It was another week of acutely unsettled financial markets. Despite considerable volatility, the Dow ended the week down 1.5% and the S&P500 about 1%. The Utilities dipped 1%. The Transports, Morgan Stanley Consumer, and Morgan Stanley Cyclical indices declined 2%. The small cap Russell 2000 dipped 1%, while the S&P400 Mid-cap index slipped less than 1%. The technology stocks were mixed. The NASDAQ100, Morgan Stanley High Tech, and The Street.com Internet indices declined 1%. But the Semiconductors added 2% and the NASDAQ Telecommunications index gained 3% (y-t-d gain up to 8%). The Biotech index declined 2%. The Securities Broker/Dealer index ended the week unchanged, while the banks lost about 1%. With bullion down $1.80, the HUI Gold index declined 2%. The Credit market seemed to go into “melt-up” mode this week, which will surely pump additional fuel into the Mortgage Finance Bubble. Two-year Treasury yields dropped 12 basis points to 1.48%, with five-year yields sinking 18 basis points to 2.66%. Ten-year Treasuries enjoyed their strongest weekly gain this year, with yields dropping 20 basis points to 3.69%. The long-bond saw its yield drop 17 basis points to 4.67%. Benchmark agency and mortgage-backs performed well, with yields sinking between 17 and 20 basis points. The spread on Fannie’s 5 3/8 2011 note was unchanged at 29, while the 10-year dollar swap spread widened 1.5 to 42. Corporate spreads widened moderately. Both the dollar and the CRB index declined slightly. With stockpiles at 20-month lows (“strong Asian demand”), Nickel prices are at the highest level since June 2000. Propane traded to the highest level “in at least 31 years.” Crude oil traded to 12-year highs this week. March Heating Oil traded above $1.15 gallon, the highest since heating oil futures began trading on the NY Merc back in 1978. February 26 – Bloomberg: “Copper prices rose to a 21-month high on signs of strengthening demand from China, which is vying with the U.S. to be the world’s biggest user of the metal, increased demand...an expanding Chinese economy has contributed to a 14 percent rise in copper prices this year. Chinese demand will rise 12 percent this year to 2.85 million metric tons… ‘There is strong consumption coming out of the Far East,’ said James Koppel, a managing director at SG Commodities Group… ‘If China continues its buying activity, it will be enough to offset some marginal increase, or decrease, in consumption in the U.S.’ This week saw continued robust debt issuance. Wells Fargo sold $1.5 billion of floating rate notes. JC Penney raised its deal to $600 million from $350 million. Healthcare Properties sold $200 million. El Paso Corp. received a $1 billion loan. A unit of Williams Company raised $175 million in the junk bond market. Occidental Petroleum raised $300 million, ANR Pipeline $300 million, Southern Natural Gas $400 million, and Chesapeake Energy $300 million (inflation in the energy sector “fueling” Credit creation?). In regard to the demand for the company’s $250 million 10-year notes, Potash Corp.’s CEO was quoted by Bloomberg: “I’m told it was excellent, substantially over-subscribed, north of $1 billion.” “Sales the past two months by more than 160 companies and sovereign borrowers… have brought year-to-date issuance in the U.S. to more than $129 billion, some 27 percent higher than in the same period in 2002, according to Bloomberg data.” And according to Merrill Lynch, Investment-grade debt returned 1.7% this month (up 6.74% since October 10th). Junk bonds earned 1% during February and are up 4% y-t-d. Junk bond funds were said to have received inflows of $1.5 billion last week, not far from the record $1.6 billion of inflows received in August (from AMG). Year-to-date junk issuance of $20 billion compares to last year’s comparable $11 billion. February 28 – Bloomberg: “Tax-free debt yields close to 35-year lows and New Jersey’s $1.65 billion tobacco bond sale made for the largest February ever for municipal bond sales, the second consecutive record month this year. Municipal bonds worth $26.84 billion were sold this month, according to the Bond Buyer newspaper, that’s up 28 percent from last year and eclipses the previous February record of $24.55 billion in 1998. January sales set a record of $23.39 billion in bonds for public purposes. Last year, public issuers sold $357 billion in bonds, the most ever.” February 26 – Dow Jones (Stan Rosenberg): “It took record long-term yields Wednesday to sell $1.65 billion of tax-exempt bonds issued by New Jersey’s Tobacco Settlement Financing Corporation. The bonds, backed by revenues from a settlement between 46 states and the four largest cigarette manufacturers, represented the largest offering among several major municipal bond issues priced. Those issues totaled about $2.8 billion… The New Jersey issue offered investors tax-exempt returns of up to 7.10% for bonds coming due in 2041, as well as 7.05% yields for securities maturing in 2039 and 2043, both the loftiest yields ever for securities backed by the 1998 pact… The market has been saturated with tobacco offerings, especially since budget-strapped states have turned to the use of non-recurring, or ‘one-shot’, revenue sources as short-term solutions to long-term problems. New Jersey is facing a $5 billion budget deficit for the fiscal year beginning July 1. All tobacco bonds, however, are backed by the same settlement and are viewed by professionals as essentially the same security… The result has been higher yields with each offering.” Broad money supply (M3) expanded $20.5 billion last week and is up $100.5 billion in five weeks. Since October (19 weeks), “money” has surged $254.3 billion, or 8.4% annualized. Since April (44 weeks), money supply has increased $519.7 billion, or 7.6% annualized. Last week by money supply component, Currency was up $1.4 billion, Demand Deposits $15.5 billion, and Savings Deposits $15.1 billion ($52.5 in two weeks). Savings Deposits have now expanded 20% y-o-y to $2.863 Trillion. Last week, Small Denominated Deposits declined $1.4 billion and Retail Money Fund deposits were up $0.8. Institutional Money Fund deposits added $3.2 billion, while Large Denominated Deposits were down $9.3 billion. Repurchase Agreements were down $0.9 billion and Eurodollars declined $3.1 billion. Elsewhere, Total Bank Assets jumped $41.4 billion last week. Securities holdings added $13.6 billion, with three-week gains of $58.2 billion. Loans and Leases declined $0.7 billion, with Commercial and Industrial loans up $2.4 billion and Real Estate loans declining $$9.9 billion. Over the past 52 weeks, Total Bank Assets were up 10.2% to $7.03 Trillion. Real Estate loans jumped $16.8% to almost $2.1 Trillion, while Commercial and Industrial (C&I) loans declined 6.6% to about $1 Trillion. Since May (41 weeks), Real Estate loans have expanded at a 20% rate, while C&I loans have declined at an 8% annualized rate. February 25 – Bloomberg: “Debt secured by credit card, airplane leases and other types of payments had a record amount of downgrades and defaults in 2002, as a slow economy hurt the ability of borrowers to make payments, according to Standard & Poor’s. Downgrades of so-called asset-backed debt more than tripled to 356 from 2003, while the number of issues upgraded declined by more than half to 39, S&P said. Defaults rose to 58 from 12 in the previous year.” February 25 – Moody’s: “While fewer corporate issuers defaulted on rated bonds in 2002, the total dollar volume of defaulted debt soared to over $163 billion, up from $106 billion in 2001, Moody’s Investors Service reported today in its 16th annual study of global defaults and ratings performance.” February 25 – Bloomberg: “Spiegel Inc., the owner of Eddie Bauer stores and the Spiegel catalog, was ordered by the Office of the Comptroller of the Currency to start liquidating its credit-card business. The company won’t meet requirements on two of the securities backed by the bankcard debt and is in danger of defaulting on a third that is backed by the credit-card receivables, according to a regulatory filing. The cards are issued by Spiegel’s First Consumers National Bank division... About 41 percent of its sales in 2001 were made with its credit cards. Spiegel agreed last year to either sell or liquidate the bankcard portfolio by April 30. Spiegel may not be able to repay the principle on the asset-backed securities that it is required liquidate if it doesn’t meet the targets and isn’t allowed to borrow more, it said in the Securities and Exchange Commission filing.” Today from St. Louis Federal Reserve President William Poole: “This is the most sound, lowest risk place in the world to place a buck… The Fed stands ready to respond vigorously and dramatically to upsets in the market, whatever they might be.” Keeping in mind our theme that economic imbalances are today a Key Credit Inflation Manifestation, we discern only greater regional disparities going forward. The Chicago Purchasing Manager index came in at a stronger-than-expected 54.9. This index was a 46.1 back in November and was in the upper-thirties during the first half of 2001. Prices Paid increased 0.7 to 54.9 and New Orders added one to 59. Production remains quite strong at 62.4. This report is consistent with the much stronger-than-expected 3.3% increase in Durable Goods Orders. But it’s a different story in New York. The February New York City Purchasing Management business activity index sank 17.4 point to 34.5, the weakest reading in 13 months. Curiously, the Non-manufacturing index sank 18.5 points to 33, while the Manufacturing index declined 8.1 points to 47.6. Prices Paid jumped six points to 50 (up nine points in two months). Elsewhere, the Milwaukee index added three to 53, the strongest reading since October. In our attempt to monitor global demand for U.S. securities, we pay close attention to the monthly Foreign Purchases and Sales of U.S. Securities report from the Treasury Department. December foreign-sourced purchases of $37.7 billion were down from November’s $69.7 billion. Demand for Agency Securities remains strong, accounting for 43% of December purchases. This compares to U.S. Stocks at 6%, U.S. Corporate Bonds at 35%, and Treasuries at 38%. Agency purchases were also the largest category for the year, with acquisitions of about $190 billion up 16% y-o-y. It is worth noting that Agencies and Treasuries combined for 52% of total foreign net purchases during 2002, up from the previous year’s 36%. For the year, U.S. stocks dropped from 23% to 9% and U.S. Corporate Bonds from 45% to 34%. This data is consistent with the U.S. financial sector bias. Lenders remain eager to finance mortgage and government borrowings, with relatively little interest in directing finance to sound investment (outside of the now Bubbling energy sector!). It is also worth noting that 64% of December's net acquisition and disposition of Agency securities internationally was from the Caribbean. Existing Home Sales were reported at a stronger-than-expected and record annualized rate of 6.09 million. To put this sales level into perspective, January sales were more than double the level from the dark days of the early nineties recession. January (annualized) sales were also up 40% from the pre-Bubble January 1997 level. And with both sales and average prices up 40%, total Calculated Transaction Value has almost doubled in six years to $1.24 Trillion (4.34 million units at $145,800 versus 6.09 million units at $204,000). January’s Calculated Transaction Value is up 8% y-o-y and 34% over two years. Conversely, New Home Sales were reported at a disappointing 914,000 pace. This was the weakest reading in a year, although sales were up 5.1% y-o-y. Notably, the inventory of New Homes continues to “build,” increasing 7,000 for the month to 346,000 units. This is the highest inventory since March 2001. Looking at the dollar value of inventories, we see a y-o-y increase of 12.4% and a 30% rise in less than two years. From the California Association of Realtors: “The robust momentum we witnessed in the California housing market throughout 2002 continued in January. The Median price of a home has increased by double digits for the last 14 months and shows no signs of abatement as we approach the traditional spring selling season.” There are two distinct California Housing Bubble stories. First, even the most inflated markets are apparently not giving up any air. Year-over-year, median prices are up 4% in Santa Clara, 6.4% in San Francisco, 7.5% in the Monterey Region, and 10.6% in Santa Barbara County. And while previous Bubble prices are sustained, the lower spectrums gain full Bubble status. Year-over-year, the Central Valley is up 22.2%, High Desert 17.7%, Los Angeles 18%, and Riverside/San Bernardino 20.9%. Prices are up 26.9% in San Diego, 25.6% in Sacramento, 21.9% in Orange County and 27.9% in North Santa Barbara County. For the state as a whole, y-o-y median prices are up $49,660, or 17.3%, to $336,740. This provides much inflated “equity” to extract during refinance or through a home equity loan, with all the ingredients in place for an interesting spring and summer for the Great California Housing Bubble. The mortgage refi application index jumped 10% to the highest level since mid-November, and remains more than double the year ago level. Perhaps weather related, but it is worth noting that Purchase applications dropped 7.5% to the lowest level since February 2002, and is now slightly below the year ago level. There were 28,724 bankruptcy filings during the holiday-shortened week. After four months of the fiscal year, federal finances could not appear more dismal. Fiscal year-to-date revenues are down a striking 8.1%. Individual Income Tax receipts have declined 9.4% to $306.5 billion, while Corporate Income Tax receipts are down 47% to $34.2 billion. Social Insurance and Retirement receipts are up 4.5% to $167.2 billion. At the same time, fiscal y-t-d Outlays have jumped 7.8%. With receipts and outlays in anomalous divergence, last year’s $98 billion y-t-d surplus has evaporated to this year’s $8 billion. By largest Outlay category, Health and Human Services expenditures are up 12.6% to $170 billion, Social Security Administration up 6.6% to $168.4 billion, Defense up 19% to $123.4 billion, Agriculture up 4.5% to $33.6 billion, Labor up 27.2% to $23.2 billion, and Veterans Affairs up 22% to $20.3 billion. Noteworthy increases from smaller departments include Emergency Management up 18%, Housing and Urban Development 10.2%, and Civil Defense up 14.6%. Year-to-date Interest payments on Treasury Debt have declined 2% to $131.4 billion. In last week’s Bulletin I made use of a thermostat analogy for describing how the seductive ease of managing Credit inflation can not only suddenly vanish, but quickly spiral out of control. “Then one day, somehow, it’s at the same time too hot and too cold; then it’s boiling hot in one room and freezing in the next. The small adjustments that always did the trick before have become impotent. Major alterations only exacerbate the extremes; and then things fall into disarray and beyond control.” To expand and clarify this analysis, over many years we watched the awe-inspiring power of slight changes in Fed interest rates (or hints of minor adjustments) evolve to the point where even an historic collapse in rates garners only a tepid response from the real economy (and has had no discernable impact on the stock market). During the boom, just the thought of a Fed rate cut would spur a speculative melee in the financial markets and almost instantaneously augment Credit Availability. This was the marvel of the contemporary securities-based Credit system. But nowadays, after years of Credit and Speculative Abuse, distorted financial and economic systems respond to stimuli much differently. First of all, the previously effective small rate cuts (minor adjustments to the thermostat) no longer incite heightened speculative response (after years of over-stimulation). There is, then, little marginal impact on general Credit Availability. Moreover, major rate cuts (big adjustments to the thermostat) today only tend to exacerbate the inflationary bias for sectors already affected by profligate Credit Availability (“Liquidity Loves Inflation” – with thermostat adjustments making the hot rooms only steamier). We see such dynamics at work today throughout the manic mortgage finance super-sector, impacting home values, and certainly agency and mortgage-backed securities prices. Additionally, mortgage Bubble-induced trade deficits are increasingly recycled directly back to agency and mortgage-backed securities in the circular Bubble of Structured Finance. At the same time, other sectors suffering various degrees of post-Bubble depression (such as the stock market, technology industry or, perhaps, even the goods sector) remain generally numb (“deflationary” bias) to even enormous systemic Credit and speculative stimulus. Much to the detriment of the already distorted system, the amount of Credit necessary to stimulate these despondent sectors exacerbates and tends to grossly disturb the manic sectors. If the operator of the thermostat is fixated only on the cold rooms, there’s going to be some awfully sweltering rooms and a very heavy cost to keep the home heated. After years of Credit inflation and its cumulative distorting effects, enormous and unrelenting Credit excess is required to generally stimulate (stabilize) the maladjusted U.S. economy. Some inflating sectors (the California Housing Bubble or healthcare, for example) ripen into absolute Credit Gluttons, much at the expense of other