08/02/2007 Credit Market Dislocation *

For the week, the Dow dipped only 0.6% (up 5.8% y-t-d), but more intense selling saw the S&P500 was hit for 1.8% (up 1.0%).  The Transports were slammed for 3.2% (up 6.9%), while the Utilities managed a 0.2% rise (up 1.6%).  The Morgan Stanley Cyclical index declined 0.9% (up 13.8%), and the Morgan Stanley Consumer index dipped 0.2% (up 0.8%).  The broader market was under heavier selling pressure.  The small cap Russell 2000 sank 2.9% (down 4.1% y-t-d), and the S&P400 Mid-Cap index fell 2.1% (up 4.5%).  The NASDAQ100 dropped 1.9% (up 9.2%), and the Morgan Stanley High Tech index sank 2.5% (up 8.7%).  The Semiconductors fell 2.9% (up 4.2%).  The Street.com Internet Index declined 1.5% (up 7.5%), and the NASDAQ Telecommunications index dipped 0.4% (up 11.5%).  The Biotechs dropped 2.5% (down 0.7%).  Financial stocks were under heavy selling pressure.  The Broker/Dealers were clobbered for 7.6% (down 11.3%), and the Banks dropped 3.5% (down 13.3%).  With Bullion gaining $11.80, the HUI Gold index added 0.5% (up 0.4%). Two-year U.S. government yields this week declined 7 bps to 4.42%.  Five-year yields fell 8 bps to 4.48%.  Ten-year Treasury yields dropped 9 bps to 4.68%.  Long-bond yields ended the week 7 bps lower at 4.86%.  The 2yr/10yr spread ended the week at a positive 26 bps.  The implied yield on 3-month December ’07 Eurodollars dropped 11.5 bps to 4.985%.  Benchmark Fannie Mae MBS yields fell 12 bps to 6.10%, this week only partially recovering from last week’s significant widening versus Treasuries.  The spread on Fannie’s 5% 2017 note widened 2 to 65, and the spread on Freddie’s 5% 2017 note widened one to 65.  The 10-year dollar swap spread declined one to 74.65.  Corporate bond spreads widened further, with the spread on a junk index this week widening 50 bps.     Investment grade debt issuers were limited to GE Capital $2.0bn and Coca-Cola Enterprises $450 million.    August 2 – Bloomberg (Fabio Alves):  “Investors pulled money out of high-yield corporate bond funds for an eighth straight week, according to AMG… High-yield bond funds reported net outflows of $2.7 billion in the week ended Aug. 1…” No junk issuance this week.     Convert issuers included Horizon Lines $300 million. No international dollar bond issuance this week. German 10-year bund yields were little changed at 4.32%, and the DAX equities index down 0.2% (up 12.7% y-t-d).  Japanese 10-year “JGB” yields declined one basis point to 1.77%.  The Nikkei 225 fell 1.8% (down 1.4% y-t-d).  Emerging debt and equity market trading has turned highly unstable.  Brazil’s benchmark dollar bond yields sank 31 bps this week to 6.16%.  Despite wild volatility, Brazil’s Bovespa equities index closed the week down only 0.1% (up 18.8% y-t-d).  The Mexican Bolsa dropped 1.9% (up 12.2% y-t-d).  Mexico’s 10-year $ yields dropped 16 bps to 5.88%.  Russia’s RTS equities index added 0.2% (up 2.5% y-t-d).  India’s Sensex equities index declined 0.6% (up 9.8% y-t-d).  China’s Shanghai Composite index ended the week 5% higher to a new record high (up 70.5% y-t-d and 185% over the past year). Freddie Mac posted 30-year fixed mortgage rates dipped one basis point this past week to 6.68% (up 5bps y-o-y).  Fifteen-year fixed rates fell 5 bps to 6.32% (up 5bps y-o-y).  One-year adjustable rates dropped 10 bps to 5.59% (down 10 bps y-o-y).  The Mortgage Bankers Association Purchase Applications Index declined 1.8% this week to a 13-wk low.  Purchase Applications were up 9.8% from one year ago, with dollar volume 15.5% higher.  Refi applications increased 1.8% for the week, and dollar volume was up 24.6% from a year earlier.  The average new Purchase mortgage was little changed at $234,300 (up 5.2% y-o-y), while the average ARM slipped to $393,500 (up 13.1% y-o-y).  Bank Credit added $2.8bn (week of 7/25) to $8.646 TN, after gaining $24.2bn the prior week.  For the week, Securities Credit declined $4.5bn.  Loans & Leases gained $7.3bn to $6.332 TN.  C&I loans dipped $0.5bn, while Real Estate loans jumped $10bn.  Consumer loans declined $1.4bn.  Securities loans fell $6.2bn, while Other loans increased $5.5bn.  On the liability side, (previous M3) Large Time Deposits dropped $10.4bn.      M2 (narrow) “money” increased $8.1bn to $7.273 TN (week of 7/23).  Narrow “money” has expanded $229bn y-t-d, or 5.6% annualized, and $428bn, or 6.3%, over the past year.  For the week, Currency rose $1.7bn, while Demand & Checkable Deposits declined $11.9bn.  Savings Deposits jumped $19bn, while Small Denominated Deposits dipped $0.2bn.  Retail Money Fund assets slipped $0.5bn.        Total Money Market Fund Assets (from Invest. Co Inst) surged $23bn last week to a record $2.607 TN.  Money Fund Assets have increased $225bn y-t-d, a 15.8% rate, and $436bn over 52 weeks, or 20.1%.      Total Commercial Paper declined $11.9bn last week to $2.213 TN, with a y-t-d gain of $238bn (20.3% annualized).  CP has increased $423bn, or 23.6%, over the past 52 weeks.  Fed Foreign Holdings of Treasury, Agency Debt last week (ended 7/18) rose $7.0bn to a record $2.010 TN.  “Custody holdings” were up $258bn y-t-d (24.7% annualized) and $356bn during the past year, or 21.6%.  Federal Reserve Credit last week jumped $7.4bn to $857.6bn.  Fed Credit has expanded $5.4bn y-t-d, with one-year growth of $24.6bn (3.0%).     International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $846bn y-t-d (30% annualized) and $1.095 TN y-o-y (24%) to a record $5.657 TN.  August 2 – Bloomberg (Kim Kyoungwha):  “South Korea’s foreign-exchange reserves, the world’s fifth largest, rose last month as the central bank earned more from interest payments.  The reserves increased to $254.8 billion in July, a $4.1 billion gain from the previous month…” August 1 – Dow Jones:  “Brazil’s foreign currency reserves grew by $8.8 billion in July as the central bank continued actively buying U.S. dollars… Brazilian foreign reserves reached $155.9 billion on July 31…   At the end of the first seven months, reserves were up 81.6% when compared with the end of last year. The country’s reserves were $85.839 billion at the end of 2006.” Currency Watch: The spot dollar index dropped 1% to 80.117.  On the upside, the Norwegian krone gained 1.5%, the Swiss franc 1.5%, the Euro 1.0%, the Danish krone 1.0%, and the British pound 0.8%.   On the downside, the New Zealand dollar fell 0.6%, the South African rand 0.3%, and the Brazilian real 0.3%. Commodities Watch August 1 – Financial Times (Javier Blas):  “Tin yesterday rose to an all-time high, propelled by supply concerns and robust speculative buying.  The metal, one of the most illiquid contracts on the London Metal Exchange, has risen 42% since January…” For the week, Gold rose 1.8% to $673 and Silver 3.5% to $13.16.  Copper rose 2.5%.  September crude declined $1.98 to $75.04.  September gasoline declined 1.3%, and September Natural Gas dropped 2.6%.  For the week, the CRB index slipped 0.5% (up 3.6% y-t-d), and the Goldman Sachs Commodities Index (GSCI) declined 1.3% (up 16% y-t-d).  Japan Watch: August 2 – Bloomberg (Lily Nonomiya and Masahiro Hidaka):  “Japanese companies may increase spending at the fastest pace in 17 years, the Development Bank of Japan said, adding to evidence that the central bank may raise interest rates as soon as this month.  Companies plan to increase spending 11% in the year ending March 31…” August 1 – Bloomberg (Kathleen Chu):  “Japanese land prices rose 8.6% last year, more than nine times faster than in 2005, when a 16-year property slump ended because of a rebound in the world’s second-largest economy.  The average price of land jumped to 126,000 yen ($1,063) per square meter…” China Watch: August 2 – Bloomberg (Zhao Yidi):  “China’s central bank said will set up a deposit insurance plan to guarantee savings and protect depositors from bankrupt banks, seeking to instill public confidence in the country’s financial system.  The People’s Bank of China today signed an accord with the U.S. Federal Deposit Insurance Corp. to cooperate on financial services and deposit insurance, according to a statement.  China’s central bank, custodian of the world's largest foreign-currency reserves, wants to shield the country’s 36.9 trillion yuan ($4.87 trillion) of local-currency deposits from bankrupt banks and maintain public confidence in the financial industry. The assurance plan comes amid increasing calls by government officials for banks to refrain from lending money to stock market punters and real estate speculators.” July 31 – Bloomberg (Li Yanping):  “China’s inflation may accelerate in the third quarter of this year to reach 4.8%, the China Business Times reported, citing Song Guoqing, an economist at Peking University’s China Center for Economic Research.” July 30 – Bloomberg (Nipa Piboontanasawat):  “China ordered banks to set aside larger reserves for the sixth time this year to curb lending and investment after the economy grew at the fastest pace since 1994.  Lenders must put aside 12% of deposits as reserves, starting Aug. 15, up from 11.5%, the People’s Bank of China said…   China is trying to stop the flood of cash from record trade surpluses from fueling inflation, asset bubbles and overcapacity in manufacturing.” July 31 – Bloomberg (Wendy Leung):  “Hong Kong’s retail sales climbed a more-than-expected 14.3% in June from a year earlier as stock-market gains, rising wages and a low jobless rate encouraged spending.” India Watch: July 31 – Bloomberg (Cherian Thomas):  “India’s central bank unexpectedly ordered lenders to set aside larger reserves for the third time this year to remove excess money that may stoke inflation.” Asia Boom Watch: August 1 – UPI:  “South Korea…reported a trade surplus of nearly $1.5 billion for July, its 52nd consecutive month of such positive performance.  