Saturday, November 8, 2014

Weekly Commentary, August 170, 2012: The Winding Down of Fannie and Freddie

The Dow Jones Industrial Average closed this week at its highest level since December 2007. The S&P 500 trades only 10% below its 2007 high. The S&P 400 Mid-Cap index is just 4% below its all-time high (April 2011). The Morgan Stanley Retail Index is up 14% so far in 2012 and rests only 3.7% below its record high (March 2012). The small cap Russell 2000 is 5.2% below its all-time high (April 2011). While still some distance from 2000 Bubble peaks, the Nasdaq100 sports a 2012 y-t-d gain of 22% and the Morgan Stanley High Tech is up better than 17%. Near record debt issuance has corporate Credit poised for its strongest growth since 2007 (Q1 7.2% growth rate). At almost $30bn, junk bond issuance so far this month is already an August record and compares to the 5-year average for the month of $8.4bn.

My thesis has been one of a historic global Credit Bubble and financial mania. For the past 18 months, Europe has been the focal point of my and others’ macro analysis. I’ve viewed the Greek debt crisis eruption as the first crack in the “global government finance Bubble.” Not unexpectedly, aggressive policy responses have done little to resolve the steady downward debt spiral in Europe. As the crisis that began at Europe’s periphery methodically engulfed the core, confidence in the sustainability of euro monetary integration began to falter. Structural flaws and deep political fissures have been exposed. Confidence in the European banking system has waned. The resulting severe tightening of financial conditions and weakening economies are having an increasing global impact, especially on the overheated “developing” economies. Europe has been at the precipice of unleashing a historic global financial and economic crisis.

At the same time, the U.S. these days remains firmly immersed in its Credit Bubble, fueled predominately by Washington-based debt, federal guarantees and monetary distortions. Somewhat ironically, the European crisis has worked to exacerbate U.S. Bubble excess, as Treasury bond and market yields have sunk to record lows. While risk aversion and the tightening in global financial conditions have repeatedly threatened U.S. shores, the bottom line is that Credit conditions here have remained extraordinarily loose. With Europe in somewhat of a late-summer crisis respite, I’ll take the opportunity to focus on U.S. Bubble dynamics.

When Europe is unraveling, global de-risking/de-leveraging market dynamics are in command, and U.S. confidence is waning - the feeble U.S. recovery becomes immediately susceptible to recessionary forces. Not irrationally, market attention quickly returns to the Fed’s itchy QE trigger finger. Yet, a few weeks of potent “risk on” have an impact: things start to look different and not particularly deflationary. Crude oil is back above $96, the housing recovery appears on track, spending looks resilient and the U.S. stock market is posting boom-time gains. Suddenly, the case for additional quantitative easing seems really weak. The bond market gets fidgety.

The Standard and Poor’s 500 Homebuilding index sports a y-t-d gain of 71% and a 52-wk rise of 123%. July Building Permits were reported at a four-year high, although they remain at less than half of boom-time levels. Yet housing fundamentals have clearly improved. An increasing number of locations are again enjoying strong price appreciation, with froth returning to scattered markets. Given sufficient time, incredibly low mortgage rates will work their magic.

The consensus view holds that the worst of the housing crisis is fading into history. Friday, from the Treasury Department’s Michael Stegman: "With today's announcement, we are taking the next step toward responsibly winding down Fannie Mae and Freddie Mac, while continuing to support the necessary process of repair and recovery in the housing market.” The plan is to push forward with the shrinking of Fannie and Freddie’s balance sheets. This implies real reform, with reduced reliance on these troubled institutions and less exposure burdening the U.S. taxpayer (federal bailout $190bn and counting).

Truth be told, Fannie, Freddie, and the American taxpayer and economy will remain highly exposed to mortgage Credit risks for many years to come. While GSE mortgage holdings (and balance sheets) have been somewhat reduced, exposure to mortgages they’ve insured remains at near-record levels. Fannie’s “Total Book of Business” (mortgages held in the portfolio and MBS insured) ended June at $3.183 TN, little changed for 2012 and down only about 2% from the March 2010 high. Across town at Freddie Mac, total mortgage exposure remains above $2.0 TN, down only 10% from record highs. It is also worth noting that FHA guarantees have increased dramatically since the 2008 crisis to exceed $1.0 TN. I’ve argued that there will be “no exit” from Federal Reserve “easy money,” and there will similarly be “no exit” from federal control over mortgage Credit.

