| The Dow gained 0.7%, and the S&P500 added 0.7%. The Morgan Stanley Cyclical index jumped 1.3% (up 9.4% y-t-d), and the Transports rose 0.9% (up 12.2% y-t-d). The Utilities added 0.3%, and the Morgan Stanley Consumer index increased 0.8%. The small cap Russell 2000 gained 0.5% and the S&P400 Mid-cap index rose 0.5%. Technology stocks were volatile, although the NASDAQ100 finished the week up just 0.5%, while the Morgan Stanley High Tech index was little change. The Semiconductors gained 1.0% and the Street.com Internet Index rose 1.2%. The NASDAQ Telecommunications index declined 1.5%. The Biotechs jumped 2.7%, increasing y-t-d gains to 11.5%. The Broker/Dealers’ 2% rise increased 2006 gains to 19.1%. The Banks added 0.3%. With bullion up $8.05, the HUI Gold index gained 2.9%. For the week, two-year Treasury yields dropped 13 bps to 4.75%. Five-year yields also fell 13 bps, ending the week at 4.63%, while bellwether 10-year yields dropped 11.5 bps to 4.67%. Long-bond yields fell 11 bps to 4.80%. The 2yr/10yr spread ended the week inverted 8 bps. The implied yield on 3-month December ’07 Eurodollars sank 16.5 bps to 4.83%. Benchmark Fannie Mae MBS yields fell 13 bps to 5.84%, this week performing right in line with Treasuries. The spread on Fannie’s 4 5/8% 2014 note narrowed one to 31, and the spread on Freddie’s 5% 2014 note narrowed one to 30. The 10-year dollar swap spread declined 1.2 to 52.8. Corporate bonds held their own, with junk spreads little changed for the week. Investment grade issuers included Bank of America $3.1 billion, GE Capital $700 million, CIT Group $500 million, Ryder Systems $300 million, and Duke Energy $300 million. Junk bond funds posted weekly outflows of $27.3 million (from AMG). But that did not slow another huge week of junk issuance. Issuers included Michaels Stores $1.15 billion, Owens Corning $1.2 billion, Metropcs Wireless $1.0 billion, Hexion Specialty $825 million, Level 3 $600 million, Plains All America Pipeline $1.0 billion, Host Hotels $500 million, Supervalue $500 million, National Power $500 million, Fibertower $350 million, Convert issuers included United Therapeutic $250 million, Wesco International $250 million and Kemet Corp $160 million. October 26 – Bloomberg (Harris Rubinroit): “Banks and hedge funds will lend more than $30 billion to U.S. technology companies this year, making a record wager that the software industry’s predictable revenue will mean fewer defaults… Technology lending in 2006 will jump at least 40 percent from last year’s $22.5 billion and is up from $8.6 billion in 2004, according to Standard & Poor’s.” International dollar debt issuers included Taqa Abu Dhabi $2.5 billion, VTB Capital $1.75 billion and Cap Cana $250 million. Japanese 10-year “JGB” yields fell 6.5 bps this week to 1.73%. The Nikkei 225 index was about unchanged (y-t-d up 3.5%). German 10-year bund yields dipped 3 bps to 3.805%. Emerging debt markets were strong and equities were mostly higher. Brazil’s benchmark dollar bond yields dropped 10 bps to 6.19%. Brazil’s Bovespa equities index gained 1.8% this week (up 17.6% y-t-d). The Mexican Bolsa declined 2% (down 2.5% today), reducing 2006 gains to 27.9%. Mexico’s 10-year $ yields sank 12 bps to 5.69%. The Russian RTS equities was little changed (y-t-d and 52-week gains of 44.6% and 81.1%. India’s Sensex equities index added 0.4%, increasing 2006 gains to 37.3%. China’s Shanghai Composite index gained 1%, increasing y-t-d gains to 55.7%. This week, Freddie Mac posted 30-year fixed mortgage rates rose 4 bps to 6.40%, up 25 bps from one year ago. Fifteen-year fixed mortgage rates gained 4 bps to 6.10% (up 41 bps y-o-y). One-year adjustable rates gained 3 bps to 5.60% (up 69 bps y-o-y). The Mortgage Bankers Association Purchase Applications Index dipped 0.6% this week. Purchase Applications were down 17.6% from one year ago, with dollar volume 18.3% lower. Refi applications added 1.8%. The average new Purchase mortgage declined to $224,800, and the average ARM slipped to $367,300. The volatility in Bank Credit continues, with the unusual $139 billion gain during the week of October 4th standing. Bank Credit dropped $52 billion last week to $8.133 TN. Year-to-date, Bank Credit has expanded $627 billion, or 10.3% annualized. Bank Credit inflated $708 billion, or 9.5%, over 52 weeks. For the week, Securities Credit dropped $35.6 billion. Loans & Leases declined $16.4 billion during the week, with a y-t-d gain of $482 billion (10.9% annualized). Commercial & Industrial (C&I) Loans have expanded at a 14.7% rate y-t-d and 13.3% over the past year. For the week, C&I loans added $1.3 billion, while Real Estate loans dipped $3.8 billion. Real Estate loans have expanded at a 15.8% rate y-t-d and were up 15.3% during the past 52 weeks. For the week, Consumer loans declined $5.0 billion, and Securities loans fell $6.1 billion. Other loans dipped $2.8 billion. On the liability side, (previous M3 component) Large Time Deposits declined $7.3 billion. M2 (narrow) “money” supply dipped $3.5 billion to $6.930 TN (week of 10/16). Year-to-date, narrow “money” has expanded $244 billion, or 4.5% annualized. Over 52 weeks, M2 has inflated $303 billion, or 4.6%. For the week, Currency added $0.6 billion, while Demand & Checkable Deposits fell $25.9 billion. Savings Deposits jumped $17.1 billion, and Small Denominated Deposits gained $4.1 billion. Retail Money Fund assets increased $0.7 billion. Total Money Market Fund Assets, as reported by the Investment Company Institute, declined $6.3 billion last week to $2.26 Trillion. Money Fund Assets have increased $197 billion y-t-d, or 11.6% annualized, with a one-year gain of $270 billion (13.6%). Total Commercial Paper rose $5.8 billion last week to $1.899 Trillion. Total CP is up $258 billion y-t-d, or 19.0% annualized, while having expanded $272 billion over the past 52 weeks (16.7%). Asset-backed Securities (ABS) issuance jumped this week to $20 billion. Year-to-date total ABS issuance of $595 billion (tallied by JPMorgan) is running about 6% below 2005’s record pace, with 2006 Home Equity Loan ABS sales of $405 billion about 2% under comparable 2005. Also reported by JPMorgan, y-t-d US CDO (collateralized debt obligation) Issuance of $259 billion is running 71% ahead of 2005. Fed Foreign Holdings of Treasury, Agency Debt were about unchanged during the week at $1.686 Trillion (week of 10/25). “Custody” holdings were up $167 billion y-t-d, or 13.3% annualized, and $209 billion (14.2%) over the past 52 weeks. Federal Reserve Credit dipped $0.6 billion to $830.8 billion. Fed Credit is up $4.4 billion (0.6% annualized) y-t-d, while having expanded 4.1% ($32.9bn) over the past year. International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $627 billion y-t-d (18.7% annualized) and $688 billion (17.3%) in the past year to a record $4.673 Trillion. October 27 – Bloomberg (Anoop Agrawal): “India’s foreign-exchange reserves rose by $1.2 billion to $166.15 billion in the week ended Oct. 20…” Currency Watch: October 26 – Bloomberg (Yanping Li): “China’s foreign-exchange reserves may double by 2010 should the government not control growth of foreign direct investment, said He Fan, senior economist at the Chinese Academy of Social Science. Holdings may reach $2 trillion, after they surged to $988 billion at the end of September, 28.5 percent higher than a year ago…” The dollar index fell 0.8% to 85.34. On the upside, the Turkish lira jumped 2.7%, the Norwegian krone 2.2%, the Hungarian forint 1.8%, the South African rand 1.6%, and the Australian dollar 1.3%. On the downside, the Iceland krona declined 1.0% and the New Zealand dollar 0.9%. Commodities Watch: Gold gained 1.4% to $599.65, and Silver increased 1% to $12.08. Copper declined 1.6%, reducing y-t-d gains to 76%. December crude jumped $1.42 to end the week at $60.75. November Unleaded Gasoline rose 6%, while December Natural Gas fell 4.7%. For the week, the CRB index rallied 2.2% (down 5.9% y-t-d), and The Goldman Sachs Commodities Index (GSCI) gained 1.5 (up 2.3% y-t-d). China Watch: October 27 – Bloomberg (Luo Jun): “Industrial & Commercial Bank of China Ltd.’s shares surged on their debut in the biggest-ever initial public offering, increasing the market value by about $26 billion to make it the world’s fifth-largest bank… Hong Kong billionaire Li Ka-shing was among investors who ordered more than $500 billion of stock in the Beijing-based bank, or 26 times what was on offer.” October 24 – Bloomberg (Nipa Piboontanasawat and Yanping Li): “Profits at Chinese industrial companies increased 29.6 percent in the first nine months from a year earlier… Combined net income rose to 1.3 trillion yuan ($165 billion)… Total sales jumped 26.3 percent…” October 25 – Bloomberg (Irene Shen): “Investment growth in China’s real estate industry accelerated in the first nine months of the year…indicating that central government cooling measures have yet to take effect. Property investment rose 24.3 percent…in the nine months to Sept. 30…” October 24 – Bloomberg (Philip Lagerkranser): “Goldman Sachs…raised its estimate for China’s economic growth next year, citing an improved outlook for exports and a reduced risk that the government will tighten curbs on investment. China’s economy will expand 9.8 percent in 2007, up from an earlier estimate of 9.1 percent…” October 24 – Bloomberg (Kelvin Wong): “Macau casinos’ gross revenue rose 19 percent in the third quarter as the number of tourists visiting the Chinese city grew and Wynn Resorts Ltd. launched a $1.2 billion hotel-casino.” India Watch: October 24 – Bloomberg (Cherian Thomas): “India’s exports