The commerce and industry ministry reported that July exports rose 20% to $30.9 billion from the same month of last year, driven largely by sales of automobiles and cell phones.” July 31 – Bloomberg (Seyoon Kim):  “South Korea’s service companies expanded at the fastest pace in almost five years in June, the latest indication that economic growth may accelerate.” Unbalanced Global Economy Watch: August 2 – Bloomberg (Peter Woodifield):  “U.K. farm land prices are rising at the fastest rate for 30 years, as bankers and traders flush with bonuses from a record year in the financial markets are joining mainly Irish foreign investors to buy farms and country estates.  Prices rose 10% in the second quarter and 27% in the year to June 30, the most since 1977, London-based realtor Knight Frank said…” July 31 – Bloomberg (Robin Wigglesworth):  “Norway’s domestic credit growth slowed to 14.7% in June as 11 interest rate increases in two years and the prospect of more to come began to take their toll on consumers’ debt appetite.  Credit growth for households, companies and municipalities eased from 14.8% in May…” August 2 – Bloomberg (Maria Levitov):  “Russia’s former acting Prime Minister Yegor Gaidar said inflation will probably surpass the government's target and reach 8.6% this year.  ‘When your economy depends on oil and gas prices and these prices are abnormally high, monetary risks emerge,’ Gaidar, director of The Institute for the Economy in Transition, said… The government aims to slow inflation to 8% this year from last year’s rate of 9%.” August 1 – Bloomberg (Mark Bentley):  “Turkey’s exports jumped 28% in July from a year earlier, the Turkish Exporters’ Assembly said…  Export growth accelerated from 17% in June.” July 31 – Bloomberg (Nasreen Seria and Mike Cohen):  “South African credit growth unexpectedly accelerated to an annual 24.9% in June, adding pressure on the central bank to raise interest rates… The pace of growth in borrowing by households and companies accelerated from 24.8% in May…” Latin American Boom Watch: July 31 – Bloomberg (Patrick Harrington):  “Bank of Mexico economist Manuel Ramos Francia said the recent acceleration of inflation in the country was caused by a food ‘supply shock’ and not a general increase in consumer prices.” August 1 – Bloomberg (Eliana Raszewski):  “Argentina’s tax revenue rose 37.7% in July from a year earlier as the economy heads into a fifth straight year of growth.” July 31 – Bloomberg (Helen Murphy):  “Colombia’s imports rose 24.8% in May from a year earlier, helped by a surge in purchases of automobiles and car parts.” Central Banker Watch: August 3 – Bloomberg (Helene Fouquet):  “European Central Bank President Jean-Claude Trichet, likening inflation to a drug, said the bank may raise interest rates next month to keep prices stable.  ‘Strong inflation is a bit of a drug,’ Trichet told Europe 1 radio in an interview… ‘It gives you immediate satisfaction and then you pay a high price for it.’” Mortgage Finance Bubble Watch: August 3 – Bloomberg (Chen Shiyin and Pimm Fox):  “The U.S. subprime-market rout that wiped out $2.1 trillion from global share values last week has ‘got a long way to go,’ said Jim Rogers… ‘This was one of the biggest bubbles we’ve ever had in credit,’ Rogers, chairman of New York-based Beeland Interests Inc., said in an interview from Hong Kong.” August 3 – Bloomberg (Kathleen M. Howley and Jody Shenn):  “U.S. mortgage lenders such as Wells Fargo & Co. and Wachovia Corp. are raising rates and imposing stricter standards on some of their most creditworthy borrowers as slumping demand in the mortgage bond market chokes off funding.  …Wells Fargo, the second-biggest U.S. home lender, curbed its funding of Alt-A loans, made to borrowers with near-prime credit ratings or prime borrowers who don't document income.  …Wachovia, the fourth-largest U.S. bank, also stopped making Alt-A loans through brokers and smaller lenders and curtailed some adjustable rate mortgages, spokeswoman Christy Phillips-Brown said.  ‘The credit crunch is here,’ said Keith Shaughnessy, president of Foundation Mortgage Corp.” August 2 – Bloomberg (Jody Shenn and Bradley Keoun):  “IndyMac Bancorp Inc. is joining rival lenders in making ‘very major changes’ to loan standards and raising interest rates because of a slump in mortgage securities, an e-mail to the company’s employees said.  The market for mortgage bonds has become ‘very panicked and illiquid,’ Chief Executive Officer Michael Perry wrote…  National City Corp. yesterday told companies from which it buys loans that it won’t accept second mortgages and some low-documentation loans… Wachovia Corp. today decided to stop making Alt A mortgages through brokers in one of its mortgage units.  ‘Unlike past private secondary mortgage market disruptions, which have lasted a few weeks or so, our industry and IndyMac have to be prudent and assume that this present disruption, which appears broader and more serious, might take longer to correct itself,’ Perry wrote.    The additional credit tightening by IndyMac, the ninth largest U.S. mortgage lender, and competitors on loans considered less risky than so-called subprime, comes at a time when it’s ‘difficult’ to trade even AAA-rated mortgage bonds that aren’t guaranteed by government-chartered Fannie Mae and Freddie Mac, or federal agency Ginnie Mae, Perry wrote.” August 2 – Bloomberg (Bradley Keoun):  “American Home Mortgage Investment Corp. plans to halt operations, becoming the second-biggest residential lender to fail this year as bad loans spread to people with good credit records.  The last day for most employees will be tomorrow, Chief Executive Officer Michael Strauss told the staff… Investment bankers cut off credit earlier this week, leaving the… company unable to fund at least $750 million of mortgages promised to thousands of now-stranded borrowers.  ‘Conditions in both the secondary mortgage market as well as the national real estate market have deteriorated to the point that our business is no longer viable,'' Strauss wrote today.” Foreclosure Watch: July 30 – Bloomberg (Kathleen M. Howley):  “U.S. foreclosures rose 58% in the first half of 2007 from a year earlier, led by California and Florida, as more homeowners fell behind on their monthly mortgage payments, RealtyTrac Inc. said.  Lenders sent notices of default, scheduled auctions or repossessions to 573,397 properties in the January to June period…  California foreclosures surged 170% to 104,572, the highest in the nation, and Florida gained 77% to 64,250.” Real Estate Bubbles Watch: August 2 – The Wall Street Journal (Ryan Chittum and Kemba J. Dunham):  “The fuel behind the skyrocketing commercial real-estate prices of the past three years -- cheap debt and easy lending terms -- is running low. As a result, high-risk buyers might be left behind and the pace of real-estate companies going private might slow.  Low-cost loans with lenient terms have propelled the commercial-real-estate market to what many feared was an unsustainable level. The boom was propped up by the commercial-mortgage-backed securities markets, which allowed banks to issue mortgages, pool them and sell them as bonds. With less risk on their books, banks were able to lend with cheaper rates and looser terms, making it easier for private-equity firms to buy huge portfolios and real-estate investment trusts. The buying frenzy culminated in Blackstone Group’s landmark, $23 billion acquisition of Equity Office Properties Trust in February. Many of those EOP properties were quickly flipped at even higher prices.  In the past few weeks, though, nervous buyers of these commercial securities have pulled out of the market altogether or demanded sharply higher yields, fearing that many transactions were too risky. That has forced lenders to raise interest rates, increasing the cost of buying real estate.” August 2 – Bloomberg (Dan Levy):  “The Italian palazzo-style home in San Francisco’s Pacific Heights neighborhood has a living-room view of the Golden Gate Bridge and Alcatraz Island, and billionaires Gordon Getty and Larry Ellison for neighbors.  What the house doesn’t offer is a security system, a renovated kitchen, or updated fixtures in the 7 1/2 bathrooms.  Both the heating and plumbing systems are original to the 1927 structure.  That isn’t stopping the seller from listing the seven-bedroom house for $55 million -- more than double the highest price ever paid for a San Francisco residence.  ‘You don’t have the fancy granite, marble and luxury finishes you’d expect in a $55 million house,’ said broker Joseph Moore of Alain Pinel Realtors. ‘It’s a fixer.’” Energy Boom and Crude Liquidity Watch: August 2 – Bloomberg (Matthew Brown):  “High inflation in the Persian Gulf will slow real gross domestic product growth, Gulf News reported, citing a report from the National Bank of Dubai.  Rising costs are hampering economic diversification away from oil in the region as they deter foreign investors, Gulf News said…” July 31 – Bloomberg (Matthew Brown):  “Qatar’s annual inflation slowed to 12.8% in the second quarter from 14.8% in the first as increases in the cost of housing eased.” Speculator Watch: July 31 – Bloomberg (Jenny Strasburg and Katherine Burton):  “Sowood Capital Management LP lost 50% in July, or about $1.5 billion, the biggest hedge-fund manager to collapse after declines in the corporate bond and loan markets.  Sowood sold most of its assets to Citadel Investment Group LLC and will unwind its two funds, Jeff Larson, founder…told investors… Sowood sought a buyer when it couldn’t meet lenders’ demands for more collateral…  ‘The transaction enabled us to avoid anticipated forced sales at extreme prices,’ Larson, a former Harvard University endowment manager, said in the letter. ‘The weakness in corporate credit, particularly focused on loans and loan credit-default swaps, accelerated sharply during the week of July 23.’  