Saturday, September 20, 2014

09/28/2007 Clash of the Paradigms *

(up 11.5% y-t-d), while the S&P500 was little changed (up 7.6%). The Utilities were hit for 1.6% (up 8.0%), while the Morgan Stanley Consumer index gained 0.8% (up 7.4%). The Morgan Stanley Cyclical index increased 0.5% (up 18.8%), and the Transports added 0.2% (up 6.1%). The broader market appeared increasingly vulnerable. The small cap Russell 2000 declined 0.9% (up 2.3%), while the S&P400 Mid-cap index gained 0.4% (up 10.0%). The high-flying NASDAQ100 jumped 2%, increasing y-t-d gains to 19.0%. The Morgan Stanley High Tech index rose 1.6% (up 17.6%), while the Semiconductors dipped 0.2% (up 6.9%). The Internet Index gained 1.4% (up 17.3%), and the NASDAQ Telecommunications index surged 2.7% (up 23.1%). The Biotechs were little changed (up 8.9%). Financial stocks again underperformed. The Broker/Dealers slipped 0.6% (down 4.6%), and the Banks dropped 2.3% (down 9.8%). Although Bullion rose another $11.60, the HUI Gold index declined 1.7% (up 16.2%).

Will the weak dollar finally place a floor under U.S. yields? Three-month T-bill rates rose 4 bps this week to 3.80%. At the same time, two-year U.S. government yields declined 6.5 bps to 3.97%, and five-year yields fell 5.5 bps to 4.24%. Ten-year Treasury yields declined 4.5 bps to 4.58%, and long-bond yields ended the week 4.5 bps lower at 4.83%. The 2yr/10yr spread ended the week at 61 bps. The implied yield on 3-month December ’07 Eurodollars jumped 11 bps to 4.83%. Benchmark Fannie Mae MBS yields added 2 bps to 5.965%, this week underperforming Treasuries. The spread on Fannie’s 5% 2017 note narrowed 4 to 42, and the spread on Freddie’s 5% 2017 note narrowed about 3 to 43. The 10-year dollar swap spread declined 1.8 to 62.5. Corporate bond spreads were mixed. The spread on a junk index ended the week 7 bps wider.

September 27 – Financial Times (Stacy-Marie Ishmael): “The global market for credit derivatives grew 32% in the first half and increased 75% over the year to the end of June, the slowest rate of growth since 2003. Credit derivatives volumes outstanding rose by almost a third, to $45,460bn at June 30 from $34,420bn at the end of last year, the International Swaps and Derivatives Association said… Over the same period last year, the notional volume of contracts outstanding more than doubled… Contracts to swap between fixed and floating interest payments, the biggest component of the over-the-counter derivatives markets, increased 38% to $347,100bn over the year to June 30... Volumes in equity derivatives…grew 40% in the first half, and are up 57% over the past year, to $10,100bn.”

September 28 – Bloomberg (Sarah Rabil): “Bear Stearns Cos….and newspaper owner Quebecor Media Inc. led companies selling U.S. bonds this week, taking advantage of an easing in the credit rout that roiled sales in July and August. U.S. corporate bond offerings reached $25.6 billion this week, Bloomberg data show, pushing September issuance to a record $112 billion.”

Investment grade debt issuers included Goldman Sachs $2.5bn, Bear Stearns $2.5bn, Thomson Corp $800 million, Oneok Partners $600 million, Kohls $1.0bn, Exelon Generation $700 million, Eaton Vance $500 million, Oglethorpe Power $500 million, Hospitality Properties $350 million, Protective Life $300 million, and PNC Funding $250 million.

Junk issuers included USG $500 million, American Tower $500 million, Range Resources $250 million, Downstream Development $200 million, Waterford Gaming $130 million, MCBC Holdings $105 million, and Standard Pacific $100 million.

Convert issuers included USEC $575 million and General Cable $475 million.

Foreign dollar bond issuance included Mexico $3.5bn, Royal Bank of Scotland $3.1bn, ICICI Bank $2.0bn, Turkey $1.25bn, Ghana $750 million, Corp Durango $520 million, and Grupo Senda $150 million.

German 10-year bund yields dipped 3 bps to 4.32%, as the DAX equities index added 1.1% (up 19.4% y-t-d). Japanese 10-year “JGB” yields were unchanged at 1.675%. The Nikkei 225 rallied 2.3% (down 2.6% y-t-d). Most emerging debt and equities Bubbles took on additional air. Brazil’s benchmark dollar bond yields fell almost 5 bps to 5.85%. Brazil’s Bovespa equities index jumped 4.6% to a record high (up 36% y-t-d). The Mexican Bolsa declined 0.9% (up 14.5% y-t-d). Mexico’s 10-year $ yields rose 8.5 bps to 5.63%. Russia’s RTS equities index gained 2.2% (up 7.8% y-t-d). India’s Sensex equities index surged 4.4% to an all-time high (up 25.4% y-t-d and 40% y-o-y). China’s Shanghai Composite index gained 1.7% to another record high (up 108% y-t-d and 220% y-o-y).

September 25 - Financial Times (Joanna Chung): “Emerging market equities are defying the financial turmoil. Having staged a dramatic recovery in the past month, more than recouping the losses suffered over the summer, emerging market share prices yesterday pushed to an all-time high to stand 28% above the low seen on August 16, as measured by the MSCI emerging markets index. But this spectacular performance of assets that usually retreat in times of crisis has raised questions about whether a bubble is developing in emerging markets. Those questions have been fuelled by the US Federal Reserve's interest rate cut last week, which triggered a strong rally in stock markets globally. Rate cuts have produced bubbles before. One of the unintended consequences of monetary easing during the credit market crises of the late 1980s and the late 1990s - following crises in Latin America, Asia and Russia - were bubbles in the Japanese equity market and the technology stocks sector, said Michael Hartnett, emerging market equity strategist at Merrill Lynch. ‘It’s essentially 1998 in reverse,’ he said. ‘The credit problem is now in the US rather than emerging markets. So liquidity to ease the US credit problem will be redirected towards emerging markets just as liquidity to ease the Asian and Russian financial crisis and problems stemming from Long-Term Capital Management was redirected toward technology.’”

Freddie Mac posted 30-year fixed mortgage rates jumped 8 bps this week to 6.42% (up 11bps y-o-y). Fifteen-year fixed rates rose 11 bps to 6.09% (up 11bps y-o-y). Moving the other direction, one-year adjustable rates fell 5 bps to 5.60% (up 13bps y-o-y).