The virtual nationalization of U.S. mortgage Credit in concert with incredible monetary stimulus has ensured the ongoing availability of inexpensive mortgage Credit. Fannie, Freddie and the FHA – key players in the Mortgage Finance Bubble – are today important participants in the Government Finance Bubble. There will be huge future costs, but for now housing and the economy enjoy the stimulus. And while mortgage Credit in aggregate remains stagnant, there are indications of typical problematic excesses spurred by mispriced finance.

I have posited that today’s Bubble is the latest in a series of Fed-accommodated bouts of Credit and speculative excess. And as each successive Bubble grows larger and more systemic, the effects actually become less conspicuous. The technology Bubble was rather obvious, although the greatest associated excesses were more generally contained (i.e. Internet/technology stocks, telecom debt, California incomes and real estate). The mortgage finance Bubble was much less conspicuous until the arrival of the more egregious late-cycle price and construction excesses. Few appreciated how Trillions of new mortgage debt were inflating incomes, spending, and corporate profits, while covertly distorting the economic structure. Today, it seems that virtually no one recognizes how Government Finance Bubble excesses inflate incomes, spending, profits, state & local government receipts, and equities and bond prices.

In the five years 2003 through 2007, total mortgage debt increased about $6.2 TN, or almost 75%. This historic Credit expansion saw National Income inflate $3.0 TN, or 32%, to $12.4 TN, with Total Compensation increasing 29% to $7.9 TN. Corporate profits (before tax) surged 128% to $1.74 TN. The 2009 recession saw a one-year 3.7% decline in National Income, a 3.2% fall in Total Compensation, and a 22% drop in profits. But unprecedented Washington stimulus was immediately forthcoming.

In the 15 quarters June 30, 2008 to March 31, 2012, Treasury debt increased almost $5.6 TN, or 106%, to $10.828 TN. This massive inflation of government Credit, in concert with Federal Reserve rate cuts and monetization, reflated system price levels that in 2009 had commenced a problematic downward spiral. Indeed, National Income jumped 4.5% in 2011 to a record $13.421 TN, after increasing 5.7% in 2010. After gaining 4.0% in 2010 and 3.3% in 2011, Total Compensation has also grown to record levels. Corporate profits have inflated to record levels after increasing 25% in 2010 and another 4% in 2011. As bullish analysts extrapolate corporate profit growth, U.S. stock prices appear “cheap” after doubling from 2009 lows.

The key has been that overall system Credit resumed its historic expansion. While down from 2007’s 8.4% growth rate, U.S. Non-Financial Credit still increased 5.9% in 2008, 3.1% in 2009, 4.1% in 2010 and 3.6% in 2011. It didn’t really matter that the vast majority of 2009-2011 growth originated from Treasury debt. Massive Washington stimulus was able to sustain inflated price levels throughout much of the economy – perhaps not home prices, but definitely system incomes, spending, GDP, and profits, while state & local receipts bounced back to, and in many case surpassed, pre-crisis levels.

There was a school of thought coming out of the bursting of the technology Bubble that a jump in mortgage Credit growth was necessary to help ward off dangerous deflationary forces. And, predictably, once the mortgage finance Bubble gained momentum no one was willing to take away the punchbowl. Today, our policymakers are using government finance to inflate system Credit and price levels, and are again willing to tolerate excesses that will only become more unwieldy over the life of this latest Bubble. Somehow, the Fed’s biggest concern is the timing of its next spike to the punchbowl.

From Bloomberg: (Sarika Gangar, August 16): “Sales of junk bonds in the U.S. have already set a record for August… Charter Communications Inc., the cable-TV provider that emerged from bankruptcy in 2009, and Energy Future Holdings Corp., the Texas power producer struggling with $36.6 billion of long-term debt, are among companies that have sold $29.6 billion of speculative-grade securities this month. That compares with an average $8.4 billion in August sales for the past five years… Companies are tapping into an unprecedented $44.9 billion of cash that has poured into funds that buy junk bonds in 2012 as the fourth year of near-zero short-term interest rates prompts investors to put their money into higher-yielding assets. Issuance accelerated even as the pace of earnings at speculative-grade companies slowed in the second quarter… ‘It has become such a feeding frenzy,’ Bonnie Baha, who helps oversee $40 billion as head of global developed credit at DoubleLine Capital… said… ‘It’s almost like credit fundamentals don’t even matter in markets like this. You’ve got too many dollars chasing too few bonds.”

