Friday, October 3, 2014

05/16/2008 A Red Herring *

For the week, the Dow gained 1.9% (down 2.1% y-t-d), and the S&P500 rose 2.7% (down 2.9%). Economically-sensitive issues were strong. The Transports jumped 3.4%, increasing y-t-d gains to 17.5%. The Morgan Stanley Cyclicals surged 3.9% (up 2.0%). The Morgan Stanley Consumer index rose 2.4% (down 4.7%), and the Utilities added 1.4% (down 5.1%). The broader market enjoyed another week of strong gains. The small cap Russell 2000 increased 2.9% (down 3.2%). The S&P400 Mid-Caps rose 3.5%, putting 2008 gains at 3.0%. Technology stocks remained strong. The NASDAQ100 gained 3.6% (down 2.6%), with one-month gains of 10%. The Morgan Stanley High Tech index surged 5.3% (down 1.2%), with one-month gains of 11.4%. The Semiconductors rose 5.8% (up 3.3%); the Internet Index 3.9% (down 0.3%); and the NASDAQ Telecommunications index 5.1% (up 2.9%). The Biotechs added 0.7% (down 4.2%). The Broker/Dealers gained 2.2% (down 15.7%), while the Banks dipped 0.4% (down 8.9%). With Bullion rallying $17.60, the HUI Gold index gained 2.8% (up 6.2%).

One-month Treasury bill rates jumped 18 bps this week to 1.85%, and 3-month yields gained 11 bps to 1.84%. Two-year government yields jumped 20 bps to 2.44%. Five-year T-note yields increased 14 bps to 3.11%, and 10-year yields rose 8 bps to 3.85%. Long-bond yields increased 5.5 bps to 4.58%. The 2yr/10yr spread ended the week at 141 bps. The implied yield on 3-month December ’08 Eurodollars jumped 19 bps to 2.98%. Benchmark Fannie MBS yields added 3 bps to 5.40%. The spread between benchmark MBS and 10-year Treasuries narrowed 5 to 155 bps. The spread on Fannie’s 5% 2017 note narrowed one to 58 bps, and the spread on Freddie’s 5% 2017 note narrowed one to 57 bps. The 10-year dollar swap spread declined 1.5 to 58.75. Corporate bond spreads were mostly narrower. An index of investment grade bond spreads narrowed 10 to 93 bps, and an index of junk bond spreads narrowed 9 to 615 bps.

Corporate debt issuance surpassed $30 billion for the sixth straight week. Investment grade issuance included Philip Morris $6.0bn, Simon Properties $1.5bn, Harley-Davidson $1.0bn, United Technologies $1.0bn, Eaton $750 million, Starwood Hotels $1.0bn, Nisource Finance $545 million, PNC Bank $500 million, Sovereign Bank $500 million, Ace INA Holdings $450 million, Entergy $375 million, Columbus Southern Power $350 million, Centerpoint Energy $300 million, BJ Services $250 million, Tampa Electric $150 million, and Empire Electric $90 million.

Junk issuers included Laureate Education $1.0bn, Sandridge Energy $750 million, Nortek $750 million, I-Star Financial $750 million, AES Corp $625 million, Hovnanian $600 million, Jabil Circuit $400 million, and Copano Energy $300 million.

Convert issuance this week included SBA Communications $550 million, Health Management Association $225 million, and JA Solar $400 million.

International dollar bond issuance included HBOS $2.0bn, Evraz Group $2.0bn, Petro-Canada $1.5bn, Canadian Pacific Railroad $700 million, and Mangrove RE $210 million.

German 10-year bund yields jumped 18 bps to 4.18%, as the DAX equities index gained 2.2% (down 11.3% y-t-d). Japanese 10-year “JGB” yields rose 14 bps to 1.69%. The Nikkei 225 surged 4.1% (down 7.1% y-t-d and 18.9% y-o-y). Emerging debt markets were mixed, while equities were mostly much higher. Brazil’s benchmark dollar bond yields declined another 4.5 bps to 5.98%. Brazil’s Bovespa equities index jumped 4.5% to a record high (up 13.9% y-t-d). The Mexican Bolsa gained 2.7% (up 6.6% y-t-d). Mexico’s 10-year $ yields rose 10 bps to 4.88%. Russia’s RTS equities surged 8.5% (up 8.2% y-t-d). India’s Sensex equities index rallied 4.2%, cutting y-t-d losses to 14.1%. China’s Shanghai Exchange added 0.3%, with 2008 losses now at 31.1%.

Freddie Mac 30-year fixed mortgage rates declined 4 bps to 6.01% (down 20 bps y-o-y). Fifteen-year fixed rates were unchanged at 5.60% (down 32bps y-o-y). One-year adjustable rates dropped 9 bps to 5.18% (down 30bps y-o-y).

Bank Credit declined $8.0bn to $9.417 TN (week of 5/7). Bank Credit has expanded $204bn y-t-d, or 6.1% annualized. Bank Credit posted a 42-week surge of $773bn (11.1% annualized) and a 52-week rise of $885bn, or 10.4%. For the week, Securities Credit increased $2.1bn. Loans & Leases fell $9.0bn to $6.917 TN (42-wk gain of $592bn, or 11.6% annualized). C&I loans added $1.1bn, with one-year growth of 20.1%. Real Estate loans dropped $9.2bn (up 4.2% y-t-d). Consumer loans increased $2.7bn, while Securities loans declined $2.9bn. Other loans slipped $1.7bn. Examining the liability side, Deposits dropped $30.4bn.

M2 (narrow) “money” supply was little changed at $7.655 TN (week of 5/5). Narrow “money” has expanded $192bn y-t-d, or 7.4% annualized, with a y-o-y rise of $439bn, or 6.1%. For the week, Currency was about unchanged, while Demand & Checkable Deposits declined $7.1bn. Savings Deposits jumped $18.5bn, while Small Denominated Deposits declined $2.1bn. Retail Money Funds fell $8.4bn.

Total Money Market Fund assets (from Invest Co Inst) surged $26bn last week to $3.498 TN, while posting a y-t-d gain of $385bn, or 33.8% annualized. Money Fund assets have posted a one-year increase of $1.013 TN (40.8%).

Asset-Backed Securities (ABS) issuance jumped to $9.0bn. Year-to-date total US ABS issuance of $85bn (tallied by JPMorgan's Christopher Flanagan) is running 29% of the comparable level from 2007. Home Equity ABS issuance of $303 million compares with 2007's $156bn. Year-to-date CDO issuance of $13bn compares to the year ago $161bn.

Total Commercial Paper dropped $19.7bn to two-year low $1.734 TN. CP has declined $489bn over the past 40 weeks. Asset-backed CP sank $11.1bn (40-wk drop of $473bn) to $722bn. Over the past year, total CP has contracted $353bn, or 16.9%, with ABCP down $399bn, or 35.6%.