A $53.5bn decline in Securities Credit pushed Bank Credit $42.6bn lower for the week (9/19) to $8.882 TN. Bank Credit is now up $241bn over the past eight weeks, with a $585bn, or 9.7% annualized, y-t-d gain. For the week, Loans & Leases increased $10.9bn to a record $6.539 TN (8-wk gain of $210bn). C&I loans jumped $11.6bn, increasing the y-t-d growth rate to 20%. Real Estate loans dropped $10bn. Consumer loans rose $8.4bn. Securities loans declined $8.1bn, while Other loans gained $9.0bn. On the liability side, (previous M3) Large Time Deposits surged $32.4bn.

M2 (narrow) “money” jumped $18.9bn to a record $7.370 TN (week of 9/17). Narrow “money” has expanded $327bn y-t-d, or 6.3% annualized, and $487bn, or 7.1%, over the past year. For the week, Currency was about unchanged, while Demand & Checkable Deposits fell $16.1bn. Savings Deposits surged $29.8bn, and Small Denominated Deposits increased $4.4bn. Retail Money Fund assets added $1.9bn.

Total Money Market Fund Assets (from Invest. Co Inst) jumped $29.8bn last week to a record $2.855 TN. Money Fund Assets have now posted a 9-week gain of $271bn and a y-t-d increase of $473bn (26.5% annualized). Money fund asset have surged $637bn over 52 weeks, or 28.7%.

Total CP declined $13.7bn to $1.855 TN, boosting the seven-week drop to $368bn. Asset-backed CP fell $6.3bn (7-wk drop of $251bn) to $922.6bn. Year-to-date, total CP is now down $118.9bn, with ABCP declining $161.3bn. Over the past year, Total CP has contracted $47bn, or 2.5%.

Asset-backed Securities (ABS) issuance slowed to $5.7bn this week. Year-to-date total US ABS issuance of $461bn (tallied by JPMorgan) is now running 30% behind comparable 2006. At $210bn, y-t-d Home Equity ABS sales are half of last year’s pace. Year-to-date US CDO issuance of $261 billion is running only slightly ahead of 2006 sales.

Fed Foreign Holdings of Treasury, Agency Debt last week (ended 9/26) gained $7.7bn to $1.995 TN. “Custody holdings” were up $243bn y-t-d (18.5% annualized) and $334bn during the past year, or 20.1%. Federal Reserve Credit last week jumped $6.6bn to $860bn. Fed Credit has increased $7.4bn y-t-d and $34.3 over the past year (4.2%).

International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $905bn y-t-d (25.1% annualized) and $1.120 TN y-o-y (24.4%) to $5.716 TN.
Credit Market Dislocation Watch:

September 28 – Financial Times (Lina Saigol and James Politi): “The global mergers and acquisitions market reached a record $3,850bn over the first nine months of the year as a whole, but experienced a dramatic drop in the third quarter as the credit markets seized up and buy-out activity collapsed. The volume of deals worldwide fell 42% to $1,000bn during the third quarter… Dealogic…said.”

September 28 – Financial Times (James Politi and Lina Saigol): “For a while, it seemed that strategic buyers would try to take advantage of private equity's immobility by making acquisitions that they had long coveted but decided not to pursue during the buy-out boom for fear that they could be outbid. But those hopes have not yet materialised. This is partly because the credit squeeze has hurt confidence across the board… According to Dealogic, global M&A activity in August and September combined was worth $417bn, only 73% of July’s volume of $574.7bn… According to Dealogic, $119.8bn worth of deals were announced in Brazil, Russia, India and China - the highest quarterly total on record for those countries. Latin American deal activity hit $30.5bn - the second- highest quarterly total after the second quarter of 2006.”

September 28 – Financial Times (David Oakley): “The world of junk-rated corporate bonds and leveraged loans came to a juddering halt in the third quarter this year as the credit squeeze took a heavy toll on issuance. Global bond and loan issuance fell sharply as even the US, which had withstood the shocks of the credit turmoil better than other regions, suffered… Leveraged loan volumes fell 26% to $65bn in the third quarter… European bond issuance also showed a big slump with volume falling 31% to $323.5bn in the third quarter… Like the US, it was in the high-yield space that volumes dropped most markedly, with not one deal pricing since July… Asia, excluding Japan, also saw bond issuance decline in the third quarter. Total debt volume in the third quarter stood at $45.6bn, down 40%...”

September 28 - Reuters (Walden Siew): "Global sales of collateralized debt obligations plunged by about 50% in the third quarter, a drop that means sales are unlikely to reach record levels this year, Thomson Financial said... Global sales of CDOs fell...$61.6 billion in the third quarter, from $120.1 billion for the same period in 2006, as deteriorating subprime loans sapped demand for structured debt..."

September 28 – Bloomberg (Neil Unmack): “Sales of collateralized debt obligations backed by European high-risk, high-yield loans may stutter into next year as investors avoid the securities following losses on subprime debt, Fitch Ratings said. ‘Deals are getting postponed continuously,’ Stefan Bund, a managing director at Fitch…said…We expected a recovery in September, but that may be put back to October or November, or even after that.’ Sales of collateralized loan obligations…slumped to 4.9 billion euros ($7 billion) in the past three months, a 40% drop from the previous quarter…”

September 27 – Financial Times (James Mackintosh): “Hedge funds are about to be hit by several billion dollars of withdrawals as a popular method of gearing up investment in the industry is reversed in the wake of poor performance this summer. Fund-linked derivatives, which have been booming as investors pile cash into hedge funds, are likely to finish their quarterly reviews by the end of next week, and, bankers say, many will trigger automatic redemptions… Big withdrawals could spark crises at funds investing in illiquid assets and prompt further selling pressure in markets dominated by hedge fund money… Bankers specialising in the area estimated the total structured product exposure at about $200bn, and said several billion of that would be redeemed this month, with money likely to come out by the end of the year… There are two main ways in which investors in hedge funds have used derivatives to boost returns. But both work in the same broad way: banks offer finance at a set multiple of the investment, and modify it every month or every quarter to ensure multiple remains within certain limits, typically a cushion of 3-5 per cent. For example, an investor putting $100m into a fund of funds might secure matching funding of $300m from a bank, giving a total investment of $400m, with a condition that the investor’s money make up a minimum of 20% of the total… If the fund then fell 10%, the investment is worth only $360m, wiping out $40m of the original investment and triggering redemptions, as the investor now has only 17% of the total. The first way this is applied is via leveraged share classes, typically in funds of funds, which spice up returns for investors who find the 7-9 per cent annual returns of many in the industry too dull.”

