Wednesday, September 10, 2014

06/28/2007 First-Half Global Liquidity Watch *

A volatile second quarter ended with heightened volatility and nervousness.  For the week, the Dow gained 0.4% (up 7.6% y-t-d), and the S&P500 added 0.1% (up 6.0%).  The Utilities rallied 2.0% (up 6.2%), while the Transports dipped 0.2% (up 11.8%).  The Morgan Stanley Cyclical index fell 0.6% (up 20.5%), while the Morgan Stanley Consumer index gained 0.4% (4.8%).  The broader market was little changed.  The small cap Russell 2000 (up 5.8%) and the S&P400 Mid-cap (up 11.3%) indices both slipped 0.1%.  Technology stocks continue their outperformance.  For the week, the NASDAQ100 gained 0.6% (up 10.1%), while the Morgan Stanley High Tech index was little changed (up 9.6%).  The Semiconductors lost 0.7% (up 7.1%).  The Internet index rose 1.5%, increasing y-t-d gains to 10.0%.  The NASDAQ Telecommunications index surged 2.9%, increasing 2007 gains to 11.0%.  Financial stocks were out of favor.  The Broker/Dealers dropped 1.6% (up 4.1%), and the Banks fell 0.6% (down 3.9%).  With bullion down $4.85, the HUI Gold index declined 2.0% (down 2.6%).

Some flight from Credit risk to Treasuries.  Two-year U.S. government yields fell 4 bps to 4.87%.  Five-year yields dropped 8 bps to 4.93%.  Ten-year Treasury yields sank 10 bps to 5.03%.  Long-bond yields ended the week down 12 bps to 5.13%.  The 2yr/10yr spread ended the week sharply flatter at 16 bps.  The implied yield on 3-month December ’07 Eurodollars declined 0.5 bps to 5.285%.  Benchmark Fannie Mae MBS yields declined 5 bps to 6.26%, this week significantly underperforming Treasuries.  The spread on Fannie’s 5% 2017 note widened 2 to 44, and the spread on Freddie’s 5% 2017 note widened about 2 to 45.  The 10-year dollar swap spread increased 1.8 to a notable 63.8.  Corporate bond spreads widened meaningfully, with the spread on a junk index surging 25 bps to a near three-month high.  

June 29 – Financial Times:  “The retreat from risk in global credit markets gathered pace yesterday as investors demanded stricter terms for North American high-yield bond issues and a London hedge fund said it would wind down after suffering big losses on US subprime mortgages.  Dollar General, a leading US retail chain, was forced to shelve its planned offering of $725m in ‘payment-in-kind toggle’ notes, an aggressive financing structure that allows borrowers to choose whether to pay investors back in cash or additional debt… The issuance of bonds and loans with few, if any covenants, has been one of the most controversial practices of the recent leveraged buy-out boom.
Separately, CanWest MediaWorks…cut its own high-yield offering from $650m to $400m.  ‘The balance between sellers of debt and buyers of debt is evening out,’ said Eirik Winter, co-head of fixed income capital markets at Citi… Carlyle Group, the US private equity company, delayed at the last minute the flotation in Amsterdam of an investment fund dealing in residential mortgage-backed securities to cut the offer price because of volatility.”

June 27 – Financial Times (Richard Beales):  “Debt investors are reassessing the risks they are taking and how much they need to be paid for them in a decisive shift away from the borrower-friendly market that has persisted in recent months.  ‘Previously the attitude was ‘tough luck, you have to take what we give you’,” says Kingman Penniman of KDP Advisors, a high-yield consultancy. Now borrowers are finding it difficult to secure the more aggressive financing structures.  In particular, investors are rebelling against some of the terms sought by private equity firms financing buyouts.  Financing for US Foodservice, Thomson Learning and others have faced particular pressure on the most aggressive structures, including ‘payment-in-kind’ or Pik notes that allow borrowers to pay investors with more bonds rather than using up sometimes scarce cash.”

