| The Dow declined 1.4% and the S&P500 1.1%. The Transports declined 1.0%, and the Morgan Stanley Cyclical index slipped 0.7%. The Utilities gained 0.9%. The Morgan Stanley Consumer index was hit for 1.2%. The small cap Russell 2000 declined 0.8%, and the S&P400 Mid-Cap index fell 1.1%. The NASDAQ100 dipped 0.1%, and the Morgan Stanley High Tech index lost 0.7%. The Semiconductors dipped 0.6%. The Street.com Internet Index declined 0.9%, while the NASDAQ Telecommunications index gained 0.8%. The Biotechs added 0.3%. Financial stocks were under pressure. The Broker/Dealers dropped 3.1%, and the Banks declined 2.3%. Although bullion gained almost $2, the HUI Gold index declined 0.4%. Two-year government yields dropped 8 bps to 4.59%. Five-year yields declined 6 bps to 4.47%, and 10-year Treasury yields fell 4 bps to 4.55%. Long-bond yields slipped two bps to 4.70%. The 2yr/10yr spread ended the week inverted only 4 bps. The implied yield on 3-month December ’07 Eurodollars dropped 6 bps to 4.86%. Benchmark Fannie Mae MBS yields fell 6 bps to 5.68%, this week outperforming Treasuries. The spread on Fannie’s 5 1/4% 2016 note widened two to 40, and the spread on Freddie’s 5 1/2% 2016 note widened one to 39. The 10-year dollar swap spread was unchanged at 54.0. Corporate bond spreads were again volatile, with junk spreads ending the week a few bps wider. Investment grade issuers included TXU $1.8 billion, AIG $900 million, CIT Group $750 million, Eaton Corp $500 million, Honeywell $1.0 billion, Cigna $750 million, Commonwealth Edison $625 million, McDonalds $400 million, Coventry Health $400 million, XTRA Finance $400 million, White Mountains $400 million, Southern Natural Gas $500 million, and Stanley Works $200 million. March 14 – Bloomberg (Kim-Mai Cutler): “Freeport-McMoRan Copper & Gold Inc. sold $6 billion of bonds today in the second-biggest junk bond offering ever to finance a leveraged buyout, according to…Bloomberg. The sale is second only to the $8.5 billion in junk bonds raised by Kohlberg Kravis Roberts & Co. for its $31.3 billion takeover of RJR Nabisco Inc. in 1989.” Junk issuers included Freeport-McMoran $6.0 billion, TRW Automotive $1.1 billion, Hawker Beechcraft $1.1 billion, Stone Container $675 million, PPL Capital Funding $500 million, Belden CDT $350 million, General Cable $325 million, US AGBank $225 million, Centene $175 million, and Asbury Auto Group $150 million. Convert issues included Macerich $800 million, Alpharma $300 million, National Financial $230 million, SPS $150 million, Asbury Auto Group $100 million and Conceptus $86 million. International issuers included Canadian Natural Resources $2.2 billion and TNK-BP $1.3 billion. Japanese 10-year “JGB” yields declined 3 bps this week to 1.575%. The Nikkei 225 fell 2.4% (down 2.8% y-t-d). German 10-year bund yields fell 5 bps to 3.90%. Emerging debt markets again held their own, while equities markets were under some pressure. Brazil’s benchmark dollar bond yields dipped one bp this week to 5.81%. Brazil’s Bovespa equities index dropped 3.2% (down 3.9% y-t-d). The Mexican Bolsa slipped 0.8% (up 1.7% y-t-d). Mexico’s 10-year $ yields fell 6 bps to 5.48%. Russia’s 10-year Eurodollar yields declined 2 bps to 6.68%. India’s Sensex equities index dropped 3.5% for the week (down 9.8% y-t-d). China’s Shanghai Composite index dipped 0.3%, reducing 2007 gains to 9.5%. Freddie Mac posted 30-year fixed mortgage rates were unchanged last week at 6.14% (down 20 bps y-o-y). Fifteen-year fixed rates added two bps to 5.88% (down 10 bps y-o-y). And one-year adjustable rates fell 5 bps to a 10-week low 5.42% (up 5 bps y-o-y). The Mortgage Bankers Association Purchase Applications Index gained 2.2% this week. Purchase Applications were up 2.8% from one year ago, with dollar volume up a notable 9.6%. Refi applications rose 3.5% to the strongest level since September 2005. The average new Purchase mortgage jumped to a record $248,000 (up 5.3% y-o-y), and the average ARM rose to a record $409,400 (up 18.5% y-o-y). Bank Credit jumped $23.9 billion (week of 3/7) to a record $8.437 TN. Bank Credit has expanded at a 9.0% annualized rate y-t-d (10 wks), with a one-year gain of $788 billion, or 10.3%. For the week, Securities Credit increased $16.5 billion. Loans & Leases rose $7.4 billion to a record $6.174 TN. Commercial & Industrial (C&I) Loans expanded 12.1% over the past year. For the week, C&I loans declined $3.4 billion, while Real Estate loans gained $5.9 billion. Year-to-date, C&I loans have expanded at