The firm’s credit holdings plummeted in value as investors shunned riskier debt such as subprime mortgages and bonds used to fund leveraged buyouts…  Sowood’s Alpha Fund Ltd. lost 57% in the month and Alpha Fund LP dropped 53%. The funds plunged 56% and 51% for the year… ‘It’s mind-boggling,’ said Bradley Alford, a former investment manager at the Duke University endowment who runs Atlanta-based money-management firm Alpha Capital Management LLC.  ‘This last week, the velocity of losses has picked up dramatically. The models work when they look at history, but not when history is all new.’” July 31 – Financial Times:  “Forget vulture funds that feed on the carcasses of dying companies or investment vehicles by snapping up chunks of distressed debt. Citadel is proving to be more of a whale – simply swallowing them whole.  Last year, the $14bn hedge fund teamed up with JPMorgan Chase to ingest Amaranth’s positions at bargain rates when the $9bn hedge fund made disastrous bets on natural gas. Its latest move is to buy Sowood’s credit portfolio, after the once-$3bn hedge fund saw its value halve as a result of bad bets… Unlike some funds that manage many billions of dollars with small staffs, Citadel employs more than 1,000 people.” July 31 – Bloomberg (Neil Unmack and Jacqueline Simmons):  “Oddo & Cie, a French stockbroker and money manager, plans to close three funds totaling 1 billion euros ($1.37 billion), citing the ‘unprecedented’ crisis in the U.S. asset-backed securities market.  Oddo said it will wind down the funds within the ‘shortest possible time frame’ after struggling to value holdings of collateralized debt obligations…  ‘Like many actors, we have tried to revitalize the performance of our funds by investing in CDOs,’ Arnaud Ploix, a spokesman for…Oddo, said… ‘Like others, we noticed recent problems with short-term liquidity and were caught out by the subprime dilemma.’” July 31 – Bloomberg (Aaron Pan):  “London raised average daily currency trading in April to more than double the level of New York, extending its lead as the world’s largest center for foreign exchange…  Trading rose to an average $1.34 trillion a day in London, a 27% gain from October, while in New York it grew 16% to $618 billion…” Credit Market Dislocation: July 31, 2007:  “C-BASS LLC, an affiliate of MGIC Investment Corporation and Radian Group Inc. today issued the following statement in response to the announcements made last night by MGIC and Radian regarding the liquidity challenges faced by C-BASS.  While nothing fundamentally has changed at C-BASS, like many other firms in the industry, the current severe state of disruption in the credit markets has caused C-BASS to be subject to an unprecedented amount of margin calls from our lenders. The frequency and magnitude of these calls have adversely affected our liquidity. To address this, C-BASS is in advanced discussions with a number of investors to provide increased liquidity and is exploring all options to mitigate the liquidity risk in this difficult market.” August 1 – Financial Times (Tim Bartz, Elisabeth Atzler, Joanna Chung, Paul J Davies and Stacy-Marie Ishmael):  “The German government has pulled together a rescue operation – drawing in all three pillars of the country’s banking system – to shore up Europe’s first major casualty of the subprime crisis. The rescue of IKB, a specialist lender based in Dusseldorf, began on Sunday when Peer Steinbrück, the German finance minister, called leading banking executives to discuss a bailout. According to people who took part in the conference call, Jochen Sanio, head of Germany’s financial regulator, is said to have warned of the worst banking crisis since 1931.” August 2 – Financial Times (Gillian Tett):  “Bitter disputes are developing behind the scenes in the hedge fund industry about the way funds are valuing some assets for their end-of-month performance reports.  In particular, the recent violent swings in the credit markets are making it unusually hard for some funds to agree the value of these assets with their administrators…  That may mean investors will be forced to wait longer than usual for performance reports about the net asset value (NAV) of hedge funds' portfolios in July.  It may even form fertile ground for future lawsuits, since sharp differences in the perceived value of hedge fund portfolios could influence investor confidence.  ‘There is a lot of wrangling going on behind the scenes, because it’s getting hard to agree [about] how to value a lot of stuff,’ says one US banking official. ‘The bid-offer spreads can be incredibly wide - and that can really affect the NAV…’ The data on funds’ NAV for the end of July is currently awaited with particular eagerness by many credit funds, since some are believed to have suffered painful losses as a result of the recent market turmoil - not only in the subprime sector but corporate credit markets in general.  Indeed, many bankers assume there will be further hedge fund implosions during coming weeks, adding to the list of those already forced to close their doors, or to take extreme measures such as banning investor redemptions.” August 2 – Financial Times (Anuj Gangahar):  “Investment banks are responding to rising credit concerns by imposing tougher lending terms on hedge funds, in a move that threatens to exacerbate investor unease in the financial markets. Prime brokerage departments at several investment banks have raised their margin requirements for certain hedge fund clients as they seek to insure themselves against the possibility of new hedge fund collapses as a result of the recent market turmoil.  ‘Financing terms for hedge funds are being tightened and this is forcing a further deleveraging of risk across global markets,’ said Gerald Lucas, senior investment adviser at Deutsche Bank.” August 2 – Financial Times (Paul J Davies, Gillian Tett, Joanna Chung and Stacy-Marie Ishmael):  “When an ordinary sounding Australian mutual fund run by Macquarie Bank’s asset management division warned investors they could lose up to 25% of their money this week it was shocking for two reasons. First, it was a retail fund, so the investors were everyday people. Second, their money had not been anywhere near US subprime mortgages… The fund was actually invested in senior secured corporate loans, which are mainly the leveraged debt used in private equity-backed buy-outs – and these assets were fundamentally sound and performing well, the fund insisted.  What caused the embarrassing loss was ‘supply-demand imbalances’ in the market – which in plain English means many need to sell but few want to buy.  The saga illustrates an ominous point, namely that as market turmoil rises, financial problems are no longer simply confined to a risky corner of the US mortgage market. This stems from another key theme now haunting the markets: namely that liquidity is evaporating from numerous corners of the financial world, as both investors in hedge funds and the banks that lend to them try to cut and run from recent losses… ‘In many ways, this episode is similar to the LTCM crisis in 1998, as margin calls on leveraged investors are forcing them to sell illiquid assets into unreceptive markets at ever-lower prices,’ says Larry Cantor of Barclays Capital.” August 3 – The Wall Street Journal (Victoria Howley, Kate Haywood, and Marietta Cauchi):  “The big chill gripping global credit markets has caused 46 leveraged financing deals around the world to be pulled since June 22, representing more than $60 billion in funding that companies had planned for mergers and acquisitions. The number of deals pulled last year: zero. The credit squeeze has slowed to a trickle the flood of debt financing that has driven the buyout boom for the past couple of years. None of the 46 pulled financings have led to the cancellation of takeovers. But with banks saddled with billions of dollars of debt they can’t sell to investors, it could make it harder for other deals to get initial financing from banks.  Already, some companies that had put themselves on the auction block are shelving sale plans.” August 3 – Financial Times (Peter Thal Larsen):  “Leading bankers on Thursday moved to calm the global markets even as they admitted that the shockwaves from of the US subprime collapse could put private equity deals on hold for the next few months.  Shares in European and US banks have slumped in the past week as investors have fretted about their exposure to subprime-related losses as well as leveraged loans stuck on their balance sheets. Analysts estimate large banks have underwritten loans worth $300bn to finance deals not yet been completed.” August 3 – Financial Times (Kate Burgess):  “Axa Investment Managers, the Paris-based asset manager, has taken a highly unusual step to shore uptwo of its funds hit by the turmoil in the subprime market in order to protect its brand.  The group said it would invest its own money in both funds to ensure their liquidity while allowing all investors to sell their holdings if they wish. The objective of the two funds, both named US Libor Plus, was to pay a return of 50 bps above the one month US Libor.  However, the assets of both funds have fallen by about 21% since the beginning of July.  About 41% of both funds, which between them have about $712m under management, were invested in subprime mortgages…  Some in the industry said the names of the funds ‘were unfortunate’, since they might have been construed as lower-risk money market funds…” August 3 – Dow Jones (Danielle Reed ):  “As fallout from subprime mortgage troubles continues, commercial mortgage bond investors are watching risk premiums widen like it’s 1998.  Though commercial mortgage bonds - especially the AAA classes - were long seen as safer and more stable assets than subprime mortgage bonds, now even prices for AAA commercial mortgage bonds are falling.  