regions and sectors. Other fledgling inflation beneficiaries (such as the energy sector) spring to life with increasingly crazed appetites for Credit (again at the expense of the post-Bubble depressed). Manifestly, the amount of gross excess necessary to stimulate the imbalanced and generally despondent real economy provides jet fuel to the inflating speculative Bubble in the U.S. Credit market. There is no way around the fact that, at this stage and going forward, Credit inflation will spread quite unevenly through the real economy sphere. It will also surely further exacerbate dangerous excesses and instability throughout the financial sphere. We view Credit Inflation Manifestations in the financial sphere as The Big Unexplored Story. There is also the critical issue of our authorities (and the U.S. financial sector) striving to sustain inflated boom-time consumer demand, with resulting over-consumption and ballooning trade deficits. Today, an enormous amount of Credit inflation is “exported.” We see this as a case of further risky expansion of the U.S. financial sector that provides little benefit to the faltering Bubble economy. And that the marginal consumer borrower is today a very weak Credit ensures only poorer U.S. financial asset quality and eventual impairment. Less conspicuous but no less important, we also see this Credit inflation funneling additional finance to the irrepressible global Leveraged Speculating Community. Surging (and hyper-volatile) energy, Gold, and general commodity prices are an obvious Manifestation. This “funneling” was for some time seductively agreeable, as speculative flows were immediately and painlessly “recycled” back to the inflating U.S. equity and bond Bubbles. Credit surged, the markets rose, the economy boomed and the dollar excelled. Self-reinforcing speculative flows were largely responsible for The Grand Illusion of Immortal King Dollar, impervious to even gross Credit excess and severe economic impairment. But, in the end, this Illusion was dangerous and self-defeating – speculation-induced market distortions coming home to roost. Going forward, we expect the ballooning “export” component of U.S. Credit inflation to provide increasingly unwieldy Inflationary Manifestations. It is worth repeating that I view the demise of King Dollar as a critical inflection point in financial and economic history. Following a pattern similar to other major bull markets, it is ending in one final wild and destructive period of Credit and speculative “blow-off” excess. Resulting U.S. financial and economic sector impairment will linger for years. At the very minimum, the faltering dollar marks a critical juncture for the nature of Credit Inflation consequences. Namely, it ushers in an environment of only greater financial market and economic instability - erratic prices for things real and financial, at home and globally. And with one eye on the energy markets, we see support for the notion that a faltering currency sets in motion self-reinforcing (Credit-induced) Inflation dynamics. In a week that saw a 30% one-day spike in natural gas prices and crude surge to 12-year highs, it is fair to say that commodity prices are garnering increased speculative interest (“animal spirits”). We see this as further confirmation of a sea change in inflation psychology, for commodities, currencies, and other things non-dollar. Not only will the speculators be keen to rising prices, evolving market psychology will alter behavior in the real economy. We have read recent reports that the Chinese are considering establishing a petroleum reserve, as well as being aggressive purchasers of cotton, copper and other commodities. Global producers are now keen to the risk of depleted inventories of fuel and basic commodities. Gold producers and speculators will now think twice before shorting the shiny metal. Many will come to see the value of holding real gold, crude oil, natural gas, cotton, platinum, and such, as opposed to futures contracts or derivative hedging instruments. We would expect only heightened interest – speculative and investment - in acquiring things real; and the less elastic the supply the more appealing. As such, we suspect the relative allure of holding (too easily inflated) things financial, especially claims denominated in dollars, will only dim. With such profound changes in market psychology in the works, we should expect great uncertainty and instability, especially following history’s greatest Bubble in dollar financial assets. We must then ponder what this all means for the “fabricators” of and “intermediaries” for the ever-inflating mountain of U.S. financial assets. As often discussed, we have reached the stage where it requires massive and unrelenting Credit excess to maintain the dangerous U.S. financial and economic Bubbles. We also appreciate that “Structured Finance” has come, by necessity, to dominate the Credit creation process. Only this mechanism could today possibly transform the massive quantities of risky loans into highly-rated securities palatable to the marketplace. Structured Finance has won command of the U.S. “money” and Credit system by default – by Bubble necessity – with unknowable but quite disconcerting consequences. Indeed, a paradoxical and problematic environment for “Structured Finance,” hence the U.S. financial sector and dollar, is now coming into clearer focus. Structured finance exists based upon an immutable reliance on historical data, statistical analysis, sophisticated modeling, and the rather predictable forecasts that the future will be much like the past. Uncertainly is basically taken out of the equation. Yet, presuming the arrival of an historic financial and economic inflection point, we see the past as providing only comforting deceptions for an especially uncertain and problematic future. Importantly, the unending Credit excess now required to keep the U.S. financial and economic wheels from seizing up ensures atypical and especially unpredictable outcomes. Uncertainty now reigns supreme. We wouldn’t want to be a writer (insurer) of Credit protection or financial risk these days… Similar to the recent spikes in California and New York home values, this week’s surge in energy prices should be recognized as evidence we have commenced a period of even greater financial and economic instability. Furthermore, these types of extreme price gyrations are anathema to writers of derivative protection, the Credit insurers, and financial risk intermediaries generally – the very parties directly responsible for fueling the destabilizing Bubble. While not especially unambiguous, Structured Finance and general financial system disarray have become A Key Contemporary Inflationary Manifestation. It remains my view that Structured Finance and the dollar are now irreversibly linked to each other. They are also both hostage to the Credit Bubble. Granted, the dollar has suffered a meaningful decline with little appreciable impact on the U.S. financial sector or securities markets. Interest rates have remained in steady decline, spreads have narrowed sharply, and liquidity flows (overly) abundant. Importantly, inflating prices have thus far considerably offset currency losses for our foreign creditors. But we see all of this as a Bubble anomaly and part of the same issue – and key to an amazing financial puzzle. My analysis leads me to believe that it is actually the massive Credit creation husbanded by Structured Finance that is largely responsible for the flood of liquidity that continues to inflate debt securities prices. It is, then, an enormous expansion of financial sector liabilities (financial Credit) fueling the self-reinforcing Ultimate Bubble throughout the U.S. Credit market. But what would it take for “virtuous cycle” to become “vicious spiral”? Well, we think the combination of a faltering dollar, rising yields and widening spreads would not be well-received by our foreign-sourced financers. With this in mind, we suspect that this gigantic Bubble is today acutely vulnerable to any reduction in U.S. financial sector expansion/liquidity creation. Yet, the amount of unrelenting dollar financial asset Inflation now required to sustain the Bubble is today increasingly fomenting a change in market perceptions – stoking inflationary psychology for things non-dollar. There will come a day when a major adjustment in U.S. debt securities values will be unavoidable - either lower prices (higher yields) or a devalued dollar (much higher prices for things non-dollar). This is a major problem- the proverbial Catch22 – that leads us to believe that complacency with respect to the dollar is unjustified. Today, one need look only to unparalleled mortgage Credit growth for the major source of systemic liquidity creation. This is problematic on many levels. It is simply incredible that the American household sector is taking on record amounts of debt at this very late stage of the Bubble. For the real economy this fosters only greater maladjustment; for the financial sector, only weaker debt structures and acute financial fragility. While the Mortgage Finance Bubble did sustain the system through the bursting of the Technology and stock market Bubbles, it has absolutely buried the consumer sector in debt. And despite an elongated mortgage refi boom, we see increased evidence of serious cracks in the foundation of consumer finance. Structured Finance single-handedly transformed subprime (credit cards, auto, mortgages, motor cycles, boats, facelifts, etc.) from an odd peripheral player to the powerful Credit mechanism financing the marginal buyer sustaining the vulnerable U.S. Bubble economy. And despite the predictable serious troubles now asphyxiating subprime Credit cards and auto finance, reckless excess runs out of control in subprime mortgage lending. That the major Credit insurers have significant exposure to subprime is today a developing issue. That subprime mortgage excess is sowing the seeds of its own destruction is also not in doubt. An unparalleled consumer borrowing binge may have mitigated the corporate debt crisis, but there will be no similar expedient to rescue the over-borrowed U.S. consumer. What's more, Inflationary manifestations such as surging fuel, healthcare and insurance costs will only play a greater role in hastening unfolding consumer debt problems. General financial and economic instability will also be increasingly debilitating for the household sector. And we do expect the eventual piercing of the consumer debt Bubble to severely impair the Structured Finance Monetary Regime, leading to the “vicious spiral” of faltering Credit availability, reduced Credit creation, faltering systemic liquidity, and perhaps a problematic run on dollar assets. How quickly the market discounts this eventuality is today unknown. Importantly, it is our view that consumer finance has supplanted corporate finance as the weakest link in the financial daisy chain. Structured Finance is now clearly in the crosshairs, and it difficult to envision a scenario where the dollar does not face severe problems in the not too distant future. Psychology is changing and so are Key Inflationary Manifestations. Instability Abounds. |
Wednesday, September 3, 2014
02/28/2003 Key Inflationary Manifestations *
02/21/2003 Fiat Money and Credit Inflation in America *
Temporary perhaps, but the bulls used a semblance of a lull in escalating geopolitical tensions to gain some ground. For the holiday-shortened week, the Dow, S&P500, Utilities, Morgan Stanley Consumer and Morgan Stanley Cyclical indices all gained around 1.5%. The Transports lagged, ending the week about unchanged. The broader market advanced, with the small cap Russell 2000 adding 1.6% and S&P400 Mid-Cap index gaining an impressive 2.7%. The tech sector enjoyed another solid performance and is beginning to distance itself from the field. For the week, the NASDAQ100 jumped 3.4%, the Morgan Stanley High Tech index 3.7%, and the Semiconductors 4.6%. The Street.com Internet index gained 3.5% and the NASDAQ Telecommunications index rose 2.7%. The NASDAQ100 now sports a y-t-d gain of 3.2% and the NASDAQ Telecom index almost 5%. For the week, the Biotechs added 2%. The financial stocks posted solid gains, with the Securities Broker/Dealer index up 3% and the Banks almost 2%. With bullion down 40 cents, the HUI gold index was about unchanged.
Rallying stocks and a startling surge in wholesale prices failed to unnerve the Credit market. For the week, two-year Treasury yields declined two basis points to 1.60%, with five-year yields declining seven basis points to 2.85%. The 10-year Treasury yield dipped six basis points to 3.89%, while the long-bond saw its yield decline four basis points to 4.84%. Benchmark mortgage-backs and agency debt performed well, with yields generally declining 8 basis points. The spread on Fannie’s 5 3/8 2011 note narrowed almost two to a notably narrow 29. The 10-year dollar swap spread dropped 1.5 to 40.5, and one must go all the way back to August 1997 to see the last time this spread traded below 40. Corporate spreads were generally stable this week. Heightened inflationary pressures are apparently good news for those calling for “reflation” and playing the corporate spread game. The dollar ended the week about unchanged.
The holiday (and inclement weather) made for a somewhat slower week of corporate issuance. Wal-Mart issued $1.5 billion of debt, Morgan Stanley sold $2 billion of 10-year bonds (147 bps over Treasuries), American Express $750 million of notes, Deutsche Bank $800 million of notes due 2015 (158 bps over Treasuries) and Duke Energy sold $500 of 5-year notes (100 bps over Treasuries). Citgo sold $550 million of junk debt, although at yields considerably higher than initially expected. MBNA issued $500 million of 10-year notes to yield 6.134%, 225 basis points over Treasuries. Morgan Stanley also sold 850 million of 7-year euro-denominated bonds this week and was joined by Bank America which issued 1 billion of 5-year euro debt. Russia’s largest company, Gazprom, enjoyed bids of $6 billion for its sale of $1.75 billion of 10-year bonds (another example of heightened inflationary pressures – in this case rising energy prices – fostering Credit growth).
Broad money supply (M3) declined $7.5 billion last week. With Demand and Checkable Deposits declining $23.2 billion, M1 gave up recent strong gains. Savings Deposits surged $37.5 billion, Small Denominated Deposits dipped $1.8 billion and Retail Money Fund deposits declined $3.3 billion. Institutional Money Fund deposits dropped $19.2 billion, while Large Denominated Deposits added $2.3 billion. Repurchase Agreements and Eurodollars declined slightly. Foreign Holdings of U.S. Debt Securities increased $4.7 billion. Total Commercial Paper (CP) borrowings declined $6.7 billion ($21.3 billion over two weeks), with total Financial sector issuance down $11.2 billion. Non-financial CP borrowings increased $4.5 billion. Elsewhere, Bank Total Assets declined $6.1 billion following the previous week’s $71.6 billion surge. However, Bank Credit advanced $19.9 billion. Securities holdings were up $10.6 billion (up $44.8 billion in two weeks) and Loans and Leases gained $9.2 billion. Real Estate loans were up $12.2 billion (up $35.1 billion in three weeks), while Commercial and Industrial loans declined $1.8 billion (down $9.4 billion over three weeks). Bloomberg’s year-to-date tally of U.S. Domestic Debt issuance now stands at $319 billion (up 37% from the comparable 2002 period). Over $10 billion of ABS was issued this week.
Weekly bankruptcy filings were 29,931, up 9% y-o-y. MasterCard is estimating 2003 bankruptcies at 1.652 million, 5% above 2002’s record. After the big November and December post-strike catch-up, January’s imports into the ports of Long Beach and Los Angeles slowed somewhat to a still strong 432,867 containers. This was up 11% y-o-y. Notably, export containers were up 6% y-o-y, the best performance since May. All the same, outbound empty containers were 59% of full inbound containers.
Yesterday’s economic news was especially dismal. The December Trade Deficit shot up to a record $44.2 billion, 14% above the consensus forecast. The deficit, now running completely out of control, was up an eye-opening 62% year-over-year, with a 2002 trade gap of $435.2 billion. The intractable deficit was up 21.4% for the year and an incredible 300% from the $108 billion deficit recorded during pre-Bubble – and not that many years ago - 1997. For the year, our deficit with Canada was $49.8 billion, Mexico $37.2 billion, Western Europe $89.2 billion, the Pacific Rim $215 billion, South/Central America $17.9 billion, and OPEC $34.5 billion. 2002 Imports from China surged 22.4% to $125.2 billion, while Imports from Japan declined 3.9% to $121.5 billion. Imports from Canada decreased 2.6% to $210.6 billion, while Imports from Mexico increased 2.6% to $134.7 billion.
Compared to year ago levels, December Goods Imports were up 20% to $103.9 billion, as exports inched up 1% to $55.6 billion. For December, Goods Imports were 87% greater than Goods Exports. Amazing. By Import category, Capital Goods were up 9.9% y-o-y in December (telecom equipment 25.3%, Semiconductors 8.2%), Industrial Supplies 35% (crude oil 59.6%), Consumer Goods 25.3% (pharmaceuticals 62.5%, apparel 23.6%), Automotive 14.5%, and Services 17.9%. By Export category, Capital Goods was down 5.6% y-o-y (telecom equipment down 29.7%) and Consumer Goods declined 2.4%. Industrial Supplies Exports jumped 10.5% (price increases), Automotive was up 6.6%, Food & Beverages increased 8%, and Services were up 2.7%.