Fed Foreign Holdings of Treasury, Agency Debt last week (ended 5/14) dipped $1.1bn to $2.279 TN. “Custody holdings” were up $222bn y-t-d, or 28.1% annualized, and $339bn year-over-year (17.5%). Federal Reserve Credit declined $1.4bn to $866bn. Fed Credit has contracted $7.3bn y-t-d, while having increased $18.4bn y-o-y (2.2%).

International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $1.428 TN y-o-y, or 27%, to a record $6.790 TN.
Global Credit Market Dislocation Watch:

May 15 – Financial Times (Bertrand Benoit and James Wilson): “Global financial markets have become ‘a monster’ that ‘must be put back in its place’, the German president has said, comparing bankers with alchemists who were responsible for ‘massive destruction of assets’. In some of the toughest comments by a leading European politician since the start of the subprime crisis, Horst Köhler - a former head of the International Monetary Fund - called for tougher regulations and the reconstruction of a ‘continental European banking culture’… ‘The complexity of financial products and the possibility to carry out huge leveraged trades with little own capital have allowed the monster to grow . . . also responsible [is] the grotesquely high compensation of individual finance managers…’ Bankers ‘have made huge mistakes’, Mr Köhler told Stern magazine… ‘I am still waiting for a clear, audible mea culpa. The only good thing about this crisis is that it has made clear to any thinking, responsible person in the sector that international financial markets have developed into a monster that must be put back in its place,’ Mr Köhler said… The German president’s spectacular attack reflects the broader feeling of contempt among German politicians towards bankers since the start of the subprime crisis…”

May 16 – Financial Times (Paul J Davies, Norma Cohen and Anousha Sakoui): “The European Central Bank yesterday voiced its ‘high concern’ at growing evidence that banks are exploiting its efforts to unblock the frozen funding markets by using its liquidity scheme to offload more risky assets than it envisaged. Yves Mersch, a governing council member, said the ECB was now ‘looking very hard at whether there is not a specific deterioration of collateral’ which the central bank is accepting in return for funds. He was speaking amid signs of some banks creating low-rated assets specifically so they can be traded for treasuries at the European Central Bank.”

May 12 – Bloomberg (Ryan J. Donmoyer and Alison Fitzgerald): “U.S. and European banks and financial institutions have ‘enormous losses’ from bad loans they haven’t yet recognized and may have a harder time wooing sovereign-fund rescuers, Carlyle Group Chairman David Rubenstein said. ‘Based on information I see,’ it will take at least a year before all losses are realized, and some financial institutions may fail, Rubenstein said… ‘The sovereign wealth funds are not likely to jump into the fray again to bail out these institutions,’ Rubenstein said. ‘Many financial institutions aren’t going to be able to survive as independent institutions.’”

May 14 – Bloomberg (Pierre Paulden and Christine Harper): “Banking fees for leveraged finance deals are down 90% as banks struggle to sell a backlog of high-yield, high-risk debt from last year’s buyouts, according to Deutsche Bank AG global banking head Michael Cohrs. ‘That revenue engine we built is not going to function for some period of time,’ Cohrs told investors… adding ‘that business is effectively closed.’”

May 15 – Financial Times (Michael Mackenzie and Gillian Tett): “Interest rates in dollar money markets rose sharply yesterday amid a welter of speculation over changes to the calculation of Libor… Rates in the money markets have been moving in an increasingly volatile manner ahead of a crucial meeting at the end of the month of the British Bankers Association, which calculates the benchmark. The BBA is due to submit a report on Libor to an advisory committee on May 30, which will be used as the basis for a discussion about whether this index needs to be changed. Pressure has been rising to change the dollar Libor system because of concern the benchmark does not accurately reflect conditions in the American markets.”

May 14 – Bloomberg (Gavin Finch and Ben Livesey): “ICAP Plc, the biggest broker of transactions between lenders, has no ‘concrete timetable’ for a U.S. alternative to the London interbank offered rate as it seeks to sign up banks. ‘We hope to launch it soon, but we don’t have a concrete timetable,’ Lou Crandall, chief economist at the… company’s New York research unit, said… ‘We’re having individual discussions with banks who understandably want to make sure they know what they’re getting into before taking the jump.’ ICAP plans to start the New York Funding Rate as the accuracy of Libor, a benchmark for corporate loans, at least $347 trillion of derivatives and 6 million U.S. mortgages, is being called into question. For the first time since 1998, the British Bankers' Association, which oversees Libor, is considering changing the way it sets the measure, according to Chief Executive Officer Angela Knight.”

May 13 – Bloomberg (Ben Livesey and Gavin Finch): “The benchmark interest rate for $62 trillion of credit derivatives and mortgages for 6 million U.S. homeowners faces its biggest shakeup in a decade as lawmakers question if banks are understating borrowing costs. For the first time since 1998, the British Bankers’ Association is considering changing the way it sets the London interbank offered rate…”

May 13 – Financial Times (Saskia Scholtes): “MBIA, Ambac Financial and other bond insurers have suffered huge losses on complex structured securities they guaranteed known as collateralised debt obligations. CDOs package other types of debt securities, such as mortgages or corporate bonds, into a portfolio against which new bonds are issued. And in some cases, such vehicles package bonds from other CDOs in a structure known as a ‘CDO-squared.’ …MBIA has projected that 55-100% of CDOs backed by mortgage assets contained within its insured CDO-squared transactions will default, and that losses resulting from these defaults will be as high as 75 to 100%.”

May 14 – Bloomberg (Christine Richard and Jody Shenn): “Moody’s… said deepening losses at MBIA Inc. and Ambac Financial Group Inc. may imperil their Aaa credit ratings less than three months after affirming the top grade. The two largest bond insurers recorded a total $6.7 billion of first-quarter charges for losses on home-equity loans and collateralized debt obligations, ‘elevating existing concerns about capitalization levels relative to the Aaa benchmark,’ Moody’s said…”

May 16 – Bloomberg (Sarah Mulholland): “Ford Motor Co.’s finance unit sold $5.3 billion in auto-loan bonds, the automaker’s biggest sale in more than six years, indicating investor demand for asset-backed securities is returning.”
Global Inflation Turmoil Watch:

May 13 – Financial Times (Simeon Kerr): “Inflation has replaced unemployment as the most pressing short-term problem facing the oil-rich Gulf economies, which are reaping the benefits of record oil revenues but do not have the tools available to cap rising prices, the International Monetary Fund warned… ‘Inflation is now a serious problem – because there are very few ways of tackling it,’ Mr Khan told the Financial Times. He warned that increasing wages to cope ran the risk of locking the region into an inflationary spiral. The IMF predicts the Arab Gulf states’ consumer price index will average 7.1% this year, up from 6.1% in 2007 – while the broader Middle East and north Africa region will reach 10.4% this year.”