Today from the Financial Times, “The Danger of Getting Hooked on Junk Bonds” and “Debt Dealers Await Move From Greed to Fear.” This week from Bloomberg: “Morgan Stanley Leading Long-Bond Sales to Record.” From the Wall Street Journal: “As Corporate-Bond Yields Sink, Risks for Investors Rise.” And from the New York Times: “Muni Bonds Not as Safe as Thought,” and “Risk Builds as Junk Bonds Boom.” Current excesses certainly go well beyond junk. With record issuance and market prices that make little sense, Bubble excess is increasingly conspicuous throughout the entire fixed income complex. To be sure, the Fed-induced yield chase has created historic price distortions from Treasury bonds to corporates to municipal debt.

From Bloomberg: (Brian Chappatta and Tim Jones, August 16): “Illinois has set aside only 45% of what it needs to meet public-worker pension obligations, the worst of any U.S. state. Standard & Poor’s may cut its bond rating if lawmakers don’t come up with a fix tomorrow. Investors are unfazed. The fifth-most populous state’s unfunded pension liability is growing by an estimated $12.6 million a day… Yet the penalty on general-obligation bonds from issuers in Illinois, relative to top-grade debt, fell to 1.51 percentage points last month, the lowest since February 2011…”

Over the years, I’ve noted how the Credit Bubble saw annual non-financial debt growth increase from about $650bn in the mid-nineties to surpass $2.0 TN by 2004. This enormous Credit expansion inflated price levels throughout the entire economy, with non-financial Credit growth peaking at 2007’s $2.5 TN. Non-financial Credit growth dropped to $1.1 TN in 2009, before bouncing back somewhat in 2010 and 2011. Importantly, however, growth appears to have more recently jumped back to the $1.8 TN range. Such Credit growth implies that an inflationary bias is quietly regaining a foothold in the U.S. economy.

“Risk on” has seen 10-year Treasury yields jump 40 bps off July 24 lows to 1.81%. The way things are unfolding, the placid Treasury market might turn into rather treacherous waters. I expect Draghi’s Plan to be yet another European disappointment. “Risk off” waits patiently. But it’s also apparent that over-liquefied U.S. securities markets have turned highly speculative. An enduring “risk on” backdrop could easily see things get out of hand. Amazingly, as the signs of excess become increasingly apparent, the Fed apparently remains ready with additional monetary stimulus. It’s going to be an interesting fall.

For the Week:

The S&P500 increased 0.9% (up 12.8% y-t-d), and the Dow gained 0.5% (up 8.7%). The broader market outperformed. The S&P 400 Mid-Caps rose 1.7% (up 11.2%), and the small cap Russell 2000 jumped 2.3% (up 10.7%). The Morgan Stanley Cyclicals jumped 2.2% (up 10.4%), and the Transports rose 2.6% (up 3.4%). The Morgan Stanley Consumer index added 0.7% (up 8.0%), while the Utilities fell 1.6% (up 1.6%). The Banks increased 1.4% (up 20.0%), and the Broker/Dealers gained 0.9% (down 2.9%). The Nasdaq100 was up 2.1% (up 22.1%), and the Morgan Stanley High Tech index gained 1.4% (up 17.3%). The Semiconductors slipped 0.2% (up 11.2%). The InteractiveWeek Internet index jumped 2.1% (up 13.1%). The Biotechs increased 0.4% (up 32.8%). While bullion slipped $4, the HUI gold index gained 1.1% (down 12.8%).

One-month Treasury bill rates ended the week at 9 bps and three-month bills closed at 8 bps. Two-year government yields were up 2.5 bps to 0.29%. Five-year T-note yields ended the week 9 bps higher at 0.80%. Ten-year yields jumped 16 bps to 1.81%. Long bond yields surged 18 bps to 2.93%. Benchmark Fannie MBS yields rose 20 bps to 2.58%. The spread between benchmark MBS and 10-year Treasury yields widened 4 bps to 77 bps. The implied yield on December 2013 eurodollar futures increased 4.5 bps to 0.54%. The two-year dollar swap spread was unchanged at 21 bps, and the 10-year dollar swap spread was unchanged at 11 bps. Corporate bond spreads narrowed. An index of investment grade bond risk declined 3 to 100 bps. An index of junk bond risk fell 8 to 541 bps.

Debt issuance remained quite strong. Investment grade issuers included JPMorgan Chase $2.5bn, Philip Morris $2.25bn, American Express $2.0bn, Liberty Mutual $1.5bn, Continental Resources $1.2bn, Duke Energy $1.2bn, Thermo Fisher $800 million, Pacific Gas & Electric $750 million, International Lease Finance $750 million, Blackstone $650 million, Burlington Northern $650 million, Moody's $500 million, Broadcom $500 million, Mississippi Power $450 million, Ameren Illinois $400 million, Ryder Systems $350 million, and Appalachian Power $275 million.