Recent comments from Treasury Secretary John Snow on the U.S. current account deficit: ‘At the current levels of the current account deficit, I’m not particularly troubled by it. It’s something we should keep our eye on, but it’s the $400 billion annual or so that it’s running is really a small part of the size of the total US economy and is certainly manageable… What it really means in its simplest terms is that Americans value the world goods more than they value the dollars that they’re expending to get those goods. At some point, people can run into too much debt, I grant you that.’” (Especially after yesterday’s monster of a trade deficit, we suggest our new Treasury Secretary go back and check his math. We see current account deficits soon surpassing 5% of GDP. The alarm bells are sounding.)
February 20 – Bloomberg: “U.S. state and local governments face mounting losses on interest-rate swaps they entered to pay off variable-rate debt, Standard & Poor’s said. The transactions involve selling bonds with interest rates that change every few days or weeks, giving access to the lower rates in the short-term debt market. The swaps, agreements to exchange fixed- for variable- rate payments on the bonds’ principal, were meant to guard against rises in short-term rates. Instead, the swaps have exposed state and local governments to another financial risk, said Peter Block, a director at S&P. ‘Issuers in the last two years have taken a gamble that they would be hedged, and they’re not.’ The risk resulted from assumptions about the index on which the swaps were based. State and local governments often use the London interbank offered rate, or Libor, a benchmark set by three-month U.K. bank loans.”
February 19 – Dow Jones (Stan Rosenberg): “While ratings of cities have been more stable than those of states over the past 12 to 18 months, cities will face more fiscal pressure in the future as the economic recovery remains sluggish, rating agency Standard & Poor’s said…Budget-strapped states, no longer able to defray revenue shortfalls, are by necessity, ‘passing the pain to municipalities.’ The city of Atlanta, dropped to double-A-minus from double-A, represented S&P’s only downgrade among the largest cities since January 2002. During the same period, just two cities - single-A-rated New York and triple-A Dallas -had their outlooks revised to negative from stable. But that situation won’t last, S&P said. ‘For cities, rising health care costs, homeland security, underperforming pensions and multi-year wage contracts will continue to pressure budgets…Strong steady growth in state aid is leveling off and in some instances declining.’”
Week 35 of the Great Mortgage Finance blow-off saw refi applications about steady at 180% of the year ago level. Purchase applications were up 6% for the week (up 14% y-o-y). Golden West Financial’s mortgage portfolio expanded at a 13% annualized rate during January, with a notable 90% of originations consisting of adjustable rate mortgages (Feeding the Great California Housing Bubble). January Housing Starts were reported at 1.85 million units, four percent above the consensus forecast to the strongest level since May 1986 (1.854 million). Led by a major construction boom in the West (California), national Single family Starts were up 13.1% y-o-y to the highest rate since November 1978. Single-Family Starts were up 40.3% y-o-y in the West, 19.4% in the Midwest, and 2.9% in the South. Unusually cold weather was blamed for the 15.6% y-o-y decline in Northeast Single-family Starts. 2002 Housing Starts of 1.706 million were up 6.4% from 2001 to the highest level since 1984. January Building Permits were up 6% y-o-y (1.781 million), with Single-Family Permits up 9.1% y-o-y. The West reported y-o-y Permits up 32.4%, while Northeast Permits were down 12.9% y-o-y.
February 18 - Minneapolis Star Tribune (Jim Buchta): “After more than 15 years working for boom-and-bust Silicon Valley technology companies, Sonia Armstrong couldn’t hack it anymore. So she pursued a job with a more certain future: Selling subprime mortgages for Wells Fargo.” In my mailbox this week arrived a “No Down Payment? No problem” promotion from mortgage company Assistance for America. This is a division of Renaissance Acceptance Group, previously Cardiac Control Systems that filed for bankruptcy in 1999. Lots of folks working to profit (and find a new lease on financial life) from the Great Mortgage Finance Bubble…
Wednesday’s Wall Street Journal: “If Fan and Fred were completely private financial institutions - with no government guarantee, implicit or explicit - they would have to almost double their capital to more than $99 billion from $52 billion now. And even that increase would only bring them to the minimal capital that banks must maintain for mortgages, but perhaps still short of earning a AAA rating. The result? Return on equity would fall from 25% to 12% or 13%, which is what comparable banks earn, thus transforming Fan and Fred into much less profitable financial companies.” (The Journal’s ruminations recall for me an old Saturday Night Live bit, “The Bears.” “Hey, who’d win if (Chicago Bears’ coach Mike) Ditka took on Godzilla?”)
February 19 – Bloomberg: “Conseco Inc. is asking a bankruptcy judge to release its finance unit from servicing $23 billion in mobile-home loans, saying uncertainty about the money-losing agreements threatens the unit’s sale. Conseco Finance says in a court filing it was losing $15 million a month on agreements to manage loan-payment collections before the Dec. 17 bankruptcy filing… The loan portfolios have been a ‘monumental distraction,’ Conseco Finance says in an emergency filing with U.S. Bankruptcy Court in Chicago… The Federal National Mortgage Association, which holds $7 billion of certificates on the mobile home loans, has objected to Conseco Finance’s request, saying the servicing is a valuable asset.”
February 20 - Dow Jones (Dawn Kopecki and Eric Ahlberg): “Mortgage finance company Fannie Mae placed a $70 million bid Wednesday for the servicing rights to $23 billion in manufactured-housing mortgages in the bankruptcy of Conseco Inc. Trouble with Conseco Finance’s money-losing mobile home mortgage portfolio helped propel its parent company into Chapter 11 bankruptcy protection… ‘We did this to resolve an impasse in the court over the disposition of the manufactured housing servicing platform in bankruptcy,’ said Fannie Mae spokeswoman Janice Daue… Conseco Finance is the largest servicer of manufactured-housing contracts in the U.S. with more than 55% of the entire market. The unit is scheduled to be sold off at a Feb. 28 auction with the final sale hearing set for March 5. Bear Stearns & Co. and General Electric Capital Corp., a major competitor of Fannie Mae’s in the secondary mortgage markets, have been named as potential bidders for the finance unit. Fannie Mae is the largest beneficial holder of roughly $10 billion of Conseco Finance’s asset-backed manufactured-housing certificates.”
So, Fannie has interest in somewhere between $7 billion and $10 billion of the $23 billion of Conseco securitizations (recalls rumors back in the tumultuous fall of 1998 that Fannie was acquiring entire Conseco (and other) securitization deals before they were offered in the marketplace.) And Fannie may dive headfirst into the mobile home loan servicing business? Oh, what a tangled web…and sliding only more quickly down the slippery slope of subprime (with the Credit insurers).
February 21 - Dow Jones: “FM Watch, the anti-Fannie Mae/Freddie Mac coalition, said with respect to Fannie Mae’s bid to enter the mortgage-servicing business that it ‘plans to take appropriate action to make sure that this incursion is stopped.’ ‘Fannie Mae’s decision to enter the mortgage servicing business through this maneuver is the perfect indication of just how far Fannie has strayed from its original mission of providing liquidity to the secondary mortgage market for conventional mortgage loans.’”
February 20: “Fitch Ratings places the ‘A’ medium-term notes rating, ‘A-‘ preferred stock rating, and ‘F1’ commercial paper rating of Countrywide Home Loans, Inc. Rating Watch Negative. Fitch also places the ‘A’ convertible debentures rating of parent company Countrywide Financial Corp. (CFC) on Rating Watch Negative. Over $18 billion of rated debt is affected by this action. Today’s action is due to concerns within Fitch regarding the increasing risk of impairment that is present within mortgage banking companies’ balance sheets. This risk is particularly prevalent for those companies that have significant business concentrations in mortgage banking, such as CFC, with high levels of capitalized mortgage servicing rights (MSRs) as a percentage of equity. At initiation, MSRs are derived from the present value of expected future income to be received over the expected life of the mortgages. The value is based on assumptions regarding prepayment rates, discount rates, ancillary fees, and costs to service.” Countrywide’s servicing portfolio has surged to $469 billion, a cause for concern considering issues raised post-Conseco’s collapse.
February 18 - Dow Jones (Agnes T. Crane): “While everyone from Federal Reserve Chairman Alan Greenspan to the nation’s largest purchaser of home mortgages insist there is no national housing bubble in the U.S., percolating hot spots in regional residential real estate markets are cause for concern…According to a recent study by TimesSquare Capital Management…‘a number of major housing markets are vulnerable to severe price declines, due to a troublesome combination of above-average appreciation in recent years and growing unemployment.’ The study highlights a number of metropolitan areas that have experienced higher home price rates from the first quarter of 1997 to the third quarter of 2002 that were well above the national average of 42%. For example, New York City home prices rose 67% in that period, Jersey City, N.J., increased 75%, Boston, 69% and San Francisco, 88%…”
February 17 – Financial Times (Sheila McNulty): “The debt crisis in the US gas and power sector continued to grow over the past year and has become more acute, with $477.6bn in outstanding borrowings, research commissioned by the Financial Times reveals. The energy traders are responsible for a large portion of that debt, according to SNL Financial, an independent research firm that says $116.65bn of the sector’s debt is held by what - pre-crisis - were the top nine traders, companies such as Dynergy and El Paso, both Texas-based, and Duke Energy of North Carolina.”
In the category “just couldn’t leave well enough alone,” Barron’s Gene Epstein has returned to his “the consumer is in great shape” disinformation campaign. It’s all so tiring… We suggest that he refrain from his “debt service as a percentage of income” fixation and look deeper than this one clearly deceiving ratio (again, it’s too similar to how Bubble-induced earnings growth was used to justify exorbitant P/E ratios). There is no denying or muddling the fact that Household Sector Debt is up more than 110% during the past decade. And, fueled by unprecedented mortgage borrowings, total Household debt growth has been accelerating. To illustrate: Household Sector borrowings increased on average $71 billion per quarter during the first eight years of the nineties. But during the past 19 quarters, average quarterly borrowings have jumped to $138 billion (reaching $199bn during the third quarter and $185bn for 2002 Q2!). It’s not a “debt service” issue, but an issue of sustainability. And we suggest that Mr. Epstein take note of the unfolding subprime collapse (the marginal consumer borrowers and lenders) and follow the experiences of NextCard, Metris, AmeriCredit, Conseco and others. All is well in consumer finance? And just wait until the Mortgage Finance Bubble blow-off runs its course… And, most importantly, don’t disregard that it is specifically unparalleled consumer Credit excess that is the fuel behind the much-trumpeted income growth – household income expansion that is conveniently used to justify rising consumer debt loads. It’s self-reinforcing and unsustainable, and exactly why they’re called Bubbles…
Credit card behemoth MBNA financial shook a bit of confidence when it reported that managed net loan Credit losses jumped 41 basis points during January to 5.59% (up 46 basis points y-o-y). Delinquencies were up another 12 basis points to the highest level in twelve months. Other managed Consumer (non-Credit card) losses were reported at 8.46%, with delinquencies at 6.11% (this detail was provided for the first time).
February 19 – European Central Bank: “In the third quarter of 2002 the annual growth rate of financing of the non-financial sectors in the euro area decreased to 3.9%, down from 4.1% in the previous quarter and from 5.5% one year earlier. The corresponding growth rate of debt financing was 4.7%... The annual growth rate of debt financing by households increased slightly, from 5.8% in the second quarter of 2002 to 6.1% in the third quarter…”
February 19 – Washington Post (Jonathan Weisman): “President Bush will sign legislation this week setting a 2003 budget that raises federal spending by 7.8 percent over last year, capping a remarkable two years in which the federal budget increased by 22 percent. Although Bush has made controlling spending a recurring theme in recent months, the $791.5 billion spending bill for 2003 that he plans to approve by Thursday night will be one for the record books. The 2003 rate of discretionary spending increases -- the part of the budget subject to Congress’s annual oversight - will be the second-fastest since 1985. It is topped only by the 2002 increase… The government has not experienced a two-year leap in spending of this magnitude since expenditures jumped 24.5 percent between 1976 and 1978. ‘We have a long way to go to, quote, rein things in,’ said G. William Hagland, budget adviser to Senate Majority Leader Bill Frist.”
Certainly not unrelated to ballooning mortgage borrowings and (trade and fiscal) deficits, we see evidence of intensifying inflation manifestations in the strongest increase in Producer Prices since 1990. Wholesale price jumped 1.6%, compared to a sanguine consensus forecast of 0.5%. The core PPI (ex food and energy), jumped 0.9%, the strongest gain since December 2000. Pricing pressures were strong throughout, with Finished Goods up 1.6%, Intermediate Materials up 1.3% and Crude Materials up 6.9%.
February 20 – Fannie’s Franklin Raines: “In 2002 we think mortgage originations were about $2.6 trillion. We think they’ll be about $2 trillion this year. That’s a lot. I never thought in my lifetime I’d see $2 trillion worth of mortgages originated. Overall it will be a good year for the mortgage business… I don’t think there’s a danger of inflation…What we know is that for the average person a strongly growing economy is more important than anything else. I’m in favor of stimulus and enough stimulus to really get the economy moving to soak up this excess capacity as soon as possible…”
It feels rather silly nowadays to refer to the eighties as the “Decade of Greed.” Like NASDAQ, the GSEs, mortgage finance, and shopping malls, we appreciate today that what appeared at the time gross excess ended up looking quite feeble in comparison to the “blow-off” excesses that were to follow. But our focus on Fiat Money and Credit Inflation in America demands that we return briefly to the 1980s. Of course, we should really commence our analysis with the sixties (“guns and butter”) inflation, the consequent collapse of dollar gold-convertibility, and the resulting 1970’s (“garden-variety”) inflation surge. But, for our purposes this week, let’s set our sights on the cutting-edge, uncommonly seductive (“non-garden…”) strain of Credit inflation that began to take root in the period 1984 to 1989. Over this six-year period, total Credit Market Debt outstanding surged 72% to $12.8 Trillion. Importantly, this bout of Credit inflation was all-encompassing and uniform. We see that Total Mortgage Debt jumped 69% to $3.56 Trillion, Non-financial Corporate debt 67% to $2.4 Trillion, and Federal Government debt 65% to $2.25 Trillion. Structured Finance was in its thriving infancy, hardly stymied by its prominent role in the ’87 Crash.
And despite brief fears of a potential post-’87 stock market crash depression, subsequent (Greenspan, along with the Japanese and global central bankers) “easy money” propelled the U.S. and global industrialized economies into a robust late-decade inflationary boom (to which the Japanese are still suffering and the U.S. eagerly sustaining). With the advantage of hindsight - and after witnessing the extraordinary developments transpiring since – we now realize that the general economy had not by late (post-crash) 1987 suffered from the type of prolonged period of maladjustments that create vulnerability to economic depressions. Additionally, and of momentous importance, the Credit system had not regressed to the type of derangement capable, over a period of years, of creating the colossal and fragile debt structures susceptible to collapse. Monetary Processes dominated by speculative financial flows were not yet indelibly entrenched.
