| It was relatively quiet for equities. For the week, the Dow declined 1%, with the S&P500 down 0.4%. The Utilities gained 1%, while the Transports dropped 1%. The Morgan Stanley Cyclical index was about unchanged, while the Morgan Stanley Consumer index fell 0.7%. The broader market was flattish, with the small cap Russell 2000 and S&P400 Mid-cap indices little changed. Technology stocks were under some moderate selling pressure. For the week, the NASDAQ100, Morgan Stanley High Tech and The Street.com Internet indices were all down about 1%. The highflying semiconductors were hit for 1.7%, and the NASDAQ Telecommunications index was down 0.4%. The Biotechs were slightly positive. The Broker/Dealers declined 1%, and the Banks dipped 0.3%. With bullion surging $23 to a 24-year high of $526, the HUI gold index posted a gain of 5%. For the week, two-year Treasury yields dipped one basis point to 4.41%. Also down one basis point, five-year government yields declined to 4.43%. Bellwether 10-year yields added 2 basis points for the week to 4.53%. Long-bond yields were about unchanged at 4.79%. The spread between 2 and 10-year government yields widened 2 to 12bps. Benchmark Fannie Mae MBS yields declined 4 basis points to 5.86%, this week outperforming Treasuries. The spread (to 10-year Treasuries) on Fannie’s 4 5/8% 2014 note was unchanged at 38.5, and the spread on Freddie’s 5% 2014 note was unchanged at 39. The 10-year dollar swap spread was unchanged at 56.0. The implied yield on 3-month December ’06 Eurodollars was unchanged at 4.855%. Investment grade corporate issuance surged to $18 billion (from Bloomberg). Issuers included American Express $2.0 billion, Kinder Morgan $2.15 billion, Credit Suisse USA $2.05 billion, US Bancorp $2.0 billion, GE $1.5 billion, ZFS Finance $1.3 billion, Transatlantic Holdings $750 million, State Street $600 million, St. Jude Medical $600 million, Western Corp $500 million, Aegon Funding $500 million, Progress Energy $450 million, Bank of New York $400 million, PNC Funding $400 million, Popular North American $400 million, CVS Lease $390 million, Union Electric $260 million, Allstate Life $250 million, Carramerica $250 million, Laboratory Corp of America $250 million, Harley Davidson $200 million, and Indiana Michigan Power $125 million. Junk bond funds saw inflows jump to $361 million this week. Junk bond issuers included Massey Energy $760 million, Galaxy Entertainment $600 million, Istar Financial $475 million, Reinsurance Group $400 million, Ventas Realty $200 million, Clarke American $175 million, Cleveland Unlimited $150 million, CMS Energy $125 million, Denbury Resources $150 million and Zentas Realty $125 million. Foreign dollar debt issuers included BHP Billiton $1.35 billion, Ecuador $650 million, UOB Cayman Bank $500 million, and AES Dominicana $160 million. Japanese 10-year JGB yields rose 5 basis points this week to 1.555%. Emerging debt and equity markets traded well. Brazil’s benchmark dollar bond yields declined 9 basis points to 7.24%. Brazil’s Bovespa equity index was slightly positive, with a y-t-d gain of almost 26%. The Mexican Bolsa jumped 2.4% to yet another record, with 2005 gains rising to 36%. Mexican govt. yields rose 5 basis points to 5.56%. Russian 10-year dollar Eurobond yields increased 4 basis points to 6.49%. The Russian RTS equity index added 1%, increasing y-t-d gains to 76%. Freddie Mac posted 30-year fixed mortgage rates rose 6 basis points to 6.32%, an increase of 62 basis points from one year ago. Fifteen-year fixed mortgage rates were up 6 basis points to 5.87%, and were up 73 basis points in a year. One-year adjustable rates were unchanged at 5.16%, an increase of 101 basis points from one year ago. The Mortgage Bankers Association Purchase Applications Index rose 4% last week to a 7-week high. Purchase Applications were up 1.8% from one year ago, with dollar volume up 9.2%. Refi applications jumped 7.6%. The average new Purchase mortgage increased to $244,400, and the average ARM rose to $364,500. The percentage of ARMs was little changed at 33.1% of total applications. Broad money supply (M3) added $2.1 billion (week of November 28) to a record $10.112 Trillion. Over the past 28 weeks, M3 has inflated $494.2 billion, or 9.5% annualized. Year-to-date, M3 has expanded at a 7.3% rate, with M3-less Money Funds expanding at an 8.2% pace. For the week, Currency gained $0.9 billion. Demand & Checkable Deposits fell $8.1 billion. Savings Deposits dipped $2.3 billion. Small Denominated Deposits added $2.7 billion. Retail Money Fund deposits increased $0.6 billion, while Institutional Money Fund deposits declined $1.9 billion. Large Denominated Deposits fell $3.4 billion. Year-to-date, Large Deposits are up $257 billion, or 25.8% annualized. For the week, Repurchase Agreements jumped $10.4 billion, and Eurodollar deposits added $3.5 billion. Bank Credit dropped $37 billion last week to $7.429 Trillion. Year-to-date, Bank Credit has inflated $665 billion, or 10.7% annualized. Securities Credit declined $5.8 billion during the week, with a year-to-date gain of $146 billion (8.2% ann.). Loans & Leases have expanded at an 11.9% pace so far during 2005, with Commercial & Industrial (C&I) Loans up an annualized 