 – Bloomberg: “Texas’ budget shortfall, driven by falling sales tax receipts, will be $9.9 billion by September 2005, nearly double projections and $495 for every resident of the country’s second most-populous state. Texas faces a $1.8 billion deficit in its current fiscal year, which ends Sept. 30, and an $8.1 billion deficit in the 2004-2005 fiscal year, Texas Comptroller Carole Keeton Strayhorn said… The deficit widened from $5.1 billion as sales, franchise and automobile taxes declined. ‘The aspects of our economy that feed the sales tax, by far, our most important source of revenue, have declined,’ Strayhorn said… Texas’ revenue fell 9.54 percent as franchise, sales and automobile taxes paid by businesses and sales taxes and other revenue declined in the quarter ended Dec. 31…”
January 17 – Bloomberg: “Arizona Governor Janet Napolitano wants to borrow against state lottery revenue, state-owned buildings and a land trust fund as part of a plan to close a $1 billion budget deficit without raising taxes.”
January 17 – Bloomberg: “The Texas Teacher Retirement System faces a $3.3 billion unfunded liability, according to the Web site of Pensions & Investments magazine, citing a report by the state auditor. The $67 billion fund, nation’s seventh-largest pension system, went from fully funded to under funded in 2002, because of market declines the last two years that led to net investment losses of $16.2 billion…” (If Only…the Fed could inflate equities back to Bubble peaks…)
January 16 – Bloomberg: “California paying the biggest interest premium ever for a U.S. tobacco bond to sell a record $3 billion in debt may signal that other states will need to boost yields to attract buyers. The Golden State Tobacco Securitization Corp. sold the bonds yesterday to yield a top 7 percent, or 220 basis points more than the 4.8 percent for top-rated state debt… Yields on tax-exempt tobacco bonds began rising last year as a surge of sales put some investors near limits for holding the debt. Dozens of states and municipalities have sold $17.5 billion in bonds backed by a 1998 settlement with big cigarette makers in the U.S., such as Philip Morris Cos. California plans another $2 billion tobacco bond sale in April. Other states, including New York and Oregon, may add as much as $10 billion more. A 7 percent tax-free yield translates into a taxable equivalent return of 12.57 percent for a California resident in the top federal and state income tax brackets.” (If Only…the Fed could inflate state revenues…without impacting consumer prices.)
The Consumer Price Index (CPI) saw its y-o-y change rise to 2.4% in December, up from November’s 2.2%. The y-o-y change for the index was at 1.5% in September and 1.1% for June. Yet, last month y-o-y Transportation costs were up 3.8%, Medical Care 5%, and Housing 2.4%. The Producer Price Index (PPI) was up 1.2% year-over-year, the highest rate since September 2001. Keep in mind that the y-o-y change in the PPI was a negative 2.70% in January and was at negative 1.90% as recently as September 2002. Importantly (especially for an economy that is currently importing on a monthly basis 70% more goods than it is exporting), the Import Price Index saw its y-o-y increase jump to 4.2%, the highest rate since November 2000. The y-o-y Import price change had been negative for 19 months before turning positive only three months previously in September. Looking back one year (December 2001), we see that year-over-year Import Prices were actually down 8.9%. In stark contrast, December 2002 Import Prices by category saw Petroleum up 57.9% y-o-y, Industrial Prices up 22% y-o-y, Foods, Beverages up 6.2% y-o-y, Capital Goods down 2.5% y-o-y, and Consumer Goods down 0.7% y-o-y. For comparison, December 2001 y-o-y price changes by import category had Petroleum down 38.5%, Industrial Supplies down 23.9%, Foods, Beverages down 4.9%, Capital Goods down 2.6%, and Consumer Goods down 0.8%. What a difference a year makes, and we fully expect that the death of King Dollar marks a historic inflection point with regard to relative prices for so many things, real and financial.
If Only…the Fed could inject sufficient money into the system to inflate Capital Goods prices, while not inflating oil and import prices...