Yet by 1990, previous inflationary distortions, that culminated with the rampant Credit inflation and financial excess of 1988/89, had left the financial system and economy acutely susceptible to severe problems. Facing an insolvent (and imploding) S&L industry, a collapsing junk bond market, the coastal real estate inflations turning problematic busts, the residual of the oil patch inflationary boom and subsequent bust, and an increasingly impaired banking system, there was (as we have often discussed) real risk of financial and economic collapse in the early nineties. The economy was already at this point desperate for another inflationary jolt, but the banking system was in dire straits and largely incapacitated. Not to worry. With Alan Greenspan quite eager, the rapidly ascending Wall Street Money and Credit Inflation regime was more than willing to capture and resolutely clutch the monetary reins. An historic inflationary jolt was delivered – more powerful and intoxicating than anyone could ever have imagined.
The Roaring Nineties can be viewed as the Decade of Structured Finance. From the beginning of 1993 through 2002’s third-quarter, GSE assets were up $1.9 Trillion, or 345%, mortgage-backed securities $1.8 Trillion, or 143%, and asset-backed securities $1.89 Trillion, or 465%. Since the end of 1992, ballooning broad money supply doubled to $8.55 Trillion. As a percentage of GDP, total “Structured Finance” financial claims/Credit creation (GSE assets, and outstanding ABS and MBS) jumped from 35% to 75% ($2.23 Trillion to $7.84 trillion). Inarguably, we have witnessed truly one of history’s great Money and Credit Inflations. Its unusual nature allowed it to run rampant and unchecked; instead of repressed, it was celebrated as a New Era. Indeed, this strain of inflation had all appearances (and propaganda) of unleashing a quantum leap in sophisticated finance and risk management, combining powerful new computing technologies with sophisticated statistical analysis and modeling. Behind all the “sophistication” and “complexity,” however, there has been an old familiar bottle and a liberated genie of virulent (electronic) Credit inflation.
Now bear with me, as I interrupt our analysis with excerpts from Fiat Money Inflation in France, a brilliant and provocative little book originally written in the 1870’s by American “historian, educator, and diplomat” Andrew Dickson White (with a wonderful forward in the 1959 publication by eminent economist and statesman Henry Hazlitt). White begins: “Early in the year 1789 the French nation found itself in deep financial embarrassment: there was a heavy debt and a serious deficit. The vast reforms of that period, though a lasting blessing politically, were a temporary evil financially. There was a general want of confidence in business circles; capital had shown its proverbial timidity by retiring out of sight as far as possible; throughout the land was stagnation… There was a general search for some short road to prosperity: ere long the idea was set afloat that the great want of the country was more of the circulating medium; and this was speedily followed by calls for an issue of paper money.” (pages 23/24) What began with a 400 million issue of assignats (government issued fiat currency) fully backed by property (confiscated for this purpose), ended six years later with “forty-five thousand millions of assignats. The nation in general, rich and poor alike, was plunged into financial ruin from one end to the other.”
From the following extracts (and we highly recommend this timeless classic in its entirety!), I hope readers will capture the essence of the powerful allure of monetary inflation and how, once commenced, it takes on a precarious life of its own. Unless quashed, it will lurch to ever more dangerous extremes. And the longer it runs unchecked, the more distorted the system, thereby the greater the dislocation and hardship required to return to monetary and economic order. The larger the mistakes made by the monetary authorities, the more likely they will accept greater, increasingly desperate inflations as their only option. The recurring folly of monetary “management.”
Money and Credit Inflation is, all the while, seductive, misunderstood, too easily misinterpreted, and held as seemingly to the great betterment of many and the benefit of virtually all. Importantly, the inflation expedient feeds and emboldens speculation like an expanding snowball set loose from a mountaintop. It can be captivating, exhilarating, and even entertaining, but the final uncontrollable avalanche wreaks absolute havoc on things both real and financial. How monetary inflation seems to work wonderfully – like magic – so manageable, similar to the ease of adjusting the thermostat. Then one day, somehow, it’s at the same time too hot and too cold; then it’s boiling hot in one room and freezing in the next. The small adjustments that always did the trick before have become impotent. Major alterations only exacerbate the extremes; and then things fall into disarray and beyond control. History may not repeat, but, at times, the rhymes are darn right eerie.
“What chiefly strikes today’s readers is the astonishing similarity of the arguments put forward by our own contemporary inflationist to those of the inflationists of eighteenth-century France… But these parallels strike us so forcibly today, not primarily because White underlined them for his hearers in 1876, but primarily because the course of inflation everywhere – economically, psychologically, politically, and morally – does in fact follow the same pattern… The most striking parallel between the events recorded in Andrew White’s essay and the situation in the modern world is psychological. It is the persistence of delusions.” Henry Hazlitt 1959 (pages 8/9/11)
“What the country needs is more ‘purchasing power.’ And as this remedy fails, and quite different results follow, the sole solution of the inflationists is still more money, still more ‘purchasing power.’ The broad patterns of all inflations, historic and modern, is the same. The first result is commonly the ‘recovery’ that the inflationists, like others, are seeking. It is not until later that its disappointing and poisonous effects become apparent.” Henry Hazlitt 1959 (page 11)
“It would be a great mistake to suppose that the statesmen of France, or the French people, were ignorant of the dangers in issuing irredeemable paper money. No matter how skillfully the bright side of such a currency was exhibited, all thoughtful men in France remembered its dark side. They knew too well, from that ruinous experience, seventy years before, in John Law’s times, the difficulties and dangers of a currency not well based and controlled. They had then learned how easy it is to issue it; how difficult it is to check its overissue; how seductively it leads to the absorption of the means of the workingmen and men of small fortunes; how heavily it falls on all those living on fixed incomes, salaries, or wages; how securely it creates on the ruins of the prosperity of all men of meager means a class of debauched speculators, the most injurious class that a nation can harbor – more injurious, indeed, than professional criminals whom the law recognizes and can throttle; how it stimulates overproduction at first and leaves every industry flaccid afterward; how it breaks down thrift and develops political and social immorality. (page 29)”
“In vain did Maury (a prominent Assemblyman) show that, while the first issues of John Law’s paper had brought prosperity, those that followed brought misery; in vain did he quote from a book published in John Law’s time, showing that Law was at first considered a patriot and friend of humanity; in vain did he hold up to the Assembly one of Law’s bills and appeal to their memories of the wretchedness brought upon France by them…” (page 46)
“France was now fully committed to a policy of inflation; and, if there had been any questions of this before, all doubts were removed now by various acts very significant as showing the exceeding difficulty of stopping a nation once in the full tide of a depreciating currency.” (page 48)
“The great majority of Frenchmen now became desperate optimists, declaring that inflation is prosperity… The nation was becoming inebriated with paper money. The good feeling was that of a drunkard just after his draught; and it is to be noted as a simply historical fact, corresponding to a physiological fact, that, as draughts of paper money came faster the successive periods of good feelings grew shorter.” (page 51)
“’It is true that at first the assignats gave the same impulse to business in the city as in the country, but the apparent improvement had no firm foundation, even in the towns. Whenever a great quantity of paper money is suddenly issued we invariably see a rapid increase of trade. The great quantity of the circulating medium sets in motion all the energies of commerce and manufacturers; capital for investment is more easily found than usual and trade perpetually receives fresh nutriment… If…the new paper is of precarious value, as was clearly seen to be the case with the French assignats…it can confer no lasting benefits. …this prosperity would necessarily collapse and be succeeded by a crisis all the more destructive the more deeply men had engaged in speculation under the influences of the first favorable prospects.” (page 56/57)
“A still worse outgrowth was the increase of speculation and gambling… For at the great metropolitan centers grew a luxurious, speculative stock-gambling body, which like a malignant tumor, absorbed into itself the strength of the nation and sent out its cancerous fibers to the remotest hamlets. At these city centers abundant wealth seemed to be piled up. In the country at large there grew a dislike of steady labor and a contempt for moderate gains and simple living.” (page 59)
“From this was developed an even more disgraceful result – the decay of a true sense of national good faith.” (page 63)
“It will doubtless surprise many to learn that, in spite of these evident results of too much currency, the old cry of a ‘scarcity of circulating medium’ was not stilled; it appeared not long after each issue, no matter how large. But every thoughtful student of financial history knows that this cry always comes after such issues – nay, that it must come – because in obedience to a natural law, the former scarcity, or rather insufficiency of currency, recurs just as soon as prices become adjusted to the new volume, and there comes some little revival of business with the usual increase of credit.” (page 83)
“None felt any confidence in the future in any respect; few dared to make a business investment for any length of time, and it was accounted a folly to curtail the pleasures of the moment, to accumulate or save for so uncertain a future. This system in finance was accompanied by a system in politics no less startling, and each system tended to aggravate the other.” (page 91)
“From the early reluctant and careful issues of paper we saw, as in immediate result, improvement and activity in business. Then arose the clamor for more paper money. At first, new issues were made with great difficulty; but, the dike once broken, the current of irredeemable currency poured through; and swollen beyond control. It was urged on by speculators for a rise in values; by demagogues who persuaded the mob that a nation, by its simple fiat, could stamp real value to any amount upon valueless objects. As a natural consequence, a great debtor class grew rapidly, and this class gave its influence to depreciate more and more the currency in which its debts were to be paid. The government now began, and continued by spasms to grind out still more paper; commerce was at first stimulated by the difference in exchange; but this cause soon ceased to operate, and commerce, having been stimulated unhealthfully, wasted away. Manufacturers at first received a great impulse; but, ere long, this overproduction and overstimulus proved as fatal to them as to commerce.” (page 106)
“Out of the inflation of prices grew a speculating class; and, in the complete uncertainty as to the future, all business became a game of chance, and all businessmen, gamblers.” (page 108)
“And, finally, as to the general development of the theory and practice which all this history records: my subject has been Fiat Money Inflation in France: how it came; what it brought; and how it ended. It came by seeking a remedy for a comparatively small evil in an evil infinitely more dangerous. To cure a disease temporary in its character, a corrosive poison was administered, which ate out the vitals of French prosperity. It progressed according to a law in social physics which we may call the ‘law of accelerating issue and depreciation.’ It was comparatively easy to refrain from the first issue; it was exceedingly difficult to refrain from the second; to refrain from the third and those following was practically impossible.” (page 110)
“All this vast chapter in financial folly is sometimes referred to as if it resulted from the direct action of men utterly unskilled in finance. This is a grave error. That wild schemers and dreamers took a leading part in setting the fiat money system going is true; that speculation and interested financiers made it worse is also true; but the men who had charge of French finance during the Reign of Terror and who made these experiments, which seem to us so monstrous, in order to rescue themselves and their country from the flood which was sweeping everything to financial ruin were universally recognized as among the most skillful and honest financiers in Europe.” (page 85)
“Never was theory more seductive both to financiers and statesmen.” (page 28)
Returning to our analysis of contemporary Fiat Money and Credit Inflation in America, we see evidence of some profound developments. First, we have reached the point where enormous Credit Inflation provides only minimal stimulation. Moreover, the maladjusted financial and economic systems function sporadically and poorly with only “minimal stimulation.” As such, we’ve reached the intractable “too hot here and biting cold there” syndrome.
Second, dissimilar to the eighties variety of “all encompassing and uniform” inflation, recent (and foreseeable) inflation is overwhelmingly in the mortgage and government sectors. Investment, sound or otherwise, will no longer be a prominent “manifestation.” We are left to ponder how major a role this will play in future consumer goods/services pricing pressures. For the first three quarters of 2002, Non-financial Corporate Borrowings expanded $40 billion, or 1.1% annualized; Federal and State and Local Government borrowings increased $251.4 billion, or 7.0% annualized; and Total Mortgage Borrowings surged $620 billion, or 10.9% annualized. Why would we not expect today’s strain of inflation – virtually devoid of “supply side” spending/investment in goods and service-producing enterprises – to harbor disparate inflationary manifestations compared to those that we (and the markets) have become comfortably accustomed?
Third, the massive leveraged speculating community - that really received its critical impulsion from Greenspan’s powerful early nineties inflation to “recapitalize” the impaired U.S. banking system and reflate the faltering economy (and then again from the Mexican bailout inflation, the post-Russia/LTCM inflation, the pre-Y2K inflation, the bursting NASDAQ Bubble inflation, the post-9/11 inflation, etc.) – is an increasingly distorting and destabilizing influence demanding of continued rampant inflation (rising securities prices and continued speculative gains). Furthermore, with previous stock and corporate bond Bubbles having burst, the “good old days” when herds of leverage speculators were anxious acquirers of securities has evolved into a much less “cohesive” and market-friendly environment that includes a significant component of selling and shorting stocks and bonds. And, of course, the halcyon days of King Dollar have ended. Speculators from near and far will no longer ponder only what type of U.S. securities make for the best bets, now having the world of currencies, commodities and markets in which to explore for trading gains. At the same time, the enormous global financial conglomerates that were beating down the door to play the great American securities inflation are in dollar retreat.
Nonetheless, chairman Greenspan and Wall Street have good reason to confidently indulge in blind faith for the future success of the latest round of inflation. It’s worked repeatedly in the past. And, in the final analysis, aren’t we just dealing with debit and Credit entries on some enormous electronic ledger? And we’ve, after all, over the years watched myriad companies, industries, governments, markets and entire economies rescued by the magic of journaling some more entries - Credit “reflation.” And what is the recourse for the over-borrowed, susceptible to an overdue bout of frugality, American household sector? Well, just a minor adjustment to the thermostat and let the warmth of a refi boom temper nipping debt service to a comfortable level.
But if it all seems too good to be true… The Catch has been - is today and always will be - that it takes unending Money and Credit Inflation to keep this sordid Game going. And the system better not skimp on quantities of new Credit, especially in the enormously distended mortgage sector. As always, over time the source, nature and consequences of the created purchasing power (Money and Credit Inflation) transform, mutate and diverge. For now, we see the distinct inflationary manifestations of massive trade deficits, dollar vulnerability, heightened pricing pressures, and general pricing disorder. Today’s Credit inflation is both extreme and aberrant; manifestations, necessarily, will be likewise. The alluring nineties manifestations – surging stock and bond prices, rising perceived wealth for virtually everyone, plush government revenues, booming investment, an historic technology growth cycle, and consequent enormous foreign-sourced (investment and speculative) financial flows – were sure a lot more enticing than a faltering dollar, economic stagnation, and general “stagflation.”
But no amount of Fiat Money and Credit Inflation in America will bring back the glorious nineties inflationary boom with its favored manifestations. It’s simply impossible. As students of the history of inflationary booms and busts, we appreciate that the old medicine has not only lost its magic, it’s evolved into a strain especially poisonous to the diseased patient.