September 26 - Financial Times (Jane Croft ): “As the dust settles after the Northern Rock crisis, the spotlight will shift to other small banks such as Alliance & Leicester and Bradford & Bingley, as well as the UK’s 59 building societies. The Northern Rock debacle has increased worries about the banking sector, particularly those institutions that rely in part on wholesale funding. Questions have been raised about how UK banks, particularly small mortgage banks without the comfort blanket of large balance sheets, will access wholesale funding - given that capital markets are in effect closed for business…”

September 24 - Bloomberg (Cecile Gutscher): “Banks reduced the backlog of unsold corporate debt to $370 billion after seizing on improved investor demand to issue $7 billion of leveraged loans and bonds in the past two weeks, Bank of America Corp. analysts said… ‘The door creaks slowly open in credit markets,’ Bank of America strategists led by Jeffrey Rosenberg said… Banks in the U.S. and Europe still have to syndicate the equivalent of almost three-quarters of the entire $500 billion of loans held by money managers in America, according to the research published Sept. 22.”

September 27 – Bloomberg (Frederic Tomesco): “Banks and investors seeking to restructure C$35 billion ($35 billion) of Canadian asset-backed commercial paper said they need more time to come to an agreement. ‘Given the highly complex process and the significant number of stakeholders involved, a successful restructuring cannot be completed by mid-October’ as agreed to, Purdy Crawford, who leads the investor committee, said… Under the so-called Montreal proposal announced Aug. 16, the group, which includes banks and pension funds, would convert the commercial paper into floating-rate notes. The group has until Oct. 15 to come up with a plan for restructuring the debt.”

September 28 – Bloomberg (Maria Levitov): “Investors withdrew a net $5.5bn from Russia in August because of international turmoil on financial markets, the Economy Ministry said, citing the central bank’s preliminary calculations. ‘The mortgage market crisis and the difficulties with liquidity on the global financial markets affected Russia’s financial system,’ the Moscow-based ministry said…”

September 27 – Financial Times (Catherine Belton): “A senior Russian banker warned yesterday of debt defaults as the liquidity squeeze in Russia tightened following the global credit crunch and interbank lending rates climbing to a two-year high. ‘If debt markets remain closed until the end of the year the situation is going to get very difficult for many banks,’ said Oleg Vyugin, chairman of privately owned MDM Bank and former head of Russia's financial markets regulator. ‘There could be some defaults. The Russian rouble bond market is not working.’ Overnight lending rates in Russia climbed to 10%, the highest since mid-2005, even after the central bank yesterday pumped an additional $2.56bn into the banking system via two one-day repo auctions… ‘Banks are not lending to each other,’ said Alexei Yu, a fixed income trader at Aton brokerage….The Central Bank was also forced to pump liquidity into the system via repo auctions at the end of August after foreign investors fled Russian money markets amid the flight to quality following the US subprime crisis and tax payments fell due. Russia racked up more than $5bn in net capital outflows in August.”
Currency Watch:

September 25 - Financial Times (Krishna Guha, Eoin Callan and John Authers): “The dollar closed at a record low on Tuesday after data showed US consumer confidence fell and the overhang of unsold homes grew. The figures intensified concerns that the strain in the credit markets was affecting the economy, although the severity is hard to gauge. The reports also made investors more confident that the Federal Reserve – which cut interest rates by 50 basis points last week – will reduce rates further to offset economic weakness. Bond markets rallied with the yield on the two-year note falling 5 basis points to 3.99 per cent. With yields falling, the dollar’s appeal diminished and measured against an index of major currencies, it finished at its lowest level in New York trading since the benchmark was initiated in 1973.”

September 25– Bloomberg (Kim-Mai Cutler): “Foreign-exchange trading rose 65% to a record $3.2 trillion a day on average, led by growth in hedge funds and foreign investors, the Bank for International Settlements said… The increase in the value of transactions from 2004 was the biggest in the survey’s 18-year history… At current exchange rates, turnover rose 71%.... ‘It’s really massive and it says a lot about financial globalization,’ said Stephen Jen, the…global head of currency research at Morgan Stanley… ‘Trades can go up in any local market but the survey tells us that cross-border flows have shifted into a higher gear…’ At the same time, hedge fund assets have risen to a record $1.76 trillion, according to…Hedge Fund Research Inc. Transactions involving hedge funds, pension funds, mutual funds and insurance companies rose to 40% of all trades, from 33% in 2004…”

September 25 – Bloomberg (John Fraher): “The U.K.’s foreign-exchange market has almost doubled in the past three years, further evidence that London has cemented its position as the predominant centre for currency trading, a survey by the Bank of England showed. The value of daily currency transactions in April was $1.4 trillion, compared with $753 billion in the same month in 2004…”

September 26 – Bloomberg (Joshua Gallu): “The value of transactions in Switzerland’s foreign exchange and derivatives markets tripled in the past three years to an average $242 billion a day in April, according to…the Swiss National Bank.”

The dollar index sank 1.1% to 77.69. The Fed's trade weighted dollar index fell to the lowest level since 1971. For the week on the upside, the Australian dollar increased 2.2%, the Norwegian krone 2.2%, the Brazilian real 2.1%, the New Zealand dollar 1.6%, the Danish Drone 1.2%, and the Euro 1.2%. On the downside, the Paraguay guarani declined 1.4%, the Ghana cedi 0.9%, and the Algerian dinar 0.9%.
Commodities Watch:

September 28 – Bloomberg (Millie Munshi): “Commodities headed for the biggest monthly gain in 32 years, led by wheat, crude oil and gold, as the dollar’s slump enhanced the appeal of energy, grains and precious metals as a hedge against inflation. The 19-commodity Reuters/Jefferies CRB Index was up 8.7% this month, the most since July 1975. Wheat climbed to a record in September amid a global grain shortfall, boosting corn and soybeans. Oil also hit a record, and gold reached a 27-year high. The Federal Reserve cut borrowing costs to bolster the U.S. economy, sending the dollar tumbling.”

September 28 – Bloomberg (Danielle Rossingh): “Gold rose to the highest since 1980 in London as the dollar weakened against currencies including the euro, increasing demand for bullion as an alternative asset.”

September 28 – Bloomberg (Jae Hur and Madelene Pearson): “Wheat futures headed for the biggest two-month gain in 34 years after adverse weather in Australia,Canada and Ukraine crimped harvests. Prices have risen 59% since July 1… Global reserves are headed for a 26-year low as a drought in Australia…threatens the crop for a second year in a row. ‘The supply situation is still critical and demand doesn’t seem to be waning at high prices,’ Simon Roberts, head of agricultural commodities at Australia & New Zealand Banking Group Ltd., said…”

September 24 - Bloomberg (Katherine Espina): “Coal and iron ore shipping rates may extend gains to records this week on rising demand to transport raw materials across the Pacific and the Atlantic amid a limited supply of vessels. The Baltic Dry Index, an overall measure of commodity-shipping costs on different routes and ship sizes, advanced 3.9%to 8,956 on Sept. 21, setting a record for a second day… This year, the measure has broken records for a total of 83 days. ‘There seemed to be no stopping the market as it rocketed’ in both the eastern and western regions last week… shipbroker Galbraith’s Ltd. Said… Charter rates for tankers have more than doubled in the past year…”

September 27 – Bloomberg (Tan Hwee Ann and Helen Yuan): “Cia. Vale do Rio Doce, Rio Tinto Group and BHP Billiton Ltd., the world’s three largest iron-ore exporters, may increase prices by 30 percent next year as demand driven by steelmakers in China outpaces growth in supply.”