in September recovered from the previous month as rain-fed flood waters receded, enabling higher overseas sales of gems, textiles and manufactured products. Exports, which make up more than a tenth of India’s $775 billion economy, increased 22 percent to $10.3 billion in September from a year earlier…” October 27 – Bloomberg (Anoop Agrawal): “Money supply growth in India quickened in the two weeks ended Oct. 13 from the previous two- week period… The M3 measure of money supply increased 19 percent in the two weeks through Oct. 13 from a year earlier, faster than 18.5 percent in the previous two weeks…” Asia Boom Watch: October 24 – Bloomberg (Theresa Tang and George Hsu): “Taiwan’s export orders rose at the slowest pace in 14 months in September as U.S. and Japanese demand for the island’s electronics weakened. Export orders, indicative of actual shipments in one to three months, climbed 12 percent after increasing 18.3 percent in August…” October 26 – Bloomberg (Aloysius Unditu and Wahyudi Soeriaatmadja): “Indonesia lowered the economic growth estimate for this year to 5.6 percent from its earlier 5.8 percent prediction as investment hasn't risen as expected, Finance Minister Sri Mulyani Indrawati said.” October 25 – Bloomberg (Jake Lee and Yumi Kuramitsu): “Thailand’s baht climbed to the highest in more than six years as investors bought equities on prospects the economy’s expansion will accelerate.” Unbalanced Global Economy Watch: October 24 – Bloomberg (Simon Kennedy): “Companies around the world are finding it harder to hire qualified workers, forcing them to increase wages, according to a survey by Manpower, the world’s second-largest provider of temporary workers. Talent shortages meant a quarter of employers paid higher salaries compared with a year ago to fill permanent positions, said the survey, which was based on 32,000 companies across 26 countries and territories… ‘The talent shortage is here and wage inflation is increasing,’ Jeffrey Joerres, chief executive officer of…Manpower, said…” October 26 – Bloomberg (Matthew Brockett and Brian Swint): “Consumer confidence in Germany, Europe’s largest economy, rose to the highest level in five years as households bring forward spending to avoid a tax increase….” October 27 – Bloomberg (Flavia Krause-Jackson): “Italy’s economy will grow this year at its fastest pace since 2000, beating the government’s last forecast, Industry Minister Pierluigi Bersani said… A recovery in manufacturing ‘will permit growth in 2006 close to 2 percent,’ Bersani said…” October 24 – Bloomberg (Ben Sills): “Spain’s economy expanded in the third quarter at least as fast as in the previous three months, Deputy Finance Minister David Vegara said. The nation’s economy expanded 3.7 percent in the second quarter…” October 27 – Bloomberg (Ben Sills): “Spain’s jobless rate fell to the lowest level in almost three decades in the third quarter as economic growth sustained hiring. The unemployment rate fell to 8.2 percent, the lowest since 1979, from 8.5 percent…” October 26 – Bloomberg (Jonas Bergman): “Swedish household debt grew an annual 12.4 percent in September as rising interest rates crimped borrowing. Household borrowing slowed from annual 12.7 percent in August and from more than 13 percent earlier this year…” October 26 – Bloomberg (Tasneem Brogger): “Denmark’s jobless rate unexpectedly dropped to 4.2 percent in September, the lowest since 1974, as employers hired more workers to keep pace with rising demand...” October 24 – Bloomberg (Alistair Holloway): “Finland’s jobless rate fell to 6.8 percent in September, the lowest for that month since 1990, fueling concern that skilled workers are in short supply. The unemployment rate fell from 7.1 percent in September…” October 27 – Bloomberg (Alistair Holloway): “Finnish retail sales rose an annual 7.2 percent in September, the 23rd consecutive monthly gain, as tax cuts boosted consumer spending.” October 24 – Bloomberg (Monika Rozlal and Marta Waldoch): “Polish retail sales rose at the fastest annual pace in 30 months as the expanding economy pushed up wages and spending. Annual retail sales growth accelerated 14.5 percent in September…” October 24 – Bloomberg (Marta Srnic): “Romania’s economy probably will expand more than 7 percent this year, surpassing previous forecasts, Cristian Popa, deputy central bank governor said.” October 26 – Bloomberg (Svenja O’Donnell): “The Russian economy grew an annual 6.9 percent in the third quarter, the Economy Ministry said…” October 24 – Bloomberg (Svenja O’Donnell): “Russian President Vladimir Putin said foreign investment in Russia increased 41.9 percent in the first half of the year, Interfax reported.” October 26 – Bloomberg (Bradley Cook): “Vneshtorgbank and Vneshekonombank, the former Soviet Union’s trade and debt