I’ll conclude with a couple of final extractions from Henry Hazlitt’s Introduction (1959):
“It begins to be believed that the value of the monetary unit is going to continue to fall – that it will be less next year than this year, less next month than this month. Once such a belief has taken hold, the decline in the value of the monetary unit is anticipated. The value of the monetary unit begins to fall faster than the supply is or can be increased. The monetary managers are from then on in a necessarily losing battle. The more they increase the supply of money, the more public opinion anticipates still further increases…” (page 19)
“Inflation, in its final stages, always ends in prostration, in what modern economists call a ‘stabilization crisis.’ The explanation of this stabilization crisis is not mysterious. During the inflation…prices do not respond in simple proportionality to the increase in the money supply. Some prices race beyond this, anticipating a further inflation. Even if inflation is halted at some point and no deflation sets in – that is, even if the increased supply of money is merely locked where it is and not reduced – the stabilization crisis sets in because these anticipatory prices collapse. The stabilization crisis, like the drunkard’s hangover, is part of the price that must be paid for every inflationary orgy.” (page 20)
Thanks for reading!
Rallying stocks and a startling surge in wholesale prices failed to unnerve the Credit market. For the week, two-year Treasury yields declined two basis points to 1.60%, with five-year yields declining seven basis points to 2.85%. The 10-year Treasury yield dipped six basis points to 3.89%, while the long-bond saw its yield decline four basis points to 4.84%. Benchmark mortgage-backs and agency debt performed well, with yields generally declining 8 basis points. The spread on Fannie’s 5 3/8 2011 note narrowed almost two to a notably narrow 29. The 10-year dollar swap spread dropped 1.5 to 40.5, and one must go all the way back to August 1997 to see the last time this spread traded below 40. Corporate spreads were generally stable this week. Heightened inflationary pressures are apparently good news for those calling for “reflation” and playing the corporate spread game. The dollar ended the week about unchanged.
The holiday (and inclement weather) made for a somewhat slower week of corporate issuance. Wal-Mart issued $1.5 billion of debt, Morgan Stanley sold $2 billion of 10-year bonds (147 bps over Treasuries), American Express $750 million of notes, Deutsche Bank $800 million of notes due 2015 (158 bps over Treasuries) and Duke Energy sold $500 of 5-year notes (100 bps over Treasuries). Citgo sold $550 million of junk debt, although at yields considerably higher than initially expected. MBNA issued $500 million of 10-year notes to yield 6.134%, 225 basis points over Treasuries. Morgan Stanley also sold 850 million of 7-year euro-denominated bonds this week and was joined by Bank America which issued 1 billion of 5-year euro debt. Russia’s largest company, Gazprom, enjoyed bids of $6 billion for its sale of $1.75 billion of 10-year bonds (another example of heightened inflationary pressures – in this case rising energy prices – fostering Credit growth).
Broad money supply (M3) declined $7.5 billion last week. With Demand and Checkable Deposits declining $23.2 billion, M1 gave up recent strong gains. Savings Deposits surged $37.5 billion, Small Denominated Deposits dipped $1.8 billion and Retail Money Fund deposits declined $3.3 billion. Institutional Money Fund deposits dropped $19.2 billion, while Large Denominated Deposits added $2.3 billion. Repurchase Agreements and Eurodollars declined slightly. Foreign Holdings of U.S. Debt Securities increased $4.7 billion. Total Commercial Paper (CP) borrowings declined $6.7 billion ($21.3 billion over two weeks), with total Financial sector issuance down $11.2 billion. Non-financial CP borrowings increased $4.5 billion. Elsewhere, Bank Total Assets declined $6.1 billion following the previous week’s $71.6 billion surge. However, Bank Credit advanced $19.9 billion. Securities holdings were up $10.6 billion (up $44.8 billion in two weeks) and Loans and Leases gained $9.2 billion. Real Estate loans were up $12.2 billion (up $35.1 billion in three weeks), while Commercial and Industrial loans declined $1.8 billion (down $9.4 billion over three weeks). Bloomberg’s year-to-date tally of U.S. Domestic Debt issuance now stands at $319 billion (up 37% from the comparable 2002 period). Over $10 billion of ABS was issued this week.
Weekly bankruptcy filings were 29,931, up 9% y-o-y. MasterCard is estimating 2003 bankruptcies at 1.652 million, 5% above 2002’s record. After the big November and December post-strike catch-up, January’s imports into the ports of Long Beach and Los Angeles slowed somewhat to a still strong 432,867 containers. This was up 11% y-o-y. Notably, export containers were up 6% y-o-y, the best performance since May. All the same, outbound empty containers were 59% of full inbound containers.
Yesterday’s economic news was especially dismal. The December Trade Deficit shot up to a record $44.2 billion, 14% above the consensus forecast. The deficit, now running completely out of control, was up an eye-opening 62% year-over-year, with a 2002 trade gap of $435.2 billion. The intractable deficit was up 21.4% for the year and an incredible 300% from the $108 billion deficit recorded during pre-Bubble – and not that many years ago - 1997. For the year, our deficit with Canada was $49.8 billion, Mexico $37.2 billion, Western Europe $89.2 billion, the Pacific Rim $215 billion, South/Central America $17.9 billion, and OPEC $34.5 billion. 2002 Imports from China surged 22.4% to $125.2 billion, while Imports from Japan declined 3.9% to $121.5 billion. Imports from Canada decreased 2.6% to $210.6 billion, while Imports from Mexico increased 2.6% to $134.7 billion.
Compared to year ago levels, December Goods Imports were up 20% to $103.9 billion, as exports inched up 1% to $55.6 billion. For December, Goods Imports were 87% greater than Goods Exports. Amazing. By Import category, Capital Goods were up 9.9% y-o-y in December (telecom equipment 25.3%, Semiconductors 8.2%), Industrial Supplies 35% (crude oil 59.6%), Consumer Goods 25.3% (pharmaceuticals 62.5%, apparel 23.6%), Automotive 14.5%, and Services 17.9%. By Export category, Capital Goods was down 5.6% y-o-y (telecom equipment down 29.7%) and Consumer Goods declined 2.4%. Industrial Supplies Exports jumped 10.5% (price increases), Automotive was up 6.6%, Food & Beverages increased 8%, and Services were up 2.7%.
Recent comments from Treasury Secretary John Snow on the U.S. current account deficit: ‘At the current levels of the current account deficit, I’m not particularly troubled by it. It’s something we should keep our eye on, but it’s the $400 billion annual or so that it’s running is really a small part of the size of the total US economy and is certainly manageable… What it really means in its simplest terms is that Americans value the world goods more than they value the dollars that they’re expending to get those goods. At some point, people can run into too much debt, I grant you that.’” (Especially after yesterday’s monster of a trade deficit, we suggest our new Treasury Secretary go back and check his math. We see current account deficits soon surpassing 5% of GDP. The alarm bells are sounding.)
February 20 – Bloomberg: “U.S. state and local governments face mounting losses on interest-rate swaps they entered to pay off variable-rate debt, Standard & Poor’s said. The transactions involve selling bonds with interest rates that change every few days or weeks, giving access to the lower rates in the short-term debt market. The swaps, agreements to exchange fixed- for variable- rate payments on the bonds’ principal, were meant to guard against rises in short-term rates. Instead, the swaps have exposed state and local governments to another financial risk, said Peter Block, a director at S&P. ‘Issuers in the last two years have taken a gamble that they would be hedged, and they’re not.’ The risk resulted from assumptions about the index on which the swaps were based. State and local governments often use the London interbank offered rate, or Libor, a benchmark set by three-month U.K. bank loans.”
February 19 – Dow Jones (Stan Rosenberg): “While ratings of cities have been more stable than those of states over the past 12 to 18 months, cities will face more fiscal pressure in the future as the economic recovery remains sluggish, rating agency Standard & Poor’s said…Budget-strapped states, no longer able to defray revenue shortfalls, are by necessity, ‘passing the pain to municipalities.’ The city of Atlanta, dropped to double-A-minus from double-A, represented S&P’s only downgrade among the largest cities since January 2002. During the same period, just two cities - single-A-rated New York and triple-A Dallas -had their outlooks revised to negative from stable. But that situation won’t last, S&P said. ‘For cities, rising health care costs, homeland security, underperforming pensions and multi-year wage contracts will continue to pressure budgets…Strong steady growth in state aid is leveling off and in some instances declining.’”
Week 35 of the Great Mortgage Finance blow-off saw refi applications about steady at 180% of the year ago level. Purchase applications were up 6% for the week (up 14% y-o-y). Golden West Financial’s mortgage portfolio expanded at a 13% annualized rate during January, with a notable 90% of originations consisting of adjustable rate mortgages (Feeding the Great California Housing Bubble). January Housing Starts were reported at 1.85 million units, four percent above the consensus forecast to the strongest level since May 1986 (1.854 million). Led by a major construction boom in the West (California), national Single family Starts were up 13.1% y-o-y to the highest rate since November 1978. Single-Family Starts were up 40.3% y-o-y in the West, 19.4% in the Midwest, and 2.9% in the South. Unusually cold weather was blamed for the 15.6% y-o-y decline in Northeast Single-family Starts. 2002 Housing Starts of 1.706 million were up 6.4% from 2001 to the highest level since 1984. January Building Permits were up 6% y-o-y (1.781 million), with Single-Family Permits up 9.1% y-o-y. The West reported y-o-y Permits up 32.4%, while Northeast Permits were down 12.9% y-o-y.
February 18 - Minneapolis Star Tribune (Jim Buchta): “After more than 15 years working for boom-and-bust Silicon Valley technology companies, Sonia Armstrong couldn’t hack it anymore. So she pursued a job with a more certain future: Selling subprime mortgages for Wells Fargo.” In my mailbox this week arrived a “No Down Payment? No problem” promotion from mortgage company Assistance for America. This is a division of Renaissance Acceptance Group, previously Cardiac Control Systems that filed for bankruptcy in 1999. Lots of folks working to profit (and find a new lease on financial life) from the Great Mortgage Finance Bubble…
Wednesday’s Wall Street Journal: “If Fan and Fred were completely private financial institutions - with no government guarantee, implicit or explicit - they would have to almost double their capital to more than $99 billion from $52 billion now. And even that increase would only bring them to the minimal capital that banks must maintain for mortgages, but perhaps still short of earning a AAA rating. The result? Return on equity would fall from 25% to 12% or 13%, which is what comparable banks earn, thus transforming Fan and Fred into much less profitable financial companies.” (The Journal’s ruminations recall for me an old Saturday Night Live bit, “The Bears.” “Hey, who’d win if (Chicago Bears’ coach Mike) Ditka took on Godzilla?”)
February 19 – Bloomberg: “Conseco Inc. is asking a bankruptcy judge to release its finance unit from servicing $23 billion in mobile-home loans, saying uncertainty about the money-losing agreements threatens the unit’s sale. Conseco Finance says in a court filing it was losing $15 million a month on agreements to manage loan-payment collections before the Dec. 17 bankruptcy filing… The loan portfolios have been a ‘monumental distraction,’ Conseco Finance says in an emergency filing with U.S. Bankruptcy Court in Chicago… The Federal National Mortgage Association, which holds $7 billion of certificates on the mobile home loans, has objected to Conseco Finance’s request, saying the servicing is a valuable asset.”
February 20 - Dow Jones (Dawn Kopecki and Eric Ahlberg): “Mortgage finance company Fannie Mae placed a $70 million bid Wednesday for the servicing rights to $23 billion in manufactured-housing mortgages in the bankruptcy of Conseco Inc. Trouble with Conseco Finance’s money-losing mobile home mortgage portfolio helped propel its parent company into Chapter 11 bankruptcy protection… ‘We did this to resolve an impasse in the court over the disposition of the manufactured housing servicing platform in bankruptcy,’ said Fannie Mae spokeswoman Janice Daue… Conseco Finance is the largest servicer of manufactured-housing contracts in the U.S. with more than 55% of the entire market. The unit is scheduled to be sold off at a Feb. 28 auction with the final sale hearing set for March 5. Bear Stearns & Co. and General Electric Capital Corp., a major competitor of Fannie Mae’s in the secondary mortgage markets, have been named as potential bidders for the finance unit. Fannie Mae is the largest beneficial holder of roughly $10 billion of Conseco Finance’s asset-backed manufactured-housing certificates.”
So, Fannie has interest in somewhere between $7 billion and $10 billion of the $23 billion of Conseco securitizations (recalls rumors back in the tumultuous fall of 1998 that Fannie was acquiring entire Conseco (and other) securitization deals before they were offered in the marketplace.) And Fannie may dive headfirst into the mobile home loan servicing business? Oh, what a tangled web…and sliding only more quickly down the slippery slope of subprime (with the Credit insurers).
February 21 - Dow Jones: “FM Watch, the anti-Fannie Mae/Freddie Mac coalition, said with respect to Fannie Mae’s bid to enter the mortgage-servicing business that it ‘plans to take appropriate action to make sure that this incursion is stopped.’ ‘Fannie Mae’s decision to enter the mortgage servicing business through this maneuver is the perfect indication of just how far Fannie has strayed from its original mission of providing liquidity to the secondary mortgage market for conventional mortgage loans.’”
February 20: “Fitch Ratings places the ‘A’ medium-term notes rating, ‘A-‘ preferred stock rating, and ‘F1’ commercial paper rating of Countrywide Home Loans, Inc. Rating Watch Negative. Fitch also places the ‘A’ convertible debentures rating of parent company Countrywide Financial Corp. (CFC) on Rating Watch Negative. Over $18 billion of rated debt is affected by this action. Today’s action is due to concerns within Fitch regarding the increasing risk of impairment that is present within mortgage banking companies’ balance sheets. This risk is particularly prevalent for those companies that have significant business concentrations in mortgage banking, such as CFC, with high levels of capitalized mortgage servicing rights (MSRs) as a percentage of equity. At initiation, MSRs are derived from the present value of expected future income to be received over the expected life of the mortgages. The value is based on assumptions regarding prepayment rates, discount rates, ancillary fees, and costs to service.” Countrywide’s servicing portfolio has surged to $469 billion, a cause for concern considering issues raised post-Conseco’s collapse.
February 18 - Dow Jones (Agnes T. Crane): “While everyone from Federal Reserve Chairman Alan Greenspan to the nation’s largest purchaser of home mortgages insist there is no national housing bubble in the U.S., percolating hot spots in regional residential real estate markets are cause for concern…According to a recent study by TimesSquare Capital Management…‘a number of major housing markets are vulnerable to severe price declines, due to a troublesome combination of above-average appreciation in recent years and growing unemployment.’ The study highlights a number of metropolitan areas that have experienced higher home price rates from the first quarter of 1997 to the third quarter of 2002 that were well above the national average of 42%. For example, New York City home prices rose 67% in that period, Jersey City, N.J., increased 75%, Boston, 69% and San Francisco, 88%…”
February 17 – Financial Times (Sheila McNulty): “The debt crisis in the US gas and power sector continued to grow over the past year and has become more acute, with $477.6bn in outstanding borrowings, research commissioned by the Financial Times reveals. The energy traders are responsible for a large portion of that debt, according to SNL Financial, an independent research firm that says $116.65bn of the sector’s debt is held by what - pre-crisis - were the top nine traders, companies such as Dynergy and El Paso, both Texas-based, and Duke Energy of North Carolina.”