a 6.6% rate and Real Estate loans at a 8.4% pace. Bank Real Estate loans expanded 14.0% over the past year. For the week, Consumer loans added $2.1 billion, and Securities loans increased $5.0 billion. Other loans declined $2.3 billion. On the liability side, (previous M3) Large Time Deposits jumped $18.4 billion. M2 (narrow) “money” fell $16.8bn to a record $7.128 TN (week of 3/5). Narrow “money” has expanded $84bn y-t-d, or 6.2% annualized, and $374bn, or 5.5%, over the past year. For the week, Currency dipped $0.1 billion, while Demand & Checkable Deposits jumped $31.6bn. Savings Deposits dropped $50.1bn, while Small Denominated Deposits added $0.1bn. Retail Money Fund assets increased $1.5bn. Total Money Market Fund Assets (from Invest. Co. Inst) declined $8.0 billion last week to $2.431 TN. Money Fund Assets have increased $169 billion over the past 20 weeks (19.5% annualized) and $383 billion over 52 weeks, or 18.8%. Total Commercial Paper gained $2.3 billion last week to $1.995 TN, with a y-t-d gain of $18.6 billion (4.5% annualized). CP has increased $96 billion (13.1% annualized) over 20 weeks, and $285 billion, or 16.7%, over the past 52 weeks. March 15 – Bloomberg (Shamim Adam): “Global sales of collateralized debt obligations surged 90 percent in the first two months of this year as issuers rushed to complete deals while the subprime bond market was collapsing, Morgan Stanley said. CDO sales in January and February totaled $80.8 billion, up from $42.6 billion in the same 2006 period…” March 13 – Bloomberg (Caroline Salas and Darrell Hassler): “Bond investors rattled by mounting losses in subprime U.S. mortgages say trouble is brewing in collateralized debt obligations, the same securities that fueled the boom in leveraged buyouts and cut-rate finance. Sales of CDOs, which package loans, bonds and derivatives into new securities, rose by almost half to $918 billion last year, according to…JPMorgan Chase & Co.” Fed Foreign Holdings of Treasury, Agency Debt increased $11.4bn last week (ended 3/14) to a record $1.860 TN, with a y-t-d gain of $96.3bn (26% annualized). “Custody” holdings have expanded at a 27% rate over 20 weeks and 16.6% y-o-y ($265bn). Federal Reserve Credit last week declined $164 million to $852bn. Fed Credit was up $31.5bn y-o-y, or 3.8%. International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $841 billion y-o-y (20%) to a record $5.048 TN. Currency Watch: The dollar index dropped 1.5% to 82.94. On the upside, the Czech koruna gained 2.8%, the Swiss franc 2.3%, the Australian dollar 2.0%, and the Swedish krone 1.5%. On the downside, the South African rand declined 1.8%, the Philippines peso 0.9%, the Mexican peso 0.6%, and the Indonesian rupiah 0.5%. Commodities Watch March 16 – Bloomberg (Yuriy Humber): “Russia, the world’s biggest oil and natural gas producer, will boost atomic power output and increase uranium reserves by a quarter as electricity demand grows faster than generation, threatening to curb a nine-year economic boom. ‘The need to diversify our fuel-energy balance is obvious,’ Deputy Prime Minister Sergei Ivanov said… ‘In the foreseeable future, Russia will take third place in the world in terms of uranium resources, which will be about 1 million tons.’ Russia plans to spend 674 billion rubles ($26 billion) in the next eight years to develop its nuclear industry…” March 15 – Bloomberg (Angela Macdonald-Smith): “Uranium’s average spot price may almost double this year to $90 a pound and may rise further in 2008, Goldman Sachs JBWere Pty. said. The average spot price may peak at $95 a pound in 2008…as secondary supplies of the nuclear fuel decline and demand growth accelerates…” March 15 – Bloomberg (Yoshifumi Takemoto): “Thieves are taking playground slides and cemetery incense trays in Japan as soaring metal prices cause everyday items to be stolen and sold as scrap. Thefts of metal objects in Tokyo reached 40 percent of last year’s total in the first two months of 2007…” March 12 – Bloomberg (Ying Lou): “China imported 8% more crude oil in February as refiners increased shipments to meet rising energy demand and the nation sourced supplies for its emergency crude stockpile. Exports of the fuel dropped to zero. The world’s second-largest energy consumer imported 12.1 million metric tons (3.2 million barrels a day) of oil last month…” For the week, Gold gained 0.3% to $652.20 and Silver 1.5% to $13.205. Copper surged 8.3%. April crude dropped $2.89 to $57.07. April Gasoline was about unchanged, while April