May 12 – Bloomberg (Naila Firdausi): “Indonesian police used water cannons to break up a student protest in Jakarta against the government’s proposal to raise fuel prices by as much as 30%. About 6,000 students…protested against rising inflation and the plan to cut fuel subsidies… A 47% rise in local crude oil prices in the past five months is forcing President Yudhoyono, who faces elections next year, to renege on a pledge not to increase pump prices.”

May 12 – Bloomberg (Farhan Sharif): “Pakistan’s inflation accelerated at the fastest pace in at least 25 years in April because of surging food and fuel prices, straining a six-week-old coalition government already on the brink of collapse. Consumer prices jumped 17.21% from a year earlier…”

May 14 – Bloomberg (Rattaphol Onsanit): “The benchmark price for rice exported from Thailand, the world’s biggest supplier, breached $1,000 a metric ton for the first time today as importers rushed to secure supplies, heightening concern about a global food crisis.”

May 12 – Bloomberg (Soraya Permatasari): “Malaysia, which relies on Thailand for most of its rice imports, extended price caps to more varieties of the staple and raised the amount paid to local farmers to safeguard domestic supplies and rein in inflation. ‘Actions need to be taken to ensure there is adequate supply,’ Prime Minister Abdullah Ahmad Badawi said…”

May 14 – New York Times (Heather Timmons): “Instead of blaming India and other developing nations for the rise in food prices, Americans should rethink their energy policy — and go on a diet. That has been the response, basically, of a growing number of politicians, economists and academics here, who are angry at statements by top United States officials that India’s rising prosperity is to blame for food inflation. The global food problem has clearly been created by Americans, who take in far more calories than the typical person in India, said Pradeep S. Mehta, secretary general of the center for international trade, economics and the environment of CUTS International, an independent research institute center… Mr. Mehta’s comments reflected ballooning criticism of the United States in India…”
Currency Watch:

The dollar index declined 0.3%, ending the week at 72.84. The "commodities" currencies led the gainers. For the week on the upside, the South African rand increased 1.9%, the Brazilian real 1.3%, the Mexican peso 0.8%, the Australian dollar 0.8%, the Taiwanese dollar 0.5%, the Norwegian krone 0.5%, and the Canadian dollar 0.4%. On the downside, the Japanese yen declined 0.4%, the Swiss franc 0.4%, and the Singapore dollar 0.3%.
Commodities Watch:

May 12 – Bloomberg (Wang Ying): “China increased its crude oil imports by 9.8% in the first four months to 59.8 million metric tons, the government said.”

May 12 – Bloomberg (Marianne Stigset and Nina de Roy): “Jonathan Fenby, China director at Trusted Sources UK Ltd., comments on the outlook for food inflation and supply of agricultural commodities in China… ‘Food has been the big driver of inflation, starting with pork this time last year. Pork is now up 68% year-on-year. But the really worrying thing is that inflation seems to be spreading to other sectors. So there is an inflationary momentum going there… Natural disasters such as today’s earthquake ‘will affect food resources. China has a lot of natural disasters. There’s a much more serious drought going on, particularly in northern China, that’s been affecting 14 provinces and has had an effect on food supplies. Flooding in other parts of China has also affected food supplies… China ‘has an ongoing water problem. There’s huge land erosion… ‘Zimbabwe would be quite a possibility for China to go in and develop land there. The idea is being discussed. ‘We should go abroad, buy land, plant food there and bring it back to China.’ In the last couple of months, the Chinese have been clamping down quite hard on food exports, doubled the export duty on fertilizer. They are definitely trying to hoard all the food that they can.’”

May 13 – Bloomberg (Diana Kinch): “Chinese demand for metallurgical coal and coke will drive a record-setting price rally for the raw materials used to make steel, consultants and analysts say… China reduced exports this year because of bad weather and to meet rising domestic demand as steel output climbs… ‘Current prices are becoming unworkable for steelmakers,’ Andrew Jones, a coal market analyst with Belgian research organization Resource-Net, said… ‘Steelmakers may introduce production cuts if coke prices, which are set monthly, continue to rise.’”

May 14 – Bloomberg (Irene Shen and Helen Yuan): “Chinese shipments of steel, copper and other commodities were disrupted after the country’s worst earthquake in 58 years closed the main railway in the country’s central region. ‘The available capacity should be used for aid as a first priority,’ Wang Yongping, a Ministry of Railways spokesman, said… ‘The railway disruption will boost metal prices,’ said Xu Minle, BOC International Ltd.’s… steel analyst.”

May 15 – Bloomberg (Alistair Holloway and Alaric Nightingale): “Commodity shipping rates jumped to a record on increasing Chinese demand for iron ore and may advance further as rising finance costs curb growth in shipbuilding. The Baltic Dry Index, a measure of costs to move everything from coal to grain, gained 418 points, or 3.9%, to 11,067 points on the Baltic Exchange in London.”

May 13 – Financial Times (Robert Wright and Javier Blas): “Consumers of basic commodities face some of the highest ever costs to ship goods after a combination of port delays, strong demand and ship shortages last week sent bulk shipping rates back close to record levels. The increases - an almost 80% jump in the past year - come after iron ore producers in Brazil won large price increases from steelmakers, encouraging them to make more ore available for shipment.”

Gold rallied 2.0% to $902.40, and Silver added 0.3% to $16.96. June Crude added 65 cents to a record $126.61. June Gasoline gained 1.0% to a record high (up 31% y-t-d), while June Natural Gas declined 3.9% (up 48% y-t-d). July Copper rose 2.9%. July Wheat fell 3.6%. The CRB index was little changed (up 18.9% y-t-d). The Goldman Sachs Commodities Index (GSCI) added 0.1% to another record high (up 28.3% y-t-d and 63.6% y-o-y).
China Watch:

May 15 – Bloomberg (Li Yanping): “China’s factory and property spending climbed 25.7% in the four months through April and may accelerate as southwestern Sichuan province rebuilds after the country’s worst earthquake in more than 50 years.”

May 13 – Bloomberg (Nipa Piboontanasawat): “China’s wholesale-price inflation accelerated in April to the fastest since at least 1999. The wholesale price index rose 10.3% from a year earlier after gaining 10.2% in March…”

May 12 – MarketNews International: “The rebound in Chinese money supply growth in April underlines the challenge facing the People’s Bank of China in reining in excess liquidity and curbing inflation… Chinese money supply growth rebounded to a 16.9% rate in April from March’s 16.3%...”

May 13 – Bloomberg (Paul Panckhurst): “China’s retail sales climbed at the fastest pace since at least 1999, signaling that domestic consumption may help to buffer the world’s fourth-biggest economy against an export slowdown. Sales rose 22% to a record 814.2 billion yuan ($116 billion) in April…”

May 12 – Bloomberg (Irene Shen): “China’s vehicle sales rose 14% in April, the slowest pace in almost two years, as a combination of inflation and a slumping stock market curbed demand for passenger cars.”