In the category “just couldn’t leave well enough alone,” Barron’s Gene Epstein has returned to his “the consumer is in great shape” disinformation campaign. It’s all so tiring… We suggest that he refrain from his “debt service as a percentage of income” fixation and look deeper than this one clearly deceiving ratio (again, it’s too similar to how Bubble-induced earnings growth was used to justify exorbitant P/E ratios). There is no denying or muddling the fact that Household Sector Debt is up more than 110% during the past decade. And, fueled by unprecedented mortgage borrowings, total Household debt growth has been accelerating. To illustrate: Household Sector borrowings increased on average $71 billion per quarter during the first eight years of the nineties. But during the past 19 quarters, average quarterly borrowings have jumped to $138 billion (reaching $199bn during the third quarter and $185bn for 2002 Q2!). It’s not a “debt service” issue, but an issue of sustainability. And we suggest that Mr. Epstein take note of the unfolding subprime collapse (the marginal consumer borrowers and lenders) and follow the experiences of NextCard, Metris, AmeriCredit, Conseco and others. All is well in consumer finance? And just wait until the Mortgage Finance Bubble blow-off runs its course… And, most importantly, don’t disregard that it is specifically unparalleled consumer Credit excess that is the fuel behind the much-trumpeted income growth – household income expansion that is conveniently used to justify rising consumer debt loads. It’s self-reinforcing and unsustainable, and exactly why they’re called Bubbles…
Credit card behemoth MBNA financial shook a bit of confidence when it reported that managed net loan Credit losses jumped 41 basis points during January to 5.59% (up 46 basis points y-o-y). Delinquencies were up another 12 basis points to the highest level in twelve months. Other managed Consumer (non-Credit card) losses were reported at 8.46%, with delinquencies at 6.11% (this detail was provided for the first time).
February 19 – European Central Bank: “In the third quarter of 2002 the annual growth rate of financing of the non-financial sectors in the euro area decreased to 3.9%, down from 4.1% in the previous quarter and from 5.5% one year earlier. The corresponding growth rate of debt financing was 4.7%... The annual growth rate of debt financing by households increased slightly, from 5.8% in the second quarter of 2002 to 6.1% in the third quarter…”
February 19 – Washington Post (Jonathan Weisman): “President Bush will sign legislation this week setting a 2003 budget that raises federal spending by 7.8 percent over last year, capping a remarkable two years in which the federal budget increased by 22 percent. Although Bush has made controlling spending a recurring theme in recent months, the $791.5 billion spending bill for 2003 that he plans to approve by Thursday night will be one for the record books. The 2003 rate of discretionary spending increases -- the part of the budget subject to Congress’s annual oversight - will be the second-fastest since 1985. It is topped only by the 2002 increase… The government has not experienced a two-year leap in spending of this magnitude since expenditures jumped 24.5 percent between 1976 and 1978. ‘We have a long way to go to, quote, rein things in,’ said G. William Hagland, budget adviser to Senate Majority Leader Bill Frist.”
Certainly not unrelated to ballooning mortgage borrowings and (trade and fiscal) deficits, we see evidence of intensifying inflation manifestations in the strongest increase in Producer Prices since 1990. Wholesale price jumped 1.6%, compared to a sanguine consensus forecast of 0.5%. The core PPI (ex food and energy), jumped 0.9%, the strongest gain since December 2000. Pricing pressures were strong throughout, with Finished Goods up 1.6%, Intermediate Materials up 1.3% and Crude Materials up 6.9%.
February 20 – Fannie’s Franklin Raines: “In 2002 we think mortgage originations were about $2.6 trillion. We think they’ll be about $2 trillion this year. That’s a lot. I never thought in my lifetime I’d see $2 trillion worth of mortgages originated. Overall it will be a good year for the mortgage business… I don’t think there’s a danger of inflation…What we know is that for the average person a strongly growing economy is more important than anything else. I’m in favor of stimulus and enough stimulus to really get the economy moving to soak up this excess capacity as soon as possible…”
It feels rather silly nowadays to refer to the eighties as the “Decade of Greed.” Like NASDAQ, the GSEs, mortgage finance, and shopping malls, we appreciate today that what appeared at the time gross excess ended up looking quite feeble in comparison to the “blow-off” excesses that were to follow. But our focus on Fiat Money and Credit Inflation in America demands that we return briefly to the 1980s. Of course, we should really commence our analysis with the sixties (“guns and butter”) inflation, the consequent collapse of dollar gold-convertibility, and the resulting 1970’s (“garden-variety”) inflation surge. But, for our purposes this week, let’s set our sights on the cutting-edge, uncommonly seductive (“non-garden…”) strain of Credit inflation that began to take root in the period 1984 to 1989. Over this six-year period, total Credit Market Debt outstanding surged 72% to $12.8 Trillion. Importantly, this bout of Credit inflation was all-encompassing and uniform. We see that Total Mortgage Debt jumped 69% to $3.56 Trillion, Non-financial Corporate debt 67% to $2.4 Trillion, and Federal Government debt 65% to $2.25 Trillion. Structured Finance was in its thriving infancy, hardly stymied by its prominent role in the ’87 Crash.
And despite brief fears of a potential post-’87 stock market crash depression, subsequent (Greenspan, along with the Japanese and global central bankers) “easy money” propelled the U.S. and global industrialized economies into a robust late-decade inflationary boom (to which the Japanese are still suffering and the U.S. eagerly sustaining). With the advantage of hindsight - and after witnessing the extraordinary developments transpiring since – we now realize that the general economy had not by late (post-crash) 1987 suffered from the type of prolonged period of maladjustments that create vulnerability to economic depressions. Additionally, and of momentous importance, the Credit system had not regressed to the type of derangement capable, over a period of years, of creating the colossal and fragile debt structures susceptible to collapse. Monetary Processes dominated by speculative financial flows were not yet indelibly entrenched.
Yet by 1990, previous inflationary distortions, that culminated with the rampant Credit inflation and financial excess of 1988/89, had left the financial system and economy acutely susceptible to severe problems. Facing an insolvent (and imploding) S&L industry, a collapsing junk bond market, the coastal real estate inflations turning problematic busts, the residual of the oil patch inflationary boom and subsequent bust, and an increasingly impaired banking system, there was (as we have often discussed) real risk of financial and economic collapse in the early nineties. The economy was already at this point desperate for another inflationary jolt, but the banking system was in dire straits and largely incapacitated. Not to worry. With Alan Greenspan quite eager, the rapidly ascending Wall Street Money and Credit Inflation regime was more than willing to capture and resolutely clutch the monetary reins. An historic inflationary jolt was delivered – more powerful and intoxicating than anyone could ever have imagined.
The Roaring Nineties can be viewed as the Decade of Structured Finance. From the beginning of 1993 through 2002’s third-quarter, GSE assets were up $1.9 Trillion, or 345%, mortgage-backed securities $1.8 Trillion, or 143%, and asset-backed securities $1.89 Trillion, or 465%. Since the end of 1992, ballooning broad money supply doubled to $8.55 Trillion. As a percentage of GDP, total “Structured Finance” financial claims/Credit creation (GSE assets, and outstanding ABS and MBS) jumped from 35% to 75% ($2.23 Trillion to $7.84 trillion). Inarguably, we have witnessed truly one of history’s great Money and Credit Inflations. Its unusual nature allowed it to run rampant and unchecked; instead of repressed, it was celebrated as a New Era. Indeed, this strain of inflation had all appearances (and propaganda) of unleashing a quantum leap in sophisticated finance and risk management, combining powerful new computing technologies with sophisticated statistical analysis and modeling. Behind all the “sophistication” and “complexity,” however, there has been an old familiar bottle and a liberated genie of virulent (electronic) Credit inflation.
Now bear with me, as I interrupt our analysis with excerpts from Fiat Money Inflation in France, a brilliant and provocative little book originally written in the 1870’s by American “historian, educator, and diplomat” Andrew Dickson White (with a wonderful forward in the 1959 publication by eminent economist and statesman Henry Hazlitt). White begins: “Early in the year 1789 the French nation found itself in deep financial embarrassment: there was a heavy debt and a serious deficit. The vast reforms of that period, though a lasting blessing politically, were a temporary evil financially. There was a general want of confidence in business circles; capital had shown its proverbial timidity by retiring out of sight as far as possible; throughout the land was stagnation… There was a general search for some short road to prosperity: ere long the idea was set afloat that the great want of the country was more of the circulating medium; and this was speedily followed by calls for an issue of paper money.” (pages 23/24) What began with a 400 million issue of assignats (government issued fiat currency) fully backed by property (confiscated for this purpose), ended six years later with “forty-five thousand millions of assignats. The nation in general, rich and poor alike, was plunged into financial ruin from one end to the other.”
From the following extracts (and we highly recommend this timeless classic in its entirety!), I hope readers will capture the essence of the powerful allure of monetary inflation and how, once commenced, it takes on a precarious life of its own. Unless quashed, it will lurch to ever more dangerous extremes. And the longer it runs unchecked, the more distorted the system, thereby the greater the dislocation and hardship required to return to monetary and economic order. The larger the mistakes made by the monetary authorities, the more likely they will accept greater, increasingly desperate inflations as their only option. The recurring folly of monetary “management.”
Money and Credit Inflation is, all the while, seductive, misunderstood, too easily misinterpreted, and held as seemingly to the great betterment of many and the benefit of virtually all. Importantly, the inflation expedient feeds and emboldens speculation like an expanding snowball set loose from a mountaintop. It can be captivating, exhilarating, and even entertaining, but the final uncontrollable avalanche wreaks absolute havoc on things both real and financial. How monetary inflation seems to work wonderfully – like magic – so manageable, similar to the ease of adjusting the thermostat. Then one day, somehow, it’s at the same time too hot and too cold; then it’s boiling hot in one room and freezing in the next. The small adjustments that always did the trick before have become impotent. Major alterations only exacerbate the extremes; and then things fall into disarray and beyond control. History may not repeat, but, at times, the rhymes are darn right eerie.
“What chiefly strikes today’s readers is the astonishing similarity of the arguments put forward by our own contemporary inflationist to those of the inflationists of eighteenth-century France… But these parallels strike us so forcibly today, not primarily because White underlined them for his hearers in 1876, but primarily because the course of inflation everywhere – economically, psychologically, politically, and morally – does in fact follow the same pattern… The most striking parallel between the events recorded in Andrew White’s essay and the situation in the modern world is psychological. It is the persistence of delusions.” Henry Hazlitt 1959 (pages 8/9/11)
“What the country needs is more ‘purchasing power.’ And as this remedy fails, and quite different results follow, the sole solution of the inflationists is still more money, still more ‘purchasing power.’ The broad patterns of all inflations, historic and modern, is the same. The first result is commonly the ‘recovery’ that the inflationists, like others, are seeking. It is not until later that its disappointing and poisonous effects become apparent.” Henry Hazlitt 1959 (page 11)
“It would be a great mistake to suppose that the statesmen of France, or the French people, were ignorant of the dangers in issuing irredeemable paper money. No matter how skillfully the bright side of such a currency was exhibited, all thoughtful men in France remembered its dark side. They knew too well, from that ruinous experience, seventy years before, in John Law’s times, the difficulties and dangers of a currency not well based and controlled. They had then learned how easy it is to issue it; how difficult it is to check its overissue; how seductively it leads to the absorption of the means of the workingmen and men of small fortunes; how heavily it falls on all those living on fixed incomes, salaries, or wages; how securely it creates on the ruins of the prosperity of all men of meager means a class of debauched speculators, the most injurious class that a nation can harbor – more injurious, indeed, than professional criminals whom the law recognizes and can throttle; how it stimulates overproduction at first and leaves every industry flaccid afterward; how it breaks down thrift and develops political and social immorality. (page 29)”
“In vain did Maury (a prominent Assemblyman) show that, while the first issues of John Law’s paper had brought prosperity, those that followed brought misery; in vain did he quote from a book published in John Law’s time, showing that Law was at first considered a patriot and friend of humanity; in vain did he hold up to the Assembly one of Law’s bills and appeal to their memories of the wretchedness brought upon France by them…” (page 46)
“France was now fully committed to a policy of inflation; and, if there had been any questions of this before, all doubts were removed now by various acts very significant as showing the exceeding difficulty of stopping a nation once in the full tide of a depreciating currency.” (page 48)
“The great majority of Frenchmen now became desperate optimists, declaring that inflation is prosperity… The nation was becoming inebriated with paper money. The good feeling was that of a drunkard just after his draught; and it is to be noted as a simply historical fact, corresponding to a physiological fact, that, as draughts of paper money came faster the successive periods of good feelings grew shorter.” (page 51)
“’It is true that at first the assignats gave the same impulse to business in the city as in the country, but the apparent improvement had no firm foundation, even in the towns. Whenever a great quantity of paper money is suddenly issued we invariably see a rapid increase of trade. The great quantity of the circulating medium sets in motion all the energies of commerce and manufacturers; capital for investment is more easily found than usual and trade perpetually receives fresh nutriment… If…the new paper is of precarious value, as was clearly seen to be the case with the French assignats…it can confer no lasting benefits. …this prosperity would necessarily collapse and be succeeded by a crisis all the more destructive the more deeply men had engaged in speculation under the influences of the first favorable prospects.” (page 56/57)
“A still worse outgrowth was the increase of speculation and gambling… For at the great metropolitan centers grew a luxurious, speculative stock-gambling body, which like a malignant tumor, absorbed into itself the strength of the nation and sent out its cancerous fibers to the remotest hamlets. At these city centers abundant wealth seemed to be piled up. In the country at large there grew a dislike of steady labor and a contempt for moderate gains and simple living.” (page 59)
“From this was developed an even more disgraceful result – the decay of a true sense of national good faith.” (page 63)
“It will doubtless surprise many to learn that, in spite of these evident results of too much currency, the old cry of a ‘scarcity of circulating medium’ was not stilled; it appeared not long after each issue, no matter how large. But every thoughtful student of financial history knows that this cry always comes after such issues – nay, that it must come – because in obedience to a natural law, the former scarcity, or rather insufficiency of currency, recurs just as soon as prices become adjusted to the new volume, and there comes some little revival of business with the usual increase of credit.” (page 83)
“None felt any confidence in the future in any respect; few dared to make a business investment for any length of time, and it was accounted a folly to curtail the pleasures of the moment, to accumulate or save for so uncertain a future. This system in finance was accompanied by a system in politics no less startling, and each system tended to aggravate the other.” (page 91)
“From the early reluctant and careful issues of paper we saw, as in immediate result, improvement and activity in business. Then arose the clamor for more paper money. At first, new issues were made with great difficulty; but, the dike once broken, the current of irredeemable currency poured through; and swollen beyond control. It was urged on by speculators for a rise in values; by demagogues who persuaded the mob that a nation, by its simple fiat, could stamp real value to any amount upon valueless objects. As a natural consequence, a great debtor class grew rapidly, and this class gave its influence to depreciate more and more the currency in which its debts were to be paid. The government now began, and continued by spasms to grind out still more paper; commerce was at first stimulated by the difference in exchange; but this cause soon ceased to operate, and commerce, having been stimulated unhealthfully, wasted away. Manufacturers at first received a great impulse; but, ere long, this overproduction and overstimulus proved as fatal to them as to commerce.” (page 106)
“Out of the inflation of prices grew a speculating class; and, in the complete uncertainty as to the future, all business became a game of chance, and all businessmen, gamblers.” (page 108)
“And, finally, as to the general development of the theory and practice which all this history records: my subject has been Fiat Money Inflation in France: how it came; what it brought; and how it ended. It came by seeking a remedy for a comparatively small evil in an evil infinitely more dangerous. To cure a disease temporary in its character, a corrosive poison was administered, which ate out the vitals of French prosperity. It progressed according to a law in social physics which we may call the ‘law of accelerating issue and depreciation.’ It was comparatively easy to refrain from the first issue; it was exceedingly difficult to refrain from the second; to refrain from the third and those following was practically impossible.” (page 110)
“All this vast chapter in financial folly is sometimes referred to as if it resulted from the direct action of men utterly unskilled in finance. This is a grave error. That wild schemers and dreamers took a leading part in setting the fiat money system going is true; that speculation and interested financiers made it worse is also true; but the men who had charge of French finance during the Reign of Terror and who made these experiments, which seem to us so monstrous, in order to rescue themselves and their country from the flood which was sweeping everything to financial ruin were universally recognized as among the most skillful and honest financiers in Europe.” (page 85)
“Never was theory more seductive both to financiers and statesmen.” (page 28)
Returning to our analysis of contemporary Fiat Money and Credit Inflation in America, we see evidence of some profound developments. First, we have reached the point where enormous Credit Inflation provides only minimal stimulation. Moreover, the maladjusted financial and economic systems function sporadically and poorly with only “minimal stimulation.” As such, we’ve reached the intractable “too hot here and biting cold there” syndrome.