Natural Gas declined 2.0%. For the week, the CRB index declined 1.2% (down 0.9% y-t-d), and the Goldman Sachs Commodities Index (GSCI) fell 0.9% (up 0.9% y-t-d). Japan Watch: March 12 – Bloomberg (Lily Nonomiya): “Japan’s economy expanded 5.5%, the fastest pace in three years, as surging exports prompted companies to increase spending on factories and machinery.” March 12 – Bloomberg (Toru Fujioka): “Japan’s current account surplus widened more than expected in January as exports surged and the nation’s companies and individuals earned more from overseas investments. The surplus expanded 50 percent to…$10.1 billion from a year earlier…” March 13 – Bloomberg (Toru Fujioka): “Tokyo, whose economy is bigger than Canada's, will remain the world’s largest city economy ahead of New York until at least 2020, according to a report by PricewaterhouseCoopers LLP.” China Watch: March 16 – Bloomberg (Josephine Lau and Yanping Li): “China’s economic expansion, the source of about a 10th of global growth last year, is unstable and environmentally unsustainable, Premier Wen Jiabao said. ‘China’s investment growth is too high, lending growth too fast, liquidity excessive and trade and international payments very imbalanced,’ Wen said… Energy efficiency and environmental protection issues haven’t been ‘properly resolved,’ he said.” March 15 – Bloomberg (Nipa Piboontanasawat): “China’s industrial production accelerated in the first two months, adding pressure on the central bank to raise interest rates to prevent the world’s fastest-growing major economy from overheating. Output rose 18.5% in January and February…after gaining 14.7% in December.” March 12 – Bloomberg (Nipa Piboontanasawat and Yanping Li): “China’s trade surplus was three times more than economists expected in February, giving more ammunition to U.S. lawmakers calling for a stronger yuan. The gap widened to $23.76 billion, the second-highest monthly surplus ever…” March 14 – Bloomberg (Nipa Piboontanasawat): “China’s retail sales grew at the fastest pace in more than two years as rising incomes boosted spending on food, cars, electronics and clothes. Sales for January and February combined rose 14.7%...” March 12 – Bloomberg (Nipa Piboontanasawat): “China’s money supply grew at a faster pace in February as the country’s trade surplus surged and the central bank added money to the financial system ahead of the week-long Lunar New Year holiday. M2…rose 18% from a year earlier…” March 13 – Bloomberg (Nipa Piboontanasawat): “China’s inflation accelerated in February as food prices jumped, adding pressure on the central bank to raise interest rates in the world’s fastest-growing major economy. Consumer prices rose 2.7% from a year earlier after gaining 2.2% in January…” March 14 – Bloomberg (Xiao Yu): “China’s wholesale prices for grains rose 9.2% in February from a year earlier, the People’s Bank of China said.” March 14 – Bloomberg (Helen Yuan): “The average wholesale price of steel products in China, the world’s largest user of the metal, rose 8.6% in February from a year earlier, the People’s Bank of China said.” India Watch: March 12 – Bloomberg (Cherian Thomas): “India’s industrial production grew faster than expected in January, putting pressure on the central bank to increase interest rates for a second time this year to curb inflation. Production at factories, utilities and mines rose 10.9% from a year earlier…” March 15 – Bloomberg (Ashok Bhattacharjee and Cherian Thomas): “India may have the highest salary increase among Asian countries this year… Indian wages may increase an average 14.5% in 2007…” Asia Boom Watch: March 14 – Bloomberg (Seyoon Kim): “South Korea’s jobless rate dropped to the lowest in more than four years in February as builders hired workers, which may help stoke consumer spending in Asia’s third-largest economy. The unemployment rate fell to 3.2%...” March 15 – Bloomberg (Shamim Adam): “Singapore’s unemployment rate fell to an eight-year low in 2006 as a record number of jobs were created… Southeast Asia’s fourth-largest economy added an unprecedented 176,000 new positions in 2006, pushing the jobless rate down to 2.7% from 3.1%...” Unbalanced Global Economy Watch: March 14 – Bloomberg (William McQuillen): “The International Monetary Fund predicts global growth will slow to 4.9 percent this year from 5.3 percent in 2006…” March 16 – Bloomberg (Jennifer Ryan): “U.K. wage bargainers agreed pay increases matching the fastest pace in eight years in the quarter through February after