The market has seen selling of AAA commercial mortgage bonds in recent sessions, amid talk that hedge funds and other investors who bought the bonds with borrowed money may have been forced to make those sales.” August 3 – Bloomberg (Darrell Hassler):  “Sales of bonds backed by low-rated commercial loans have stalled as investors demand higher interest rates amid an onslaught of debt to finance leveraged buyouts, according to RBS Greenwich Capital.  There hasn’t been a sale in the U.S. since July 25 of collateralized debt obligations with a rating below AAA that are backed by mortgages for hotels, apartment buildings or offices, RBS analyst Lisa Pendergast wrote in a report yesterday.” August 3 – CNBC (Diana Olick’s blog):  “They’re pulling themselves out of the market to regroup,” is what one of my mortgage broker buddies told me on the phone this morning when I asked how in the heck Wells Fargo could raise rates on a 30-year jumbo fixed rate mortgage from 6 7/8% to 8% overnight. A jumbo is anything over $417,000, and given today’s home prices, that’s going to hit an awful lot of borrowers.” August 3 – Bloomberg (Jody Shenn):  “The perceived risk of AAA rated subprime-mortgage securities surged after Wells Fargo & Co., Wachovia Corp. and other lenders tightened standards on less risky homeowner debt, benchmark credit-derivatives prices show.  An index of credit-default swaps linked to 20 bonds rated AAA and created in the second half of 2006 fell 2.4% to a new mid-price low of 87.5… The ABX-HE-AAA 07-1 index has dropped by more than 11% since June, suggesting a similar fall in the value of the bonds. An index tracking BBB- rated securities also fell to a new low.” I’m never comfortable with the idea of “yelling ‘fire’ in a crowded theater.”  But Jim Cramer already did as much late this afternoon on CNBC.  His “we’re in Armageddon” tirade (available at CNBC.com) was made moments after Bear Stearns’ CFO Samuel Molinaro offered a disconcerting assessment of market conditions during the company’s hastily called conference call:  “I’ve been out here for 22 years, and this is as bad as I’ve seen it in the fixed-income markets.”  A highly-aroused Mr. Cramer, volunteering to speak on behalf of Wall Street, called for the Fed to aggressively cut rates and “open the discount window.”  The Credit Market has Dislocated, liquidity has evaporated, and our academically-inclined new Fed chairman is in store for a historically challenging real world first test.  Wall Street has been conditioned over the years to expect “bailouts.”  Only months on the job, Alan Greenspan stepped up and assured the markets that the Fed was ready to add liquidity after the ’87 stock market crash.  The Greenspan Fed acted aggressively during the LTCM crisis and, later, Dr. (“Helicopter”) Bernanke played an instrumental role in the Fed talking the risk markets higher in late 2002.  To be sure, Fed “reliquefications” played a conspicuous role in fostering ever greater and more unwieldy Bubbles - and this will remain in the back of FOMC members’ minds.  The Bernanke Fed today would likely prefer to maintain a “hands off” approach for as long as possible – which has already been too long for an acutely fragile “Wall Street.” And let’s not forget the (unsung hero) GSE “backstop bid.”  The GSEs ballooned their balance sheets $150bn to absorb speculative de-leveraging during the 1994 de-leveraging and bond market rout – about double 1993’s expansion, at the time record.  GSE balance sheets (chiefly holdings of mortgages and MBS) ballooned $305bn during tumultuous 1998, $317bn during 1999, $238bn in 2000, and $344bn during liquidity challenged 2001.  Agency balance sheets mustered growth of $37bn last year.  Importantly, the GSE’s are definitely in no position these days to aggressively create marketplace liquidity by expanding their (money-like) liabilities to aggressively purchase MBS - in the process stabilizing market prices (especially for the leveraged speculators).  Wall Street must all of a sudden feel short of friends. Appearing this evening with Larry Kudlow, Larry Lindsey called upon Fannie and Freddie to loosen lending standards to help ameliorate the rapidly accelerating Mortgage Credit Crunch.  I was immediately reminded of how Washington nurtured the $200bn (or so) S&L bailout from what should have been resolved years earlier at a fraction of the cost to taxpayers.  The GSE tab is today running out of control.  Keep in mind that Fannie and Freddie already have combined “Books of Business” (MBS holdings and guarantees) of almost $4.0 TN supported (in the best case) by stockholders’ equity in the neighborhood of $60bn (current financial statements not available!).  The thinly-capitalized Federal Home Loan Bank System has another $1.0 TN of assets.  Before all is said and done, taxpayer GSE exposure will likely reach the trillions – to add to other untenable ballooning federal contingent liabilities. This week, the unfolding financial crisis reached a problematic stage on several fronts.  For one, illiquidity hit the gigantic “AAA” market for “private-label mortgage-backed securities.”  The booming market for non-agency MBS has played an instrumental role in ensuring abundant cheap mortgage Credit – on the one hand filling the liquidity void created by the constrained GSEs (balance sheets) and, on the other, providing virtually unlimited inexpensive “jumbo” mortgage finance to inflate upper-end housing Bubbles in California and the most desirable locations and neighborhoods across the country.  While the subprime implosion was a major marketplace development, in reality only a small segment of the mortgage marketplace was actually impacted by significantly tighter Credit conditions.  Today, we are in the throes of a dramatic, broad-based and momentous tightening of mortgage Credit.  Importantly, key players and sectors throughout the mortgage risk intermediation process are increasingly impaired and now in full retreat.  This includes entities such as the mortgage insurers, MGIC’s and Radian’s faltering C-BASS securitization unit, REITs such as failed American Home Mortgage and others, hedge funds such those that failed at Bears Stearns and many more, the broker/dealer community and the expansive mortgage derivatives market generally.  There is also the issue of exposed mutual funds, money market funds, pension funds and the banking system in general.  Just like NASDAQ went to unimaginable extremes than then doubled during a fateful “blow-off” – total mortgage Credit doubled subsequent to the Greenspan Fed’s reckless post-tech Bubble “reflation.”  Risky mortgage exposure now permeates the (global) system and is highly susceptible to “Ponzi Finance” dynamics.  The process of transforming risky mortgage loans into coveted perceived safe and liquid (“money”-like) Credit instruments has broken down on several fronts.  Not only is the risk intermediation community impaired, marketplace confidence and trust in the quality, safety, and liquidity of mortgage (and mortgage-related) securities is being shattered.  There are apparently serious problems developing throughout the massive marketplace for (“repo”) financing MBS.  And it is precisely the market for financing the top-rated mortgage securitizations – where the perceived risk was minimal – where I suspect the greatest abuses of leverage occurred.  The marketplace is now experiencing forced de-leveraging and a liquidity Dislocation - with major systemic ramifications. I mostly downplayed the marketplace liquidity and economic impact of the housing downturn last fall and the subprime implosion this past February.  For the system as a whole, the Credit spigot remained wide open.  My view of current developments is markedly different.  I cannot this evening overstate the dire ramifications for the unfolding Credit Market Dislocation.  There is today serious risk of U.S. financial markets - distorted by years of accumulated leverage and derivative-related risk distortions - of “seizing up.”  A system so highly leveraged is acutely vulnerable to speculative de-leveraging and a catastrophic “run” from risk markets.  At the same time, the Bubble Economy and inflated asset markets – by their nature – require uninterrupted abundant liquidity.  The backdrop could not be more conducive to a historic crisis, yet most maintain unwavering confidence that underlying fundamentals are sound. I am this evening unclear how the enormous ongoing demand for new California mortgage Credit will be financed going forward.  With the market having lost all appetite for “jumbo” MBS, mortgages must now be priced generally in accordance with the standards of increasingly cautious loan officers willing to live with these loans on their banks’ balance sheets (a radical departure from pricing set by originators selling loans immediately in an overheated MBS market).  And, let there be no doubt, the prospective Credit tightening will hit grossly inflated and highly susceptible “Golden State” housing prices hard – a scenario that will force lenders to incorporate significantly higher Credit losses into their loan pricing terms (perhaps Cramer was speaking to CA homeowners when he jingled house keys in front of the camera during Wednesday’s show and suggested it was perfectly rational to mail your keys to the bank).  Furthermore, I expect the pricing and availability of Credit required to refinance millions of rate-reset mortgages in California and elsewhere to turn prohibitive for many.  And the home equity well is about to run dry – from a combination of sharply tightened Credit conditions and accelerating home price declines.   A severe tightening in mortgage Credit is in itself sufficient to pierce a vulnerable U.S. Bubble Economy.   But there is as well an abruptly brutal tightening in corporate Credit.  The junk bond market has basically closed for business.  