15.4%. For the week, C&I loans slipped $2.7 billion, and Real Estate loans declined $2.1 billion. Real Estate loans have expanded at a 13.7% rate during the first 48 weeks of 2005 to $2.861 Trillion. Real Estate loans were up $342 billion, or 14.5%, over the past 52 weeks. For the week, Consumer loans dipped $2.9 billion, and Securities loans fell $8.4 billion. Other loans dropped $15.0 billion. Total Commercial Paper declined $5.2 billion last week to $1.653 Trillion. Total CP has expanded $239.3 billion y-t-d, a rate of 18.0% (up 18.7% over the past 52 weeks). Financial CP rose $1.5 billion last week to $1.501 Trillion, with a y-t-d gain of $216.2 billion, or 17.9% annualized (up 19.1% from a year earlier). Non-financial CP dropped $6.7 billion to $152.6 billion (up 18.9% ann. y-t-d and 15% over 52 wks). ABS issuance surged to $25 billion (from JPMorgan). Year-to-date issuance of $750 billion is 23% ahead of comparable 2004. Home Equity Loan ABS issuance of $487 billion is 22% above comparable 2004. December 7 – Bloomberg (Hamish Risk): “Sales of collateralized debt obligations in the U.S. may rise 50 percent to a record $140 billion this year, led by demand for securities that package derivatives, Moody’s Investors Service said in report. Issuance of the bonds, which are comprised of other debt, rose more than 49 percent in the third quarter to $41.5 billion from the same period in 2004…” Fed Foreign Holdings of Treasury, Agency Debt jumped $7.4 billion to $1.511 Trillion for the week ended December 7. “Custody” holdings are up $175.6 billion y-t-d, or 14.0% annualized (up $182.1bn, or 13.7%, over 52 weeks). Federal Reserve Credit increased $0.9 billion to $813.6 billion. Fed Credit has expanded 3.1% annualized y-t-d (up $29.5bn, or 3.8%, over 52 weeks). International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $530 billion, or 15.2%, over the past 12 months to a record $4.01 Trillion. India reserve assets were up 13.9% over the past year to $136 billion. Currency Watch: The dollar index declined less than 1% this week. On the upside, the Indonesian rupiah gained 3.2%, the Romanian leu 1.6%, the Philippines peso 1.3%, and the British pound 1.3%. On the downside, the Brazilian real declined 1.9%, the Mexican peso 1.6%, the New Zealand dollar 1.3%, and the Argentine peso 0.9%. Commodities Watch: December 7 – Bloomberg (Chia-Peck Wong): “China, the world’s biggest user of aluminum, may consume 19 percent more of the metal next year as expansion in the world’s fastest-growing major economy stokes demand for cars and homes, an official said. Chinese aluminum demand will rise to 8.3 million metric tons in 2006, from 7 million tons this year, Pan Jiazhu, vice chairman of the China Nonferrous Metals Industry Association, said… Demand will climb 50 percent to 10.5 million tons by 2010, and more than double to 15 million tons by 2020, he said. Soaring Chinese demand, fueled by 9.5 percent economic growth in each of the last two years, has sent aluminum prices to a 16-year high.” The action was in commodities markets, especially the metals and energy. January crude oil increased 7 cents to $59.37. January Unleaded Gasoline rose 1%, and a wild January Natural Gas ended the week with a 3% gain. For the week, the CRB index gained 1.4% to the highest level since mid-October, increasing y-t-d gains of 15.5%. The Goldman Sachs Commodities index rose 1.1%, with 2005 gains rising to 41.4%. China Watch: December 6 – Bloomberg (Nerys Avery): “China’s economy will probably expand about 9.2 percent next year, spurred by growth in exports and investment of 20 percent, a government economist wrote in the official China Securities Journal. Retail sales, which the government forecasts will rise 13 percent this year, will grow by about 12 percent in 2006…” Asia Boom Watch: December 6 – Bloomberg (Mariko Yasu): “Morgan Stanley, the second-largest U.S. securities firm by market value, sold 56.3 billion yen ($465 million) of bonds backed by Japanese properties, boosting such sales this year to a record… Sales of commercial mortgage-backed bonds…reached 1.17 trillion yen this year, exceeding the full-year record of 797 billion yen in 2002…” December 5 – Bloomberg (Lindsay Whipp): “Japan’s capital spending rose at the fastest pace in a year in the third quarter, signaling the government may raise its economic growth estimate, after property developers and manufacturers started more projects. The broadest measure of investment climbed 9.6 percent…” December 8 – Bloomberg (Mayumi Otsuma): “Bank of Japan Governor Toshihiko Fukui said his board is close to ending its deflation-fighting policy because consumer prices will show ‘solid’ gains in the first quarter. ‘It is clear to everyone that the end is close,' Fukui said in a speech in Nagoya City, referring to the quantitative easing’ policy of flooding the banking system with cash.” December 7 – Bloomberg (Theresa Tang): “Taiwan’s export growth unexpectedly slowed in November as sales to markets including China, its biggest market, and Japan cooled. Shipments gained 10.7 percent to $17.2 billion from a year earlier after climbing 16.6 percent in October…” December 6 – Bloomberg (Seyoon Kim): “The Bank of Korea predicted accelerating economic