inflation reached a decade-high, Industrial Relations Services said. A survey of 186 salary agreements showed worker compensation rose a median 3.5%...” March 15 – Bloomberg (Simon Packard): “Prices for luxury homes in London rose last month at the fastest annual rate in 28 years, cementing the British capital’s position as the most expensive city in the world for prime residential real estate. The average price for a luxury home rose 31% in February from a year earlier, according to…Knight Frank LLP” March 12 – Bloomberg (Sheyam Ghieth): “Italian industrial production fell the most in almost six years in January as manufacturing of consumer goods such as washing machines and refrigerators declined. Production dropped 1.4% from December…” March 14 – Bloomberg (Harry Papachristou): “Greece’s unemployment rate fell to the lowest level in at least nine years in 2006, helped by an economy that is expanding at twice the pace of the euro region… ‘The jobless rate is expected to have dropped to an average rate of 8.9 percent last year,’ economy minister George Alogoskoufis said…” March 12 – Bloomberg (Maria Levitov): “Russia raised its economic growth forecast for 2007 to 6.2%, less than a month after the Economy Ministry cut the end-year estimate because of an expected decline in oil prices.” March 15 – Bloomberg (Maria Levitov): “Russia’s foreign currency and gold reserves rose to a record $317.3 as the world’s largest energy exporter reaped revenue from oil and natural gas exports.” Latin American Boom Watch: March 15 – Bloomberg (Katia Cortes): “Brazilian retail sales climbed in January as lower lending rates and rising wages spur consumer spending on cars, refrigerators and other goods. Retail, supermarket and grocery store sales, as measured by units sold, rose 8.5% in January…” March 16 – Bloomberg (Alex Emery): “Peru’s economic growth accelerated in January, because of increased manufacturing and construction output… Gross domestic product expanded 9.2% from a year earlier compared with 8.9% growth in December…” Central Banker Watch: March 15 – Bloomberg (Tracy Withers): “New Zealand central bank Governor Alan Bollard says ‘exuberance’ by consumers and banks to borrow and lend ‘cheap international money’ has stymied his attempts to slow consumer spending and the housing market. Bollard hinted in a speech…that unless consumers and lenders curbed the borrowing binge, he may be forced to raise interest rates…‘We need to see realization amongst borrowing households and lending banks that this period of cheap international money has been unusual… That means thinking about other eventualities ahead, and in some cases showing less exuberance.’” March 15 – Bloomberg (Simone Meier): “The Swiss central bank…raised interest rates for the sixth time since late 2005 to keep an expanding economy from stoking inflation. The Swiss National Bank…raised the benchmark three-month Libor target rate a quarter-point to 2.25 percent. It also raised its inflation forecast for this year and next.” March 15 – Market News International: “Norway’s central bank announced…to raise the key sight deposit rate 25 basis points to 4.00%... For the future outlook, the Bank hinted that further gradual monetary policy tightening was likely, whilst it mulls further data and economic developments.” March 15 – Bloomberg (Sam Nagarajan): “European Central Bank council member Axel Weber said he still sees ‘complacency’ in global financial markets after the recent slump in equities. ‘Despite the marked correction in various financial markets quite recently, there are ongoing signs of relatively low risk premia and still increasing use of leverage instruments such as in the credit market… Both developments reflect a rather pronounced feeling of complacency among many market participants.’” Bubble Economy Watch: The February Consumer Price index rose a stronger-than-expected 0.4%. The CPI is now up 2.4% y-o-y, with Core CPI’s 2.7% y-o-y increase making nine straight months above 2.5%. At 2.5%, the year-over-year increase in the Producer Price Index was the strongest since August. March 13 – Bloomberg (Brian K. Sullivan and James M. O’Neill): “Wall Street recruiters can be as aggressive as professional football players, says Chris Eitzmann, who will receive his MBA degree in May from Dartmouth College’s Tuck School of Business. ‘Once given the offer, you are getting anywhere from two or three to four phone calls a day,’ said Eitzmann, 29… ‘They want to know if they can talk to your wife. Can they have their wife talk to your wife?’ Competition for MBAs from banks such as New York-based Citigroup Inc. and Goldman Sachs Group Inc. may push starting-pay packages above last year, when graduates averaged a record $186,174 in total compensation at Harvard Business School and $183,000 at Stanford University’s Graduate School of Business.” March 14 – Dow Jones (Anjali Cordeiro): “Wm. Wrigley Jr. Co. said it will raise the price of its products in the U.S. by an average 10% to combat continued commodity price pressures.” Financial Sphere Bubble Watch: March 15 – Financial Times (Gillian Tett): “The cost of buying protection against a default by some investment banks rose yesterday amid growing nervousness about risks in some big financial groups. The rise means the debt derivatives are trading at levels normally associated with companies holding credit ratings close to junk - even though investment banks’ ratings are more secure. The pattern comes at a time when the sector is enjoying strong earnings…The deterioration in sentiment in the derivatives market has partly arisen because of problems in the US subprime sector. More broadly, there is concern that a factor behind the rise in earnings is that some investment banks are taking big proprietary risks - a tactic that may backfire if markets become more turbulent.” Mortgage Finance Bubble Watch: March 13 – Bloomberg (Sharon L. Crenson and Kathleen M. Howley): “U.S. subprime borrowers fell behind on their mortgages at the highest rate in four years in the fourth quarter and foreclosures begun on all types of home loans rose to an all-time high, the Mortgage Bankers Association said. The share of subprime borrowers making late payments rose to 13.33% from 12.56% in the third quarter…” March 12 – Bloomberg (Jody Shenn): “Mortgage defaults over the next two years may climb to $225 billion, probably not enough to be a drag on the U.S. economy, according to debt strategists at Lehman Brothers Holdings Inc. The forecast, based on an assumption of flat home prices, compares with about $40 billion annually in 2005 and 2006…” Real Estate Bubbles Watch: March 15 – Reuters (Al Yoon): “No-down-payment loans available at virtually every subprime lender last year are disappearing at a rapid pace this month as lenders see them as a primary cause of their mortgage losses. Some of the biggest lenders, including Countrywide Financial Corp. and the RESCAP unit of consumer finance giant GMAC in the past week blasted e-mails to mortgage brokers putting an abrupt end to programs offering mortgages to risky borrowers who can not come up with at least 5% of a home’s purchase price.” March 12 – Bloomberg (Bob Ivry): “Hold on to your assets. The deepest housing decline in 16 years is about to get worse. As many as 1.5 million more Americans may lose their homes, another 100,000 people in housing-related industries could be fired, and an estimated 100 additional subprime mortgage companies that lend money to people with bad or limited credit may go under, according to realtors, economists, analysts and a Federal Reserve governor.” March 14 – Bloomberg (Dan Levy): “Sales of homes in Southern California last month fell to their lowest level in a decade as potential buyers waited for prices to fall and the subprime mortgage crisis created a ‘different mindset,’ DataQuick…said. In the six counties that make up the Southern California region, 17,680 new and existing homes were sold last month, the lowest total since February 1997… Potential buyers ‘have a different mindset and are wondering if they can get a better deal in the future,’ DataQuick analyst Andrew LePage said… ‘There has been a huge psychological shift. Buyers are waiting for fear of paying too much.’” March 14 – Bloomberg (Craig Torres and Alison Vekshin): “The Federal Reserve and the Office of the Comptroller of the Currency took little action in public to police the $2.8 trillion boom in the U.S. mortgage market… The Fed, which is responsible for the stability of the banking system, didn’t publicly rebuke any firm for failing to follow up warnings on home-lending practices between 2004 and 2006. The OCC, which supervises 1,793 national banks, took only three public mortgage-related consumer-protection enforcement actions over the same period.” March 15 - Dow Jones: “Commercial real estate vacancies are expected to rise this year, in part driven by businesses moving into newer buildings, the National Association of Realtors said… Office vacancies are expected to rise to an