Junk bond funds saw inflows slow to $378 million (from Lipper). The bevy of junk issuers included Davita $1.25bn, General Motors $1.0bn, Tronox $900 million, Caesars $750 million, ServiceMaster $750 million, Concho Resources $700 million, Belden $700 million, Univision Communications $625 million, Penske Auto Group $550 million, Graton Economic Development Authority $450 million, Scientific Games International $300 million, Media Broadband $300 million, American Gilsonite $260 million, Legend $250 million, Live Nation Entertainment $225 million, Unisys $210 million, and Taylor Morrison $125 million.

I saw no convertible debt issued.

International dollar bond issuers included Rio Tinto $3.0bn, Shell $2.5bn, Cenovus Energy $1.25bn, Kommunalbaken $900 million, and ICICI Bank $750 million.

Spain's 10-year yields ended the week down 46 bps to 6.39% (up 135bps y-t-d). Italian 10-yr yields declined 12 bps to 5.76% (down 127bps). German bund yields rose 11 bps to 1.49% (down 33bps), and French yields increased 6 bps to 2.12% (down 102bps). The French to German 10-year bond spread narrowed 5 bps to 63 bps. Ten-year Portuguese yields fell 18 bps to 9.38% (down 339bps). The new Greek 10-year note yield rose 16 bps to 23.55%. U.K. 10-year gilt yields jumped 13 bps to 1.67% (down 31bps). Irish yields were up 2 bps to 5.84% (down 242bps).

The German DAX equities index gained 1.4% (up 19.4% y-t-d). Spain's IBEX 35 equities index surged another 7.3% (down 11.7%), and Italy's FTSE MIB gained 3.8% (up 0.2%). Japanese 10-year "JGB" yields increased 3 bps to 0.83% (down 16bps). Japan's Nikkei gained 3.1% (up 8.4%). Emerging markets were mixed but for the most part notably unimpressive. Brazil's Bovespa equities index slipped 0.3% (up 4.1%), and Mexico's Bolsa declined 0.7% (up 9.4%). South Korea's Kospi index was unchanged (up 6.6%). India’s Sensex equities index added 0.8% (up 14.5%). China’s Shanghai Exchange dropped 2.5% (down 3.8%).

Freddie Mac 30-year fixed mortgage rates rose 3 bps to 3.62% (down 53bps y-o-y). Fifteen-year fixed rates increased 4 bps to 2.88% (down 48bps). One-year ARMs were up 4 bps to 2.69% (down 17bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates unchanged at 4.22% (down 69bps).

Federal Reserve Credit increased $4.8bn to $2.840 TN. Fed Credit was down $8.6bn from a year ago, or 0.3%. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 8/15) increased $9.8bn to a record $3.546 TN. "Custody holdings" were up $126bn y-t-d and $67bn year-over-year, or 1.9%.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $396bn y-o-y, or 3.9% to a record $10.532 TN. Over two years, reserves were $1.984 TN higher, for 23% growth.

M2 (narrow) "money" supply dropped $17.8bn to $10.018 TN. "Narrow money" has expanded 6.4% annualized year-to-date and was up 6.1% from a year ago. For the week, Currency increased $1.2bn. Demand and Checkable Deposits declined $16.8bn, while Savings Deposits added $0.6bn. Small Denominated Deposits declined $2.6bn. Retail Money Funds slipped $0.3bn.

Total Money Fund assets rose $12bn to $2.574 TN. Money Fund assets were down $121bn y-t-d and $57bn over the past year, or 2.2%.

Total Commercial Paper outstanding rose $6.7bn to $1.020 TN. CP was up $61bn y-t-d, while having declined $126bn from a year ago, or down 11.0%.

Global Credit Watch:

August 14 – Bloomberg (Ben Sills): “Spanish lenders’ net borrowings from the European Central Bank rose to a record 376 billion euros ($465bn) in July as investors shunned the country’s banks… Net average ECB borrowings climbed from 337 billion euros in June… Gross borrowing was 402 billion euros, up from 365 billion euros in June, accounting for 33% of borrowing in the euro region… ‘These banks clearly are having to borrow more from the ECB so that they can continue to buy the debt and this can only go on for so long,’ Peter Chatwell, a fixed-income strategist at Credit Agricole Corporate & Investment Bank in London, said… Spanish lenders are tapping the ECB to finance purchases of government debt as foreign investors dump the bonds binding the sovereign and the banks together.”