June 25 – Financial Times (Richard Beales):  “Bankers have started hawking $62bn in debt for Chrysler, the US carmaker that Cerberus, the private equity group, last month agreed to buy from DaimlerChrysler.  Loans totalling $22bn will test the strength of the market, at a time when big leveraged buy-out financings are in the pipeline and investors are nervous amid rising long-term interest rates and fallout from the market for US subprime mortgage- related debt.  ‘Volatility is hitting leveraged loans hard, just as a procession of gigantic LBOs inch toward the market,’ said analysts at Standard & Poor’s… A syndicate of banks is showing the Chrysler deal to investors around the US this week, with the financing set to close in a few weeks.”

Investment grade issuers included Goldman Sachs $1.8bn, MidAmerican Energy $650 million, and Equifax $250 million.

June 29 - Dow Jones (Daisy Maxey):  “Junk-bond investors have lately had a case of the jitters, and so have investors in junk-bond mutual funds: Their shareholders withdrew more than $400 million in the week ended Wednesday, according to AMG…”

Junk issuers included Community Health $3.0bn, Dollar General $1.9bn, Varietal Distribution $675 million, Telcordia Technologies $555 million, Nevada Power $350 million, Sierra Pacific Power $325 million, Metals USA $300 million, Paetec Holding $300 million and NMH Holdings $175 million.

This week’s convert issuers included Gannett $1.0bn, Tektronix $300 million, Boston Private Financial $288 million, GCI Commerce $125 million, and Parker Drilling $125 million.

International dollar bond issuers included La Caixa $2.8bn, Opti Canada $750 million, Suncor Energy $750 million, FMC Finance $500 million, Canwest Media $400 million, and Bemax Resources $175 million.

German 10-year bund yields dropped 8 bps to 4.57%, while the DAX equities index added 0.7% (up 21.4% y-t-d).  Japanese 10-year “JGB” yields declined 2.5 bps to 1.87%.  The Nikkei 225 slipped 0.3%, reducing y-t-d gains to 5.3%.  Emerging markets were mixed.  Brazil’s benchmark dollar bond yields added 2 bps this week to 6.10%.  Brazil’s Bovespa equities index added 0.2%, increasing y-t-d gains to 22.3%.  The Mexican Bolsa declined 1.6% (up 17.8% y-t-d).  Mexico’s 10-year $ yields declined 4 bps to 5.91%.  Russia’s RTS equities index was little changed (down 1.3% y-t-d).  India’s Sensex equities index rallied 1.3%, increasing 2007 gains to 6.3%.  China’s Shanghai Composite index sank 6.6% for the week (up 42.8% y-t-d and 129% over 52-weeks).

Freddie Mac posted 30-year fixed mortgage rates dipped 2 bps to 6.67% (down 11 bps y-o-y).  Fifteen-year fixed rates fell 3 bps to 6.34% (up 9bps y-o-y).  One-year adjustable rates dipped one basis point to 5.65% (down 17bps y-o-y).  The Mortgage Bankers Association Purchase Applications Index dropped 4.9% this week.  Purchase Applications were up 10% from one year ago, with dollar volume 16.4% higher.  Refi applications declined 2.5% for the week, although dollar volume was up 31.4% from a year earlier.  The average new Purchase mortgage increased to $238,100 (up 5.8% y-o-y), and the average ARM rose to $398,900 (up 16.7% y-o-y).  

Bank Credit added $0.3bn (week of 6/20) to a record $8.588 TN.  For the week, Securities Credit declined $11.5bn.  Loans & Leases jumped $11.9bn to $6.281 TN.  C&I loans surged $15.6bn, and Real Estate loans jumped $17.7bn.  Consumer loans increased $3.1bn.  Securities loans dropped $20.0bn, and Other loans declined $4.7bn.  On the liability side, (previous M3) Large Time Deposits fell $9.6bn.     

M2 (narrow) “money” jumped $20.8bn to $7.252 TN (week of 6/18).  Narrow “money” has expanded $208bn y-t-d, or 6.2% annualized, and $442bn, or 6.5%, over the past year.  For the week, Currency added $0.4bn, while Demand & Checkable Deposits dropped $24.6bn.  Savings Deposits surged $42.1bn, while Small Denominated Deposits were unchanged.  Retail Money Fund assets increased $2.9bn.       