average of 13.9% by the end of 2007, up from 12.6% in the fourth quarter of 2006, according to…the NAR. ‘A flight to quality office space, notably in new buildings, will raise vacancy rates in older class B and class C buildings,’ the NAR said.” Energy Boom and Crude Liquidity Watch: March 13 – Financial Times (Ed Crooks): “In the gold rush of today’s energy business, companies such as Halliburton are the modern equivalents of Levi Strauss and Wells Fargo. Providing services to oil companies has been an even better business than finding and producing oil in recent years. Since the start of 2003, ExxonMobil’s shares have roughly doubled; those of Royal Dutch Shell, now the runner-up among Western oil majors, have risen about 40 per cent… Scarcity of equipment and skilled personnel at a time of bumper investment in oil exploration and production have sent the costs of oil services soaring. BP estimated its cost inflation was 14 per cent last year, and oil services companies were among the beneficiaries.” March 11 – Bloomberg (Matthew Brown): “The United Arab Emirates’ economy grew 23.4 percent in 2006, the Ministry of Economy said, as the price of oil climbed.” March 13 – Bloomberg (Zainab Fattah): “Inflation in the United Arab Emirates, estimated at 7.3 percent, will erase wage increases of 5 percent, Gulf News said… Employers in the U.A.E. have been struggling to attract qualified workers as inflation erodes pay increases…” Climate Watch: March 15 – Associated Press: “This winter was the warmest on record worldwide, the government said…in the latest worrisome report focusing on changing climate. The report comes just over a month after the Intergovernmental Panel on Climate Change said global warming is very likely caused by human actions and is so severe it will continue or centuries. The National Oceanic and Atmospheric Administration said the combined land and ocean temperatures for December through February were 1.3 degrees Fahrenheit above average for the period since record keeping began in 1880.” Speculator Watch: March 14 – Financial Times (James Mackintosh): “Hedge funds have inherent conflicts of interest in the way they value their investments, international financial regulators warned yesterday as they laid out principles to mitigate the problem. The International Organisation of Securities Commissions said valuations of the complex instruments used by many hedge funds could put the interests of managers and their investors at odds. Valuation of the increasingly complex futures, options, structured credits and over-the-counter derivatives used by hedge funds is a major issue for investors in the $1,500bn hedge fund industry. Incorrect valuations can mean investors buy units in a fund at too high a price, lose out when they sell or pay too much to managers in performance fees. ‘The manager may have both the incentive and the ability to influence the valuation of the financial instruments in the portfolio in ways that do not reflect their value,’ Iosco said.” March 13 – Bloomberg (Yalman Onaran): “Lehman Brothers Holdings Inc., the fourth-biggest U.S. securities firm, bought 20 percent of D.E. Shaw group, its second purchase of a stake in a hedge fund this year. Terms weren't disclosed.” Financial Sphere Earnings Watch: Goldman Sachs posted record first quarter Net Earnings of $3.197bn, up 29% from the Q1 2006. “Net Revenues in Trading and Principal Investments were $9.42bn, 35% higher than the first quarter of 2006… [with] Net Revenues in Fixed Income, Currencies and Commodities were $4.60 billion, 20% higher…reflecting higher net revenues in credit products and mortgages… Net Revenues in Equities were $3.09 billion, 26% higher than the first quarter… Principal Investments recorded net revenues of $1.73 billion…” The company repurchased 13 million shares during the quarter (avg. price $207.26). Lehman Brothers’ Net Income was up 13% y-o-y to $1.146 billion. “Net revenues (total revenues less interest expense) for the first quarter of fiscal 2007 were a record $5.0 billion, an increase of 13%... Capital Markets reported record net revenues of $3.5 billion…an increase of 15%...Fixed Income Capital Markets reported net revenues of $2.2 billion, its second highest revenue quarter and an increase of 3%...reflecting record results in credit products as well as a strong performance in real estate… Equities Capital Markets reported record net revenues of $1.3 billion, an increase in 42%...” Total Assets surged a noteworthy $57.0bn, or 45% annualized, during