August 14 - UK Guardian (Stephen Burgen): “House prices in Spain fell by 11.2% in July, the biggest monthly fall since March last year. Overall prices have fallen by 31% since the financial crisis hit in 2008. Spain has an estimated 2 million unsold homes… The government's decision to raise VAT from 4% to 10% on house purchases as of next year is expected to depress the market still further."

August 15 – Bloomberg (Emma Ross-Thomas): “Spanish Prime Minister Mariano Rajoy risks irking the European policy makers he needs on his side after he extended unemployment benefits to avoid stoking social unrest. Rajoy said yesterday his government will continue to make payments to the long-term unemployed, extending for six months a benefit adopted by his Socialist predecessor three years ago that was due to expire today.”

August 16 – Bloomberg (Emma Ross-Thomas): “Five Spanish autonomous regions will defy the central government and offer health care to immigrants living in Spain illegally, El Pais says. Andalusia, Asturias, Basque Country, Catalonia and Canary Islands will continue to offer universal health care after Sept. 1, when the central government’s limit on health services to undocumented immigrants comes into effect…”

August 13 - Bloomberg (Chiara Vasarri): “Italian government debt reached a record 1.97 trillion euros ($2.42 trillion) at the end of June, the Bank of Italy said today in its public-finances supplement. Italy’s debt rose by 6.6 billion euros in June from the previous month.”

August 14 – Market News International: “The European Central Bank has not reached a consensus on specific conditions that would trigger future bond market interventions, Governing Council member Luc Coene said… Comments by the Belgium National Bank head suggests that hawkish Governing Council members may be pushing to delay out market interventions for as long as possible to keep up pressure on governments. ‘We all agree specific conditions must be met before we can intervene. About those conditions, the ECB board members do have different opinions from time to time,’ Coene said… To avoid public disagreement over bond market interventions undermining their effectiveness, as experienced under the SMP, Draghi may have to ensure that hawkish Council members' desire for tough conditionality will be met. ‘We haven't forgotten what happened in August of last year: We bought Italian bonds and right after that the Italian government reneged on its pledges… The conclusion is clear: When you take away the market pressure, you take away the pressure on politicians to act.’”

August 14 - Bloomberg (Lukanyo Mnyanda): “European Central Bank President Mario Draghi’s pledge to resume sovereign bond purchases has done little to convince Edinburgh’s two biggest money managers that it’s time to buy Italian and Spanish debt. Standard Life Investments and Scottish Widows Investment Partnership, which together manage about $460 billion, say they would rather settle for record low yields from AAA rated Germany and look as far as Australia to seek returns with lower risk… ‘Once the dust settles, it may be that what is announced by the ECB isn’t the breakthrough that we would be looking for,’ said Jack Kelly, who’s responsible for about 6 billion euros ($7.4bn) of government bonds as investment director at Standard Life Investments… ‘An ECB bond-buying program is essentially a palliative rather than a cure.’”

Global Bubble Watch:

August 15 – Financial Times (Vivianne Rodrigues and Michael Mackenzie): “Sales of long-term US corporate debt this week surpassed the entire amount sold in 2011 in what is shaping up as a banner year for long-term funding. This comes as companies… sold a total of $86.3bn in 30-year bonds in the year to date. This compares with overall sales of $84.7bn for 2011, according to Dealogic. Further, the total amount sold so far this year is nearly double the volume sold over the same period last year."

August 16 – Bloomberg (Sarika Gangar): “Sales of junk bonds in the U.S. have already set a record for August, as yields at about record lows combined with a slowdown in earnings growth spark concern the market for the riskiest corporate debt has peaked. Charter Communications Inc., the cable-TV provider that emerged from bankruptcy in 2009, and Energy Future Holdings Corp., the Texas power producer struggling with $36.6 billion of long-term debt, are among companies that have sold $26.8 billion of speculative-grade securities this month. That compares with an average $8.4 billion in August sales for the past five years… Junk-bond offerings in August, typically constrained by U.S. summer holidays, surpassed the previous record of $23.7 billion for the month in 2010… Sales through yesterday were higher than the monthly average of $16.1 billion the past five years and less than the $44.7 billion sold in May 2011, the most in any month. Companies have sold $197 billion of the debt this year.”