For the week, Gold jumped 1.6% to $743.1 and Silver 2.2% to $13.92. December Copper added 1.3%. November crude slipped 23 cents to $81.39. October gasoline added 0.3%, while November Natural Gas declined 2.2%. December Wheat jumped another 7.4%. For the week, the CRB index added 0.2% (up 8.6% y-t-d). The Goldman Sachs Commodities Index (GSCI) gained 0.3% (up 25.9% y-t-d) to another record high.
Japan Watch:

September 26 – Business Standard India: "Planning Commission deputy chairman Montek Singh Ahluwalia has projected that India needs $492 billion investments in the infrastructure sector to its maintain growth. Addressing a gathering of top CEOs and business persons at the conference India @60: A New Age for Business… Ahluwalia said the challenge is to create the right policies that will attract additional funding of this size.”

September 26 – Bloomberg (Lily Nonomiya): “Japan’s August trade surplus widened to 743.2 billion yen ($6.5 billion), three times higher than economists predicted, as car and steel shipments jumped and import growth slowed. Exports rose at more than twice the pace of imports… Exports climbed 14.5% in August, faster than July’s 11.8%...”
China Watch:

September 26 - Financial Times (Richard McGregor): “In any other country, a shortage of pigs might be brushed off as a temporary phenomenon, cured by another turn in the perennial ‘hog cycle’ as rising prices prompt higher meat production. But in China, where pork is the staple meat and food counts for a large part of the household budget, the shortage – and its feared spillover to other parts of the economy – is being treated as something approaching a national emergency. The spectre of inflation fomenting broader discontent – as it did two decades ago, culminating in the Tiananmen Square protests of 1989 – taps into the deepest existential fears of Chinese rulers about mass disorder and regime survival. In recent weeks, protests by students angry at higher prices and smaller food servings in their canteens have been reported in Anhui and Guangdong provinces. Even in affluent urban centres, including Beijing and Shanghai, the food price rises are causing resentment. Inflation hit 6.5% in August, the highest rate in 11 years, largely because of a 49% year-on-year surge in meat and poultry prices…. ‘We have entered a very delicate stage of our development,’ says a senior economist and government adviser… ‘For a long time, I was very optimistic about China’s growth, but now I am quite worried. Real inflation is much higher. No one believes the government’s figures.’”

September 27 – Bloomberg (Nipa Piboontanasawat and Patricia Chua): “Profits at Chinese industrial companies surged 37% in the first eight months from a year earlier, adding to funds that fuel investment in the world’s fastest-growing major economy. Combined net income rose to 1.6 trillion yuan ($213 billion)… Sales jumped 27.4% to 24.5 trillion yuan.”

September 26 – Bloomberg (Chua Kong Ho): “Citic Securities Co. is the fastest-growing brokerage firm in the world thanks to the booming market for Chinese stocks, and Wall Street may have to get used to the industry neophyte challenging Goldman Sachs Group Inc., Morgan Stanley and Merrill Lynch & Co. as the biggest. Founded just 12 years ago, Beijing-based Citic now has a market capitalization of $40.7 billion, or $8.8 billion more than Lehman Brothers Holdings Inc., $24.4 billion more than Bear Stearns Cos. and $16.4 billion more than Charles Schwab Corp., after rising more than threefold in 2007. Haitong Securities Co., China’s No. 2, also eclipsed Bear Stearns as the seven largest U.S. brokers lost $37 billion in value this year.”

September 26 – Bloomberg (Bei Hu and Winnie Zhu): “China Shenhua Energy Co., the Nation’s largest coal producer, attracted at least 2.6 trillion yuan ($350 billion) of orders for its Shanghai share sale, a record…”
Asia Bubble Watch:

September 24 - Bloomberg (Shamim Adam): “Singapore’ consumer prices rose in August at the fastest pace in more than 12 years, suggesting the central bank will maintain a policy of allowing its currency to appreciate to damp inflation. The consumer price index increased 2.9% from a year Earlier…”

September 25– Bloomberg (Jason Folkmanis): “Vietnamese inflation accelerated in September for a seventh month to the highest since January 2006, driven by surging food prices. Consumer prices climbed 8.8% from a year earlier…”
Unbalanced Global Economy Watch:

September 28 – Bloomberg (Fergal O’Brien): “European confidence in the economic outlook dropped to a 16-month low in September and inflation accelerated above the European Central Bank's ceiling as borrowing costs climbed and oil prices reached a record.”

September 27 – Bloomberg (Gabi Thesing): “Money-supply growth in the euro region held close to a 28-year high in August, adding to the European Central Bank’s inflation concerns. M3 money supply…rose 11.6% from a year earlier, after 11.7% in July… The three-month average of the annual growth rate of M3 through August rose to 11.4% from 11.1% through July… Loans to the private sector rose 11.2% in August from a year earlier, up from 11%... That’s the highest since November 2006.”

September 27 – Bloomberg (Jennifer Ryan): “U.K. lenders approved fewer home loans in August after a credit-market slump and five interest-rate increases in the past year made mortgages more expensive… Banks granted 61,051 loans for house purchase, down from 66,965 in July… The reading is 14% lower than a year ago.”

September 24 - Bloomberg (Mark Deen): “Britain had a 9.1 billion-pound ($18.4 billion) budget deficit in August, the largest for the month in at least 14 years, as spending grew at double the pace of tax income.”