May 12 – Bloomberg (Nipa Piboontanasawat): “China ordered banks to set aside larger reserves for the fourth time this year after inflation accelerated to close to the fastest pace since 1996. The requirement will rise to a record 16.5% of deposits from 16%...”

May 14 – Bloomberg (Kevin Hamlin): “China’s industrial production growth slowed more than economists estimated… Output rose 15.7% in April from a year earlier… after climbing 17.8% in March… Weaker industrial output growth ‘doesn’t justify a change in the government’s tight monetary policy stance,’ said Shuji Tonouchi, senior economist at Mitsubishi… ‘Inflation is the biggest issue.’”

May 14 – Bloomberg (Melinda Cao and Judy Chen): “Overseas investors placing money in China’s bank accounts betting on yuan gains will face ‘risks’ because the regulators may change the rules, said China Banking Regulatory Commission’s Li Fuan… ‘Money inflows for pure speculative purposes will face policy risks,’ said Li… ‘The regulators will make appropriate control rules if needed.”

May 12 – Bloomberg (Li Yanping): “China’s exporters face a rising number of payment defaults in the U.S. because of the subprime crisis, China Central Television reported… Total delayed overseas payments are now more than $100 billion, and are rising by $15 billion annually, CCTV reported, citing… a research institute affiliated with the trade ministry.”
Japan Watch:

May 16 – Bloomberg (Jason Clenfield): “Japan’s economy grew 3.3% last quarter, faster than economists estimated, as exports to Asia and emerging markets helped the nation weather the U.S. slowdown.”

May 14 – Bloomberg (Mayumi Otsuma): “Japan’s wholesale prices rose at close to the fastest pace in almost three decades in April, prompting companies to pass higher costs onto clients or absorb them by sacrificing profits. Producer prices climbed 3.7% from a year earlier, after a 3.9% gain in March…”
India Watch:

May 16 – Bloomberg (Cherian Thomas): “India’s inflation rate unexpectedly rose to the highest in 3 1/2 years… Wholesale prices gained 7.83% in the week…from a year earlier…”

May 12 – Bloomberg (Kartik Goyal): “India’s industrial production grew at the slowest pace since 2002 in March… Production at factories, utilities and mines rose 3% from a year earlier after gaining 8.6% in February…”
Asia Watch:

May 14 – Bloomberg (Arijit Ghosh and Aloysius Unditu): “Indonesia’s new car sales rose 47% in April to a three-year high as the lowest interest rates in three years encouraged consumers to borrow to buy cars before a proposed increase in fuel prices.”

May 16 – Bloomberg (Jason Folkmanis): “Accelerating inflation in Vietnam has caused builders to halt residential property projects that they no longer view as economically viable, Morgan Stanley said. Vietnam’s year-on-year inflation rate reached 21.4% last month, the highest since at least 1992…”
Latin America Watch:

May 15 – Financial Times (David Oakley): “Brazil is pricing bond deals at lower spreads than Berkshire Hathaway… The country priced a 10-year bond on Wednesday last week at 15 bps tighter than a deal of the same maturity launched by triple A rated Berkshire Hathaway Finance the previous day. The Brazilian deal, which was priced 600bp tighter than similar bonds five years ago, is a sign of the country’s growing reputation as a place to channel money…”

May 14 – Bloomberg (Telma Marotto): “Banco do Brasil SA, Latin America’s largest bank by assets, posted a 67% increase in first- quarter profit on more borrowing by consumers and farmers and a one-time gain from selling a stake in Visa Inc. Net income increased to 2.35 billion reais ($1.4 billion)… Demand for credit increased with gains in employment and household income. Bank lending in the country, which has expanded every month since February 2004, rose 6.1% in the quarter and 31% in the 12 months ending in March…”

May 15 – Bloomberg (Joe Carroll): “Petroleo Brasileiro SA, Brazil’s state-controlled oil company, leased about 80% of the world’s deepest-drilling offshore rigs to explore prospects including the Western Hemisphere’s biggest discovery in decades. Petrobras… is hiring rigs that can drill in at least 3,000 meters of water… The world has 21 such vessels, according to, which tracks the offshore drilling industry. The company’s ‘insatiable’ demand is forcing producers including Exxon Mobil Corp. and BP Plc to pay more as they compete for the remaining units, said Kjell Erik Eilertsen and Truls Olsen, analysts at Fearnley Fonds AS… Explorers that don’t have rigs under contract may delay projects or pay rents of more than $600,000 a day. ‘The oil majors have their backs against the wall as Petrobras has aggressively locked up significant rig capacity,’ said Omar Nokta, head of maritime research at Dahlman Rose & Co.”

May 14 – Bloomberg (Valerie Rota): “Mexico’s peso-denominated bonds fell, pushing the yield on the benchmark security to a four-month high, on speculation rising tortilla prices will fuel faster inflation. …the Milenio newspaper reported that prices of tortillas, a Mexican staple, are poised to increase by 40% over the next few weeks because of higher global grain costs.”

May 15 – Bloomberg (Carlos Barletta): “Panama’s consumer prices rose 8.5% in April from a year earlier, driven by rising food and transportation costs.”
Unbalanced Global Economy Watch:

May 15 – Bloomberg (Patrick Donahue): “First came the booming economies. Then came the rush of investors. Now the so-called BRIC nations -- Brazil, Russia, India and China -- are talking about forming a political alliance. The four largest emerging economies are sending their foreign ministers to Yekaterinburg, Russia, to meet on May 16 for the first time outside the venue of the United Nations. On the agenda are such non-economic issues as weapons proliferation, counter-terrorism, energy and climate change… In the past two years stocks in the BRIC nations have risen 70 percent, versus the 42 percent increase of emerging markets overall. ‘It’s really a group that first existed as a concept in the minds of analysts and subsequently came to exist as a practice between the countries,’ Brazilian Foreign Minister Celso Amorim said… ‘The meeting is recognition of the fact that we are four big economies with a large influence in the world.’”

May 12 – Bloomberg (Jennifer Ryan): “U.K. producer prices climbed in April at the fastest annual pace since at least 1986 as raw-material costs jumped, adding to the case for the Bank of England to moderate the pace of interest-rate cuts. Prices charged by factories rose 7.5% from a year earlier…”

May 14 – Bloomberg (Svenja O’Donnell and John Fraher): “The Bank of England said inflation will accelerate, breaching the government’s 3% limit for ‘several quarters,’ making it harder for policy makers to cut interest rates as economic growth slows.”

May 13 – Bloomberg (Jennifer Ryan): “London’s property market had the most widespread price declines in at least 14 years last month as the slump in financial services deepened and banks curbed lending, the Royal Institution of Chartered Surveyors said… The reading for the whole country fell to minus 95.1, the least since the series began in 1978.”