The leveraged loan marketplace is in turmoil and scores (46 – see WSJ above) of debt deals have been pulled.  And, more ominously, the previously booming ABS and CDO markets have slowed to a crawl.  Perhaps not immediately, but it will not be long before the economy succumbs to recession.  Credit Market Dislocation now dictates the assumption that Federal Reserve liqudity assurances and rates cuts are on the near horizon.  And while they will likely incite the expected knee jerk response in the equities market, I don’t expect they will have much lasting effect on our impaired Credit system.  Current issues are much more complex and serious than ’87, ’98, 2000, or 2002.  The dilemma today is that confidence in “Wall Street finance” has been shattered.  The manic Bubble in Credit insurance, derivatives, and guarantees is bursting.  The manic Bubble in leveraged speculation is in serious jeopardy.  The currency markets are a derivative accident in waiting.  Fed rate cuts risk a dollar dislocation and/or a further destabilizing (for spreads) Treasury melt-up. A focal point of my Macro Credit Analysis has for some time been the grave risks posed to markets and economies commanded by the seductive elixir of speculative liquidity.  I have compared the current backdrop to that of 1929.  For too long our Bubble Economy and Bubble Asset Markets have luxuriated in liquidity created in the process of leveraging speculative securities positions (especially in the Credit market).  We are now witnessing how abruptly euphoric boom-time liquidity abundance can transform to a liquidity crisis.    I apologize for appearing overly dramatic.  But this evening I have nagging feelings that for me recall the disturbing emotions following the terrible 9/11 tragedy.  I know the world has changed and changed for the worse – yet I recognize that I don’t know how and to what extent.  I fear for our markets, our economy, our currency and our system.  I received an email this week on my Bloomberg that said something to the effect, “You all must be happy in Dallas.”  I can tell you we’re instead sickened by what has transpired during the late-stages of this senseless Credit and speculative orgy.  The Great Credit Bubble has been pierced, and there will now be a very, very heavy price to pay.  And, as always, I hope I am proved absolutely wrong.

07/19/2007 The Hand of Finance *

In a volatile and rather ominous week, the Dow dipped 0.4% (up 11.1% y-t-d) and the S&P500 declined 1.2% (up 8.2%).  The Transports dipped 0.2% (up 17.5%), and the Morgan Stanley Cyclical index declined 1.3% (up 24.2%).  The Morgan Stanley Consumer index dropped 1.9% (up 5.1%), and the Utilities slipped 0.7% (up 8.8%).  The broader market was under selling pressure.  The small cap Russell 2000 was hit for 2.3% (up 6.2% y-t-d), and the S&P400 Mid-Cap index fell 1.3% (up 13.6%).  Technology out-performance continued.  The NASDAQ100 mustered a 0.2% gain (up 15.9% y-t-d), and the Morgan Stanley High Tech index rose 0.6% (up 15.0%).  The Semiconductors gained 1.3% (up 14.7% y-t-d).  The Street.com Internet Index declined 0.9% (up 13.0%), and the NASDAQ Telecom index fell 1.1% (up 17.6%).  Financial stocks were under pressure.  The Broker/Dealers were smacked for 5% (up 2.9%), and the Banks sank 3.1% (down 5.1% y-t-d).  With bullion gaining $16.50, the HUI gold index advanced 3.8%. Accelerating Flight to Quality.  Two-year U.S. government yields this week fell 16 bps to 4.76%.  Five-year yields dropped 17 bps to 4.84%.  Ten-year Treasury yields sank 15 bps to 4.95%.  Long-bond yields ended the week 13 bps lower at 5.06%.  The 2yr/10yr spread ended the week at a positive 19 bps.  The implied yield on 3-month December ’07 Eurodollars declined 7 bps to 5.262%.  Benchmark Fannie Mae MBS yields dipped 5.5 bps to 6.265%, this week significantly underperforming Treasuries (MBS spreads widening notably).  The spread on Fannie’s 5% 2017 note widened 5 to 51, and the spread on Freddie’s 5% 2017 note widened 5 to 52.  The 10-year dollar swap spread increased 4 to 68.8.  Corporate bond spreads widened across the board, with the spread on a junk index this week widening another 15 bps.     July 20 - Financial Times (James Mackintosh):  “Investor nervousness over subprime losses in the US, which estimates cited by Ben Bernanke…yesterday put at up to $100bn, is hurting demand for financial flotations.  London’s Man Group raised only $2.9bn against a target of $3.5bn-$3.8bn from floating MF Global, its brokerage arm…. The Man spin-off was the latest in a series of disappointments for initial public offerings of financial services, prompted by worries that credit could become tighter following the meltdown in the US subprime market.  Third Point, a New York activist hedge fund, raised $525m yesterday from listing a fund in London after a 24-hour delay, well below its $690m target. Lehman Brothers injected an extra $45m of its own money into a fund of private equity funds it listed in Amsterdam on Wednesday, to ensure hitting its $500m goal…  It remains unclear to what extent subprime contagion will spread into other markets, although widening credit spreads are already hurting some private equity buy-outs.” July 18 – Bloomberg (John Glover and Hamish Risk):  “The risk of owning corporate bonds soared to the highest in two years in Europe after Bear Stearns Cos. said investors in two U.S. subprime hedge funds will get little or no money back, credit-default swap prices show.” It was an ominously light week of debt issuance.  Investment grade debt issuers included Union Pacific $480 million.    Junk issuers included LBI media $230 million, Lea Power Partners $305 million, and Cardtronics $100 million.  Convert issuers included Health Care REIT $400 million and KKR Financial $300 million. International dollar bond issuers included Banca Mifel million. July 18 – Financial Times (Joanna Chung):  “Egypt rarely captures the attention of the world’s bond market investors.  But the North African country came under the spotlight last week when it raised $1bn with the first international bond denominated in Egyptian pounds.  The landmark sale sent the strongest signal yet of one of the defining trends in emerging market debt: a marked shift from debt denominated in hard currencies, such as the US dollar and the euro, to debt denominated in local currencies. The deal was two times subscribed in spite of the wider jitters in the market… One of the turning points came last year when trading in local market instruments hit a record high of $3,687bn, accounting for 57% of overall emerging market debt trading volume of $6,500bn - itself a record.  This compares with a 47% share in 2005 and 45% in 2004, according to data from EMTA…” German 10-year bund yields dropped 18 bps to 4.44%, and the highflying DAX equities index sank 2.7% (up 19.4% y-t-d).  Japanese 10-year “JGB” yields fell 5 bps to 1.88%.  The Nikkei 225 gained 1.0% (up 5.4% y-t-d).  Emerging debt and equity markets were mostly resilient or better – but likely increasingly vulnerable.  Brazil’s benchmark dollar bond yields rose one basis point this week to 6.10%.  Brazil’s Bovespa equities index dipped 0.3% (up 29% y-t-d).  The Mexican Bolsa fell 1.4% (up 20.7% y-t-d).  Mexico’s 10-year $ yields fell 4 bps to 5.89%.  Russia’s RTS equities index added 0.4% (up 7.7% y-t-d).  India’s Sensex equities index gained 1.9% (up 12.9% y-t-d).  China’s Shanghai Composite index ended the week 3.7% higher (up 51.7% y-t-d and 145% over the past year). Freddie Mac posted 30-year fixed mortgage rates were unchanged this past week at 6.73% (down 7bps y-o-y).  Fifteen-year fixed rates slipped one basis point to 6.38% (down 3bps y-o-y).  One-year adjustable rates added one basis point to 5.72% (down 8bps y-o-y).  The Mortgage Bankers Association Purchase Applications Index declined 1.6% this week.  Purchase Applications were up 10.9% from one year ago, with dollar volume 17.5% higher.  Refi applications jumped 4.9% for the week, and dollar volume was up 30.8% from a year earlier.  The average new Purchase mortgage rose to $235,600 (up 6.0% y-o-y), and the average ARM jumped to $402,200 (up 19.9% y-o-y).  Bank Credit was about unchanged (week of 7/11) at $8.622 TN (last week’s Bank Credit revised to a gain of $55.9bn).  For the week, Securities Credit slipped $0.5bn.  Loans & Leases added $0.4bn to $6.315 TN.  C&I loans gained $1.6bn, and Real Estate loans jumped $13.4bn.  Consumer loans added $0.7bn.  Securities loans declined $2.5bn, and Other loans fell $12.9bn.  On the liability side, (previous M3) Large Time Deposits increased $2.9bn.      M2 (narrow) “money” fell $12.8bn to $7.251 TN (week of 7/9).  Narrow “money” has expanded $208bn y-t-d, or 5.5% annualized, and $420bn, or 6.2%, over the past year.  For the week, Currency was about unchanged, while Demand & Checkable Deposits increased $7.4bn.  Savings Deposits sank $26.6bn, while Small Denominated Deposits were little changed.  Retail Money Fund assets increased $6.4bn.        Total Money Market Fund Assets (from Invest. Co Inst) declined $6.4bn last week to $2.573 TN.  Money Fund Assets have increased $191bn y-t-d, a 14.4% rate, and $425bn over 52 weeks, or 19.8%.     Total Commercial Paper jumped an additional $15.8bn last week to a record $2.195 TN, with a y-t-d gain of $220bn (20% annualized).  CP has increased $408bn, or 22.9%, over the past 52 weeks.  Fed Foreign Holdings of Treasury, Agency Debt last week (ended 7/18) increased $7.0bn to a record $1.996 TN.  “Custody holdings” were up $244bn y-t-d (25% annualized) and $362bn during the past year, or 22.2%.  Federal Reserve Credit last week dipped $0.4bn to $853.9bn.  Fed Credit has expanded $1.66bn y-t-d, with one-year growth of $23.1bn (2.8%).     International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $790bn y-t-d (29% annualized) and $1.052 TN y-o-y (23%) to a record $5.601 TN.  