growth will fuel inflation next year. Bonds fell on concern the central bank will raise interest rates. Asia’s third-largest economy may expand 5 percent in 2006 from an estimated 3.9 percent for this year…” December 5 – Bloomberg (Stephanie Phang): “Malaysian export in October expanded faster than expected as manufacturers such as Malaysian Pacific Industries Bhd. shipped more semiconductors, disk drives and laptop computers to meet rising overseas demand. Exports rose 12.4 percent to 49.64 billion ringgit ($13.13 billion)…” Unbalanced Global Economy Watch: December 8 – Bloomberg (Tracy Withers): “New Zealand’s central bank raised its benchmark interest rate a quarter point to a record 7.25 percent, saying the ninth increase since January 2004 is needed to curb household spending and inflation. ‘We remain concerned about the tightness of resources and the persistence of inflation pressures,’ Reserve Bank Governor Alan Bollard said… ‘The main driver of the strong demand is household spending, linked to a buoyant housing market.’” December 3 – Financial Times (Roula Khalaf): “When Dana Gas, the Gulf’s first private sector energy company, announced the allocation of shares to retail investors in its $561m initial public offering in October, the pan-Arab television network al-Arabiya flashed it on the screen as breaking news… Al-Arabiya’s coverage of Dana Gas underlined a new strategy by the Saudi-backed station set up in 2003 to provide a softer alternative to Qatar’s al-Jazeera. Its greater focus on business and stock market news comes in response to the new investor culture developing in the Middle East, particularly in the Gulf, where huge financial liquidity from oil revenues has generated an unprecedented interest in equity markets. The Shuaa Capital index for Gulf countries is up more than 92 per cent since the start of the year. Since July, al-Arabiya has been devoting more than four hours during the day to business programming while maintaining its focus on politics in the evenings. ‘Stock market reports are now daily news, they affect people’s lives,’ says Mr el-Haje. ‘When 8m Saudis [nearly half the population] try to buy shares in a bank, as recently happened with one IPO, that is a new trend, and one in which people are making money.’ ‘The subject all people care about in the Gulf now is the stock market, not Palestine, Iraq or terrorism,’ argues Abdelrahman al-Rashed, al-Arabiya’s general manager…Much more than during the 1970s boom, the new surge in financial liquidity is trickling down, this time through the equity and property markets.” December 7 – Financial Times (Ralph Atkins and Mark Schieritz ): “European Central Bank monetary policy remains “very accommodative” despite last week’s interest rate increase and the bank could raise borrowing costs again at any time, a member of its governing council warned on Wednesday. The quarter percentage point increase in interest rates – resisted firmly by politicians – ‘cannot be seen as a tightening of monetary policy but rather as a re- balancing,’ Yves Mersch, governor of the Luxembourg central bank, said… Future interest rate changes were likely to be well signalled, Mr Mersch said. Mr Trichet’s decision to pre-announce last week’s increase at a Frankfurt bank conference in November was “not necessarily a new rule” but “we have achieved a high degree of predictability in the financial markets, which is more or less equivalent to the US”. Would markets always know what would happen? “Nothing can be ruled out. Generally speaking we are not in the business of inflicting damage on financial markets. But if we consider it has to be done, a surprise move is never ruled out.” December 8 – Bloomberg (Brian Swint): “The European Central Bank said rising long-term interest rates and global imbalances are two of the largest risks to the financial stability of the 12 countries that share the euro. Banks may suffer if bond yields, which reached a record low this year, rise suddenly... ‘A disorderly correction in the level of long-term yields could potentially disrupt the intermediation of funds through global capital markets, which would have implications for the euro area. The risk of an abrupt unwinding of global imbalances remains, especially because these imbalances may yet widen further.’” December 6 – Bloomberg (Laura Humble): “U.K. industrial production had its biggest drop in seven months in October as manufacturing contracted and oil and gas production declined. Industrial production unexpectedly fell 1 percent, after increasing 0.5 percent in September…” December 5 – Bloomberg (Ben Sills): “Service industries that make up about one-third of the euro region’s economy expanded in November at the fastest pace in 16 months. A CIPS/RBS index of growth in services such as banks and airlines rose to 55.2, the highest reading since July 2004…” December 6 – Bloomberg (Tasneem Brogger and Jonas Bergman): “The Danish government raised its forecasts for economic growth and its surplus this year as consumer spending accelerates. The government raised the forecast for gross domestic product growth this year to 2.8 percent from 2.4 percent in August…” December 6 – Bloomberg (Jonas Bergman): “Sweden’s economy grew the most since