The November trade deficit surged to a much worse-than-expected and record $40.1 billion. And while the unloading of ships after October’s 10-day dock strike was a factor, the story here is an out-of-control trade situation, a maladjusted economy, and a faltering dollar. For the month, Goods Imports of $102.3 billion (up 14% y-o-y) were 76% above Goods Exports of $58 billion (up 3% y-o-y). Let’s take a look at December Goods Imports by category, keeping in mind that imports are surging because of both volume and price increases. Industrial Supplies were up 22.6% y-o-y, with Crude Oil up 51.6%. Consumer Goods were up 17.5%, with Pharmaceuticals up 17.5% and Apparel up 21.2%. Automotive was up 10.6% and Food & Beverage was up 10.3%. Capital Goods imports were up 6.9% y-o-y, with Telecom Equipment up 31.3%. Moreover, December data from the Ports of Los Angeles and Long Beach offer little encouragement. December year-over-year inbound containers were up 16% versus November’s 10.1%. During the month, a combined 475,048 inbound containers were unloaded, with 275,086 (58%) departing empty. The number of outbound empty containers was up 32% y-o-y.
“SLM Corporation, commonly know as Sallie Mae, today reported fourth-quarter and year-end 2002 earnings and performance results that include an 18-percent annual increase in…loan originations, resulting in a calendar year 2002 total of $11.9 billion.”
Fannie had quite a December. “Total Business Volume (total mortgage and MBS purchases) rose to $113.8 billion, the highest on record.” The previous record of $95.6 billion was set during November. Fannie’s Book of Business (retained mortgage portfolio plus guaranteed MBS held in the marketplace) expanded $40.5 billion during the month, a 31% annualized rate, to $1.82 Trillion. Fannie’s retained mortgage portfolio expanded $20 billion during December, a 59% annualized rate.
During the fourth quarter, Fannie’s Total Book of Business surged a record $78.44 billion, an annualized growth rate of 18%. Fannie’s Total Assets jumped a striking (and record) $49.5 billion, an annualized rate of 24%. For comparison, Total Assets increased $38 billion during the first three quarters of 2002. Also worth noting, the aggressive “reliquefication” efforts back in the fourth quarter of 1998 saw a record $30 billion asset growth. For 2002, Fannie’s Total Book of Business increased $256.2 billion, or 16%. To put this number into perspective, 1998 was the first year TOTAL U.S. home mortgage borrowings surpassed $250 billion. Fannie’s Total Business Volume (purchases) was up 38% last year to $849 billion. The company repurchased 15.4 million shares during 2002, up from 2001’s 6.0 million. During the past five years, Fannie’s Total Book of Business increased $925 billion (103%). Total Assets expanded $496 billion, or 127%.
Interesting comments from a Fannie Mae executive during Wednesday’s conference call: “It’s important to note that we serve a role in the financial markets of reducing systemic risk by absorbing some of the flows that you see coming through the marketplace. I think we’ve done that fairly effectively. I think that we do absorb some risk for our shareholders. We’ve tended to manage it effectively. We’ve tended to earn a good income from it over time, and still remain at a very, very low risk position. I think it’s an important role, not just for our shareholders. I think it’s an important role from a public policy standpoint. I think we done that again this year.”