July 19 – Bloomberg (Maria Levitov):  “Russia’s foreign currency and gold reserves rose to a record $411.2 billion in the week ended July 13, the central bank said.” Currency Watch: The spot dollar index fell 0.4% to a multi-year low 80.288.  On the upside, the Thai baht increased 2.4%, the Colombian peso 1.7%, the Philippine peso 1.4%, the New Zealand dollar 1.2%, the British pound 1.1%, the Australian dollar 1.0%, and the Japanese yen 0.5%.   On the downside, the Indonesian rupiah declined 0.9%, the Argentine peso 0.5%, and the Turkish lira 0.5%. Commodities Watch July 16 – Financial Times (Javier Blas and Jenny Wiggins):  “A surge in the production of biofuels derived from corn, wheat and soyabeans is helping to push up food prices so sharply that the World Food Programme, the United Nations agency in charge of fighting famine, is finding it difficult to feed as many hungry people as it has in the past.” July 20 - Financial Times (Javier Blas):  “The price of tin, which is used for soldering in the electronics industry, hit a record high yesterday, propelled by speculative money flows and supply disruptions.  London Metal Exchange tin reached an all-time high of $15,700 a tonne… The metal, one of the most illiquid contracts on the LME, has risen 38.4% since January. Gains since the start of 2006 have reached 133%.” For the week, Gold rose 2.5% to $683.40 and Silver 2.2% to $13.403.  Copper jumped 3.1%.  September crude rose $1.66 to an 11-month high $75.79.  August gasoline dropped 2.7%, and August Natural Gas sank 4.1%.  For the week, the CRB index dipped 0.2% (up 5.6% y-t-d), while the Goldman Sachs Commodities Index (GSCI) added 0.7% (up 18.2% y-t-d).  Japan Watch: July 19 – Bloomberg (Jason Clenfield):  “Japan’s department store sales rose in June at the fastest pace in nine years…  Sales climbed 5.5% from a year earlier, the quickest pace since April 1998…” China Watch: July 19 – Bloomberg (Nipa Piboontanasawat):  “China’s economy grew at the fastest pace in 12 years in the second quarter and inflation surged, prompting speculation the government will raise interest rates and push the currency higher to cool growth.  Gross domestic product expanded 11.9% from a year earlier… Inflation climbed to 4.4% in June, the fastest since September 2004, breaching the central bank’s 3% target for a fourth month.” July 18 – Bloomberg (Li Yanping):  “China’s economy showed a ‘more obvious’ trend  from fast growth to overheating in the first half of 2007, Xinhua News Agency said, citing a legislative committee.  An ‘excessive’ trade surplus, lending growth and investment expansion were still ‘prominent’ problems in the economy during the first half…” July 16 – Financial Times (Richard McGregor ):  “Like tens of millions of shoppers across China, Zhou Benqi has had to change her buying habits to cope with sharply rising prices of pork and eggs, staple foods for any Chinese family.  ‘Because of price hikes, an ordinary meal is a big constraint on us, as my pension has already been eaten into by fees for electricity, water, broadband, gas and so on,’ said Ms Zhou, a 53-year-old Shanghai native. ‘We’ve seen officials talking about adjustment many times, but so far they have failed to control prices.’” July 18 – Financial Times (Jamil Anderlini):  “China’s air pollution will cause 20m people a year to fall ill with respiratory diseases, the Organisation for Economic Co-operation and Development estimated… By 2020, the report forecast, pollution would cause ‘600,000 premature deaths in urban areas, 9m person-years of work lost due to pollution-related illness, 20m cases of respiratory illness a year, 5.5m cases of chronic bronchitis and health damage’, which could cost 13% of gross domestic product. Mario Amano, OECD deputy secretary-general, said: "Rapid economic development, industrialisation and urbanisation have generated severe and growing pressures on the environment.’” July 18 – Bloomberg (John Liu):  “China added 25 million Internet users in the first six months for a total of 162 million, narrowing the gap with the U.S., the world's biggest Internet market.”   Asia Boom Watch: July 19 – Bloomberg (Wahyudi Soeriaatmadja):  “Indonesia’s economy will grow more than 6% in the coming years helped by investment and consumer spending, President… Yudhoyono said.” Unbalanced Global Economy Watch: July 19 – Bloomberg (Jennifer Ryan):  “U.K. money supply growth slowed in June more than economists had forecast, giving the Bank of England scope to gauge the effect of previous interest-rate increases before increasing borrowing costs again.  M4… rose 13% from a year earlier, compared with 13.9% in May…” July 19 – Bloomberg (Rainer Buergin):  “German tax revenue rose in June from a year earlier… Tax revenue in June for the national government and the 16 states gained 12.6% to 49.4 billion euros ($68.2 billion)…”  July 19 – Bloomberg (Thomas Mulier):  “Swiss watch exports increased 19% in June compared with the same period a year ago as Chinese shoppers bought more timepieces in Hong Kong.” July 19 – Bloomberg (Simone Meier):  “Switzerland’s trade surplus widened in June as a decline in the Swiss franc fueled exports of machines, watches and metals. Imports fell.  The surplus rose to 1.72 billion Swiss francs ($1.43 billion) from 1.04 billion francs in May…” July 17 – Bloomberg (Simone Meier):  “Swiss retail sales rose for a 12th month in May as households spent more on consumer and office electronics, furniture and beauty products.  Sales…increased 7.2% from a year earlier…” Latin American Boom Watch: July 16 – Bloomberg (Katia Cortes):  “Brazil’s retail sales rose 10.5% in May from a year earlier, the national statistics agency said.”     Bubble Economy Watch: July 18 – Bloomberg (Mark Drajem):  “Keeping track of U.S. imports has become more difficult as regulators’ funding hasn’t kept up with surging trade and booming Internet sales, officials said.  ‘The growth in imports has strained our resources and challenges us,’ Nancy Nord, acting chairman of the Consumer Product Safety Commission, testified today.” July 19 – Bloomberg (Linda Sandler):  “U.S. hedge-fund managers Steven Cohen, Kenneth Griffin, Adam Sender, David Ganek and Daniel Loeb are among the world’s 200 most active art collectors, according to a list compiled by the magazine ARTnews.  Griffin, who runs the $14 billion Citadel Investment Group LLC, also joined Cohen in the ranks of the 10 most active art buyers, as did buyout king Henry Kravis of Kohlberg Kravis Roberts & Co. and Charles Schwab… They displaced Leon Black, Stephen Wynn and Leslie Wexner from last year’s list of the top 10 collectors… Hedge-fund managers in the art market ‘combine the means, the aggression, the enthusiasm, and access,’ Michael Findlay, a director of Acquavella Galleries in New York, told ARTnews.  ‘It’s another forum to demonstrate the same kind of acumen’ as they display in business.”  Financial Sphere Bubble Watch: July 18 – The Wall Street Journal (Peter A. McKay and Justin Lahart):  “Companies are buying back their shares at a furious pace, one of the big reasons the Dow Jones…is pushing toward 14000… In the first quarter alone, companies in the S&P 500-stock index spent nearly $118 billion to repurchase their shares, more than in any previous quarter…  Many analysts and investors question how long the buyback boom can continue, and how much support stock prices can derive from buybacks over the long haul.  Some companies are financing their share repurchases with borrowed money, which is likely to get more expensive if interest rates continue to rise…  The surge in buybacks began in late 2004, aided by low interest rates and easy access to cash, but it has since picked up pace. Share repurchases have topped $100 billion for six straight quarters… Companies announced $157.4 billion of buyback plans during the quarter, up nearly 58% from a year earlier, according to Thomson Financial.” July 16 – Financial Times (Martin Arnold):  “Private banks are rushing into a surprising new market for lending to high-flying private equity executives who are strapped for cash to invest in their own funds.  In Europe, the market for lending to private equity executives is estimated at €1bn… In the US market, thought to be bigger, JPMorgan, Deutsche Bank, Citigroup and RBS are said to be active.  In the rush to win buy-out titans as clients, some banks are offering them attractive terms, with unsecured loans that sometimes have no recourse against personal assets. Demand for loans to buy-out executives has emerged as the size of funds raised by private equity firms has ballooned in recent years.  Investors generally insist the professionals at a private equity firm put their own money into any fund they raise, usually equivalent to 1-5% of the total…. A leading UK private banker said: ‘A 35-year-old graduate of Harvard or Cambridge joining a top firm in 2002, who is asked to put money into funds in 2002, 2005 and 2007 while they also have school fees and a mortgage, is often being caught short.  ‘We can lend to them, killing two birds with one stone, both supporting our investment bank and looking after the top guys in the industry.’” July 18 – Bloomberg (Caroline Salas):  “JPMorgan Chase & Co. CEO Jamie Dimon said demand for leveraged buyout debt is drying up and banks may be left holding more loans that they can’t sell. There is ‘kind of a little freeze in the marketplace,’ Dimon said on a conference call… ‘If you see this continue you will see the Street taking on a lot of bridge loans and more aggressive repricing of those things.’”  