August 14 - Bloomberg (Lisa Abramowicz): “Junk-bond buyers are giving up the most yield in seven months to own the biggest, most-easily traded securities as they increasingly hedge their bets that the three-month rally will continue while the global economy slows. Investors are accepting 1.2 percentage points less in yield to own bonds from bigger, newer U.S. high-yield offerings that are more actively traded and easier to dispose of than older, smaller issues, according to Barclays Plc data. The gap… is the most since January and six times the 0.2 percentage-point average since August 2007. High-yield fund managers investing a record $44.9 billion of deposits this year are selecting bonds they can sell more easily if investors start withdrawing the money.”

Germany Watch:

August 17 – Bloomberg (Rainer Buergin): “Chancellor Angela Merkel is considering easing Greece’s bailout terms, fanning tensions with members of her coalition who oppose giving the Greek government any more concessions, two German lawmakers said. Merkel’s government is torn between showing some leniency toward Greece as it struggles to meet the terms of its rescues and insisting that Prime Minister Antonis Samaras deliver on his promises, Klaus-Peter Willsch and Frank Schaeffler… said… ‘The sensitivities among many more than just the 27 coalition members who voted ‘no’ last time are well known’ to Merkel, ‘so the official line is to stay tough’ on Greece, said Willsch, a member of Merkel’s Christian Democratic Union party. ‘But at the same time, some are being sent forward to test the waters on how this tough line can be abandoned.’”

August 17 – Bloomberg (Brian Parkin): “German banks could handle a Greek exit from the euro area, according to Michael Fuchs, deputy parliamentary leader of Chancellor Angela Merkel’s Christian Democratic Union party. ‘A theoretical exit for Greece would be manageable,’ Fuchs told reporters… ‘The exposure at this stage is about 17 billion euros if I’m not mistaken,’ virtually all of it in the public sector, he said.”

August 16 – Dow Jones: “Politicians in Germany's coalition government are demanding greater German influence over decision making at the European Central Bank, German daily Handelsblatt reports… ‘As the main creditor, Germany must have veto power over all decisions,’ said Klaus-Peter Willsch, a parliament member and budget expert in Chancellor Angela Merkel's Christian Democratic Union… German discontent also follows ECB President Mario Draghi's signal that the ECB is prepared to act decisively to buy a sufficient amount of sovereign bonds to bring down yields for crisis-hit members. ‘Under Draghi, the ECB is unfortunately mutating into a financier of sovereign debt and a bad bank, against European treaty law,’ Mr. Willsch said. Frank Schaeffler, finance expert of the CDU's partner in the governing coalition, the Free Democratic Party, also criticized the ECB. ‘The rules are still there on paper, but in practice they have been infinitely destroyed… That Cyprus and Malta have the same vote as Germany is a serious flaw in design,’ he said. A budget expert at the opposition Social Democratic Party, or SPD, also said the ECB should focus on its core mandate of price stability. ‘In no way should the ECB finance sovereign debt, which has already happened indirectly via the purchase of sovereign bonds,’ [said] SPD parliament member Carsten Schneider…”

August 14 – Dow Jones: “The European Central Bank is expressly forbidden from financing public expenditures, and that includes the purchase of government bonds, a former top ECB official said… ‘The ECB is expressly prohibited from financing public expenditures,’ Otmar Issing, the former economist at the ECB told the daily. ‘The ECB is a central bank with the task of keeping the value of money stable. They cannot make up for the failure of politics,’ he added. Earlier this month, ECB President, Mario Draghi, indicated that the bank could soon step in to buy government bonds on the open market and may consider other unconventional measures to lower the high borrowing costs of financially stressed euro-zone economies… Mr. Issing also warned that German tax payers wouldn't stand for sharing liability for debt with other countries in the monetary union, which would raise the interest rates for German government bonds. ‘The associated transfer of money from the German tax payer is not democratically legitimized and is unlikely to meet approval among the population,’ Mr. Issing said.”

Currency Watch:

The U.S. dollar index added 0.1% to 82.60 (up 3.0% y-t-d). For the week on the upside, the euro increased 0.4%, the Swiss franc 0.3%, the Danish krone 0.3%, and the Canadian dollar 0.2%. The British pound, Norwegian krone and Brazilian real were little changed. On the downside, the South African rand declined 2.7%, the Japanese yen 1.6%, the Australian dollar 1.5%, the Singapore dollar 0.8%, the New Zealand dollar 0.7%, the South Korean won 0.3%, the Mexican peso 0.3%, the Swedish krona 0.2% and the Taiwanese dollar 0.1%.