Total Money Market Fund Assets (from Invest. Co. Inst.) added $2.0bn last week to $2.536 TN.  Money Fund Assets have increased $154bn y-t-d, a 13.0% rate, and $419bn over 52 weeks, or 19.8%.     

Total Commercial Paper jumped $10.3bn last week to a record $2.142 TN, with a y-t-d gain of $158bn (17.0% annualized).  CP has increased $357bn, or 20%, over the past 52 weeks.  
Asset-backed Securities (ABS) issuance slowed to $10bn.  Year-to-date total US ABS issuance of $361bn (tallied by JPMorgan) is running about 3% behind comparable 2006.  At $177bn, y-t-d Home Equity ABS sales are about a third below last year’s pace.  Meanwhile, y-t-d US CDO issuance of $187 billion is running 18% ahead of record 2006 sales.  

Fed Foreign Holdings of Treasury, Agency Debt last week (ended 6/27) rose $8.2bn to a record $1.975 TN.  “Custody holdings” were up $223bn y-t-d (25.5% annualized) and $337bn during the past year, or 20.6%.  Federal Reserve Credit last week declined $4.7bn to $847.6bn.  Fed Credit has contracted $4.6bn y-t-d, with one-year growth of $22.9bn (2.8%).    

International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $625bn y-t-d (26% annualized) and $937bn y-o-y (20.8%) to a record $5.436 TN.  

June 29 – Bloomberg (Sam Nagarajan):  “India’s foreign-exchange reserves increased $1.53 billion to $212.55 billion in the week ended June 22…”

Currency Watch:

The dollar index fell 0.5% to 81.69.  On the upside, the Romanian leu increased 2.3%, South Africa’s rand 1.6%, the Thai baht 1.5%, and the New Zealand dollar 1.0%.  On the downside, the Paraguay guarani declined 1.2%, the Colombian peso 1.1%, and the Israeli shekel 0.8%.  The Swiss franc and Euro both gained about 0.5%.  The Canadian dollar this week traded to a 30-year high against the dollar.

Commodities Watch

For the week, Gold dipped 0.7% to $649.45, and Silver dropped 5.1% to $12.473.  Copper gained 2.0%.  August crude jumped $1.54 to $70.68.  August gasoline was about unchanged, while August Natural Gas sank 5.7%.  For the week, the CRB index gained 0.3% (up 2.8% y-t-d), and the Goldman Sachs Commodities Index (GSCI) added 0.1% (up 12.7% y-t-d).  

Japan Watch:

June 26 - Market News International:  “Recent currency moves are being driven by interest rate differentials and Japan should hike rates rapidly, Eisuke Sakakibara, Japan’s former top currency official, known colloquially as ‘Mr. Yen’, said in a CNBC interview.”

June 27 – Bloomberg (Ron Harui):  “Bank of Japan official Tetsuya Inoue said today he anticipates massive capital outflows as Japanese households seek to diversify domestic assets.  ‘It’s reasonable to expect that you could still see a huge amount of capital flows’ leaving Japan, Inoue, deputy director-general of the central bank’s financial markets department, said…”

June 26 – Bloomberg (Mayumi Otsuma and Harumi Ichikura):  “Japanese corporate service prices rose at the fastest pace in more than nine years in May, backing the central bank’s case that inflation will take hold in the world’s second-largest economy.  Corporate service prices climbed 1.4% from a year earlier…”

June 25 – UPI:  “Japanese sushi chefs, faced with shortages of bluefin tuna, are experimenting with alternatives, including deer meat, horse meat and U.S.-style avocado rolls.  The shortages…are being caused in part by the growing popularity of sushi worldwide, including in Russia, South Korea and China… ‘It’s like America running out of steak,’ said Tadashi Yamagata, vice chairman of Japan’s national union of sushi chefs… Japan’s Fisheries Agency said the average price of imported frozen northern and 
Pacific bluefin has risen by more than a third, to $13 a pound, since the start of 2006.”