MBS/ABS/CDO/Derivatives Watch: July 18 – Gretchen Morgenson (New York Times):  “Bear Stearns told clients in its two battered hedge funds late yesterday that their investments, worth an estimated $1.5 billion at the end of 2006, are almost entirely gone. In phone calls to anxious investors, Bear Stearns brokers reported yesterday that May and June had been devastating months for the portfolios. The more conservative fund, the High-Grade Structured Credit Strategies Fund, was down 91% by the end of June, investors were told. The High-Grade Structured Credit Strategies Enhanced Leverage Fund, which used extensive borrowings and assumed more risk, has no investor capital left, the firm said.   ‘In light of these returns, we will seek an orderly wind-down of the funds over time,’ a letter to Bear Stearns clients said. Real Estate Bubbles Watch: July 18 – Los Angeles Times (Annette Haddad):  “Home sales plunged in Southern California last month, making it the worst June in 14 years and reflecting an increasingly soft housing market — especially in outlying areas such as the Inland Empire and Antelope Valley.  Overall, values are continuing to hold their own — with the median price of a Southland home rising to $502,000, up 2.4% from a year ago. But prices fell in two-thirds of the region’s ZIP Codes, reflecting greater weakness in lower-cost housing markets… Figures…show that the number of Southland home sales plunged 36% in June from the same month last year, marking 21 straight months of year-over-year sales declines. San Bernardino County posted the worst numbers, with sales diving 50%.  Real estate experts attributed the drop to several factors, including tighter lending standards and a drop in speculative buying by house ‘flippers.’” July 18 – Bloomberg (Daniel Taub):  “San Francisco Bay Area home and condominium sales plunged 26% last month to the lowest level for a June in 12 years, DataQuick… said...  The median price paid for a home in the Bay Area rose to a record $665,000, up 0.8%... in May and up 2.6% from a year earlier.” July 18 – The Wall Street Journal (Ryan Chittum):  “Strong cross-border acquisitions helped boost global investment in real estate to a record high in the first six months of this year…  A study…by Jones Lang LaSalle Inc….found that investment activity in commercial real estate surged to $382 billion in the first half, up 16% from $328 billion a year ago.” July 19 – Bloomberg (Dan Levy):  “Apartment rents in Silicon Valley, California, rose 11% from a year ago, the biggest jump in the U.S. West, and occupancy rose to 97.3%... ‘Landlords have the ball in their court,’ Chris Bates, sales and marketing director for…RealFacts…  ‘An occupancy rate of 97.3% is essentially fully occupied.’” M&A and Private-Equity Bubble Watch: July 17 – Bloomberg (Caroline Salas and Miles Weiss):  “Goldman Sachs Group Inc., JPMorgan Chase & Co. and the rest of Wall Street are stuck with at least $11 billion of loans and bonds they can’t readily sell.  The banks have had to dig into their own pockets to finance parts of at least five leveraged buyouts over the past month because of the worst bear market in high-yield debt in more than two years…  Bankers, who just a few months ago boasted that demand for high-yield assets was so great that they would have no problem raising debt for a $100bn LBO, are now paying for their overconfidence.” July 20 - Financial Times (Paul J. Davies and Saskia Scholtes ):  “Private equity firms can now be in no doubt that they are going to have to pay more to fund the debt for buy-out deals they have already sealed.  This week alone has seen two of the biggest deals on either side of the Atlantic – buy-outs of Alliance Boots and Chrysler – forced to increase the premium, or interest rates, on loans they are trying to sell. Bankers in a flurry other deals have had to act likewise.  Late on Tuesday it emerged that Chrysler was increasing the interest rate on a $2bn second-lien loan – part of its $22bn in debt financing – by 1 percentage point…  On the same day it also emerged something similar was going on at Alliance Boots, the record UK leveraged buy-out, which is seeking some £9bn worth of loans from investors.” July 16 – Financial Times (Martin Arnold):  “There is unlikely to be much sympathy for private equity executives falling into debt to finance investments in their own funds, however much the idea clashes with public perceptions about super-rich ‘masters of the universe’.  Debt and private equity are intricately entwined and there are few more fanatical fans of leverage than buy-out bosses, who sing its praises at every opportunity.  Even so, few would imagine that, while these buy-out titans are agreeing whopping loans for their latest mega-deals, they would also need to go into hock themselves.  Yet this is exactly what has created one of the newest niche markets for private banks, which are rushing to offer loans to buy-out executives facing a cash crunch.  Many of those recruited to private equity firms in recent years have faced a string of demands to invest their own money, long before they are likely to receive any returns.  For young buy-out executives in their 30s and 40s, who often face the high cost of living in London and New York, it can be a struggle to raise the cash.” Energy Boom and Crude Liquidity Watch: July 15 – Bloomberg (Abdulla Fardan):  “Arab oil-producing countries earned $393.3 billion from selling crude in 2006, a 24% increase from the year before, as they benefited from higher international prices, the Kuwait News Agency reported.” July 16 – Bloomberg (Matthew Brown):  “Saudi Arabia, the largest Arab economy, and Kuwait had their sovereign credit ratings upgraded by Standard & Poor’s due to their strong public finances.  Saudi Arabia’s foreign and local currency long-term sovereign credit ratings were upgraded to AA-, S&P’s fourth highest rating…”  Fiscal Watch: July 19 – Bloomberg (Tony Capaccio):  “The cost of the war in Iraq will exceed the half-trillion dollar mark once Congress completes its work on a defense measure for the fiscal year beginning Oct. 1… The defense budget for fiscal 2008 that’s in various stages of congressional deliberation requests $141.7 billion to fight terrorism including the wars in Iraq and Afghanistan.  ‘If Congress approves these requests, total funding would reach about $567 billion for Iraq, $157 billion for Afghanistan’ with the remainder for enhanced U.S. homeland security, CRS analyst Amy Belasco said… Spending for the effort against terrorism since the Sept. 11, 2001, attacks is on a course to reach $758 billion after the House and Senate complete work on their respective bills…” Speculator Watch: July 17 – Bloomberg (Hamish Risk):  “Hedge funds are borrowing too much to finance investments in credit derivatives, contracts based on debt, which may magnify volatility in a market downturn, according to a Fitch Ratings survey of 65 banks, insurers and money managers.  Hedge funds’ influence on credit derivatives and debt markets has continued to grow at a ‘dramatic pace,’ Fitch said… The funds are responsible for 60% of all trading in credit-default swaps and about 33% of collateralized debt obligations…” The Hand of Finance: Beginning with my early-January “Issues 2007,” “It’s All About Finance” has been the underlying theme of almost every one of this year’s CBBs.  For me, the important unanswered questions inevitably relate back to my December 2000 presentation “How Could Irving Fisher Have Been So Wrong?”  Why are so many caught bullish – and completely oblivious to escalating risk - at major tops?  And why is it that booms and bull markets cannot endure indefinitely?  Clearly, the vast majority are today convinced they can and will.  We’re witnessing why they can’t and won’t.      Well, booms inevitably falter at The Hand of Finance.  In this distant past the post-Bubble post-mortem would simplify the state of things to “the money went bad.”  People had lost confidence and “ran” from banks and the stock market.  The Credit wheels had ground to a halt and the abundant liquidity that seemed as if it would always be readily available instead abruptly evaporated.  Jump forward to today and perceptions have it that the Fed and global central bankers are waiting to ensure that confidence is maintained and liquidity remains always bountiful.  We’re apparently so much more enlightened today, especially with our sophisticated risk monitoring and mitigating systems.  We have derivatives.  I have my somewhat different take on why Credit-induced booms are destined for bust.  Bubbles are sustained only by increasing quantities of Credit creation – a rather simplistic proposition encompassing highly complex processes.  Inevitably, the dilemma evolves (sometime late in the cycle) to the point where the quantity of requisite additional Credit turns enormous – and the rapid financial expansion accelerates to breakneck speed.  At the same time, the risk profile of the marginal (late-cycle) new loan deteriorates, while the major financial intermediaries (right along with the vast majority of market participants) are caught reaching too aggressively for perceived easy profits.  Too much Credit is financing speculative endeavors, highly inflated assets values, and enterprises that, at best, are economic only as long as boom-time conditions exist. Underlying Credit risk eventually succumbs to parabolic growth tendencies – as we’ve witnessed this past year.  Yet one critical upshot of this dynamic is the associated (Credit-induced) surge in overall system liquidity, especially in wild securities markets inflation.  Naturally, this “Monetary Disorder” unfolds some number of years into the prosperous boom – after an entrenched inflationary bias has taken firm hold in the securities markets and the economy generally.  Irving Fisher was making a fortune at the top.  He was intoxicated by his inflating wealth and was as emboldened as the naysayers were fully discredited.  Almost by cruel design, the Credit Bubble's "terminal phase" is guaranteed to entrap those willing to subscribe to New Eras. The unappreciated predicament of 1929 and today is Risk Intermediation.  