the beginning of 2004 in the third quarter as companies and consumers increased spending after the central bank in June cut interest rates to a record low. Gross domestic product grew 1 percent from the second quarter and 3.4 percent from a year earlier…” December 9 – Bloomberg (Marketa Fiserova): “Czech economic growth remained close to the fastest pace in nine years in the third quarter as exports continued to surge and consumer spending accelerated. Growth in the $111 billion economy was 4.9 percent…” December 5 – Bloomberg (Bradley Cook and Zoya Shilova): “Russia’s windfall oil fund rose to a record $43.6 billion in November as the country continued to benefit from higher-than-expected prices for fuel.” December 5 – Bloomberg (Bradley Cook): “Russian consumer prices rose 10 percent in January through November, Economy Minister German Gref told President Vladimir Putin today…” December 4 – Bloomberg (Haris Zamir): “Pakistan’s car sales in the first four months of the financial year started July 1 rose 24 percent as lower rates for car loans spurred demand.” Latin America Watch: December 8, 2005 – Los Angeles Times (Chris Kraul): “A boom in Latin America’s exports of farm products and natural resources is lifting standards of living, creating jobs and offering guarded hope that the region may improve education and reduce its many social ills. Surging prices of commodities such as coffee, soybeans, copper and petroleum — largely because of exploding demand from China and India — are bringing newfound prosperity to the region's farmers, miners and workers, according to analysts and recent studies.” December 7 – Bloomberg (Romina Nicaretta): “Brazil cut its 2005 economic growth forecast to 2.3 percent from 3.5 percent, the economic research institute of the country's planning ministry said…” December 5 – Bloomberg (Daniel Helft): “Argentina’s annual inflation rate rose to the highest in 2 1/2 years, fueled by a surge in prices of basic goods such as beef and dairy products. The annual inflation rate rose 1.2 percent in November compared with October and 12 percent in the 12 months through November…” December 6 – Bloomberg (Peter Wilson): “Venezuelan vehicle sales rose to at least a seven-year high in November as increased government spending fueled consumer demand.” Bubble Economy Watch: December 5 – Bloomberg (Scott Lanman): “A panel of economists who critique Federal Reserve policies urged the U.S. central bank to keep raising interest rates to stem inflation and public expectations that it may accelerate. Inflation is outstripping growth in circulating money and reserve bank deposits, and ‘these conditions require a more aggressive stance to ensure that inflation and inflationary expectations do not take root,’ the Shadow Open Market Committee, formed in 1973, said today in a semi-annual policy statement… Reversing this situation ‘is likely to require further increases in the federal funds rate,’ said the group… ‘The most damaging error to make is to allow inflation to surge ahead because it takes so long to dampen inflation expectations,’ committee member Lee Hoskins, former Cleveland Fed President, said in a panel discussion…‘The Fed should err on the side of tightness.’” December 6 – Market News International (Mark Pender): “Rising prices are the central concern among the Institute For Supply Management’s non-manufacturing sample, many of whom are passing along rising costs to their own suppliers, according to survey head Ralph Kauffman. Prices paid did dip back to 74.2 in November but follows record readings of 78.0 in October and 81.4 in September. November’s reading is in fact the third highest in the eight-year history of the report and follows a similar 74.0 reading in the prices paid index in last week’s ISM manufacturing report. ‘Price increases are more widespread now. ... The list for prices up is quite broad this month, and it’s not just energy. It’s various other things. The list for prices down is very short. The high level that energy prices have been at for such a long time, even though it’s off of a peak, is still working its way through other products and transportation.’” December 7 – Dow Jones (John Godfrey): “The federal government amassed a $130 million deficit for the first two months of fiscal year 2006, which began Oct. 1, the Congressional Budget Office estimated… The two-month deficit is about $14 billion higher than was recorded during the same period in fiscal 2005.” December 5 – Bloomberg (Steve Matthews): “Daniel Kulhavey, 33, completed a 50-hour training course and promptly landed a $22-an-hour job drilling for natural gas near Casper, Wyoming. Now if only Christopher Manegold can find 4,999 more like him. Manegold, president of the Casper Area Economic Development Alliance, is advertising from Oregon to Texas to find workers for Rocky Mountain energy companies. The labor shortage ‘is getting to be of crisis proportions,’ he says. More and more regional markets are reporting similar situations. In October, 111 U.S. metropolitan areas had unemployment rates below 4 percent, up from 72 a year earlier. Economists say the trend may lead to higher wages and more inflation pressures, helping convince the Federal Reserve to continue on its