When did playing central banker become part of the GSE mission? What are the systemic consequences for repeatedly putting “coins in the fuse box”? Whether their executives appreciate it or not, the reality of this endemic Bubble situation is that Fannie’s “very, very low risk position” is but a figment of imaginations; it will disappear as soon as their extraordinary growth slows. But at least the issue of the GSEs as central bank-style buyers of (first and) last resort is now out of the closet. This week, in a speech before the Exchequer Club in Washington, DC, Armando Falcon, (Director of The Office of Federal Housing Enterprise Oversight - OFHEO), made the following comment: “The Enterprises also provide liquidity and stability to the mortgage market by purchasing mortgage securities during periods of significant market turmoil. For example, in the Fall of 1998…”
OFHEO, with supposed responsibility for government-sponsored enterprise (GSE) regulatory oversight, has an impossible job. The GSEs are today much too big to fail; much too big to even slow down; and, hence, too big to regulate. Nonetheless, Mr. Falcon this week addressed many issues confronting the GSEs and made some cogent points. He recognized the “challenging” task ahead for the GSEs in their efforts to obtain sufficient derivative protection in the marketplace to hedge ballooning interest-rate exposure. However, it is our view that, as the GSE’s have come to dominate the markets, hedging operations have become little more than a ruse. And the deeper we get into the Great Mortgage Finance Bubble, the more heavily GSE risk is weighted to Credit losses rather than interest rates. In their (thus far) unfettered capacity to create money and Credit, the GSEs do exercise considerable influence over interest rates. However, this manipulation over many years has created an inflationary Bubble with unprecedented risk to sinking housing prices and Credit losses. Today, it is fair to posit that things have become so distorted that the GSEs have huge Credit exposure to even stable home prices. But there is no market for hedging systemic Mortgage Credit Risk.
Mr. Falcon also addressed another issue near and dear to our hearts: “The most significant benefit Fannie Mae and Freddie Mac enjoy is what many have described as the implied Federal guarantee.” In this regard, it is worth noting that agency spreads have now narrowed to the lowest level since pre-1998 financial crisis (when the risk profile of these institutions was a small fraction of what it is today).
Importantly, agency spreads collapsed after 9/11. Unprecedented Federal Reserve marketplace intervention rendered it incontrovertible that that the previous “implied” federal backing of the GSEs (and repo market?) had become explicit. This was an historic bestowment of financial power, with absolutely no effort by the Fed to bridle the almighty agencies. Instead, they were adopted as next of kin. This development has had a profound role in inciting the reckless terminal stage of Mortgage Finance Bubble excess, with the consequent lurch to incurable financial and economic fragility. It is simply difficult to comprehend that Fannie and Freddie have come to possess $1.6 Trillion of assets and $3.1 Trillion of total exposure.
As masters of the Great Credit Bubble – with its attendant acutely vulnerable Credit system and economy – the GSEs now have no alternative than desperate (non-productive) money and Credit inflation. This may appear “business as usual,” and is, apparently, good news for Fannie and Freddie shareholders. The system, however, is a huge loser. Many will continue painting GSE operations in a positive light, but it should be increasingly clear that these institutions have and continue to be the most responsible for our degraded currency. Being quasi-governmental lending institutions was always problematic. Having the Fed and Wall Street transform them to the status of quasi-central banks – with the incredible shift of power such status infers - is a true abomination. We live, after all, in a democracy, and neither the public nor our representatives legislated to establish a parallel GSE central bank. There should be explicit constitutional safeguards against such dangerous financial overreach and abuse of power.
We have discussed (ad nauseam) how the Fed, GSEs and Wall Street “structured finance” came to have mastered systemic liquidity creation. We now know that Fannie expanded its balance sheet by $50 billion during the fourth quarter, playing no small role in the newfound liquidity in the corporate bond market. Yet this week it appears that the marketplace came to appreciate that, unlike times in the past, it has serious issues to contend with beyond systemic liquidity. Indeed, years of Credit excess nurtured by (“coins in the fuse box”) liquidity operations have come home to roost with an unfolding serious dollar problem. U.S. savings are being devalued, as well as foreign savings held in dollar assets. Global financial markets have commenced a significant and uncertain transition, with potentially destabilizing financial flows and derivative issues. Those derivative players that have profited handsomely from writing (King) dollar protection will now be forced to earn (and dynamically trade for) their keep.
We should also expect that the battered major international super-banks/financial conglomerates have commenced a program to reduce exposure to dollar assets. And, importantly, the death of King Dollar has opened up an entire Brave New World of commodities, currencies, and other enticing markets for speculators and investors alike. For several years, King Dollar made for a one-way bet. The Fed and GSEs ensured inflated securities prices and a liquid marketplace. There was, then, little reason for global players to look beyond the U.S. Treasury, agency, mortgage-back, and “structured finance” markets.