China Watch:

June 28 – Financial Times (Richard McGregor):  “China’s new state investment agency is poised to secure its first significant tranche of funding with the announcement that the finance ministry will soon issue $200bn in bonds to capitalise the body… The launch of the Chinese agency coincides with an intensifying global debate about the role of sovereign investment bodies and their emerging clout in financial markets.  The possibility of tie-ups between such agencies was mooted yesterday by an official of a Dubai state holding company, who said the two countries were discussing mutual investments, such as asset swaps.  ‘At the highest level there is already a connection. But the next step is going to be at the various business-entity levels,’ Yu Lai Boon, chief investment officer at Dubai World Group…”

June 29 – Bloomberg (Josephine Lau):  “China’s economy may expand at the fastest pace in 12 years in 2007 and inflation will exceed the central bank’s target, according to a report by economists at the People’s Bank of China… Gross domestic product may grow 10.8%...”

June 27 – Bloomberg (Nipa Piboontanasawat):  “China’s industrial-company profits swelled 42.1% in the first five months from a year earlier, hampering government efforts to cool investment in the world’s fastest-growing major economy.  Combined net income increased to 902.6 billion yuan ($119bn)… Sales jumped 27.4% to 14.2 trillion yuan.”

June 27 – Bloomberg (Dune Lawrence):  “China’s fiscal income reached 2.17 trillion yuan ($285.1 billion) for the first five months of this year, a 31% gain from the same period a year ago… The central government’s fiscal revenue climbed 32% to 1.22 trillion yuan while local government income rose 29% to 951.4 billion…”

June 28 – Financial Times (Jamil Anderlini):  “Ten international banks, including HSBC and Standard Chartered, have been punished by China’s foreign exchange regulator for breaching strict capital controls by helping to funnel huge amounts of foreign exchange into the country’s soaring stock and property markets.  The banks are among a group of financial institutions revealed to the Financial Times after the State Administration of Foreign Exchange announced 29 banks - 19 of them domestic - had received unspecified punishment for ‘assisting speculative foreign capital to enter the country disguised as trade or investment’… The money they helped to channel was having a ‘serious effect on healthy economic development and government efforts to control growth’, Deng Xianhong, Safe’s deputy director, said…”

June 28 – Bloomberg (Josephine Lau):  “Investments by Chinese insurers in stocks and debt soared 53% in the first five months from a year earlier, as they diversify holdings and prepare to buy more equities overseas once permitted.  Such investments rose to 1.5 trillion yuan ($197 billion) through May…”

June 26 – Bloomberg (Zhao Yidi):  “China completed the world’s longest sea bridge, the Hangzhou Bay Sea-Crossing Bridge, in Zhejiang province… The 22.4 mile bridge links Zhengjiadai village located north of the Hangzhou Bay, and Shuiluwan village, situated south of the bay… The 11.8 billion yuan ($1.55 billion) bridge was China’s first major public infrastructure project that was funded mainly by private industry…”

June 29 – Financial Times:  “Ten years after the rain-drenched evening when Hong Kong passed to Chinese sovereignty, little has changed. Full democracy and cheap real estate are as elusive as ever; bars in Lan Kwai Fong as crowded; and over-subscription rates for new listings as sky-high as they ever were.  The big difference, of course, is the stock market itself.  In June 1997 mainland companies accounted for just 13% of the market; today they make up almost half the market capitalisation.  Partly as a result of mainland issuance, Hong Kong’s market cap has almost trebled to nearly US$2,000bn.  Undoubtedly bigger, then. But is it better?”

June 26 – Bloomberg (Wendy Leung):  “Hong Kong’s export growth unexpectedly slowed last month as shipments to the U.S. fell. Overseas sales rose 12.1%...”