May 13 – Bloomberg (Simon Packard): “The office market of London’s main financial district faces a ‘tidal wave’ as leasing demand slows and developers struggle to line up tenants for new construction, consultant Drivers Jonas said… Eleven developments were started in the City of London district during the past six months… These will add 1.3 million square feet… taking total space under construction to 7 million square feet. Half the space being built is scheduled for completion this year and there is ‘minimal’ pre-leasing for such projects, Drivers Jonas said. Banks and financial services companies may cut as many as 40,000 jobs, sub-leasing of unwanted space is increasing, rents are declining and landlords offer more incentives to tenants, the consultant said.”

May 16 – Bloomberg (Peter Woodifield): “Scottish house prices fell in the first quarter, the second straight decline, as mortgages became more expensive and harder to obtain. The cost of an average home dropped 5.1% in the first three months of the year to 150,257 pounds ($292,881)…”

May 15 – Bloomberg (Simon Kennedy and Fergal O’Brien): “European economic growth accelerated more than economists forecast in the first three months of 2008 as stronger expansions in Germany and France masked slowdowns in Spain and Italy. Gross domestic product in the euro area increased 0.7% from the previous three months… ‘After the strong data in the first quarter there is definitely no room for the ECB to cut rates,’ said Joerg Kraemer, chief economist at Commerzbank AG…”

May 15 – Bloomberg (Gabi Thesing): “Economic growth in Germany… accelerated to the fastest pace in 12 years in the first quarter as companies stepped up spending on machinery and construction. Gross domestic product rose 1.5% from the fourth quarter…”

May 13 – Financial Times (Richard Milne): “Germany, renowned for its high standards of engineering, is facing an acute shortage of skilled engineers. Franz Fehrenbach, chief executive of Bosch, became the latest businessman to sound the alarm when he warned this week that the lack of engineers was ‘the key problem for the future’.”

May 14 – Bloomberg (Ben Sills): “Spain’s economy expanded at the slowest pace in almost eight years as the global credit shortage exacerbated the country’s housing slump. The Spanish economy expanded 0.3% from the previous three months…”

May 13 – Bloomberg (Robin Wigglesworth and Kati Pohjanpalo): “Sweden’s inflation rate rose to 2.4% in April, the highest in five years, adding to pressure on the central bank to keep its benchmark interest rate at a six-year high.”

May 13 – Bloomberg (Robin Wigglesworth and Kati Pohjanpalo): “Sweden’s unemployment rate dropped more than expected in April, reaching the lowest in at least 15 years… The… rate fell to 2.9% from 3.2% in March…”

May 15 – Bloomberg (David Rosenberg): “Israel’s inflation rate rose more than expected to 4.7% in April, the highest in 5 years… The inflation rate rose from 3.7% in March…”

May 12 – Bloomberg (Tracy Withers): “New Zealand house sales slumped to a 16-year low in April and prices fell from the year earlier for the first time in almost seven years… The number of homes sold dropped 45.5%...”
Bursting Bubble Economy Watch:

May 16 – Bloomberg (Courtney Schlisserman): “U.S. consumer confidence was the weakest this month since Jimmy Carter was president, and single- family home construction fell to a 17-year low in April.”

May 13 – Bloomberg (David Mildenberg): “Bank of America Corp., the nation’s biggest consumer bank, said losses on home-equity loans will be even worse than predicted three weeks earlier… More customers are under financial stress and using credit cards to pay for necessities, said Liam McGee, president of the consumer and small business division… Credit and debit-card purchases for ‘necessary’ items, including fuel, food and utilities, grew by 13% in the first quarter, while spending for retail, travel and entertainment increased 0.5%...”

May 12 – The Wall Street Journal (Rachel Dodes and Ray A. Smith): “The hottest trend in footwear this season? Inflation. After a decade of declining prices, footwear makers at all levels are raising prices. The mass-market Payless… recently increased prices on shoes in stores, though it won’t say by how much. Brown Shoe Co…plans an increase of 5% to 12% for fall. And the Nine West shoe label plans to boost prices on some styles by 15% next year. The moves reflect higher costs in China, which makes about 85% of shoes sold in the U.S., as well as higher fuel costs and the weak U.S. dollar. And they could presage price increases of other goods soon: Handbags, belts and other leather accessories are made in the same region in China. The shoe price increases follow 10 years in which U.S. footwear prices fell 4.3%...”

May 12 – The Wall Street Journal (Jeffrey McCracken): “Two of the country’s largest recreational-vehicle makers, pummeled by high gasoline prices and the slumping housing market, face serious cash crunches and are taking drastic measures to ease the strain. Coachmen Industries Inc… is borrowing against the value of life-insurance policies it holds on employees and retirees. So far, the… company has tapped about half the cash value of those policies…”
Central Banker Watch:

May 14 – Financial Times (James Politi and Chris Bryant): “The Federal Reserve should forcefully tackle the risk of inflation and the weakness of the dollar now to avoid the stagflation experienced in the late 1970s, according to Paul Volcker… Testifying before Congress… Volcker warned of a ‘resemblance’ between the inflation outlook today and in the early 1970s… Mr Volcker said the response from the Fed at the time had not been ‘forceful enough’ in terms of tightening monetary policy. He added: ‘If we lose confidence in the ability and the willingness of the Fed to deal with inflationary pressures and sustain confidence in the dollar, we’ll be in trouble.’”

May 14 – Bloomberg (Craig Torres): “Former Federal Reserve Chairman Paul Volcker warned that Ben S. Bernanke’s interventions in securities markets opened the door to political interference that may threaten the Fed’s independence in setting interest rates. ‘Intervention in a broad range of credit-market instruments may imply official support for a particular sector of the market or the economy,’ Volcker said in testimony to the congressional Joint Economic Committee… Support for specific markets ‘throws them into political battles,’ he said… Volcker’s comments are his most detailed warning yet about the consequences of the Fed’s rescue of Bear Stearns Cos. and taking on mortgage securities from bond dealers… ‘Independence is integral to the central responsibility of the Federal Reserve’ for ‘the conduct of monetary policy,’ said Volcker…”

May 13 – Bloomberg (Craig Torres and Steve Matthews): “Federal Reserve Chairman Ben S. Bernanke said financial markets remain unsettled and the central bank will increase its auctions of cash to banks as needed. While markets have improved, they remain ‘far from normal,’ Bernanke said… ‘We stand ready to increase the size of the auctions if further warranted by financial developments.’”

May 13 – Bloomberg (Craig Torres and Margot Habiby): “Central bankers face a ‘major challenge’ in containing inflation… Federal Reserve Bank of Kansas City President Thomas Hoenig said… ‘Inflation has increased’ to levels that are ‘unacceptable… There is a real danger that the psychology around inflation is beginning to change.’”