Second, dissimilar to the eighties variety of “all encompassing and uniform” inflation, recent (and foreseeable) inflation is overwhelmingly in the mortgage and government sectors. Investment, sound or otherwise, will no longer be a prominent “manifestation.” We are left to ponder how major a role this will play in future consumer goods/services pricing pressures. For the first three quarters of 2002, Non-financial Corporate Borrowings expanded $40 billion, or 1.1% annualized; Federal and State and Local Government borrowings increased $251.4 billion, or 7.0% annualized; and Total Mortgage Borrowings surged $620 billion, or 10.9% annualized. Why would we not expect today’s strain of inflation – virtually devoid of “supply side” spending/investment in goods and service-producing enterprises – to harbor disparate inflationary manifestations compared to those that we (and the markets) have become comfortably accustomed?
Third, the massive leveraged speculating community - that really received its critical impulsion from Greenspan’s powerful early nineties inflation to “recapitalize” the impaired U.S. banking system and reflate the faltering economy (and then again from the Mexican bailout inflation, the post-Russia/LTCM inflation, the pre-Y2K inflation, the bursting NASDAQ Bubble inflation, the post-9/11 inflation, etc.) – is an increasingly distorting and destabilizing influence demanding of continued rampant inflation (rising securities prices and continued speculative gains). Furthermore, with previous stock and corporate bond Bubbles having burst, the “good old days” when herds of leverage speculators were anxious acquirers of securities has evolved into a much less “cohesive” and market-friendly environment that includes a significant component of selling and shorting stocks and bonds. And, of course, the halcyon days of King Dollar have ended. Speculators from near and far will no longer ponder only what type of U.S. securities make for the best bets, now having the world of currencies, commodities and markets in which to explore for trading gains. At the same time, the enormous global financial conglomerates that were beating down the door to play the great American securities inflation are in dollar retreat.
Nonetheless, chairman Greenspan and Wall Street have good reason to confidently indulge in blind faith for the future success of the latest round of inflation. It’s worked repeatedly in the past. And, in the final analysis, aren’t we just dealing with debit and Credit entries on some enormous electronic ledger? And we’ve, after all, over the years watched myriad companies, industries, governments, markets and entire economies rescued by the magic of journaling some more entries - Credit “reflation.” And what is the recourse for the over-borrowed, susceptible to an overdue bout of frugality, American household sector? Well, just a minor adjustment to the thermostat and let the warmth of a refi boom temper nipping debt service to a comfortable level.
But if it all seems too good to be true… The Catch has been - is today and always will be - that it takes unending Money and Credit Inflation to keep this sordid Game going. And the system better not skimp on quantities of new Credit, especially in the enormously distended mortgage sector. As always, over time the source, nature and consequences of the created purchasing power (Money and Credit Inflation) transform, mutate and diverge. For now, we see the distinct inflationary manifestations of massive trade deficits, dollar vulnerability, heightened pricing pressures, and general pricing disorder. Today’s Credit inflation is both extreme and aberrant; manifestations, necessarily, will be likewise. The alluring nineties manifestations – surging stock and bond prices, rising perceived wealth for virtually everyone, plush government revenues, booming investment, an historic technology growth cycle, and consequent enormous foreign-sourced (investment and speculative) financial flows – were sure a lot more enticing than a faltering dollar, economic stagnation, and general “stagflation.”
But no amount of Fiat Money and Credit Inflation in America will bring back the glorious nineties inflationary boom with its favored manifestations. It’s simply impossible. As students of the history of inflationary booms and busts, we appreciate that the old medicine has not only lost its magic, it’s evolved into a strain especially poisonous to the diseased patient.
I’ll conclude with a couple of final extractions from Henry Hazlitt’s Introduction (1959):
“It begins to be believed that the value of the monetary unit is going to continue to fall – that it will be less next year than this year, less next month than this month. Once such a belief has taken hold, the decline in the value of the monetary unit is anticipated. The value of the monetary unit begins to fall faster than the supply is or can be increased. The monetary managers are from then on in a necessarily losing battle. The more they increase the supply of money, the more public opinion anticipates still further increases…” (page 19)
“Inflation, in its final stages, always ends in prostration, in what modern economists call a ‘stabilization crisis.’ The explanation of this stabilization crisis is not mysterious. During the inflation…prices do not respond in simple proportionality to the increase in the money supply. Some prices race beyond this, anticipating a further inflation. Even if inflation is halted at some point and no deflation sets in – that is, even if the increased supply of money is merely locked where it is and not reduced – the stabilization crisis sets in because these anticipatory prices collapse. The stabilization crisis, like the drunkard’s hangover, is part of the price that must be paid for every inflationary orgy.” (page 20)
Thanks for reading!
02/14/2003 Blow off Week #34 *
Wild volatility returned to the U.S. equity market. On the back of today’s surge, the Dow and S&P500 ended the week with gains of just under 1%. The Morgan Stanley Consumer index added 1%, while the Morgan Stanley Cyclical index was about unchanged. The Transports and Utilities, however, ended the week 2% in the red. The broader market was about unchanged, with the small cap Russell 2000 flat and the S&P400 Mid-Cap index down about 1%. The technology sector was strong. The NASDAQ100 gained 3%, returning the index to break-even for the year. The Morgan Stanley High tech index added 2% and The Street.com Internet index 1%. The Semiconductors surged 7% this week, while the NASDAQ Telecom index was about unchanged. The Biotechs missed the rally, dropping 3% for the week. The Securities Broker/Dealer index was unchanged, while the Banks added about 1%. With bullion pummeled for $18.30, the HUI Gold index dropped 3%. Credit market performance was mixed. For the week, two-year Treasury yields were unchanged at 1.61%. Five-year yields declined four basis points to 2.85%, while the 10-year Treasury note saw its yield rise one basis point to 3.94%. Interestingly, the long-bond performed poorly, with yields jumping eight basis points to 4.88% (inflation worries?). Benchmark mortgage-backs appeared to under-perform (yields generally up three basis points), while agency debt continues to perform quite well (implied agency yields down three basis points). The spread on Fannie’s 5 3/8 2011 note narrowed two to a quite narrow 33 basis points. The 10-year dollar swap spread narrowed 2.5 to 42, with agency and dollar swap spreads narrowing to levels not seen since (pre-Russia/LTCM) September 1997. However, corporate spreads began to widen this week. Ford and GM saw their debt spreads (to Treasuries) widen five or six basis points. Junk bonds were pounded yesterday, with speculative grade spread indices widening almost 20 basis points. While generally unimpressive, today’s rally put the dollar slightly in the plus column for the week. Declining less than 1%, commodities gave back a portion of their recent strong gains. February 11 – Bloomberg: “Cotton prices soared the exchange-imposed limit on speculation that China has increased purchases of the fiber. China, the world's biggest consumer of cotton, has bought at least 300,000 bales of cotton from U.S. shippers, traders said... ‘China is buying anything that isn't nailed down.’” The corporate bond market continues to enjoy extraordinary liquidity. Crown Cork & Seal’s $2.12 billion (raised from $1.75 billion) issuance was the largest junk bond financing in three years (according to Bloomberg). American Electric Power raised $2 billion, CIT raised its bond issuance 33% to $1 billion, and PHH, a division of Cendant, sold $1 billion of bonds. It is worth noting, however, that Mandalay Resorts postponed their $300 million offering, while Citgo has delayed its offering until next week. California sold $900 million of general obligation bonds this week at historically wide spreads. The state sold seven-year tax-exempt bonds at a yield of 3.71% (6.66% tax equivalent), a 48 basis point premium to top-rated muni issuers. This was about 30 basis points more than state of New York yields and up from the 25 basis points premium California paid back in October. Broad money supply (M3) expanded $16.9 billion last week, with three-week gains of $87.2 billion. Currency increased $1.2 billion, while Demand and Checkable deposits jumped $11.8 billion. Curiously, narrow money (M1 – Currency, Travelers Checks, Demand and Checkable Deposits) is up almost $47 billion in three weeks. Savings Deposits declined $3.4 billion and Small Denominated Deposits decreased $1.5 billion. Retail Money Fund deposits declined $3.9 billion, and Institutional Money Fund deposits declined $6.6 billion. Large Denominated deposits increased $11.3 billion and Repurchase Agreements jumped $8.5 billion. Official Foreign Holdings of U.S. debt securities increased $4.5 billion last week to $870 billion, and is up $60 billion (30% annualized) over 13 weeks. Bank Total Assets expanded $74.1 billion last week (seasonally-adjusted), with five-week gains of $113.5 billion (17% annualized). Securities holdings jumped $35.7 billion for the week. Loans and Leases increased $9.8 billion. Real Estate loans were up $18.8 billion, while Commercial and Industrial (C&I) loans declined $5.1 billion. For the first five weeks of the New Year, Real Estate loans were up $42.8 billion (22% annualized growth rate!), while C&I loans declined $2.5 billion. Issuance of asset-backed securities was a slow $3.4 billion, with performance said to be diverging notably between top-tier issuers and the faltering subprime sector. Divergences, not surprisingly, are increasingly evident in the economic landscape as well. The manufacturing sector continues to show signs of life. This morning provided a stronger-than-expected 0.7% increase in Industrial Production (strongest gain in six months) and a slight uptick in Capacity Utilization. Earlier in the week, Retail Sales Less Autos were reported stronger-than-expected (although weak auto sales saw an overall disappointing retail sales report). Yet, Retail Sales were up 4.6% y-o-y, with Retail Sales Less Autos up 5.8% y-o-y. Sales growth was led by Building Materials up 6.6% y-o-y, Health Stores up 5% y-o-y, Gasoline Stations up 19.3% y-o-y, General Merchandise up 5.3% y-o-y, and Eating and Drinking establishments up 8% y-o-y. But while the number of (inflated) dollars expended remains relatively strong, the mood is grim. Today’s University of Michigan Consumer Confidence report had the Future Situation component sinking four points to 68.8, the weakest reading since September 1993. This index is down 12 points in two months. Yesterday the Labor Department reported that Import Prices jumped 1.5% during January, the strongest gain since last April. There have been only two stronger monthly readings during the past 10 years (a 1.6% rise in April 2002, and 1.9% in February 2000). Year-over-year import prices were up 5.5%, the highest level since August 2000. It is worth noting that y-o-y import prices were slightly negative as recently as September. Year-over-year by category, Food & Beverage prices were up 5.3%, Industrial Supplies 26.8% (fuels and lubricants up 12.5% for the month and 66% y-o-y), and Autos and Parts up 0.5%. Capital Goods prices were down only 2.1% y-o-y, and prices have declined only slightly during the past three months. Consumer Goods Ex Autos saw prices down 0.5% y-o-y, although prices have increased marginally over the past two months. February 11 – Bloomberg: “The California Public Employees’ Retirement System, the largest U.S. public pension fund, is considering selling credit enhancement to municipal bond issuers to earn as much as $17.5 million a year. Calpers’ investment committee is considering whether the pension fund should begin selling letters of credit or liquidity facilities to state and local bond issuers as a way to generate income. Under the proposal, the fund would back up to $5 billion on bonds, about 5 percent of the fund’s $133.8 billion in assets… ‘The program will provide support for California municipalities and others across the nation while adding value to our investment portfolio.’ Calpers would join a number of states that already run bond insurance programs…” February 11- Financial Times (Jenny Wiggins): “‘Bond insurers risk taking losses in their structured finance portfolios due to ongoing weakness in the credit markets,’ Moody’s Investors Service has warned. Many bond insurers are heavily exposed to the structured finance markets, having accumulated $210bn of exposure to the collateralised debt obligation (CDO) and credit default swap (CDS) markets by the third quarter of 2002. To date, Financial Security Assurance is the only bond insurer to have recorded a material loss on CDOs and significantly increased its loss reserves. It has the largest CDO/CDS exposure in the industry, accounting for 35 per cent. Other insurers with substantial exposure include MBIA, Ambac Financial, ACE Guaranty and XL Capital Assurance.” Things are turning desperate at subprime auto lender AmeriCredit. Now fighting for survival, the company is sharply reducing lending, shuttering 60% of its branch offices, and firing 1,000 employees. But retrenchment rarely proves a viable option in The Game of Subprime. Any tightening of Credit availability – and consequent constraint on lending growth – finds current “earnings” overwhelmed by ballooning Credit losses. Yet, we have been amazed that the enterprising Credit insurers have continued to play The Game - providing the Credit enhancements necessary for the company to sell its securitizations. But the well is clearly running dry, and there will be a high price to pay. We will now watch the performance of the company’s securitizations and see how quickly loss “triggers” hit the company and its various Credit insurers. This looks to be one more blow to an increasingly punch-drunk asset-backed securities marketplace, as well as a significant escalation of the bursting of the consumer debt Bubble. AmeriCredit ended 2002 with managed receivables of $16.2 billion (up 60% in 18 months!). At $1.533 billion, AmeriCredit is #16 on MBIA’s “Top 25 Structured Finance Servicer Exposures.” Dexia's Financial Security Assurance (FSA) also has signficant exposure to AmeriCredit securitizations. Weekly bankruptcy filings jumped to 32,223, up 9% for the week to the highest level since early November. Last week’s filings were up 14% y-o-y, on top of a high base created by 2001’s 19% surge and 2002’s 5.7% increase in (record) claims filed. In Blow-off Week #34 of The Great Mortgage Finance Bubble, the Mortgage Bankers Association Refi application index declined 2.7% from the previous week, while remaining up 156% from the year ago level. The Purchase application index declined 11.4% to the weakest reading since March, although it was up 4.5% y-o-y. A one-year adjustable-rate mortgage could be had last week at 3.61% (fueling the California housing Bubble?), down from the year ago 5.10%. National Mortgage News this week estimated fourth-quarter 2002 mortgage originations at a stunning $1 Trillion. Wow… Highlights from Countrywide Financial’s January production report:: “Loan fundings reached $33.7 billion, up 127 percent from last year’s $14.8 billion. This marks the third highest funding month in the Company’s history… Average Daily applications remained strong at $2.0 billion, up 111 percent from January 2002… The month end mortgage pipeline closed at $48.2 billion, up 110% over last year’s… The servicing portfolio reached a record $469 billion… Total assets at Countrywide Bank now stand at $6.5 billion…” Year-over-year, January Purchase Fundings were up 61%, Non-purchase (refi) Fundings 159%, Home Equity Fundings 47%, and Subprime Fundings 50%. Fannie Mae reported that January “Total business volume rose to a record high of $121.1 billion." Fannie’s retained mortgage portfolio jumped $19.8 billion, or 34.6% annualized, during the month to $810.6 billion. Over two months, Fannie’s retained portfolio has surged $49.9 billion, or 39% annualized. To put this Credit creation into perspective, Federal Reserve Total Assets have expanded $14.3 billion over the past two months to $697 billion, and have increased $62.4 billion (9.8%) during the past twelve months. Fannie’s total Book of Business (retained mortgage portfolio plus mortgage-backs sold into the marketplace) is up $78.7 billion, or 27% annualized, over two months to $1.859 Trillion. Fannie’s Book of Business is up $278 billion, or almost 18%, during the past twelve months. February 12, 2003: “Median existing-home prices are