Most importantly, this unending flow of speculative finance into U.S. securities (Recycling Bubble Dollars) for years buoyed the U.S. dollar, despite rampant and eventually self-defeating Credit excess and ballooning trade deficits. “Eventually” has arrived, and it is today not that bold to posit that the great dollar speculative Bubble is in the process of bursting. This will change EVERYTHING, including the efficacy of previous (bulletproof) liquidity operations.
The over-jubilant marketplace also this week came face to face with the harsh reality that unfolding Consumer Debt Problems were not magically cured by fourth-quarter “reliquefication.” Yes, the beleaguered corporate bond market – that had dislocated and was basically closed for business by early October – has been re-energized. Open up the Credit spigot to a negative cash-flow enterprise previously cut off from additional finance, and the impact can be enormous. But the issues today within consumer finance are much different. Unlike corporates, Credit Availability has not been the issue for consumer finance; the exact opposite. Accordingly, the liquidity onslaught and the drumbeat of “reflation,” so enamoring corporates, are basically non-issues for the over-borrowed consumer. In regard to consumer debt problems, “reliquefication” - and its powerful capacity to rectify Credit Availability issues - is basically moot. (And we don’t see higher oil and import prices benefiting stretched household finances.) The problem is that reckless consumer lending excesses have for too long driven spending, economic “growth,” and jobs creation. The unsound Consumer Debt Bubble is now faltering on its own weight and there is little anyone can do about this. If Only…the Fed could reflate household balance sheets and cure impaired lenders…
The acquisition by HSBC significantly reduced the systemic issues related to Household International. Yet the company still has a $100 billion plus loan portfolio we will monitor for indications as to the health of the U.S. consumer borrower. Looking at fourth-quarter data, things are not all too encouraging. Household’s “two-months-and-over contractual delinquency” jumped 42 basis points to 5.24% (Household saw a 51 basis point increase in December delinquencies, the worst performer of the major Credit card master trusts). By category, Real Estate Secured delinquencies increased 68 basis points during the quarter to 3.94% (up 126 bps y-o-y), Auto Finance 47 basis points to 3.65%, and Personal Non-Credit Card 52 basis points to 9.41%. In dollars, Total Nonperforming Managed Receivables jumped 25% during the year to $4.52 billion.
Over at AmeriCredit, things are quickly going from bad to much worse. The company reported a $27.6 million loss, quite a deterioration from the previous quarter’s $70 million profit. Combined delinquencies and foreclosures rose to 14.7% of managed receivables, up from the third quarter’s 12.2%. Total dollars delinquent actually rose about 24% during the quarter, while Total Charge-offs jumped 15% to $236.6 million. Year-over-year, charge-offs were up 82%. The fact that the company continues to lend aggressively and grow receivables makes the rapid Credit deterioration all the more alarming. Year-over-year, managed receivables were up 36% to $16.2 billion. Receivable growth has slowed, however, with the past quarter’s 2.9% (11.6% annualized) down sharply from the previous quarter’s 6.7% (26.8% annualized). Slowing growth is today's kiss of death for subprimie lending.
For those of us who have watched this company since its early days as a used car dealer in Fort Worth (U-Car-Co), it is rather incredible that near failure in the early nineties was transformed by Wall Street structured finance into a company with managed receivables of over $16 billion. We’ll stick with our view that subprime lending is not a viable business over the entire business cycle, and that the securitization and Credit insurance market have only transformed subprime into a bad business with much larger, systemic consequences. It is worth noting that behemoth Credit insurer MBIA jumped into the fray by providing insurance on a $1.7 billion securitization in October, MBIA’s first deal with AmeriCredit. The Credit insurers (and the holders of their insured bonds) will regret ever conjugating with subprime lending. What could they have been thinking?