the first quarter to $560.7 billion. Assets were up $121bn y-o-y (27.6%), $197.0bn (54%) over two years, and 270% since the beginning of 1998. Bear Stearns’ First Quarter Net Income of $554 million was up 7.7% from the year earlier period. Total Capital Market Revenues were up 15.4% y-o-y to $1.965bn, with Institutional Equities up 2.6% y-o-y, Fixed Income up 26.7% y-o-y, and Investment Banking up 2.6%. “Equities derivatives delivered a record quarter… The credit business produced record results, led by the credit derivatives and distressed areas… Equities underwriting and merger and acquisition activity remains strong…” Wealth Management Revenues were up 13.6% y-o-y to $255 million. Global Clearing Revenues were up 4.6% y-o-y to $276 million. Customer Margin Balances were up 34% y-o-y to a record $86.6bn. The company repurchased 2.9 million shares during the quarter at a cost of $473 million. Subprime Contagion Effects: The Mortgage Finance Bubble should have burst last year, taking the lead from housing market dynamics. But the extraordinary dynamism associated with global Credit, speculative and liquidity excesses proved overpowering. The global leveraged speculating community was in aggressive expansion mode; Bubble excesses were going to reckless extremes throughout “Credit arbitrage;” the M&A and corporate debt Bubbles were in full bloom; and securities leveraging was taking the entire world by storm. The resulting global liquidity cataclysm ensured insatiable demand for higher-yielding instruments, in large part satisfied by Wall Street’s unprecedented CDO (collateralized debt obligations) issuance boom. Despite the turn in U.S. housing, the unprecedented deluge in speculative finance created rapacious demand for riskier loans, certainly including subprime mortgages – vulnerable housing markets notwithstanding. Readily available mortgage finance empowered subprime originators to accommodate throngs of simply terrible Credits (many borrowers content to submit fraudulent loan applications) desperate to refinance problematic mortgages with payments about to reset significantly higher. When Wall Street pool operators recognized the unfolding disaster - and began rigorously scouring portfolios for problem loans and imperfect applications to return to the originators (“early payment defaults”) - the subprime Bubble was brought to a screeching halt. That the Mortgage Finance Bubble did not succumb last year only ensured the peril associated with a protracted period of terminal blow-off excesses. Excesses included unprecedented speculation in Credit derivatives (including a Trillion or two of new CDOs), equities Bubbles spanning the globe, and only greater Bubble distortions and imbalances in U.S. and global economies. The exponential growth in risky lending, in the leveraged speculating community, in the derivatives markets, and in speculative flows to global asset markets were accommodated another year. Wall Street finance became an only more imposing source of global “money,” Credit and marketplace liquidity, operating with the type of power and control central banks could only dream of. Reading through this week’s Wall Street earnings releases and listening to their conference calls left me with the sense that these firms and their clients are especially poorly positioned for an abrupt change in the market environment. Everyone is quick to state that their subprime exposure is small and that they have successfully “hedged.” We are also told that market tumult has been isolated in the subprime marketplace, and that marketplace liquidity remains extraordinarily abundant. All of this may be true for now, but it does not alter the reality that the subprime collapse may very well mark a key (historic?) inflection point for the U.S. Mortgage Finance Bubble and intertwined global risk markets generally. Clearly, the subprime collapse has quickly imposed dramatically tighter Credit standards and Availability for risky borrowers. I would expect this to speed housing price declines in some areas, with mounting Credit losses ushering in the ugly downside of Credit cycle. To be sure, this has provided a belated wakeup call regarding the latent Acute Financial Fragility of Ponzi Finance Units. Importantly, the flow (deluge) of speculative finance played a critical role in the subprime boom, and its abrupt reversal has instigated almost immediate collapse. In many ways, Subprime is a microcosm of U.S. Credit system and economic fragility. The bulls argue that subprime