May 15 – Financial Times (Bertrand Benoit and James Wilson): “One market bubble may be an accident; two in the space of a decade begins to look like carelessness. After the internet bubble that burst in 2000, and last year’s collapse of a credit and house price bubble, every sane central banker around the world must surely think again about whether to act against over-exuberant asset prices. That the US Federal Reserve is looking at this topic is welcome - but the correct conclusion is still far from clear. The past couple of decades have seen a growing international consensus about monetary policy: central banks should be independent, their goal should be low but stable inflation, and they should use interest rates to achieve it. But as to what central banks should do about asset price bubbles - which damage economic growth and stability when they burst - controversy still rages.”

May 14 – Financial Times (Krishna Guha): “The US Federal Reserve is reconsidering the way it deals with asset price bubbles in the wake of the housing and credit bust, in a move that could see the central bank using extra regulation - or even interest rates - to fight unjustified increases. Top officials are re-examining the Alan Greenspan doctrine that central banks should not try to tackle asset bubbles and should focus on mitigating the fallout when they burst. They are open to the possibility that the Fed might have to adopt a different approach in future, deploying either interest rates or more likely enhanced regulatory powers to put the brake on emerging bubbles. However, they have not reached any conclusions yet and could end up reaffirming their traditional hands-off stance.”
Mortgage Finance Bubble Watch:

May 14 – Financial Times (Paul J Davies): “Piggy-back mortgage loans used in the US by some borrowers to act as deposits on home purchases are seeing such poor performance that the majority of bonds backed by such loans have been downgraded, according to Moody’s… ‘Moody’s now expects 2005 vintage subprime second lien loan pools to lose 17% on average, 2006 vintage pools to lose 42% on average, and 2007 pools to lose 45% on average… In a worse-case scenario, Moody’s is projecting loss rates for 2006 and 2007 of 67% and 64% respectively.”
Real Estate Bubble Watch:

May 13 – Bloomberg (Kathleen M. Howley): “Housing prices fell in two-thirds of U.S. cities in the first three months of the year as a rise in foreclosures depressed property values and home sales tumbled 22%, the National Association of Realtors said. The median price for a single-family home fell in 100 of 149 metropolitan areas studied…”

May 14 – Bloomberg (Dan Levy): “U.S. foreclosure filings climbed 65 percent and bank seizures more than doubled in April from a year earlier as rates on adjustable mortgages increased and vacated homes added to a glut of unsold homes, RealtyTrac Inc. said. More than 243,300 properties, or one in every 519 households, were in some stage of foreclosure… California and Florida had the highest rates. Filings rose 4% from March. Properties in foreclosure ‘contribute to already bloated inventories of homes for sale, and put downward pressure on home values,’ RealtyTrac Chief Executive Officer James Saccacio said… The collapse of the U.S. housing market, the worst since the Great Depression, is contributing to the economic slowdown… Median prices for a single- family home fell 7.7% in the first quarter, the biggest drop in 29 years… There were 4.06 million U.S. homes for sale at the end of March, 40,000 more than the prior month… ‘Inventory levels have soared to unprecedented levels’ Brian Fabbri, chief North American economist for BNP Paribas, said… ‘Builders and homeowners have to lower their prices significantly to sell that inventory out.’”

May 14 – RealtyTrac: “…Foreclosure filings default notices, auction sale notices and bank repossessions were reported on 243,353 properties, a 4% increase from the previous month and a nearly 65% increase from April 2007… Although only about 2% of households nationwide are in foreclosure, these properties contribute to already bloated inventories of homes for sale, and put downward pressure on home values. Areas of California, Florida, Nevada and Arizona continue to be particularly hard-hit. Property tax bases are eroding, putting municipal budgets in peril…”
GSE Watch:

May 14 – Bloomberg (Dawn Kopecki): “Freddie Mac…posted a loss that was narrower than analysts estimated and said it will raise $5.5 billion in capital to help overcome rising credit costs… Accounting changes had a ‘significant positive effect,’ and helped reduce losses from rising delinquencies, Freddie Mac said… One accounting rule change, called FAS 157, which allows companies to estimate a value on holdings that aren’t traded, reduced some credit losses by $1.3 billion, Freddie Mac said. Another, FAS 159, lets companies pick and choose which financial assets and liabilities to measure at fair value on a recurring basis, added $1 billion to retained earnings. ‘What that gets us to is something that more closely reflects what we believe the underlying economics are,’ Chief Financial Officer Anthony Piszel said… ‘It really conveys better what’s going on. It also serves to protect our capital base, which then enables us to be more active in deploying capital to grow our business.’”
Muni Watch:

May 16 – Bloomberg (Adam L. Cataldo): “U.S. states owe at least $400 billion for health-care and other benefits promised to retired government employees, Standard & Poor’s said… The total from 41 states surveyed doesn’t include an additional $371 billion owed to worker pension plans, S&P said… States’ benefits liabilities are rising as retirees live longer and health-care costs increase. At least 25 states face budget shortfalls of as much as $40 billion for the 2009 fiscal year, according to… Center on Budget and Policy Priorities…”
California Watch:

May 15 – Reuters (James Saft): “As it did when the housing bubble began to burst, California is leading the way in the next leg: a consumer bust. Squeezed by rising unemployment, inflation in food and energy costs and plunging home values, Californians are cutting back on spending. Besides causing woes for state and local government, the cutback is giving California's economy another knock and makes further job losses, home repossessions and banking problems more likely. The figures are pretty bad. The median home price has fallen by 29% in the year to March… and repossessions are increasing. Unemployment hit 6.2% in March, up 1.2 percentage points from the same month last year. But most important, in the 10 months to the end of April, sales tax receipts in California are actually down in absolute terms.”

May 14 – Bloomberg (Michael B. Marois): “California Governor Arnold Schwarzenegger, citing an economy squeezed by the worst housing slump in 26 years, said the state must borrow $15 billion or raise taxes to close a widening deficit in the next fiscal year. Schwarzenegger… said borrowing against future lottery profits is the best alternative to raising taxes to eliminate a deficit that he said will exceed $17 billion by July 1. The plan would need voter approval in November. If voters reject it or if it falters, he said he will seek a temporary, 1 cent increase of the state’s 7.25% sales tax… ‘Our crisis is real, and it is very serious… As the deficit grew, I also knew we couldn’t make it with cuts alone, and we need additional revenue and that we need to get creative.’”