From AmeriCredit’s CEO: “We’re seeing continued weakness in recovery values on repossessed vehicles and in the overall economy, causing increases in both loss severity and frequency.” If Only... the Fed could create sufficient money to “reflate” the value of used automobiles…
And if AmeriCredit’s numbers are dreadful, they are absolutely horrendous at Metris. December charge-offs actually jumped 264 basis points during the month to a rate of 21.25%. Charge-offs were up an amazing 469 basis points in two months. But, then again, this is what subprime lenders should today expect when they hit the wall and lose the capacity to extend additional loans (raise maximum lending limits) to their bad Credits.
And while continued aggressive lending is postponing the day of reckoning, the Capital One train wreck remains firmly on course. Fourth Quarter Net Charge-Offs surged 30.6% from the previous quarter to $896 million, as the charge-off rate increased from 4.96% to 6.21%. Similar to AmeriCredit, the degree of deterioration in the face of strong receivable growth is disturbing. Total Managed Receivables expanded 5% (20% annualized) during the quarter to $59.7 billion, with y-o-y growth of 32%. Yet charge-offs were up 73% y-o-y, with estimated dollars delinquent up almost 50%. The buoyant securitization market has been a lifesaver for sustaining needed lending growth. Total assets increased by less than $500 million (all financed by deposits!) during the fourth quarter, up only 1% quarter-over-quarter (y-o-y 33%). Capital One is today running frantically but barely staying ahead of a gritty pack of loan losses. It appears to us that Credit Problems hasn’t even broken a sweat.
After a week of perusing through dismal consumer Credit data and witnessing some key lenders’ seeming acceleration toward the proverbial wall, we are increasingly confident that the worst is yet to come for “Structured Finance.” And we just can’t shake our discomfort with the major Credit insurers’ exposure to subprime, CDOs, and various festering areas. There is also the issue of the alarmingly high yields states are beginning to pay to sell some types of bonds. Recognizing that municipalities will be very heavy issuers of debt for as far as the eye can see – and that the increasingly vulnerable Credit insurers are instrumental players in this arena – and the murky scenario of systemic issues inflicting muni finance becomes a little more coherent. It is going to be an interesting year.
As informed Barron’s readers appreciated again this past week, Marc Faber runs circles around his Roundtable counterparts. The depth of his knowledge and insight, as well as his fierce devotion to critical, independent thinking, is something us regular readers of his exceptional newsletter have come to take for granted. A few months back I wrote that the extraordinary environment confronting us had rendered his always valuable Gloom, Boom & Doom Report “invaluable.” Well, we have now become only more fortunate, as he shares his wealth of knowledge on markets, history, cycles, economics and humanity in his recently published book, Tomorrow’s Gold – Asia’s Age of Discovery. It’s a wonderful read that I strongly recommend. And especially as we witness the passing of King Dollar and the consequent historic transition to a reshaped, uncertain environment, to call Dr. Faber’s book “timely” is a gross understatement. His brilliant interplay of history, theory and critical issues of contemporary finance and economics creates a strikingly pertinent book. And as someone who puts his thoughts in writing on a regular basis, I must confess to being quite envious of his impressive mastery of the subject matter, not to mention his appealing writing style.
I could have pages of pertinent extractions, but I will entice you with just a brief one:
“Can the recession and the deflationary trend be corrected by massive reflation? According to Ropke, the fact, ‘that the credit expansion of the boom leads to overinvestment, provides at the same time a proof that the capital formation induced by credit creation, and the extension of production that it sets going, leads to a painful reaction expressing itself in the crisis and the depression.” This reaction can indeed be postponed by ‘a further increase of the credit supply but only at the price of a corresponding aggravation of the ultimate reaction. An ‘eternal boom’ is therefore out of the question.”
Or perhaps a selection of chapter titles may prove more seductive: A world of change; Major future investment themes; A caution about high-return investment expectations; Business cycles – Alive and well!; New eras, manias and bubbles; The economics of Inflation; The rise and fall of centres of prosperity; etc. Anyway, it’s a heck of a good book. And to think that so much valuable knowledge and insight can be had for about $30. What a gift! A big “Hats Off” and special thanks to our good friend Marc Faber! If Only…there were more of his kind around…