Dr. Bernanke refers to the study of The Great Depression as the “Holy Grail of economics.”  He blames the “Bubble Poppers” and the Fed’s subsequent failure to create enough money.  Conventional thinking has it that had the Fed only created $5 billion and filled the hole in bank capital the devastating downturn could have been avoided.  But the issue at the time wasn’t, as conventional monetary economist believe today, the few billions necessary to recapitalize the banking system - but the ongoing tens of billions that would be required to sustain unsustainable Credit Bubble-induced inflated asset prices, inflated corporate profits, inflated earnings, and myriad worsening economic maladjustments.  Citigroup expanded its balance sheet by $200bn during the second quarter (to $2.22 TN).  JPMorgan’s Assets expanded $50bn during Q2 and Bank of America’s $32bn.  Goldman Sachs, Morgan Stanley and Lehman Brothers combined for $92bn of Q2 asset growth.  Merrill’s second quarter balance sheet is not yet available, but we do know that assets expanded $140bn during Q1.  The four “broker/dealers” have combined for one-year growth surpassing $700bn.  The “good news” is that they have to this point succeeded in supplying the necessary Credit to sustain global financial and economic booms.  The bad news is that this Credit deluge is wildly inflating global asset prices and feeding an historic worldwide speculative Bubble in debt and equity instruments, real estate, and assets generally.  We are witnessing in real time the dynamics of rapidly escalating late-cycle risk and the dilemma of how to intermediate it. With few exceptions, the major financial firms have so far reported “better-than-expected” earnings.  Almost without exception the market sold stock on the news.  Citigroup’s Q2 Revenues were up 20% from a year ago to $26.6bn.  And while Revenues in its Global Consumer division expanded only 8% from Q2 2006, Markets & Banking was up 33%, Global Wealth Management 28%, and Alternative Investments 77%.  Examining the balance sheet, Trading Assets surged $78bn (to $538bn), “fed funds/repo” $44bn (to $348bn), and Loans $50bn (to 743bn).  Citigroup is the poster child for a (struggling) major financial player responding to weakening profits and business fundamentals in its traditional lending business by pushing its capital markets activities to new extremes.  Why not, all the other firms’ stocks – until recently – were amply rewarded for doing the same.  Now they’re all fully exposed to market risk with nowhere to go.  And, for their efforts to support the boom, their stocks are now under liquidation. July 18 – Financial Times (Ken Fisher):  “Headlines herald a US prime-time, subprime mortgage implosion leading to an upcoming credit-crunch crisis - destined to sink shares, raise interest rates and impale economies. But this is demonstrable nonsense. Yes, there have been media autopsies of the few notable subprime lenders that have gone belly up. More are certainly in the wings.  But what makes this a systemic problem?  If subprime is to ripple systemically into a crisis, it is a take-it-to-the-bank certainty that we will see vast credit-spread widening. Yet spreads between high quality and low quality debt of the same maturity - by any measure - are at near record lows, in spite of six months of subprime hand-wringing.  And the biggest single days of upside volatility have been historically very subdued - about 10 to 20 basis points. Every true credit crisis in history had huge spikes in credit spreads early on and - while not always - usually well before equities implode. By contrast, wrong-headed credit fear babble blows through history like the wind without a ripple in credit spreads.” I’ll assume that if Ken Fisher ever read my analysis he would pronounce me the “king of Credit fear babble.”  The title of Mr. Fisher’s FT article was a rather catchy “Be Bullish and Watch the Bears Impale Themselves.”  Mr. Fisher did well to disregard previous Credit fears, but I suspect he will regret his current complacency.  It’s been a long and profitable bull market.  Too long. July 20 - Financial Times (Michael Gordon):  “Will the troubles in the US subprime market pass by as a little local difficulty - or will they start a rout across capital markets and bring to an end the great bull run in a broad range of asset classes? That’s the big question faced by those in capital markets right now.  Can history teach us anything on this score? Well, it’s certainly worth looking at the collapse of Long-Term Capital Management in -September 1998. The near-demise of this -mammoth hedge fund marked a turning-point for credit markets, hitting brokers and banks hard.  The debacle is less than a decade ago, but banks were smaller and less diversified firms in those days and so less able to absorb large shocks.  Also, their risk management systems were not as well developed as they are now…  Wind forward to today.  Does the collapse of confidence in the US subprime market have any similarities to the LTCM affair? Well, many of the weaknesses of the banks and brokers that emerged in 1998 have since been addressed. They are larger, more diversified institutions. They have also invested a great deal in risk management. Overall, the banks look far more resilient.” Like Ken Fisher, Michael Gordon seems blind to today’s acute financial fragility.  It is wishful thinking that “banks” are today “more resilient” than in 1998.  The financial system today has unprecedented exposure to risky mortgage Credit, highly leveraged and speculative financial markets, an M&A Bubble and global asset Bubbles.  The entire global Credit system is one vulnerable Minskian “Ponzi Finance Unit.” It may be valuable to do a little contrasting of today’s backdrop to the LTCM crisis.  The near LTCM debacle had its roots in highly leveraged speculation across many markets.  It was a Credit issue only in the context of the impact of potential forced position position unwinds and systemic de-leveraging.  It was much more about the fear of contagious liquidations than of latent Credit issues.  The underlying Credit instruments were not in and of themselves suspect.  The market dislocation was (in hindsight, easily) resolved by ameliorating the fear of de-leveraging and re-invigorating financial expansion.  Importantly, during the LTCM and other recent Credit scares the marketplace’s faith in the evolving market in “structured finance” was not in question.  Actually, it was a perceived strength.  The GSEs were recognized as powerful pillars of strength (and willing and able to balloon assets holdings at a whim).  Mortgage Credit in general was solid in 1998.  The “financial guarantors”/Credit insurers (notably MBIA and Ambac) had relatively small exposure to insuring sophisticated Wall Street securitizations.  The Credit derivatives market was small and a non-issue.  There were, at the time, no festering domestic Credit issues.  The U.S. economy was not remotely as susceptible as it is today.  The dollar was in the midst of a multi-year bull run.  The Current Account Deficit was running at about a $200bn pace. The issues today are more serious and deep-rooted.  Confidence in the dollar is faltering in the face of untenable $800bn annual Current Account Deficits.  The Credit system is weakened by unprecedented impending subprime losses and acute vulnerability throughout “prime” mortgages.  The GSEs are weak financially and extraordinarily vulnerable.  The Credit insurers are highly exposed to myriad Credit and financial risks.  The Wall Street firms and “money center banks” are heavily exposed to mortgage and capital market risk.  The untested Credit derivative marketplace has been shaken by the rapidity and severity of the subprime implosion.  The CDO market wasn’t a factor in 1998, let alone a vital facet of system Credit creation and risk intermediation.  What appeared at the time (1998) a large leveraged speculating community seems today tiny by comparision.  Today's vast global pool of speculative finance was but a little puddle, and a dollar bullish one at that.  Meanwhile, the expansive marketplace for trading Credit exposures has created a major venue for placing aggressive bets on systemic Credit conditions – over-stimulating liquidity creation when the bets are bullish only to imperil liquidity when the bulls turn, as they are these days, into enterprising bears.  Moreover, the coveted risk modeling and management systems are oblivious to end-of-cycle Credit Bubble dynamics. The most important difference between today and 1998 is that the Credit system back then was not a full decade into problematic Credit and Economic Bubble dynamics.  The amount of Credit necessary to support the economy and markets was a fraction of what it has become.  Both the quantity and quality of risk to be intermediated was relatively small in comparison and, besides, there was a bevy of risk intermediators easily up to the task.  In stark contrast, today – and going forward – there will be an unrelenting torrent of risk that must be intermediated (risky Credits transformed into palatable debt instruments), and it is not at all clear who is in a position to absorb significant risk.  The leveraged speculators are more than likely keen to shed risk.  The big “banks” and “brokers” are already fully-loaded.  And the general marketplace, well, it’s reeling with the realization that much of structured finance today suffers from pricing and liquidity issues and, worse yet, not even debt ratings can be trusted.  “Ponzi Finance” dynamics are in full play and the U.S. Bubble economy is incredibly exposed to a reversal in speculative finance and resulting liquidity crisis.  These are very serious issues and indicative of the types of unavoidable risk intermediation problems that will stymie this historic Credit Bubble.