September 26 – Bloomberg (Simon Kennedy): “French manufacturers grew more pessimistic about the economic outlook in September as increasing borrowing costs and the appreciating euro threaten to sap growth. Insee…said today an index based on a survey of 4,000 manufacturers measuring expectations for production fell to its lowest since March…”

September 27 – Bloomberg (Claudia Rach): “Germany's unemployment rate fell in September to the lowest level in 14 years as companies in Europe’s largest economy continued to recruit workers to meet rising demand for goods and services. The jobless rate, adjusted for seasonal swings, declined to 8.8% from 8.9% last month…”

September 27 – Bloomberg (Simone Meier and Gabi Thesing): “Inflation in Germany, Europe’s largest economy, accelerated to the highest rate in more than six years in September as prices of heating oil and food rose. The rate, measured using a harmonized European Union method, rose to 2.7% from 2% in August…”

September 26 – Bloomberg (Jonas Bergman): “Sweden’s consumer confidence index fell to a six-month low in September as higher interest rates pushed optimism about future growth to the lowest in almost two years. The index slid to 16.2, the lowest since March, from 19.7 in August…”

September 27 – Bloomberg (Robin Wigglesworth): “Norway’s jobless rate fell to 1.8% in September, close to the lowest in 20 years, adding to concern that a labor shortage will drive wages higher and stoke inflation.”

September 25– Bloomberg (Adam Brown): “Private debt in Romania increased an annual 50% in August as individuals and companies took out more loans in foreign currencies.”

September 24 Bloomberg (Maria Levitov): “The Russian Economy Ministry increased this year’s economic growth forecast to 7.3% from 6.5%, the ministry said…”

September 27 – Financial Times (Catherine Belton): “It is after 9pm on a Tuesday in Moscow and shoppers are still poring over television sets and washing machines at M-Video, an electronic goods retailer and one of the biggest operators in Russia’s consumer boom. But at the consumer loans desk, the bank that has played a big role in stimulating the rapid growth of Russia’s retail sector has not been issuing many loans. “A lot of customers are being rejected,” says Julia, a sales representative for Russian Standard Bank, the top consumer lender. ‘We used to approve 90% of applications for loans. Now the majority . . . are declined.’ Faced with rising borrowing costs on international markets amid a global credit squeeze, Russian Standard Bank has been rapidly reassessing its loan procedures. The bank said last week it was suspending the issuance of cash loans and mortgages while tightening requirements for credit card and point-of-sale lending, though it denied any big cutback in overall lending."
Latin America Watch:

September 27 – Bloomberg (Andre Soliani and Katia Cortes): “Brazil's central bank raised its inflation forecasts for this year and next as rising food prices spread to other sectors of the economy, boosting expectations that the central bank will pause after two years of rate cuts. The bank raised it 2007 inflation forecast by a half-point to 4.0%...”
Bubble Economy Watch:

September 26 – Bloomberg (Shobhana Chandra): “Consumer confidence in September fell more than forecast to the lowest level in almost two years, as falling home values, a deteriorating labor market and tougher borrowing standards took a toll on Americans’ spirits. The Conference Board’s index of confidence plunged to 99.8, from a revised 105.6 in August and workers were less optimistic about job prospects…”

September 28 – Bloomberg (Tom Randall): “Profit in the U.S. may grow at the slowest rate in more than five years this quarter as the housing slump hurts results at companies from IndyMac Bancorp Inc. to Target Corp. Earnings of Standard & Poor’s 500 Index members may rise an average of 3.2% from a year earlier, breaking a 20-quarter streak of gains exceeding 10%...”
Fiscal Watch:

September 27 – Financial Times (Demetri Sevastopulo): “At a dramatic congressional hearing that saw the eviction of several dozen mostly female protesters, Robert Gates, the US defence secretary, yesterday urged lawmakers to approve $190bn to pay for the wars in Iraq and Afghanistan in 2008. Mr Gates said the Pentagon needed another $42bn for the conflicts on top of the $147bn outlined earlier this year. The request would bring total US military spending for fiscal 2008, which begins in October, to $671bn. If approved, the budget would equate to spending almost $21,300 a second and would rank the Pentagon ahead of the Dutch economy, the 16th largest in the world, in terms of size."
Central Banker Watch:

Second quarter GDP expanded at a nominal 6.6% rate, up from Q1's 4.9%. August Personal Income was up 6.8% y-o-y, with the Wages & Salary component up 7.1% y-o-y. Personal Spending increased 5.2% y-o-y. Total August New and Existing Home Sales were down 14% from a year earlier. Year-to-date Total Home Sales were 10.7% below the comparable year ago level.

September 26 – Bloomberg (Scott Lanman and Anthony Massucci): “Federal Reserve Bank of Philadelphia President Charles Plosser said last week’s interest-rate cut could cause inflation to accelerate and that policy makers must be ready to reverse course if needed. ‘Cutting the funds rate has the potential for aggravating inflation, there’s no question about that,’ Plosser told the New Jersey Technology Council… Should inflation or price expectations rise in coming months, ‘the outlook will be affected and policy may have to be adjusted.’”

September 26 – Bloomberg (Robin Wigglesworth): “Norway’s krone advanced against the euro after the central bank unexpectedly raised interest rates for the sixth time this year. The krone rose to the highest since May 2006 after Norges Bank lifted borrowing costs a quarter-point to 5%...”

September 26 – Bloomberg (Meera Louis): “European Central Bank council member Guy Quaden comments on inflation and economic growth in the economy of the 13 euro nations… On growth and inflation: ‘Projections published a few weeks ago by the ECB staff indicate continued growth and persisting risks for inflation’ and that ‘is still the baseline scenario. ‘Governors have recognized that the uncertainty surrounding that scenario has strongly increased. So what we have to do these days is to wait and see and, above all, to scrutinize all the incoming data before taking the appropriate decision.’”

September 27 – Bloomberg (Lily Nonomiya): “Japan's economy may overheat should the nation's 'very low' interest rates be raised too slowly, central bank board member Miyako Suda said. ‘If adjustments are too slow, the risk of the economy overheating may rise,' Suda said... ‘It’s desirable that early and gradual action is taken.’”
California Watch:

September 25 - The California Association of Realtors (CAR): "Home sales decreased 27.8% in August in California compared with the same period a year ago, while the median price of an existing home increased 2%... 'Despite the overall increase in the statewide median price, prices declined in 11 regions last month, falling 11.5% in the Central Valley region and 12.1% in Sacramento,' said C.A.R. President Colleen Badagliacco. 'Price softness is even more pronounced when we look at different segments of the market. For example, the statewide median price in the entry-level price range of less than $500,000 fell 5.1% [y-o-y] in August to $349,360... The median price per square foot for a single-family home is also on the decline, falling 4.3% this year to $336... 'While low affordability, tighter underwriting standards and expectations of lower prices continue to pose challenges for the market, the decline in sales accelerated in August as a result of the so-called credit or liquidity crunch that began in July.,' said C.A.R. Vice President and Chief Economist Leslie Appleton-Young. 'The credit crunch emerged as uncertainty about the extent of the subprime problem drove investors across the globe to turn off the tap of funds to lenders in mortgage and other credit market segments. With credit drying up, even qualified buyers were unable to receive funding for home purchases. We expect the impact of the credit crunch to play out over the next several months, and that it will continue to negatively impact sales,' she said... C.A.R.’s Unsold Inventory Index for existing, single-family detached homes in August 2007 was 11.8 months, compared with 5.9 months (revised) for the same period a year ago." C.A.R.'s unsold inventory stood at 2.6 months in August 2005.
GSE Watch:

Fannie expanded its "Book of Business" (held mortgages and outstanding MBS) by almost $30bn during August (17.1% annualized) to $2.279 TN. Year-to-date, Fannie's Book of Business has expanded at a 12.9% pace. Freddie's Book of Business increased about $19bn during the month, an 11.6% growth rate, to $1.983 TN. Year-to-date, Freddie's Book of Business has expanded at a 12.9% pace.
Mortgage Finance Bust Watch:

September 26 – Bloomberg (Brian Louis): “Lennar Corp., the largest U.S. homebuilder, reported the biggest quarterly loss in its 53-year history after $848 million of costs to write down the value of real estate. The third-quarter net loss was $513.9 million… exceeding the most pessimistic estimates from analysts and suggesting the worst housing market in 16 years shows no signs of stabilizing. Revenue at Miami-based Lennar fell 44% to $2.34 billion, the lowest in more than three years.”
Foreclosure Watch:

September 28 – Bloomberg (Hugh Son and Josh P. Hamilton): “Defaults on privately insured U.S. mortgages climbed 30% last month from year-earlier levels, an industry trade group reported, adding to evidence that home foreclosures may continue to rise. Insured borrowers more than 60 days behind on their payments rose to 58,441 in August…Mortgage Insurance Companies of America said…”
MBS/ABS/CDO/CP/Money Funds and Derivatives Watch:

September 26 - Financial Times (Richard McGregor): “Losses in the US subprime mortgage market are set to escalate as falling house prices prevent borrowers with adjustable-rate mortgages from refinancing on better terms, data released yesterday suggest. Housing prices in the main 20 US cities fell 3.9% in July from the previous year, the worst performance this decade, according to…Case Shiller. Analysts expect house prices to decline further and predict such falls could devastate homebuyers who took out subprime mortgages in late 2005 and 2006. Many of these borrowers took out adjustable-rate mortgages in the belief that rising housing prices would increase their home equity and enable them to refinance loans before rates rose.”

September 26 – Bloomberg (Jody Shenn): “Late payments and defaults among subprime mortgages packaged into bonds rose last month, according to data for loans underlying benchmark ABX derivative indexes. After August payments, 19.1% of loan balances in 20 deals from the second half of 2005 were at least 60 days late, in foreclosure, subject to borrower bankruptcy or backed by seized property, up from 17.5% a month earlier, according to…Wachovia… Prepayment speeds for the loans slowed, suggesting it’s more difficult for borrowers to sell their homes or refinance, according to…UBS AG. Record levels of delinquencies and defaults on subprime mortgages are worsening as home prices decline and interest rates on loans adjust higher for the first time. As lenders tighten standards, borrowers are finding it harder to refinance into new mortgages with lower payments. The ‘reports showed the first inkling of the impact of shutdown of subprime market,’ the UBS analysts…wrote… ‘In our opinion, the full impact is yet to come.’”
Real Estate Bubbles Watch:

September 26 – Florida Association of Realtors: “Low mortgage rates, low unemployment rates and strong demographics continued to reflect positive economic signs in Florida in August. Statewide, sales of existing single-family homes totaled 11,279 last month and were closer to activity in August 2001 and 2002 -- before the peak of the housing boom years -- than the August 2006 figures, when 15,252 homes sold for a 26% decrease in the year-to-year comparison… Florida’s median sales price for existing single-family homes last month was $231,900; a year ago…6% [y-o-y] decrease.”

September 26 – Bloomberg (Kathleen M. Howley): “What happens in Las Vegas doesn’t stay in Vegas when it comes to the city's housing market. Tumbling home prices in the gambling Mecca will show how far and how fast U.S. property values will fall in 2008 as the housing decline enters its third year, said William Wheaton, an economics professor at the Massachusetts Institute of Technology… ‘Las Vegas is an important barometer for where the rest of the nation’s home prices are going because it’s going to show us how quickly the investors head for the doors,’ Wheaton said… Almost half of Las Vegas home sales in 2005 and 2006 were to people who intended to resell quickly for a profit, according to data compiled by Fannie Mae… Nationally, investment purchases accounted for 28% of sales in 2005…”
Speculator Watch:

September 26 - Financial Times (Peter Garnham): “London’s dominance of the global foreign exchange market has grown sharply while New York’s share has slipped, a survey revealed… The UK’s share of foreign exchange trading volumes jumped from 31.3% in 2004 to 34.1% in April 2007…from the Bank for International Settlements… This was more than double that of the US, its nearest rival, which saw its share of the market fall from 19.2% to16.6%. London’s rise in the world’s largest financial market will be a fresh blow to New York…”

September 26 – Bloomberg (Jason Kelly and Jenny Strasburg): “Carlyle Capital Corp., the publicly traded credit fund backed by private-equity firm Carlyle Group, fell 24% in August as it sold assets and global debt prices declined. Carlyle Capital’s net assets dropped to $642.1 million from $843.5 million at the end of July… The decline wiped out 61% of the $327.8 million in capital that the Guernsey, U.K-based fund raised in the previous two months.”
Crude Liquidity Watch:

September 26 – Bloomberg (Jim Kennett): “Chevron Corp…will repurchase as much as $15 billion of its stock as record crude prices increase earnings. The three-year buyback program follows stock repurchases of $5 billion each that were completed in 2005, 2006 and September 2007…”

September 24 - Bloomberg (Zainab Fattah): “The Saudi riyal hit a 21-year high against the dollar last week and is likely to be under greater pressure to re-value against the dollar if the Federal Reserve cut rates again this year, Standard Chartered Plc said.”

September 23 - Bloomberg (Arif Sharif): “Oman’s annualized M2 money supply growth…slowed to 31.2% in July from a decade-high 31.7% in June…”

Clash of the Paradigms:

David Tice, banking analyst Charlie Peabody (Portales Partners), and I led a panel discussion, “End Game for Credit Bubble: Implications for Financial Markets & Wall Street Finance,” last Thursday at an Argyle Executive Forum (“Alternative Thinking About Investments” in NYC). It was moderated by the wonderfully talented Kate Welling ( The following is certainly not an official transcript of David and my comments but, rather, Q&A expanded in hope of providing more complete responses:

Question: For starters, why don’t you provide us a framework for the analysis behind your provocative title, “The End Game for the Credit Bubble.”?