banks, are funding a $6 billion-development near Moscow to provide housing for Olympic champions and other honored Russians, Kommersant said. The project is run by Segei Chemezov, head of state arms merchant Rosoboronexport and chairman of the national Sport Fund…” October 25 – Bloomberg (Hans van Leeuwen): “Australia’s consumer prices rose faster than economists expected in the third quarter…. The consumer price index climbed 0.9 percent in the three months ended Sept. 30… The annual rate was 3.9 percent.” Latin American Boom Watch: October 24 – Bloomberg (Patrick Harrington): “Mexico’s trade deficit unexpectedly widened in September as import growth outpaced exports amid weaker demand from the U.S. The country posted a trade deficit of $1.35 billion, the largest since November 2005…” October 23 – Bloomberg (Theresa Bradley): “Venezuela’s economy will grow more than 9 percent in the fourth quarter of 2006…” October 25 – Bloomberg (Alex Emery): “Peru’s exports rose in September to the second-highest monthly total ever as copper, gold and zinc sales surged. Exports rose 42 percent from a year earlier to $2.1 billion…” Central Banker Watch: October 26 – Bloomberg (John Fraher): “European Central Bank council member Lorenzo Bini Smaghi said central banks embarked on a path of raising interest rates shouldn't end the cycle too soon because that would risk fueling further inflation pressures. ‘Be aware that if the tightening is ended too soon, interest rates might have to remain at a high level for some time, even as the economy slows down,’ said Bini Smaghi…” Bubble Economy Watch: October 27 – Bloomberg (Joe Mysak): “States and municipalities are asking a lot of voters this Election Day. To be precise, they are asking voters to approve a record $80 billion in municipal bonds. The $80 billion and counting is contained in 678 separate proposals… The amount is a record for a general election, far eclipsing the previous record of $47 billion that was placed before the voters in 2002…” October 26 – Bloomberg (Mario Parker): “Amtrak, the U.S. passenger railroad, said ticket revenue rose 11 percent for fiscal 2006 to $1.37 billion as more people rode its trains between cities. Ridership increased 300,000 to 24.3 million…” Real Estate Bubble Watch: September Existing Home Sales were down 14.2% from the year earlier period to an annualized 6.18 million pace. Average (mean) Prices were down almost $5,000 from August to $266,500, a 2.3% declined from a year ago. Year-to-date Existing Home Sales are running 7.4% below last year’s record pace. New Home Sales were a stronger-than-expect (although previous sales were revised downward) 1.075 million pace, also down 14.2% y-o-y. Average (mean) Prices were down $21,800 from the August record to $293,200, down 2.1% from September 2005. Year-to-date New Home Sales are running 15.6% below last year’s record pace. On the bright side, at least the inventory of New Homes declined 11,000 to 568,000. Total y-t-d home Sales are running 8.6% below 2005’s record pace. California single-family Home Sales dropped 31.7% from the strong year ago level (y-t-d Sales down 24%). The Median Price dropped $23,310 from the August record to $553,050 - up 1.8% y-oy. It is worth noting the CA Median Prices remain about $56,000, or 11%, higher than just 18 months ago. Condo Median Prices are little changed over the past year at $427,330, with an 18-month rise of $30,290, or 8%. The Unsold Inventory has risen to 7 months, up from 3.2 months a year earlier. October 23 - Mortgage Bankers Association: “First mortgage originations volume decreased 16 percent based in the first half of 2006… The survey results continue to show strong demand for interest-only and payment option mortgages, so-called ‘non-traditional’ products. ‘In the context of a decelerating housing market and a slowing of overall mortgage originations activity, consumers continued to choose IOs and payment option loans in the first half of 2006,’ said Doug Duncan, MBA's chief economist and senior vice president of research and business development. ‘In particular, fixed-rate IO volume increased markedly. As expected, consumers respond to changing opportunities in the marketplace, but it looks like these products serve an important need.’” October 25 – Florida Association of Realtors: “Florida’s housing sector continued to adjust to a more sustainable pace of sales in September with many markets reporting higher inventory levels of homes for sale… A total of 13,485 existing single-family homes sold statewide last month, a decrease of 34 percent… Statewide, the existing-home median price slipped 1 percent to $243,900 last month; a year ago, it was $246,100… In September 2001, the statewide median sales price was $134,000, representing an increase of about 82 percent over the five-year