May 14 – Bloomberg (Ryan Flinn): “Northern California's East Bay Municipal Utility District passed its first water-rationing resolution in 16 years, asking residents and businesses to conserve as drought saps reservoir levels… The district, with 1.3 million customers in a 325-square- mile area on the eastern bay of San Francisco, encompasses the cities of Berkeley and Oakland… ‘This is the worst situation we’ve seen in almost 20 years,’ McCrea said.”
Speculator Watch:

May 15 – Financial Times (Martin Arnold): “The president of Intel Capital, one of the biggest venture capital investors, has warned that his industry is on the brink of another dangerous asset price bubble, particularly in so-called ‘cleantech’ environmentally friendly technologies. Arvind Sodhani told the Financial Times…: ‘The biggest challenge for venture capital companies is when valuations get out of whack - this always ends in pain, and we’ve started to see a little bit of that in the recent past. ‘It is particularly the case in cleantech/greentech. These areas are hugely overvalued for their fundamentals… Mr Sodhani compared the rush to invest in areas such as solar power and waste management to the overheating of the internet boom, when venture capitalists were burnt by hundreds of failed investments after the dotcom bubble burst.”
Crude Liquidity Watch:

May 14 – Bloomberg (Alex Nicholson): “Russia’s foreign currency and gold reserves, the world’s third largest, rose to a record $536.8 billion, the central bank said.”

May 12 – Bloomberg (Ayesha Daya): “Costs to build Dolphin Energy Ltd.’s pipeline carrying Qatari gas to the United Arab Emirates reached $4.8 billion, 37% higher than previously expected.”

A Red Herring

There was a flurry of media interest this week in the issue of central banking and asset Bubbles. Federal Reserve governor Frederic S. Mishkin’s gave a speech yesterday, “How Should We Respond to Asset Price Bubbles?” This morning’s Wall Street Journal ran front-page with Justin Lahart’s article, “Bernanke’s Bubble Laboratory”. Also today, the Financial Times’ Krishna Guha penned an extensive piece “Troubled by Bubbles: central bankers re-examining the hands-off approach,” one of several thoughtful FT pieces on the issue this week.

From Ms. Guha’s article: “In the aftermath of the dotcom crash in 2002, Alan Greenspan famously argued that central banks had little power to stop bubbles inflating and then bursting. All policymakers could do, said the then Federal Reserve chairman, was to ‘focus on policies to mitigate the fallout when it occurs’. His most vocal supporter was Ben Bernanke, then a Fed governor. As an academic, Mr Bernanke had championed the view that central banks should ignore asset prices except insofar as they affect forecasts for inflation and growth. ‘Even putting aside the great difficulty of identifying bubbles in asset prices, monetary policy cannot be directed finely enough to guide asset prices without risking severe collateral damage,’ he said in 2002.”

Professor Mishkin’s speech offered at best only a flicker of hope that the Federal Reserve is moving away from failed Greenspan/Bernanke doctrine: “Financial history reveals the following typical chain of events: Because of either exuberant expectations about economic prospects or structural changes in financial markets, a credit boom begins, increasing the demand for some assets and thereby raising their prices. The rise in asset values, in turn, encourages further lending against these assets, increasing demand, and hence their prices, even more. This feedback loop can generate a bubble, and the bubble can cause credit standards to ease as lenders become less concerned about the ability of the borrowers to repay loans and instead rely on further appreciation of the asset to shield themselves from losses. At some point, however, the bubble bursts. The collapse in asset prices then leads to a reversal of the feedback loop in which loans go sour, lenders cut back on credit supply, the demand for the assets declines further, and prices drop even more. The resulting loan losses and declines in asset prices erode the balance sheets at financial institutions, further diminishing credit and investment across a broad range of assets.”

I was encouraged that the terminology “structural changes in financial markets,” “Credit booms,” and “feedback loops” were included in the initial paragraphs of Mishkin’s paper. This, presumably, would have had the analysis at least heading in the right direction. Yet the inclusion of Credit matters turned out to be little more than analytical palliative. Today, Fed policymakers have no choice but to concede that underlying Credit conditions are an issue. Meanwhile, they appear content to take the tack that not all Bubbles are created equal; that some are more impacted by Credit than others; that some are associated with more financial system risk than others – and, at the end of the day, it’s impossible for the Fed to recognize and differentiate among them until after they have burst. Scant real progress has been made.

The conclusions from Professor Mishkin’s paper differ only subtly from previous doctrine: “First, not all asset price bubbles are alike. Asset price bubbles that are associated with credit booms present particular challenges, because their bursting can lead to episodes of financial instability that have damaging effects on the economy. Second, monetary policy should not try to prick possible asset price bubbles, even when they are of the variety that can contribute to financial instability. Just as doctors take the Hippocratic oath to do no harm, central banks should recognize that trying to prick asset price bubbles using monetary policy is likely to do more harm than good. Instead, monetary policy should react to asset price bubbles by looking to the effects of asset prices on employment and inflation, then adjusting policy as required to achieve maximum sustainable employment and price stability… Third, because asset price bubbles can arise from market failures that lead to credit booms, regulation can help prevent feedback loops between asset price bubbles and credit provision. Our regulatory framework should be structured to address failures in information or market incentives that contribute to credit-driven bubbles.”

Such an “academic” approach will bear little fruit. Clearly, all the theorizing in the world will have no impact whatsoever on the burst technology and mortgage finance/housing Bubbles. There are, however, present-day issues of pressing vital concern. First of all, if a new regulatory approach is central to combating “episodes of financial instability”, I strongly suggest Professor Mishkin and the entire Bernanke Fed move immediately toward assuming GSE oversight (which they will avoid like the plague). Fannie, Freddie, and the FHLB have in total increased their “businesses” by over $900bn during the past year - and have been getting geared up to move full speed ahead. The GSE’s top regulator, commenting on CNBC back in March, stated that Fannie and Freddie “could do over $2.0 Trillion in business this year if the market needs that money.” That was a blaring warning that “regulation” will remain a major part of the problem.

I’ll posit this evening that the entire issue of “central bankers vs. asset Bubbles” has become little more than A Red Herring. While it is as of yet too early in the unfolding financial and economic crisis for “consensus opinion” to have reached a similar conclusion, in reality contemporary monetary management can already be proclaimed an unmitigated failure. Cloaked in ideology and a flawed conceptual framework, the Greenspan/Bernanke Fed sat idly by as history’s greatest Credit inflation and myriad resulting Bubbles irreparably damaged the underlying structure of the U.S. Credit system and real economy (before going global). And while the Fed executes its latest round of post-asset Bubble “mop up,” precarious Credit Bubble dynamics are left to run similar roughshod through global financial and economic systems. Better to downplay the asset Bubble issue for now, as we contemplate the nature of what will be a much altered post-Global Credit approach to central banking.

From Mishkin: “The ultimate purpose of a central bank should be to promote the public good through policies that foster economic prosperity. Research in monetary economics describes this objective in terms of stabilizing both inflation and economic activity. Indeed, these objectives are exactly what is embodied in the dual mandate that the Congress has given the Federal Reserve.”

In no way do I believe “the ultimate purpose of a central bank” is to “foster economic prosperity,” and I certainly don’t expect any such grandiose mandates to survive in the post-Bubble environment. On many levels the notion that central bank policies are instrumental in creating prosperous economic conditions is problematic. For one, it grossly over promises in regard to the long-term benefits derived from the government's manipulation of interest-rates. Secondly, it virtually guarantees an accommodative policy regime and, inevitably, a strong inflationist bias. Thirdly, such a nebulous objective invites overly discretionary policymaking, along with an activist and experimental approach to monetary management. Fourthly, such an approach ensures that policymaking errors beget greater and compounding errors.