amounts to only a small portion of mortgage debt – and thus will have only minimal economic impact. More discerning analysis would instead focus on the Financial Sphere Ramifications Associated with the Hasty Reversal of Speculative Flows from Risky Mortgage Instruments. Is the flight out of subprime mortgages, securitizations and other derivatives a harbinger of things to come for the entire mortgage marketplace? And does the move toward Risk Aversion (position liquidation and/or hedging operations) in this sector mark a momentous marketplace shift from Risk Embracement to Risk Aversion? In analyzing potential Subprime Contagion Effects, we must begin with a critical question: Is the general backdrop characterized by soundness and stability or is it more a case of excess, weak debt structures, and general fragility. Again, subprime collapsed so abruptly because of the acute fragility associated with Ponzi Finance. Unfortunately, analysis of general mortgage market vulnerability leaves me quite uneasy. The entire Mortgage Finance Bubble is today especially susceptible to Subprime Contagion Effects. For starters, lending standards should be expected to tightened significantly throughout the “Alt-A,” “jumbo,” and prime “exotic” mortgage marketplace. This will likely pose a greater dilemma than subprime restraint for vulnerable high-priced housing across the country, with all eyes on California. For years now, the “Golden State” has been at the epicenter of mortgage lending excesses. I suspect the state has also been the leader in mortgage fraud. Going forward, I fully expect California to lead the nation in Credit losses and mortgage/housing angst. Throughout the boom, the securitization of mortgage Credit provided endless finance for homebuyers and speculators, as well as endless profits for the holders of these instruments. As long as home prices were inflating, there was little concern whether the underlying collateral was a reasonably valued home in, say, Texas or a highly inflated property in the San Francisco Bay Area. Now, with Credit conditions beginning to tighten, I expect holders of MBS, ABS, CDOs, etc. to take a more keen interest in the type and location of underlying collateral. This Contagion Effect will spur risk reassessment and a consequential reversal in speculative flows from the mortgage arena. For some time it has been my belief that a California housing bust would bring an end to the GSEs as we presently know them. Never in my wildest imagination did I contemplate the median price for the entire state inflating to $560,000. A bust would now likely take down the GSEs, the mortgage insurers, scores of banks, and wreak bloody havoc throughout the entire securitization and derivatives marketplaces. While few will today subscribe to such a scenario, I certainly expect the marketplace to begin contemplating and gravitating away from such risks. And I don’t believe it will take that much for the marketplace to start nervously totaling up the capital and reserves available for future Credit losses from the thinly capitalized guarantors of the so far pristine “AAA” agency securities marketplace. Again, there are now reasons to ponder various Contagion Effects that together could foster a major and self-reinforcing reversal of speculative flows and risk-taking generally. While marketplace liquidity generally remains quite abundant today, a reversal of speculative flows and a problematic unwinding of positions in the highly leveraged mortgage arena now pose a serious threat to a liquidity backdrop that for too long has been taken for granted. Ominously, renewed dollar weakness has been an early Subprime Contagion Effect. Sure, the market now perceives the Fed will in the not too distant future cut rates and narrow rate differentials. But I also believe more may be at work. The transformation of risky Credits into perceived “money-like” instruments - that foreigners have been happy to accumulate - has lent great support to the dollar over these past few years of massive Current Account Deficits. A bursting Mortgage Finance Bubble and what it could mean for the securitization markets, risk intermediaries and leveraged speculating community create the potential for Subprime Contagion Effects to precipitate a serious problem for the dollar. I apologize for this effort. Distractions, including watching my beloved Ducks in the NCAA tournament, proved too much for me this afternoon and evening. |
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