period…” October 25 – Illinois Association of Realtors: “Mirroring a national pattern, home sales activity in September in Illinois continues to show signs of adjustment as the market transitions from several boom years. Year-to-date home sales…totaled 131,826 in 2006, down 7.4 percent from 142,319 homes sold during January through September of 2005. For the month of September, home sales were down 19.5 percent to 13,447 homes sold… The Illinois median home sale price in September was $199,900, off 3.4 percent from $207,900 a year earlier.” October 26 – Bloomberg (Mary Jane Credeur): “Rajvi Shah, an accountant at Deloitte & Touche LLP, easily finds front-row parking spaces at One-Ninety-One Peachtree Tower, a 50-story office building whose downtown location and distinctive design made it one of Atlanta’s premier business addresses when it was built in 1990. These days, Shah sees few cars in the building’s parking deck and often rides elevators that are empty, even at rush hour. The high rise…is 80 percent vacant. Other downtown buildings have similar vacancy rates. Atlanta…is reeling from the second-worst commercial real estate market in the U.S., with more than a quarter of its downtown space unoccupied.” Financial Sphere Bubble Watch: October 26 – Financial Times (Peter Thal Larsen): “Rapid growth in the market for leveraged loans has prompted banks to engage in looser lending because they are able to pass on the risk to hedge funds and other investors, Standard & Poor’s…has warned. In a report…S&P warns that a sudden change in appetite from investors could force banks to absorb large leveraged loans on to their own balance sheets. Leveraged lending has grown rapidly in the US and Europe in recent years, fuelled by demand from private equity groups for cheap debt. The demand has partly been met by the emergence of hedge funds and other investors as aggressive buyers of leveraged loan exposure… ‘It is investor liquidity that is making this market work at the moment from the point of view of risks and revenues,’ said Richard Barnes, an analyst at S&P. ‘What we are trying to highlight is that if investor demand fell away this would be a problem.’” October 26 – Dow Jones (Mohammed Hadi): “Investors continue to line up for seats on the Chicago Board Options Exchange. On Wednesday, the exchange said seat prices rose to a new record of $1.55 million the previous afternoon. That’s nearly 11% more than a membership on the exchange cost on Oct. 16…” Energy Boom and Crude Liquidity Watch: October 26 – Bloomberg (Joe Carroll): “Exxon Mobil Corp. said third-quarter profit rose 5.7 percent… Net income rose to $10.5 billion…” October 26 – Bloomberg (Stephen Voss and Fred Pals): “Royal Dutch Shell Plc, Europe’s biggest oil company, reported third-quarter profit jumped 21 percent…profit climbed to $7.03 billion…” October 27 – Bloomberg (Sonja Franklin): “Goldman Sachs Group Inc. said shares of pipeline companies and natural-gas distributors…may rise in response to infrastructure spending of $50 billion or more in the next decade. Projects may include pipelines to transport gas east from the Rocky Mountains and crude derived from Alberta’s oil sands to the U.S. as well as infrastructure to manage liquefied natural-gas imports, Goldman Sachs analysts David Chiaro and Michael Cerasoli said… ‘The energy infrastructure segment has reached an inflection point, with current capacity approaching full utilization and continued increases in consumption and a shift in primary sources of supply providing investment opportunities for pipeline and related energy infrastructure companies,’ the note said.” October 21 – Bloomberg (Claudia Maedler): “Saudi Arabia will invest 30 billion Saudi riyals ($8 billion) in the expansion of three airports as it seeks to cope with an increase in passenger traffic and two new private domestic airlines, the Khaleej Times reported.” Climate Watch: October 26 – Bloomberg (Madelene Pearson): “El Nino weather conditions, which can cause drought in the Asia-Pacific region and flooding in the Americas, intensified during October, Australia's Bureau of Meteorology said today. ‘We’ve seen quite a deal of strengthening,’ Grant Beard, senior climatologist with the bureau’s National Climate Center, said… ‘There’s an almost dead certainty now that this will be classed as an El Nino event.’” Speculator Watch: October 27 – Bloomberg (Shannon D. Harrington): “Derivatives traders may be profiting from inside information on leveraged buyouts and other takeovers, a study by Credit Derivatives Research LLC suggests. Credit-default swaps based on the bonds of 30 takeover targets, including four of the five biggest LBOs of 2006, rose before deals were announced or news reports said transactions were likely, according to the New York-based independent research