increasing at strong rates in most metropolitan areas and typically are increasing well above historic norms, according to the latest quarterly survey by (the) National Association of Realtors… The association’s fourth-quarter metro area home price report, covering changes in 120 metropolitan statistical areas, shows 39 areas with double-digit annual increases in median existing-home prices and only 10 areas posting generally small price declines… David Lereah, NAR’s chief economist, said inventory shortfalls continue to squeeze home prices in many areas. ‘There was an average 4.7-month supply of homes on the market during the fourth quarter, well below the 6.0-month level considered to be a generally balanced market between buyers and sellers. The tight supply of available homes has persisted for several years now. The result is that home prices in the fourth quarter rose almost three times faster than historic norms.” And despite increasingly vocal propaganda arguing otherwise, data are rather conclusive that we remain in the midst of an historic national Mortgage Finance Bubble. Accordingly, inflationary manifestations are rather conspicuous from coast to coast. Fourth quarter prices were up 8.8% y-o-y, with gains of 12.9% in the Northeast, 8.9% in the Midwest, 7.7% in the South, and 10.8% in the West. The California housing Bubble saw the top two along with the eighth leading price gainers by metro area, with Sacramento up 26.7% y-o-y, San Diego up 26.6%, and Orange County gaining 20.4%. Median prices were up 24.6% in Providence, RI , 23.6% in Nassau/Suffolk, NY, 22.1% in Monmouth/Ocean, NJ, 20.9% in Melbourne, FL, 20.8% in Ft. Lauderdale, FL, and 20.2% in “NY/NJ/CT.” Other notable gains included the “Los Angeles Area” up 19.8%, Milwaukee, WI 19.7%, Chicago 15.7%, Baltimore 14.2%, Washington DC 14.1%, Philadelphia 12.6%, San Francisco 11.3%, Boston 10.2%, and Minneapolis 10.2%. February 12 – Bloomberg: “Total existing-home sales, which include single-family, apartment condominium and co-operative sales, rose in 45 states and the District of Columbia in the fourth quarter of 2002 compared with the same period in 2001, the National Association of Realtors (NAR) reported today. NAR’s latest report on total existing-home sales showed that nationwide, the seasonally adjusted annual rate was 6.55 million units in the fourth quarter, up 8.6 percent from the 6.03 million-unit level in the fourth quarter of 2001. In addition, fourth-quarter sales were up 5.8 percent from a pace of 6.19 million units recorded in the third quarter of 2002 and were the second-highest level on record.” February 12, 2003 - Representative Bernard Sanders: “Mr. Greenspan, I always enjoy your presentation, because frankly, I wonder what world you live in.” Alan Greenspan does appear increasingly detached from reality, while his stature in Washington is in strikingly steep decline. For a senator to call (rather disrespectfully) for the Fed Chairman’s resignation on national television is in stark contrast to the idolatry of too many years past. And there is no denying that Greenspan’s analysis is poor and lacking of credibility, even to those that have revered him. He is clearly overstating the current economic impact from the imminent conflict with Iraq. In the same vein, he is determined to disregard the severe economic maladjustments imparted over his long tenure. His unrelenting fixation on some heroic productivity miracle is an historic blunder. And, importantly, he is seemingly hopelessly distracted from the critical issue of the impending financial and economic quagmire. Chairman Greenspan continues to trumpet the exceptional performance of contemporary finance and the U.S. financial sector specifically, while appearing oblivious to the developing dislocations throughout “structured finance.” He cannot say enough postive things about the household housing/mortgage environment, but then plays cautious when it comes to its Master, the GSEs. He can't have it both ways. And, remarkably, in just two days of testimony he at the same time disappointed the Administration and the “Keynesian” inflationists. Perhaps Dr. Greenspan has been rattled by the energy price spike and heightened inflationary pressures. Things simply could not be more fascinating. Greenspan Testimony to Senate Banking Committee: February 11, 2003 Q&A: New Hampshire Senator John Sununu: “I have one final question about the mortgage industry. You talked about the degree to which mortgage rates, being at historic lows, have encouraged refinancing, and refinancing activity is at a very high level right now. In the past, you’ve been very candid about your concerns regarding the GSEs and your thoughts regarding changing some of the current legislation that provides benefits to GSEs. Let me talk about one particular reform, which I think is topical because of the Sarbanes-Oxley bill, and that is oversight -- greater oversight or involvement of the SEC in the mortgage market and the secondary mortgage markets in particular. To what extent do you, I guess, support, or would you support SEC oversight or involvement in the GSEs, but to what extent would that affect costs of mortgages and liquidity in the mortgage markets? Chairman Greenspan: “Without stipulating whether I would agree in any particular proposal, because without seeing the specific proposal, just basically saying that this agency should oversee this part of the economy, I don’t think is enough information. But having said that, the major issue here is to what extent is the subsidy, which is implicit in the GSE debentures, even though they are not legally an obligation of the United States government, they are not backed by the full faith and credit of the United States, it’s the market which presumes that they will be bailed out that effectively enables them to sell mortgages at a number of basis points below what the market would otherwise be. As a consequence of that, some of that does go through into lower mortgage interest rates, but as best we can judge, it is a very small number. So I’m not at all convinced that many of the proposals really make all that much difference to the secondary mortgage market or to the level of mortgage interest rates to the American public. My comment: The “major issue” is certainly not related to any nominal “subsidy” shared amongst the GSEs, their shareholders, and the American homeowner. Chairman Greenspan’s analytical framework focuses on the marketplace’s perception of implicit backing of the U.S. government, which “enables them to sell mortgages at a number of basis points below what the market would otherwise be.” From this perspective, a few “basis points” would surely seem unworthy of alarm. But this completely misses the critical issue of unfettered contemporary money and Credit creation. Today, their “government-sponsored” status has created a momentous market distortion. The GSEs have the capacity to issue unlimited liabilities (monetary liabilities, as well bonds and mortgage-backs) with virtually no impact on borrowing costs (abrogating the relationship between supply, demand and the price of Credit). This structure has allowed virtually the entire country to refinance mortgages – creating unprecedented new mortgage debt in the process – while borrowing rates have declined to 40-year lows. This is no less than an absolute breakdown in the critical market pricing mechanism for Credit. The critical issue is the recognition of this dangerous market distortion and the necessity of avoiding government guarantees (explicit and implicit). And in the case where market perceptions of implied guarantees foster Credit excess and fledging distortions, the Fed must move quickly and aggressively to regulate against self-reinforcing Credit and speculative excess. Georgia Senator Zell Miller: “This also is a question that comes from personal experience. I’m sitting here between two former governors, one’s left, but from time to time - I don’t know about them, but from time to time, we get to thinking that maybe it would be better to be back in the statehouse. Except right now, it’s not too good back in the statehouse. And so my question to you is, do you think the Congress should address in any way the budget shortfalls that the states are having? And if so, what would be your approach? Chairman Greenspan: “This is a difficult question, largely because the source of the problem in many of the states, as you know, Senator, has been that with the fairly substantial surge in revenues that the states had, in many cases, and it’s hard to know how many, permanent programs for expenditures were financed. And to a large extent, because the tax rate on capital gains and options and the like are - or, I should say the tax rate on capital gains in the states are pretty much equivalent to the regular income tax rates, since the adjusted gross income from the federal returns are what are used for the income tax where it is applicable for the states. And we saw a very big surge in federal revenues, but for some states, because the tax rates are relatively higher, they saw an even greater surge. So that you have to weigh the fact that some of the states overexpended and should and will and are appropriately pulling back, and others didn’t. And the question is, how does one – how does the Congress or the federal government appropriately handle that without essentially treating those who were not sufficiently conservative t contain their funds from those who are less conservative? In other words, how does one make a program which is fair to everybody? I have no objection, obviously, to having federal funds go to the states. That’s – we’ve been doing that for decades. But I must admit, I do have some problems how one - how would one in fairness create a program which did not essentially benefit those who are the least conservative in their programs relative to those who were. If that can be done, then I think that there are obvious arguments in favor of it.” My comment: Dr. Greenspan explains this most important and difficult issue quite clearly, although he certainly avoids accepting responsibility for the unfolding crisis in state and local government finances. It cannot be explained too many times that this quagmire is the predictable consequence of the massive inflationary surge that has so distorted the entire U.S. financial and economic system since the mid-to-late 1990s. Wild money, Credit and resulting speculative excesses created inflated revenues (for taxpayers, homeowners, investors/speculators, businesses, industries, lenders, and governments). As one would expect, most state and local governments responded to this apparent bonanza by increasing spending. Why wouldn’t they - especially when the talk from our top central bankers was of New Eras and economic miracles? Politicians, again not-surprisingly, often found it advantageous to reduce fees and taxes. The self-reinforcing inflationary bulge had (and is having) disparate distorting affects on revenues, costs, and the general structure of demand. More recently, rampant mortgage Credit inflation has displaced the stock and corporate bond market Bubbles, again with disparate inflationary manifestations. Government revenues are now de-Bubblizing, while costs are not. And as Dr. Greenspan articulated, there is today no easy solution. Importantly, the necessary painful adjustment period for state and local government finances should be recognized as a microcosm for the tough medicine necessary to treat the maladjusted U.S. Bubble economy. The cure will in no way be found with only greater inflation. As Dr. Richebacher has always explained to us, “The only “cure” for a Bubble is to not allow it to develop.” Texas Representative Ron Paul: “I have a question relating to the speech that you gave at the economic club in New York in December. Because you introduced your speech with three paragraphs dealing with gold and the -- and monetary policy. And you made some very pertinent points about gold, indicating that from the year 1800 to 1929 the price levels were essentially stable under gold. And after we got rid of the gold restraint on the monetary authorities, prices have essentially increased by over tenfold since that time. But you also follow that by indicating that inflation, when it was out of control in 1979, monetary policy changed direction in a way, and they were able to take care of inflation, more or less conquer inflation, and that now you are more or less not concerned about inflation, that your concern, really, is about deflation. And it was interesting that you brought up the subject of gold, of course. And there’s a lot of speculation as to exactly why you did this and what this means. But my question deals with whether or not we should forget about inflation, whether or not this has been dead and buried. Federal Reserve credit for the last three months has gone up at the rate of over 28 percent. Inflation is a monetary event, so therefore we have monetary inflation. The median CPI is almost going up at twice the rate as the CPI, close to 4 percent. The Commodity Research Bureau index is going up in the last 15 months over 35 percent. Gold is up 36 percent over 18 months, or 15 months. Oil is up 60 percent. So we have a lot of inflation. And we have medical care costs skyrocketing, housing costs going up, the cost of education going up, the cost of energy going up. And to assume that we shouldn’t be concerned about inflation, all we can do now is print money, I would suggest that this is what we’ve been doing for three years, the monetary authorities. We’ve ... you’ve lowered the discount rate 12 times, and there's still no signs of good economic growth. So when - when will you express the concern about an inflationary recession? Because that to me seems like our greatest threat, because that has existed before, we even had a taste of it in the ‘70s. We called it stagflation. So I’d like you to comment on that as well as follow on your comments on just why you might have brought up the subject of gold as the New York speech. Chairman Greenspan: “First of all, we have not lessened our concerns about inflation. Indeed, our general presumption is that we seek stable prices. And stable prices mean no inflation or deflation. The reason I raised the issue of gold is the fact that the general wisdom during the period subsequent to the 1930s is that as we moved to essentially a fiat money standard, that there was no anchor to the general price level. And, indeed, what we subsequently observed is, as you point out, a very marked increase in general price levels, indeed, around the world as moved ourselves from commodity standards, and specifically gold. I had always thought that the fiat money system was chronically and inevitably an inflation vehicle, and indeed, said so repeatedly. I have been quite surprised, and I must say, pleased by the fact that central bankers have been able to effectively simulate many of the characteristics of the gold standard by constraining the degree of finance in a manner which effectively has brought down the general price levels. The individual price levels to which you allude are certainly correct. I might say the gold and the oil issue are clearly war related and not fundamental. But we still -- looking at the broadest measures of average inflation, and the best statistics that we have, still indicate very low inflation with no evidence of an acceleration. That does not mean, however, that we believe that inflation is somehow inconceivable anytime in the future. We will maintain a considerable vigilance on the issue of inflation, and are looking all the time for evidences of an emergence of inflation, which at this particular time we do not see. But that does not mean that we believe inflation is dead and that we need not be concerned about it. We will continue to monitor the financial system as best we can to make certain that we keep prices stable. They are stable now, and we hope to be able to continue that indefinitely into the future.” My comment: There has been considerable debate in the gold community regarding the intent of Greenspan’s recent observations on gold. I think his response to Representative Paul’s poignant question clarifies the issue. Instead of laying analytical groundwork for a future return to some type of gold-backed monetary standard, Chairman Greenspan is propagating the opposite: Although central bankers did get off to a quite rocky start in their management of a global fiat monetary regime, their experience and newfound discipline has evolved (in the mind of our Fed Chairman) into a system that “effectively simulates” the stability of a gold-anchored monetary regime. Indeed, Greenspan’s comments are consistent with Fed Governor Bernanke’s recent assertion that central bankers’ commitment to “price stability” has provided a solid “anchor” for contemporary monetary systems. That such comments could be made nowadays (with a straight face) – after recurring global financial crises and a bursting of an historic global stock market Bubble, while in the midst of out of control U.S. (and, to a lesser extent global) mortgage lending excess, out of control U.S. trade deficits, a faltering dollar (world’s reserve currency), and surging gold, energy, and commodity prices – is simply incredible. The faltering global financial system is absolutely anchorless and heading towards the rocks. Skipper Greenspan, refusing to heed increasingly desperate warning calls from the upper-deck, is locked in his quarters with the sheets pulled over his head. |
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