Commodities Watch:

The CRB index increased 0.6% this week (down 0.6% y-t-d). The Goldman Sachs Commodities Index jumped 1.7% (up 3.5%). Spot Gold slipped 0.3% to $1,616 (up 3.3%). Silver dipped 0.2% to $28.09 (up 1%). September Crude jumped $3.14 to $96.01 (down 3%). August Gasoline added 0.8% (up 14%), while September Natural Gas declined 1.8% (down 9%). December Copper rose 0.7% (unchanged). September Wheat declined 1.2% (up 34%), and September Corn slipped 0.2% (up 24%).

European Economy Watch:

August 14 - Bloomberg (Tommaso Ebhardt): “The 204,000-euro Ferrari 458 Italia has never been a particularly common sight, even on the autostrade of its native Italy. Today it’s becoming even rarer as austerity measures spur Ferrari owners to export supercars by the truckload. A crackdown on luxury goods combined with budget cuts that have pushed Italy deeper into its fourth recession since 2001 are souring demand for sporty cars and other symbols of the country’s carefree lifestyle. The number of secondhand high- performance cars exported from Italy nearly tripled to 13,633 vehicles in the first five months of 2012, from 4,923 a year earlier…”

August 16 – Bloomberg (Martijn van der Starre): “The seasonally adjusted unemployment rate in the Netherlands unexpectedly increased to 6.5% in July from 6.3% a month earlier…”

August 14 - Bloomberg (Kasper Viita): “Finland’s economy may have contracted in the second quarter as the European debt crisis weighs on exports in the northernmost euro member. Second-quarter seasonally adjusted gross domestic product shrank 1% from the prior three months, Helsinki-based Statistics Finland said… In the first-quarter, the economy grew 0.8%...”

August 13 - Bloomberg (Simone Meier and Klaus Wille): “Thomas Jordan’s fight to protect the Swiss economy is set to widen beyond currency markets and too- big-to fail risks as the central bank chairman considers how to curb the biggest real-estate boom in two decades. The Swiss National Bank may act to stem what it called risks from ‘excessive credit growth,’ economists from Bank Sarasin to UniCredit Group said."

China Watch:

August 14 – Wall Street Journal (Tom Orlik): “Investors and companies are increasingly pulling money out of China and its currency in a vote of concern over its growth prospects, a development that could hinder Beijing's efforts to spark a turnaround. New data… showed China's banks were net sellers of 3.8 billion yuan ($597 million) in foreign exchange in July, suggesting that China's exporters aren't converting their dollar earnings into yuan and some investors are taking funds out of the country. China's banks have been sellers of dollars in five of the last 10 months, purchasing a paltry 145 billion yuan in foreign exchange over that combined period, considerably less than the 905 billion yuan that flowed into the country through the trade surplus. That is a stark contrast with much of the past decade, when confidence in China's growth and hunger for yuan meant China's banks were buying up not just the entire trade surplus, but also considerable inflows of speculative capital, known as hot money. In the first 10 months of 2008, China’s banks were net purchasers of 3.6 trillion yuan in foreign exchange."

August 16 – Bloomberg: “Foreign direct investment in China fell to the lowest level in two years in July, fueling concern that waning confidence in the nation’s growth prospects may restrain any economic rebound. Investment declined 8.7% from a year earlier to $7.58 billion, the eighth drop in nine months and the smallest inflow since July 2010… Chinese financial institutions sold a net 3.8 billion yuan ($600 million) of foreign currency last month, indicating capital is flowing out as property curbs and weakness in exports slow growth and the yuan weakens… The nation reported a $71.4 billion capital account deficit in April-through-June, the biggest quarterly shortfall in data going back to 1998.”

August 17 – Bloomberg: “China’s banking regulator told lenders to push developers for faster home sales, citing signs that credit quality is worsening, a person with knowledge of the matter said. The China Banking Regulatory Commission told lenders they should also demand more collateral, or tell developers to sell projects or stakes, if the banks predict they’ll have difficulty repaying loans due within 12 months, the person said, asking not to be identified because the instructions aren’t public.”