firm.” October 26 – Dow Jones (Thomas Kostigen): “Hedge funds are mainstream. Once fanciful fodder for cocktail conversation and ego-driven symbols of whose portfolio is bigger, hedge funds have joined the ranks of Joe Sixpack. Morningstar…and Research magazine find in a new study that most advisors place their clients in hedge funds, even though they don’t particularly understand the structure. In fact, many advisors aren’t even sure if their clients are qualified to invest in them. Still, hedge funds are the product de jour, and they are about to go from Wall Street elite to Main Street, even if Main Street isn’t particularly prepared.” Current Account “Recycling” Distortions: “Central banks are now realizing they must take global levels of liquidity seriously, the ECB’s former chief economist, Otmar Issing, said Friday. ‘I am concerned about excessive liquidity in the world,’ Issing told a conference for economic students here. This concern is shared by the current members of the ECB’s Governing Council, who have taken the lead in alerting other central banks to the risks at hand, Issing noted. ‘There is now increasing support of the view that excessive liquidity world-wide is fueling asset prices and is something which has to be taken seriously by central banks…This is a real concern.’” This afternoon from Market News International. Third quarter nominal GDP decelerated to a 3.4% pace, down from Q2’s 5.9%, which was down sharply from Q1’s 9.0%. We’ll have to wait for Q3 “flow of funds” data to have a clearer picture with respect to the relative activity of the Credit apparatus. Recall that Financial Sector Credit Market Borrowings rebuffed the slowing economy during Q2. Financial Credit accelerated to a 10.2% growth rate, up meaningfully from Q1’s 8.6%. And with Bank Commercial & Industrial (C&I) lending expanding at a 15% rate during the third quarter, I would not be surprised if we learn that total Business borrowings (from the Z.1) expanded at a 10% rate. This would be up from the robust 8.6% growth during the first-half and place 2006 easily on pace for the biggest corporate borrowing binge since 2000. This is despite corporate America having for the past few years been on the receiving end of massive Credit Bubble-induced profits and cash-flows. At this point lacking all the pertinent data, I will nonetheless postulate that the immense gap between ongoing U.S. system Credit expansion and the actual financing requirements of the real economy extended further during the quarter. This would help explain the loosening of Financial Conditions we’ve witnessed over the past few months, as well as the “excessive liquidity in the world” that worries Dr. Issing and the ECB. U.S. and international equities markets have been posting big gains, global bond prices have rallied nicely, already narrow corporate Credit spreads have become only narrower, and emerging markets have inflated spectacularly. And with recent GDP deceleration largely explained by the abrupt slowing in residential construction combined with a jump in imports, there is ample support for the view the economy isn’t being buffeted by any tightening of Financial Conditions. I will continue to disappoint some readers, as I have no intention this evening of dwelling on either the economic slowdown or September’s decline in home prices. My focus will remain on the Financial Sphere -- examining the factors and dynamics behind booming global asset markets, as well as the ramifications for seemingly endless liquidity. I believe very strongly that current global securities market and asset inflations are associated with some underlying disarray in the Credit mechanism – with destabilizing finance – with Monetary Disorder. What is it? Where is it? And why is it? I remember how the GSEs’ almost 30% expansion during 1998 (to total assets of $1.4 TN) became a prevailing source for a marketplace liquidity Bubble that culminated in the technology/telecom mania in 1999/early-2000. The massive second-half 1998 GSE expansion certainly played a defining role in the post-LTCM “reliquefication.” They provided an invaluable backstop to the leveraged speculators, arresting potentially destabilizing de-leveraging, while fostering general liquidity over-abundance. If not for this powerful Monetary Process (in conjunction with Fed rate cuts, of course), I seriously doubt the system would have enjoyed the wherewithal to embark on 1999/2000’s historic telecom and corporate debt lending binge. Major Bubbles are dictated by powerful evolving processes, and clearly market perceptions of both abundant liquidity and the backstop for speculative activities cultivated a self-fulfilling boom in Credit and speculative excess. And while gross excesses were conspicuous in the stock market, the technology/telecom Bubble