India Watch:

June 28 – Bloomberg (Gautam Chakravorthy):  “India’s central bank will lend $5 billion from its foreign exchange reserves to help build roads, ports and other infrastructure, Finance Minister Palaniappan Chidambaram said.  ‘We have also persuaded the Reserve Bank of India to lend $5 billion from the foreign exchange reserves,’ to the India Infrastructure Finance Co., Chidambaram said…”

June 28 – Bloomberg (Debarati Roy):  “Exports of jewelry from India, the world’s largest producer, climbed 32% in the two months ended May… Exports reached $3.18bn…”

Asia Boom Watch:

June 25 – Bloomberg (Shamim Adam):  “Asset bubbles fueled by flows of cash into Asia may signal the risk of a financial crisis, policy makers in the region say.  Capital flows have inflated real estate and stock prices, according to officials including Singapore’s Prime Minister Lee Hsien Loong and Thai Finance Minister Chalongphob Sussangkarn.
They spoke at the World Economic Forum on East Asia conference in Singapore, 10 years after Asia’s financial crisis.  ‘While East Asia is in a stronger position today compared to 1997, mishaps can still happen,’ Singapore’s Lee said… ‘Recent signs of market exuberance have created fresh concerns.’”

June 26 – Bloomberg (Shamim Adam):  “Singapore’s industrial production in May expanded more than any economist expected, as output at pharmaceutical and transport engineering companies jumped.  Manufacturing, which accounts for a quarter of the $134 billion economy, surged 17.7% from a year earlier…”

June 26 – Bloomberg (James Peng and Tim Culpan):  “Taiwan’s export orders rose more than expected in May, buoyed by demand from China and Europe.  The island’s currency pared a decline.  Export orders, indicative of actual shipments in the next three months, climbed 11.9% from a year earlier…”

June 26 – Bloomberg (Denise Kee and Catherine Yang):  “Asian property owners are planning to sell shares in as many as 15 real estate investment trusts within the coming year, according to Michael Smith, head of Asian real estate investment banking at Goldman Sachs Group Inc.”

Unbalanced Global Economy Watch:

June 26 – Bloomberg (Gabi Thesing):  “The International Monetary Fund will raise its forecast for world economic growth this year and said inflation may accelerate as a result.  ‘Global growth is stronger than we had expected in April,’ Simon Johnson, the IMF’s economic counsellor and director of research, told reporters… ‘Inflationary pressures are definitely building up.’”

June 28 – Financial Times (Peter Thal):  “The world’s 100,000 ‘super-rich’ last year extended their lead over the merely affluent, an authoritative study of the world’s wealthy has found.  Last year, the assets of those with more than $30m to invest - the so-called ultra-high net worth individuals - expanded by 16.8%. By comparison, people with assets of $1m-$5m saw their wealth grow by 6.4%.  The number of ultra-high net worth individuals also swelled by more than 10%... The number of people with $1m or more to invest grew by 8% to 9.5m last year, and the wealth they control expanded to $37,200bn. About 35% is in the hands of just 95,000 people with assets of more than $30m.”

June 28 – Bloomberg (Simone Meier):  “Money-supply growth in the euro region unexpectedly accelerated to close to the fastest pace in 24 years in May, giving the European Central Bank room to raise interest rates further.  M3 money supply, which the ECB uses as a gauge of future inflation, rose 10.7% from a year earlier, after growing 10.4% in April…  ‘It’s surprising we haven’t yet seen a slowing down in the overall rate of M3 growth,’ said Nick Kounis, an economist at Fortis Bank in Amsterdam.  ‘Overall, we’d need to see quite a marked slowdown over the next months to change the conclusion that this is signaling upside risks to inflation and to remove the argument that further rate increases are needed.’  Loans to the private sector rose 10.3% in May from a year earlier…”

June 28 – Bloomberg (Claudia Rach):  “Germany’s unemployment rate fell to the lowest level in 12 years in June as growth in Europe’s largest economy encouraged companies to invest and hire.  The jobless rate, adjusted for seasonal swings, declined to 9.1% from 9.2% last month…”

June 28 – Market News International:  “Much as expected, French unemployment continued to decline in May, enough to trim the ILO jobless rate another notch to 
8.1%, the lowest level in 25 years…”

June 28 – Bloomberg (Christian Wienberg):  “Denmark’s jobless rate fell to a new 33-year low of 3.6% in May as rising consumer demand led industries to hire more workers, fueling concern the economy may overheat.”