path of higher interest rates. ‘The labor market is hot and getting hotter, and that is one of the reasons the Fed continues to raise rates,’ says Drew Matus, a senior economist at Lehman Brothers Inc.” December 7 – The Wall Street Journal (Jonathan Clements): “It’s tough to get ahead when you’re starting so far behind. College graduates entering the work force -- as many have this fall – are bombarded with financial advice: Build up a rainy-day reserve. Be a homeowner, not a renter. Join the company retirement plan. But for many of today’s 20-somethings, this advice is proving mighty hard to follow, thanks to daunting student loans and hefty credit-card debts… Over the past five years, total annual borrowing through student loans has soared 85%, easily outpacing the 41% rise in public-college costs and the 28% increase at private schools.” December 3 – Financial Times (Deborah Brewster ): “An interest in contemporary art has helped push prices in the US up by 40 per cent this year, passing the high set at the time of the last art boom in 1990… The latest price surge has been fuelled by contemporary art, where young British artists are strongly represented, and this has revitalised the UK market. However, the highest contemporary art prices are paid mostly in the US, by US buyers.” Speculator Watch: December 7 – Bloomberg (Malcolm Shearmur): “Rich people should keep as much as 40 percent of their assets in hedge funds to guard against down years in investment markets, said Declan McAdams, head of Anglo Irish Bank Plc’s Swiss private bank. Hedge funds, which aim to make money regardless of whether markets are rising or falling, are like an ‘insurance policy’ for investors, McAdams said… ‘Hedge funds are only of value if you have a reasonable weighting. If you only have 10 percent in hedge funds in a difficult market, it’s not going to protect you.’” December 5 – Bloomberg (Tom Cahill and Saijel Kishan): “Glencore International AG, one of the world’s biggest traders of oil, coal and metals such as zinc, had a special musical guest for its last Christmas party: Sting. Employees of the Baar, Switzerland-based company are expecting another headliner this year, after oil prices soared to records and metals from aluminum to gold rose to their highest in more than a decade, sparking competition for commodities traders. Banks such as Citigroup Inc. and JPMorgan Chase & Co., and hedge funds including the $12 billion Citadel Investment Group LLC are adding energy and metals traders to profit from high prices and increased volumes. Top energy traders may receive bonuses of as much as $10 million this year, up 50 percent from 2004, as firms fight to attract and retain talent.” December 5 – Bloomberg (Dana Cimilluca and Julia Werdigier): “Mergers and acquisitions, the most lucrative money-maker on Wall Street after trading, may provide a record $18 billion in fees to the financial industry next year as corporations use their burgeoning stockpiles of cash for the biggest spending spree since the Internet bubble burst. ‘2006 may well be the best year ever for mergers and acquisitions,’ said Paul Taubman, 44, global head of M&A at New York-based Morgan Stanley, the world's No. 2 merger adviser after Goldman Sachs Group Inc. ‘We’re entering ‘06 in a healthier environment than I think even in 2000.’” December 3 – Financial Times: “The private equity ‘barbarians’ are back. Only this time, they are not at the gate. They are inside the castle and hosting a banquet fit for a king. This week’s $15bn (£8.6bn) acquisition of TDC, the Danish telecommunications company, by a private equity consortium led by Blackstone caps a bumper year for the industry. Returns are high, funds are rushing into the sector and deal size is back to a level last seen in the late 1980s. While private equity firms have been beaten to some acquisitions by industrial buyers, investors and their advisers have every reason to celebrate. The question is, will the good times last?” “Project Energy” Watch: December 8 – Bloomberg (Dan Lonkevich): “Chevron Corp., the second-largest U.S. oil company, plans to increase capital spending next year by 35 percent, to $14.8 billion, to increase production. About 75 percent of the budget is earmarked for exploration and development of oil and natural-gas fields… The company also plans to buy back as much as $5 billion in stock within the next three years after purchasing $5 billion of its shares under a program that began in April 2004.” December 9 – AFP: “The Gulf state of Kuwait has earmarked more than 44 billion dollars over the next 15 years to upgrade its oil industry and boost output to four million barrels per day (bpd). ‘Total estimated investments in the oil sector from 2005 to 2020 will exceed 44 billion dollars. We aim to modernise the sector and boost output to four million bpd,’ energy ministry undersecretary Issa al-Oun told AFP… The money will be spent on mega projects such as a large refinery and upstream projects to raise output, in addition to a number of large petrochemicals plants, he said.” Q3 2005 “Flow of Funds”: Total Non-Financial (household, government and non-financial corporate) Debt expanded at a blistering 9.1% rate during the quarter, up from the second