was very much a creature of (nurtured and financed by) extraordinarily loose underlying Financial Conditions and resulting extreme Credit growth. This was especially the case in regard to key Monetary Processes that evolved from the GSE liquidity creation mechanism and then expanded to the massive “leveraged lending”/telecom/junk/ corporate debt lending Bubble. Throughout the boom, the stock market remained the popular analytical focus, while paramount developments were unfolding insidiously in the Credit system. A potent influx of Monetary Disorder from the GSEs energized underlying lending excesses and speculative impulse, creating a backdrop conducive to momentous financial and economic Bubbles. Returning to today’s Monetary Disorder, the environment beckons for a steadfast focus on the bowels of the Credit system, especially with regard to unusual Monetary Processes with the proclivity for nurturing Credit and speculative excess. As such, where are the key sources, intermediation, and uses of system Credit/liquidity/purchasing power? What dynamics, on the margin, are influencing the biases and endeavors of the expansive pool of speculative finance? Well, I don’t believe the ramifications of our massive Current Account Deficits receive the attention they deserve. Unprecedented in size – soon to surpass $225 billion quarterly – and duration, U.S. Current Account Deficits create one of history’s most commanding – and, I would contend, destabilizing - Flows of Finance. Think in terms of a highly integrated Credit system comprised of bank, Wall Street, finance company, securitization, and securities (leveraging) finance. This Credit apparatus freely creates financial claims/purchasing power, and a large portion of these dollar balances flow to the accounts of manufacturers, energy producers, and other exporters from around the world. This massive Flow of Finance, much of it then acquired by and intermediated through foreign central banks, is directed back to a limited supply of perceived top-quality and liquid U.S. securities. No serious analyst would dismiss the view that a dynamic involving such massive financial flows on a protracted basis would impart severe marketplace distortions. Not dissimilar to the impact of GSE operations back in 1998, the massive expansion of foreign central bank dollar holdings has gone a long way in underpinning market confidence. The overwhelming consensus view has evolved to the point of believing the bond market is safe from yield spikes and the currency markets are protected from abrupt dollar declines and crises. Clearly, Treasury market participants have for some time operated with the perception that liquidity would remain abundant and prices supported. And, more generally, bond and dollar speculators must today take comfort that irrepressible foreign buying will continue to provide an invaluable market “backstop.” Derivative players have no fear of illiquidity or market dislocation. Beyond underpinning market confidence and liquidity generally, how has this massive ongoing foreign dollar balances “recycling” operation (Monetary Process) distorted the nature of underlying speculative flows (as the GSE did post-1998)? Well, this is where the analysis gets more interesting. I’ve convinced myself that foreign buying has distorted pricing in “top-tier” U.S. securities to the point of significantly reducing prospective returns - for speculators and investors alike. And the inverted yield curve – that was seemingly destined to be a temporary anomaly in an age of (borrow short/lend long) speculative securities leveraging – now has more the appearance of an enduring effect of unrelenting Credit excess, resulting Current Account Deficits, and foreign dollar balances “recycling.” The confluence of a massive cumulating pool of global speculative finance and eviscerated speculative profits in “top-tier” (notably Treasury and agency) securities has surely fomented some serious recalibration of speculative trading strategies. For one, it has doubtlessly encouraged greater borrowing in yen, Swiss francs and other low-yielding currencies, with resulting flows providing important dollar support. Probably more important to the underlying structure of the U.S. and global economy, the speculator community has been pressed into “lower-tier” Credit instruments to achieve acceptable returns. This helps to explain the insatiable demand for securities in some notable sectors, including emerging market debt and “private-label” mortgages. It is my view, however, that the greatest unfolding Credit system distortion is a resurgent corporate debt Bubble. Importantly, the Current Account “Recycling” Distortion- induced flight into “lower-tier” Credits coincides with a significant decline in mortgage originations. The banking system is now