August 16 – Bloomberg: “China Mobile Ltd., the world’s biggest phone company by subscribers, fell the most in more than a year in Hong Kong trading as profit growth cooled to the slowest annual pace in at least 13 years. Shares closed down 5%, the biggest decline since Aug. 9, 2011… China Mobile had 683.1 million mobile-phone subscribers at the end of June, including 67.1 million users of the high-speed, third-generation service that smartphones use to access the Web…”

India Watch:

August 14 - Bloomberg (Tushar Dhara): “Indian exports fell the most in 35 months in July and the trade deficit widened as Europe’s sovereign-debt crisis hurt overseas demand… Merchandise shipments declined 14.8% to $22.4 billion last month… Imports slid 7.61% to $37.9 billion, leaving a trade deficit of $15.5 billion… The rupee, which has plunged about 18.5% against the dollar in the past year, weakened 0.7% to 55.715 per dollar…”

Latin America Watch:

August 13 - Bloomberg (Matthew Malinowski and David Biller): “Analysts covering Brazil’s economy raised their 2012 inflation forecast for the fifth straight week and cut their growth estimate as price increases show signs of accelerating even as the economy continues to sputter. Brazil’s consumer prices will rise 5.11% in 2012, according to the median estimate… Gross domestic product will expand 1.81%, the economists said, down from last week’s estimate of 1.85%.”

U.S. Bubble Economy Watch:

August 15 – Bloomberg (Barbara J. Powell): “Gasoline at the pump just had the biggest two-week gain in 17 months, leading some analysts to predict its reemergence as a political issue at the same time market measures show that prices are poised to fall.”

August 16 – Bloomberg (Shobhana Chandra and Michelle Jamrisko): “American builders took out more residential construction permits in July than at any time in the past four years… Applications, a proxy for future work, rose to an 812,000 annual rate, exceeding the highest estimate of economists surveyed by Bloomberg and the most since August 2008…”

August 15 – Bloomberg (Brad Skillman): “Median home price in the [San Francisco] region climbed to $421k in July, up 12.6% Y/y and the highest since Aug. 2008, DataQuick said…”

August 15 – Bloomberg (Freeman Klopott): “A proposal to almost triple tolls on a new Tappan Zee Bridge over the Hudson River and raise rates for truckers on the New York Thruway would be bad for business, state Comptroller Thomas DiNapoli said. The New York Thruway Authority’s operating costs have increased 36% over the last decade as annual debt-service payments doubled to $181.9 million…”

Real Estate Bubble Watch:

August 17 – Bloomberg (Noah Rayman): “Apartment owners at Manhattan’s 15 Central Park West, home to Goldman Sachs Group Inc. Chief Executive Officer Lloyd Blankfein and the musician Sting, are seeking to double their investments after the complex shattered price records and sparked a wave of ultra-luxury listings. Four condos have hit the market since May with asking prices at an average 192% premium over what owners paid in 2007 and 2008… The priciest listing came last week, with Leroy Schecter, chairman of metalworks firm Marino/Ware Industries Inc., seeking $95 million for a five-bedroom unit on the 35th floor.”

Muni Watch:

August 16 – Bloomberg (Brian Chappatta and Tim Jones): “Illinois has set aside only 45% of what it needs to meet public-worker pension obligations, the worst of any U.S. state. Standard & Poor’s may cut its bond rating if lawmakers don’t come up with a fix tomorrow. Investors are unfazed. The fifth-most populous state’s unfunded pension liability is growing by an estimated $12.6 million a day, according to Democratic Governor Pat Quinn’s budget office. Yet the penalty on general-obligation bonds from issuers in Illinois, relative to top-grade debt, fell to 1.51 percentage point last month, the lowest since February 2011…”

August 17 – Bloomberg (Elise Young): “New Jersey’s revenue collections were as much as $540 million less than targeted by Governor Chris Christie through the fiscal year ended June 30, according to a memo from the nonpartisan Office of Legislative Services.”

California Watch:

August 17 – Bloomberg (Michelle Kaske and Will Daley): “Cities in California, where three have declared bankruptcy in the past seven weeks, may get credit-rating downgrades from Moody’s… The situation is worsened by the state’s boom-bust real- estate economy and ‘hands-off’ policy on the finances of local governments, Moody’s said… ‘The risk of default on municipal bonds in California is rising,’ Managing Director Robert Kurtter, lead author of the report, said… ‘Across-the-board rating revisions are possible.’”

August 14 - Bloomberg (James Nash): “California school districts are financing projects by pushing debt payments as far as 40 years into the future, defying a warning from the Los Angeles County treasurer… Last year, 55 school districts were among local authorities selling bonds that mature in more than 25 years… The practice is akin to state and local governments raising pension benefits without funding them, said John Hallacy, head of municipal research at Bank of America Merrill Lynch… ‘It’s not so much kicking the can down the road as it is burying a drum of toxic waste in the back of the school,’ said Jonathan Fiebach, a partner at Grant Williams LP…”