quarter’s 8.1% and the year ago rate of 8.3%. To find a year of greater non-financial debt growth, one must return almost 20 years to 1986’s 11.9%. Thumbing its nose at quaint little Federal Reserve baby-steps, 2005 debt growth is running ahead of 2004’s 8.7%, which was the strongest percentage debt expansion since 1988. Household Mortgage Debt expanded at a rate of 14% during the quarter. One has to go back to 1985’s 14.1% rise for greater annual percentage growth. Corporate debt expanded at a 6.7% rate during the quarter, with 2005’s corporate borrowings on pace for the strongest year since 2000. State & Local Government borrowings increased at a 12.6% pace and one has to go all the way back to 1985… Federal Government borrowings expanded at a 5.1% rate during the quarter, benefiting from surging receipts. It is analytically worthwhile to highlight the progressive acceleration in debt growth over the past few years. Examining third quarter rates of debt growth, 1999’s 6.6% compares to 2000’s 3.7%, 2001’s 6.5%, 2002’s 6.3%, 2003’s 7.5%, 2004’s 8.3%, and 2005’s 9.1%. Or, by – seasonally-adjusted and annualized rates (SAAR) – third quarter dollars, 1999’s $1.094 Trillion compares to 2000’s $662 billion, 2001’s $1.197 Trillion, 2002’s $1.238 Trillion, 2003’s $1.606 Trillion, 2004’s $1.923 Trillion, and 2005’s $2.297 Trillion. The nature of Credit Bubbles is starkly illustrated by the almost doubling (up 86%) of net annual Credit growth comparing 2002’s third quarter to 2005’s. Total (Non-financial and Financial) Credit Market Debt (TCMD) expanded $799 billion (nominal) during the quarter, or 8.4% annualized, to $38.829 Trillion (308% of GDP). TCMD was up $3.123 Trillion over the past year (8.7%) and $5.541 Trillion over two years (16.6%). For perspective, TCMD expanded $1.679 Trillion during 2000, $1.929 Trillion during 2001, $2.213 Trillion during 2002, $2.733 Trillion during 2003, and $2.837 Trillion during 2004. Total Non-financial Debt increased $2.162 billion over the past year, or 9.2%, to $25.664 Trillion, with a two-year gain of 17.9%. Financial sector Credit market borrowings increased $854 billion over the past year, or 7.5%, to $12.219 Trillion. Financial Sector Credit Market Borrowings have been somewhat held in check by GSE stagnation, along with the rapid growth in banking sector Deposit liabilities (which are not included in Credit mkt borrowings). Total Mortgage Debt (TMD) expanded a record $1.574 Trillion SAAR during the third quarter. To put this rampant debt creation into some perspective, it is an almost six-fold increase from the nineties’ annual average TMD growth of $271 billion. Over the past year, TMD has expanded $1.357 Trillion, or 13.4%, to $11.500 Trillion. TMD has increased 27% over the past two years and has more than doubled (104%) in seven. TMD is running more than double the pace from just four years ago (2001’s $661bn), and at the current pace we’ll match TMD from the entire decade of the nineties in less than seven quarters. Wow… Home Mortgage Debt (HMD) growth expanded a record $1.225 Trillion SAAR during the quarter, up from the previous quarter’s $1.137 Trillion and the year ago $1.098 Trillion. HMD was up 13.6% over the past four quarters to $8.821 Trillion (up 27% in two years). But excesses are anything but confined to the residential sector. Commercial Mortgage Debt (CMD) expanded a record $303 billion SAAR, compared to the previous quarter’s $271 billion and the year ago $200 billion (CMD grew $114bn during 2001, $103bn during 2002, $131bn in 2003 and $181bn last year). CMD expanded 15% over the past year to $1.888 Trillion. Almost half of new Total Mortgage Debt was intermediated through the Asset-Backed Securities (ABS) marketplace during the quarter. ABS expanded $621 billion (SAAR) during the quarter to $2.836 Trillion, for the first time surpassing the size of combined GSE balance sheets ($2.754TN). ABS expanded at a 22.4% rate during the quarter and ballooned 22.8% ($527.2bn) over the past year. ABS has increased 36% in just seven quarters. ABS is on pace to expand more in 2005 than it did during the three years 2000-2002 ($578bn). Agency MBS expanded at a 5.5% rate during the quarter to $3.167 Trillion, with a one-year increase of 2.1%. GSE holdings declined at a 6.7% rate during the quarter to $2.754 Trillion, with a one-year contraction of 3.8%. GSE retrenchment has been more than mitigated by the ballooning Banking and Broker/Dealer sectors. Bank Assets expanded $719 billion SAAR during the quarter to $9.156 Trillion. This compares to average annual growth of $456 billion during the first four years of the decade and the $275 billion average annual Bank Asset expansion during the nineties. Bank Credit expanded at a 10.7% pace during the quarter, up from the previous period’s 9.5% growth rate and the year ago 4.9%. Bank Credit was up 11.0% over the past year and 21.3% in two years. For perspective, Bank Credit expanded on average 6.2% annually during the nineties and 8.5% annually during the inflationary eighties. For the quarter, Mortgage Assets expanded at a 15% pace to $2.895 Trillion. Mortgages increased 15% over the past year and were up 27.9% in two years. Corporate bond (which includes ABS) holdings expanded at a 