aggressively pushing commercial lending in an ill-advised endeavor to sustain (Mortgage Bubble-induced) inflated lending profit growth. At the same time, there are huge “capital markets” profits available for the major “banks” by matching the global speculator community with the higher-yielding securities and structures today so in demand, as well as by speculating in Credit themselves. The wall of finance flowing into the corporate debt market has had a profound effect on the availability of Credit. Spreads have narrowed and even the most vulnerable corporate borrowers have enjoyed the capacity to recapitalize. Meanwhile, those hedge funds and proprietary trading groups investing in “Credit” are today sitting near the coveted top of the global performance leader board. And, no doubt about it, major increases in sector Credit Availability and marketplace liquidity have done wonders to the ballooning Credit Derivatives market (that doubled in size the past year!). Writing corporate Credit protection these days is akin to writing flood insurance during a long drought – the only limit to profits is the amount of insurance that can be written. It’s become a full-fledged mania in desperate search of more tulip bulbs. And this is where it gets dangerous. Over-heated demand for underlying corporate loans has instigated a self-reinforcing lending boom, especially for M&A, LBOs, and stock buybacks (lending to finance real investment is simply not large enough to satisfy the enormous demand for loans). In true Bubble fashion, the greater the (non-productive) lending excess and resulting asset inflation, the more compelling it is for the next borrower to pursue an only larger loan to acquire a stock or company at a recently inflated price. And the larger the borrowings the greater the available liquidity searching for a home; the less likely it is for companies to hit the wall and default; the greater the profits on writing Credit default swaps, investing in collateralized debt obligations, and speculating in Credit generally; and the greater the gold rush mentality to envelope corporate Credit markets. Especially after suffering through this year’s stock market volatility and painful corrections in the energy and global “reflation trade,” the relative stability of returns available from the various methods of writing (flood) Credit insurance has of late looked awfully appealing. And to what extent the Bubble in corporate Credits has been fostering speculative flows into U.S. corporate securities – and in the process supporting the dollar today but creating dangerous systemic vulnerability in the process – is something to ponder. It’s not only the resurgent corporate debt Bubble that has me recalling 1999/2000. It was no coincidence that NASDAQ went parabolic about the time deterioration in underlying fundamentals was gathering pace. A spectacular short squeeze, flight into perceived safer corporate bonds, and liquidity creating securities/derivatives leveraging were prominent aspects of that period’s Monetary Disorder. Today, an extraordinary confluence of factors including the housing downturn, economic vulnerability, destabilizing Credit excesses being “recycled” back to U.S. securities markets, and a major shift of speculation into riskier Credits is fueling a corporate debt Bubble with a present scope and future consequences that greatly exceed anything from 1999. The tech Bubble was only a warm-up… Dr. Issing is absolutely correct: “… Excessive liquidity world-wide is fueling asset prices and is something which has to be taken seriously by central banks.” Tonight I’ve focused on U.S. Credit system dynamics. But our massive Current Account Deficits have as well spurred lending, liquidity and speculative excess around the world. Our degraded currency has certainly unleashed systemic global Credit inflation, with profligate domestic Credit systems no longer disciplined by the (dollar-anchored) global marketplace. It’s more aptly described as “Global Wildcat Finance,” with Credit and asset inflation readily condoned by a speculating community that has come to wield incredible power and influence. There have been scores of Current Account apologists, from Wall Street to leading academics to the very top of the Federal Reserve System. When will there finally be recognition that ongoing loose Financial Conditions, unparalleled Credit excess, and these massive Current Account Deficits pose a clear and present danger to U.S. and global stability? Is the Fed really going to simply look the other way as yet another destabilizing speculative boom engulfs U.S. and global financial markets? The last thing this unsettled world needs at this moment is a slew of runaway Credit, speculative and economic Bubbles. |
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