It is our view that we are in the midst of history’s greatest Credit Bubble. History and sound economic theory have taught us that unconstrained credit systems are inherently unstable – and the longer excesses and imbalances are accommodated the more serious the consequences from the impairment of underlying financial and economic structures. We’ll begin by presenting two slides that contrast between the current conventional view and our own. We see this very much as the Clash of Incompatible Paradigms – and it’s this “clash” that will remain at the epicenter of unfolding Credit system instability.

The Conventional View Paradigm:

· “Perfect/Efficient” Markets Paradigm

· Economic performance governs market behavior

· Underlying economic fundamentals are sound

· Fed commands system liquidity

1. Capacity to initiate reflations/reliquefications on demand

2. Disregard asset Bubbles until they come under stress

· Current Account Deficits are largely irrelevant.

· The system enjoys unlimited capacity to leverage and limitless liquidity.

· Contemporary models-based finance presumes continuous and liquid markets

·The present-day U.S. financial system is more stable, with banks actively disbursing risk throughout the markets.

Our Paradigm – History’s Greatest Credit Bubble

· Unconstrained Credit systems are inherently unstable.

· Markets are inherently susceptible to recurring bouts of instability and illiquidity.

· Wall Street financial innovation and expansion created what evolved into a precarious 20-year Credit cycle, replete with self-reinforcing liquidity abundance and speculative excess.

· “Wall Street Alchemy” – the transformation of risky loans into enticing securities/instruments - has played a momentous role in fostering myriad Bubbles.

· Unrelenting Credit and speculative excesses have masked a deeply maladjusted U.S. “services” Bubble Economy.

· The prolonged U.S. Credit Bubble and resulting interminable Current Account Deficits have cultivated myriad global Bubbles.

· Recessions are an integral aspect of Capitalistic development – and busts are proportional to the preceding booms.

· Today, speculative-based liquidity commands the financial markets and real economy, creating unparalleled fragility.

· Late-cycle “blow-off” excesses are the most perilous because of their deleterious affects upon the underlying structure of the financial system and economy.

Question: Can you provide a brief explanation of “Bubble Economies,” “Credit Bubbles” and some of your theory behind these concepts?

Bubble Economies are highly complex creatures. Clearly, they are dictated by financial excess - most notably a sustained inflation in the quantity of Credit. Substantial Bubble Economies develop over an extended period of time. The momentous variety are often nurtured by the interplay of extraordinary technological and financial innovation, and are almost always perceived at the time as so-called “miracle economies.” Both Credit and speculative excess play prominent roles, especially late in the cycle. Central bankers are likely to be caught confused and accommodating.

It is the nature of Credit that excess begets only greater excess. Major Bubbles are associated with exceptional yet generally unrecognized Credit system phenomenon (“Monetary Disorder”). It is imperative to appreciate that Bubble Economies are as seductive as they are dangerous. Credit excess causes different strains of inflation – rising consumer, commodity, and asset prices to note the most obvious. Asset inflation is the most dangerous, as there is no constituency to stand up and demand the Fed rein it in. Furthermore, the longer asset inflation and Bubbles run unchecked the greater their propensity to go to wild, destabilizing extremes – likely hamstringing policymakers in the process.

Bubble Economies become progressively distorted by inflations in incomes, corporate earnings, government receipts and spending, and Current Account Deficits. Inflationary spending, investment, and speculative financial flow distortions play prominent roles in progressive economic maladjustment. By the late stage of the Credit boom, inflation effects tend to be highly divergent and inequitable.

The greatest systemic danger arises when speculative-based liquidity comes to dominate financial flows and economic development, creating a highly Credit-dependent and unstable system. End of cycle market price distortions tend to create the greatest impairment to financial and economic systems. Bubbles are inevitably sustained only by ever-increasing Credit and speculative excess. Any bursting Bubble must be supplanted by a more pronounced one (or series of Bubbles). As we are witnessing these days, the great danger associated with central banks accommodating Credit and asset Bubbles is that a point of Acute Fragility will be reached – with policymaking gravitating toward prescriptions to sustain financial excess.

Question: You have discussed in the past a concept that you refer to as “The alchemy of Wall Street finance.” Can you describe it for us and relate it to our current environment?

There are two related concepts that are fundamental to our analytical framework – how we view Credit-induced booms and their inevitable busts. These are the “Alchemy of Wall Street Finance” and the “Moneyness of Credit.”

First, the “Alchemy of Wall Street Finance:” This is basically the process of transforming risky loans – loans that become increasingly risky throughout the life of the credit boom - into debt instruments that are appealing to the marketplace. This is very important, because as long as Credit instruments enjoy robust market demand they can be created in abundance – in an extreme case fueling a runaway Credit Bubble with dire consequences for the financial system and real economy.

Our second concept, “Moneyness of Credit,” also plays a central role in boom dynamics. If you think about contemporary “money”, it’s really not about the government printing press or Federal Reserve issuance. Instead, “money” is today largely the domain of private sector Credit and the Marketplace’s Perceptions of Safety and Liquidity. “Moneyness” always plays a prominent role in Credit booms, due to the unbounded capacity to inflate Credit instruments that are perceived as safe and liquid.

Think of it this way, a boom financed by junk bonds likely isn’t going to progress too far – market restraint will be imposed by limitations in demand for these risky Credits. On the other hand, a boom fueled by virtually endless quantities of highly-rated agency debt, ABS, MBS, commercial paper, repos and the like – instruments the market perceives as “money”-like no matter how many are issued – has the very real potential to get out of hand.

And this gets to the heart of the issue – the dangerous state of this Wall Street Alchemy. Over the life of the boom there has been a growing disconnect between the market’s perception of “moneyness” and the actual mounting risk associated with the underlying Credit instruments. Especially because of the heavy use of derivatives, sophisticated structures, and leveraging, along with Credit insurance and various guarantees throughout the intermediation process – the entire risk market became highly distorted and dysfunctional.

And we would argue that the market’s perception of “moneyness” has recently changed – and we believe this to be a momentous development. The market now has serious trust issues related to ratings, pricing, liquidity, leveraging, counter-party risk, Credit insurance, and sophisticated Wall Street structures in general. In short, Wall Street’s capacity to create contemporary “money” has been dramatically constrained.

Of late, the rapid growth of central bank and banking system balance sheets has taken up the slack. But this is only a temporary stop-gap. The unrecognized dilemma today is that to sustain our Bubble economy will require continuous huge quantities of Credit creation – and these loans are by nature high risk. Wall Street risk intermediation is impaired – the market today seeks risk avoidance and de-leveraging – and there is little alternative than the banking system turning to risky lender of last resort.

Question: So where are we today, and what are the ramifications for the current economy?