17.2% rate during the quarter to $699 billion, with a four quarter rise of 32% and a two-year surge of 52%. On the Bank Liability side, Total Deposits expanded at an 11.3% rate during the quarter to $5.37 Trillion. Total Deposits expanded 9.8% during the past year and were up a noteworthy 21.1% over two years. Commercial Banks’ net “Repo” Liability expanded at a 9.7% rate during the quarter to $1.10 Trillion (up 4% y-o-y and 17.7% in two years). Bank Credit Market Liabilities expanded at a 9.4% pace during the quarter to $811 billion. These Liabilities were up 12.1% during the past year and 26.9% over two years. Securities Broker & Dealer Assets expanded at a 10.9% rate during the quarter to $2.105 Trillion. Broker/Dealer Assets were up 19% y-o-y, with a two-year gain of 35%. Garnering much insight from the third quarter will not be easy. The Asset “Credit Market Instruments” dropped $322.3 billion SAAR (after rising $316bn SAAR during the Q2), with Treasury Securities sinking $262 billion SAAR. Meanwhile, Miscellaneous Assets ballooned $483 billion SAAR. Over the past year, “Misc. Assets” increased 30% to $1.224 Trillion (up 48% in 2 yrs), Credit Market Instruments rose 18% to $443 billion, Corporate & Foreign Bonds rose 17% to $294.8 billion (up 40% in 2 yrs), and Security Credit increased 21% to $254.5 billion. On the Liability side, Security “Repos” were up 44% over the past year to $686 billion, with a two-year gain of an astonishing 67%. “Due to Affiliates” expanded 17% over the past year to $861.7 billion (up 47% in 2 yrs). Security Credit Liabilities increased 5% over the past year to $812 billion. But rapid growth is not limited to the Banks, Securities Brokers and ABS. Funding Corp (“Funding subsidiaries, nonbank financial holding companies, and custodial accounts for reinvested collateral of securities lending operations.”) Assets expanded at a 19.6% rate during the quarter to $1.572 Trillion. Funding Corp Assets ballooned 22.5% over the past year and 34% in two years. The largest Funding Corp Asset categories were Money Market Fund Shares ($377bn), Credit Market Instruments ($443bn), Investment in Foreign Banking Offices ($187bn), and Investment in Brokers and Dealers ($565bn). On the Liability side, the largest items included Credit Market Instruments ($499bn) and Securities Loaned ($978bn). It is interesting, although not surprising, to note that the Securities Loaned Liability was up 32% over the past year. Federal Funds and Security Repurchase Agreements (“repo”) expanded at a 10.7% rate during the quarter to $1.963 Trillion. “Repos” were up 17% y-o-y and 35% over two years, although we have to keep in mind that Bank and Broker/Dealer “Repo” positions are reported after having netted “Repo” Assets against “Repo” Liabilities. Rest of World “Repo” holdings have swelled to $688 billion, after beginning 2001 at $91 billion. Over the same period, Money Market Fund “Repo” holdings grew from $183 billion to $301 billion. The Fed notes a $447 billion “Discrepancy – unallocated assets,” apparently because it cannot identify a large share of “Repo” holders. Elsewhere, Real Estate Investment Trust (REIT) Assets expanded at a 37% annualized rate during the quarter to $327 billion (up 61% y-o-y). Credit Unions expanded Assets at a 6.7% pace during the period to $688 billion (up 6.1% y-o-y). Finance Company Assets expanded at a 5.4% rate during the quarter (up 2.2% y-o-y) to $1.439 Trillion. Money Market Funds expanded Assets at a 9.7% rate to $1.877 Trillion, posting its first significant growth in some time. Life Insurance Company Assets expanded at a 10.9% rate to $4.351 Trillion (up 8.7% y-o-y). Also illuminating the inflationary forces percolating throughout the economy, third quarter Federal Government Receipts were up 9.5% from the year ago period, with Expenditures up 7.5%. From two years ago, Receipts were up 19% and Expenditures 14%. State & Local Government Receipts rose 7% from one year ago and 11.5% from 2003 Q3. State & Local Expenditures increased 5.9% and 12.1% over one and two years. The Household (including Non-profits) Balance Sheet continues to provide a wealth of insight with respect to Credit Bubble and Bubble Economy Dynamics. Household Liabilities expanded at a robust 11.0% rate during the quarter to $11.40 Trillion, with a one-year rise of 11.1% and two-year jump of 20.8%. This debt surge played a prominent role in fueling a 10.8% rate of inflation in Household Assets. And while Household Liabilities increased $331 billion during the quarter, Household Assets inflated multiples of this amount ($1.644TN!), to $62.485 Trillion. Third quarter growth easily exceeded the previous quarter’s Asset growth of $1.366 Trillion and the year ago $959 billion. Household Assets jumped $6.170 Trillion, or 11%, over the past year (almost 50% of GDP!). For perspective, Household Assets increased on average $2.554 Trillion during the decade of the nineties ($1.746TN avg. 1990-96), although this was heavily skewed by the end-of-decade technology Bubble (Household Assets increased $5.439 Trillion during 1999). Certainly explaining the resiliency of consumer expenditures, over the past year Household Net Worth surged $4.38 Trillion, or 9.7%, to $51.086 Trillion (2-yr gain of $8.372TN). Real Estate holdings increased $2.785 Trillion (16.1%) during the past year to $20.778 Trillion, with a two-year gain of 29.5%. Household holdings of Financial Assets increased $2.468 Trillion (7.2%) in a year, with a two-year rise of 16.7%. Since 1994, Household Net Worth has increased from 349% of GDP to 410%. Rest of World (ROW) increased positions in U.S. Financial Assets during the quarter by $1.006 Trillion SAAR to $10.681 Trillion, with holdings of Credit Market Instruments expanding a record $827 billion SAAR. Foreign Direct Investment increased $83 billion SAAR. ROW U.S. holdings were up a record $1.588 Trillion over the past year, or 17.5%. This compares to an average annual increase of $388 billion during the nineties and an average $651 billion during the first four years of this decade. During the quarter, ROW increased holdings of Treasuries $211.6 billion SAAR, just short of total Treasury new issuance. ROW holdings of Agency/GSE MBS surged $225.6 billion SAAR, significantly greater than new issuance. And ROW increased Corporate Bond (including ABS) holdings $418.1 billion SAAR, a significant percentage of total issuance. There is, then, no conundrum surrounding the ongoing extraordinary marketplace liquidity backdrop. One can think in terms of the unparalleled liquidity created by U.S. financial system (asset-based) debt growth (particularly, these days, through the expansion of bank Credit, ABS, and “repos”/securities finance). This created purchasing power is financing the massive Current Account Deficit (along with outbound global speculative flows). These massive international dollar flows are then largely recycled back to top-rated (“money”-like) U.S. securities, creating to this point a perpetual liquidity machine. Considering the rather unequivocal ongoing massive Credit inflation, it is surprising how much I still read about deflation. Those adhering to this view these days point first to Treasury and global market yields. I certainly don’t want to dismiss these markets out of hand. Yet the “Flow of Funds” data rather pointedly illuminate ongoing historic Credit excesses, as well as the return of this unprecedented liquidity back to U.S. securities markets (largely Treasuries, agency securities, ABS, corporate bonds, and “repos.”). Having studied and pondered these dynamics for some time, I believe a strong case can be made that we are in the midst of a marketplace liquidity dislocation. Perhaps market yields are today no more discounting prospective fundamentals than technology stocks and telecom bonds were back in 1999/early 2000. While unsustainable, these types of liquidity dislocations are nonetheless powerfully self-reinforcing – and just what we would expect from history’s greatest Credit Bubble. Considering the unequivocal ongoing massive Credit inflation, it is also surprising how often we hear that the Fed has about wrapped up this tightening cycle. The Problem with Telegraphed Baby-Step Tightening-Lite is that it specifically operates to safeguard a Credit system that has become increasingly dysfunctional over the life of the boom. There is absolutely no direct effort by the Fed to restrict Credit Availability or Marketplace Liquidity, only faith that somewhat higher funding costs at the margin will work their magic. But asset prices – the main driver of Credit expansion and liquidity excess – have been inflating much more rapidly than financing costs have been rising. Destabilizing boom-time Monetary Processes (securitizing risky mortgages, leveraged securities speculation, and the repo market – to name a few) that evolved to fuel recurring asset inflation/Bubbles are not only not repressed, they are harbored. To be sure, we have been witnessing real-time the dynamics of monetary policy falling only further behind the curve. In a robust Credit Bubble environment, baby-step rate increases virtually guarantee that Inflationary Manifestations will be easily monetized. Credit-induced real estate inflation begets accelerating Credit growth (additional borrowings to finance more real estate transactions at higher prices). Continued Credit expansion fuels rising incomes (and certainly rising wealth disparities). These higher incomes then support ongoing real estate inflation, as well as broadening Inflationary Manifestations such as intractable Current Account Deficits and rising prices for energy, commodities, collectables, tuition, medical costs and a broad range of goods and services. As always, Credit excess begets Credit excess. The white hot national housing market finally appears to be cooling somewhat. It is possible that the third quarter will mark the peak in mortgage debt growth. I remain, however, unwilling at this point to call a top in the Credit Bubble. I would be very surprised if mortgage Credit growth slows rapidly. Additionally, other sectors in the economy – notably energy, commodities, and exports – have heated up considerably, and appear poised to take up some of the potential Credit system slack a slowing housing market would provide. The Q3 2005 “Flow of Funds” argues very convincingly that the Fed still has plenty of work to do. |
Tuesday, September 9, 2014
12/09/2005 Q3 2005 'Flow of Funds' *