From Mishkin: “After a bubble bursts and the outlook for economic activity deteriorates, policy should become more accommodative. …If monetary policy responds immediately to the decline in asset prices, the negative effects from a bursting asset price bubble to economic activity arising from the decline in wealth and increase in the cost of capital to firms and households are likely to be small. More generally, monetary policy should react to asset price bubbles by looking to the effects of such bubbles on employment and inflation, then adjusting policy as required to achieve maximum sustainable employment and price stability.”

This passage, in particular, goes right to the heart of several key failings of current doctrine. The entire framework of ignoring asset Bubbles when they are expanding and “mopping up” when they burst is a recipe for disastrous policy mistakes. And how was this not made unmistakably clear when the post-tech Bubble “mop up” stoked the fledgling Mortgage Finance and Housing Bubbles?

The problem with post-asset Bubble “accommodation” is that it specifically accommodates the very Credit infrastructure and related Monetary Processes that financed the preceding boom. It works to validate the present course of financial innovation (think “Wall Street securitizations,” “CDOs” and “carry trades”), while emboldening those at the cutting edge of risk-taking (think “leveraged speculating community”). To be sure, the same Wall Street Credit infrastructure that financed the tech Bubble was empowered to regroup, reemerge, and aggressively expand to grossly over-finance much more expansive Credit and speculative booms in mortgage-related securitizations and housing. These days, powerful forces have been unleashed to over-finance the world.

Moreover, a commitment to aggressively cut rates in response to faltering asset Bubbles openly courts leveraged bond market speculation – a market dynamic that especially engenders artificially low market yields and exacerbates liquidity excess during the late-stage of asset bubbles (think bond market “conundrum”). The last thing a central bank should encourage is an entire industry dedicated to placing leveraged bets on the direction of Federal Reserve policy responses. A strong case can be made that U.S. Treasury and agency markets have become one massive Bubble.

The overriding flaw in the Greenspan/Bernanke approach has been to openly disregard Credit Bubble dynamics, in particular the increasingly profound role played by Wall Street-backed finance in fueling Credit, market liquidity and speculative excesses. I believe The Ultimate Objective of a Central Bank is to Foster Monetary Stability in the broadest sense. In this regard, asset Bubbles should be viewed primarily as important indicators of some type of underlying Monetary Disorder. The key analytical focus must be on the underlying Credit and speculative dynamics fueling the asset price distortions – to better understand and rectify the source of “disorder” – and the earlier, the better.

The most dangerous policy approach is to further incentivize a system that has already demonstrated a proclivity for Credit and speculative excess – employment, output and “deflation” concerns notwithstanding. And never ever succumb to the temptation of using the leveraged speculators as a mechanism for stimulating the markets, the Credit system and the real economy. In this regard, contemporary finance has created an especially seductive trap for policymakers.

Greenspan, Bernanke, Mishkin and others repeatedly stress the inability of policymakers to recognize the existence of a Bubble until after it pops. It is my view that the entire notion of asset prices dictating monetary policy is flawed. The focus should instead be on the underlying sources of monetary fuel – the Credit growth and financial flows underpinning asset inflation and spending boom. In the case of the technology Bubble, the Fed should have been focused on the massive issuance of telecom junk debt and leveraged loans, the fledgling CDO and “structured Credit products” markets, NASDAQ and NYSE margin debt, derivative-related leveraging, and the enormous speculative flows over-financing the industry boom. The unfolding Mortgage Finance Bubble was conspicuous as early as 2002, with the onset of annual double-digit mortgage Credit growth and the rapid expansion of Wall Street mortgage-related securitizations and derivatives.

Central bankers can and should avoid being in the difficult position of having to respond directly to inflating asset markets. Instead, there must be carefully fashioned, communicated and administered “rules of the game”. To begin with, it is incumbent upon the Fed to clearly articulate to the public (and their elected officials) the overwhelming benefits of stable Credit and financial conditions. It must be conveyed that Credit and speculative excesses are destabilizing, fostering boom and bust dynamics and structural impairment. The public must come to appreciate that the effects of destabilizing Credit inflation come in many forms, including asset price inflation and Bubbles, Current Account Deficits, currency debasement, traditional consumer price inflation, and various distortions to underlying Financial and Economic Structures.

The Fed could then take a more active role in supervising and regulating system Credit within some predetermined parameters – a “rules-based” as opposed to discretionary approach to monetary policymaking. For example, if total mortgage Credit exceeded some threshold, say 5% or 6% annualized, the Fed would have a mandate to move to restrain at the margin real estate lending (through various means, including increased reserve and capital requirements, higher interest rates and other punitive measures). Ditto for corporate and public sector debt growth. Specific margin lending limits would be enforced, and derivative and securities leveraging strategies would be closely monitored and regulated as necessary. Similarly, Credit growth beyond some predetermined threshold – albeit Bank Credit, broker/dealer liabilities, finance company borrowings, securitizations, etc. – would elicit a meaningful rebuke from monetary policy. The punchbowl would be closely guarded. There would be general parameters for major sectors, as well as for total system Credit growth.

I expect the idea of the Fed regulating Credit to be unappealing to many if not most. I offer it as food for thought. It is, after all, my strong belief that Unconstrained Credit and Speculation are the Bane of Free-Market Capitalism. For the Economic Sphere to remain generally unencumbered dictates a somewhat encumbered Financial Sphere. Unfortunately, radical and ill-conceived government intrusion into all aspect of our financial and economic lives will be the likely post-Bubble reality.

I was compelled to share some thoughts with respect to the “asset Bubble” debate. Actually, the subject matter is now little more than a distraction from more pressing Credit and pricing issues. Somewhat strangely, U.S. asset inflation is no longer the overriding concern. Instead, I ponder the ongoing issue of the current extraordinary financial backdrop: a global economy that continues to operate in a unique environment without a functioning monetary regime. There is no mechanism – gold standard, Bretton Woods, or otherwise – to in anyway limit the quantity or quality of global financial claims inflation. It has become full-fledged unfettered “wildcat” finance unlike anything the world has ever experienced.

It is tempting to fixate on the asset Bubble issue. Yet a more pressing need is for the Federal Reserve and global central bankers to begin working towards the implementation of some type of functioning monetary “regime,” with the intention of returning some semblance of order to international finance. And similar to anticipating new U.S. central banking doctrine, one can bet confidently that change will not arrive ahead of “post-Bubble impetus”. No doubt about it, Heightened Monetary Disorder - the cost associated with the Fed’s U.S. Credit system bailout - is increasingly on display. Destabilizing speculation is returning with a vengeance, and it’s anything but limited to commodities markets.