Putting it all together, a confluence of factors has created what we expect to be an ongoing highly unstable Credit backdrop. In the nomenclature of economist Hyman Minsky – we have today “Acute Financial Fragility” – as opposed to previous backdrops where the U.S. system, in particular, was positioned to weather periods of turmoil relatively well. Despite dogged global central bank interventions, we still fear the potential for the Credit market to seize up – with devastating economic consequences. And the combination of unusually frail financial and economic structures leaves us very fearful of a dollar crisis of confidence.

At the minimum, the bursting of the Mortgage Finance Bubble has instigated a serious tightening of mortgage Credit Availability, leading to escalating foreclosures, Credit losses, pressures on home prices, and ongoing marketplace illiquidity for MBS and mortgage-related debt instruments. A classic real estate bust will feed on itself, ensuring further havoc throughout mortgage finance and imperiling the over-borrowed consumer sector.

Question: There’s a lot of talk these days about the GSEs – their roles in market excess, previous financial crises, and the potential for GSE liquidity to come to the market’s rescue once again. What’s your view on these matters?

There is a key facet of GSE analysis that does not garner the attention it deserves – and it relates, importantly, to the stark contrast between the inherent stability of GSE obligations and the underlying instability of much of today’s debt market structures. Let me begin by sharing data I believe go far in illuminating recent acute financial fragility. Returning to the four-year period 1998 through ‘01, direct GSE borrowings expanded $1.2 TN versus a $788bn increase in outstanding asset-backed securities (ABS). Compare this to the three-years 2004 through ‘06, when GSE debt grew only $57bn while ABS ballooned almost $2.0 TN.

In developing his hypotheses of inherent financial instability, Hyman Minsky coined the terminology “Ponzi Finance.” It is crucial to appreciate that GSE-related debt (agency debt and MBS) behaves atypically during crisis: I refer to the GSEs as the “Anti-Ponzi Finance Units” – in that finance flows aggressively to this (quasi-government) asset class during periods of market tumult. The GSEs enjoyed basically unlimited capacity to expand liabilities during previous crises – 1994, 1998, 1999, 2000, 2001/02 – and their operations played a momentous role in repeatedly backstopping the Credit boom.

Today – the GSEs are constrained and their balance sheets will not play their typical prominent role in accommodating speculator deleveraging and system reliquefication. Furthermore, by far the greatest excesses over the past few years were in Wall Street “private-label” ABS/MBS – subprime and, more importantly, Alt-A, jumbo, interest-only and other mortgages that encouraged borrowers to reach for more home than they could afford.

So, from a GSE standpoint, these agencies played an instrumental role in fostering the Mortgage Finance Bubble. When, in 2004, the scandal-plagued GSEs faltered, Wall Street was keen to snatch control. Consequently, trillions of unstable non-GSE debt instruments now permeate the system. At the same time, the GSEs are today incapable of orchestrating their typical market liquidity operations. This helps explain the difference between previous relative stability during crises versus recent Acute Fragility – especially in Wall Street ABS, sophisticated leveraged strategies, and derivatives more generally.

And we don’t expect this dynamic to be easily reversed or even meaningfully mitigated. Central bank interventions will have minimal intermediate and long-term impact on the bursting Mortgage Finance Bubble. Liquidity today flows in abundance to gold, precious metals, crude oil, commodities and virtually any non-dollar asset market – where robust inflationary biases prevail – content to avoid Wall Street mortgage-related securities and exposures. The situation will only worsen as home price declines gather momentum and Credit losses escalate.

Question: So, it is your contention that the current crisis marks a major inflection point for the Credit system?

We strongly believe so. Going forward, markets will be decidedly more cautious when it comes to ratings and liquidity. “AAA” was perceived as “always liquid” – even in the midst of financial crisis. In reality, GSE-related debt and their ballooning balance sheets played a prominent role in fostering this fateful market misperception. Yet, over the past few years, the most egregious Credit excesses were in speculative leveraging of highly-rated non-GSE securitizations. This scheme is now over.

The bursting of the Mortgage Finance Bubble has ushered in a major tightening of mortgage Credit, which will lead to escalating foreclosures, Credit losses, home pricing pressures, and ongoing marketplace illiquidity for MBS and mortgage-related debt instruments. We see the so-called “subprime crisis” transforming over time to an expansive dislocation in “Alt-A”, jumbo and "exotic" mortgages.

There are now literally trillions - and growing - of suspect debt instruments and many multiples more in problematic derivative instruments. We suspect that the proliferation of sophisticated leveraged strategies created considerable demand for high-yielding mortgage products, and now these vehicles are trapped with losses and illiquidity. Worse yet, Credit insurance and guarantees in the tens of trillions have been written and, as the downside of the Credit cycle gains momentum, we expect this exposure to become a major systemic issue. In short, we see Credit “insurance” as a bull market phenomenon that will not stand the test of the impending Credit and economic downturns. In too many cases, Credit guarantees, “insurance,” and myriad other exposures have been “written” by thinly-capitalized speculators and financial operators. They will have little wherewithal in the event of a serious Credit event. This is a major evolving issue. We fear the entire Wall Street risk intermediation mechanism is at considerable risk.

Question: Can you wrap thing up with some summary comments?

To summarize, we believe the current fragile boom – one characterized by unprecedented imbalances and maladjustments – can only be sustained by ongoing massive Credit creation. In an increasingly risk-averse world, this poses a colossal risk intermediation challenge. Thus far, the confluence of a highly inflationary global backdrop, extraordinary central bank interventions, and a major expansion of U.S. banking system Credit has sufficed. We, however, view Fed and the U.S. banking system capabilities as constrained and aggressive actions feasible only over the short-term. Importantly, an impaired Wall Street risk intermediation mechanism – the main source of finance behind the past few years of “blow-off” excess - will be hard-pressed to meet challenges and new realities.

Likely, liquidity issues and faltering asset markets will instigate problematic de-leveraging upon highly over-leveraged Credit and economic systems. We expect significant unfolding tumult in the securitization, derivatives, and risk “insurance” marketplaces. We view ballooning Credit insurance and derivatives markets as a bull market phenomenon that won’t withstand the test of the downside of the Credit Cycle. We believe the stock market has of late benefited from a combination of complacency, misperceptions with respect to Fed capabilities, and its newfound status, by default, as favored risk asset class. We see US equities, in particular, highly susceptible to unfolding detrimental financial and economic forces. We expect the economy to soon succumb to recession. California and other inflated real estate Bubble markets are now poised to suffer severe price declines – residential as well as commercial. And we expect contemporary “Wall Street Finance” to face a crisis of confidence – to suffer on all fronts – liquidity, Credit losses and regulatory. Our faltering currency is, as well, a major issue.