June 29 – Bloomberg (Jonas Bergman):  “Swedish household debt growth accelerated in May as employment and wages rise in the largest Nordic economy.  Household borrowing increased an annual 11.9% in May…”

June 28 – Bloomberg (Robin Wigglesworth and Beate Evensen):  “Norway’s jobless rate was unchanged in the three months through May… The…unemployment rate remained at 2.7%, the lowest since at least 1989…”

June 26 – Bloomberg (Mark Sweetman):  “Russia’s central bank doubled its forecast for net capital inflow this year to $70 billion, Interfax reported.”

Latin American Boom Watch:

June 25 – Bloomberg (Telma Marotto and Katia Cortes):  “Brazilian bank lending rose 2.4% in April from a month earlier as lower interest rates spurred companies to boost production and consumers to purchase more goods…Bank lending rose 21.9% from April 2006.”

Central Banker Watch:

June 24 – Bloomberg (John Fraher):  “The credibility of central banks around the world may hinge on their response to surging money and credit growth, which is helping fuel asset bubbles, the Bank for International Settlements said.  ‘The current rapid expansion of these aggregates in various parts of the world may lead some central banks to ask soul-searching questions about the appropriate policy response,’ the BIS said… ‘Ultimately, the credibility of central banks lies in the balance.’”

Bubble Economy Watch:

June 26 - Market News International (John Shaw):  “Congressional Budget Office director Peter Orszag told the House Budget Committee…that foreign holdings of U.S. Treasury debt ‘have grown rapidly in recent years’ and now exceed $2 trillion, accounting for more than 40% of Treasury debt held by the public.  …Orszag said that foreign holdings of U.S. debt rose almost 50% between 2003 and 2006.”

June 26 – Bloomberg (Elizabeth Hester):  “Former U.S. Vice President Dan Quayle and K2 Inc. Chief Executive Officer Richard Heckmann filed to raise as much as $500 million in the second-largest initial public offering of a ‘blank check’ shell company.  Heckmann Corp….plans to sell 62.5 million units for $8 each… The offering is for a blank-check company, also known as a special-purpose acquisition company, or SPAC. Blank-check companies have raised $4.1 billion in 33 IPOs this year, compared with $1.4 billion in 22 offerings during the same period a year ago…”

June 29 – EconoPlay,com (Gary Rosenberger):  “Hiring was slower than expected in June as employers were handcuffed by a host of economic challenges led by the housing slump, the subprime blowout, and high gas prices – thwarting optimistic expectations for the second half of 2007, recruiters say.  The slowdown cut across a wide swath of skills and professions, with the normal summer ramp-up in logistics and retail deemed particularly disappointing.  Professional areas like information technology or finance and accounting were also slowed for a variety of reasons, including a paucity of ideal candidates…”

June 26 – The Wall Street Journal (Julie Jargon):  “For the second time this year, Jim Oberweis is raising the price of milk his family-owned company delivers to 35,000 homes in the Midwest and sells at its 44 dairy shops… The recent rise in milk prices is affecting everyone from small dairy companies like Oberweis to the nation’s largest milk producers and food companies. On Friday, the Agriculture Department, which regulates the minimum milk prices received by farmers, set the price that processors will have to pay for drinkable milk in July at $20.91 per hundred pounds of milk, up 17% from the June price and up 84% from a year earlier.”

Financial Sphere Bubble Watch:

June 29 – Financial Times (Saskia Scholtes):  “Rising credit market volatility has triggered concern at investment banks that they may be forced to honour commitments to provide billions of dollars of financing for private equity buy-outs that may now be difficult to place with investors.  In the coming months, bankers have close to $250bn of new bonds and loans slated for issue in the US alone, much of it related to leveraged buy-outs and other merger activity.  If they cannot sell on the debt on terms originally planned because markets have changed, they may be forced to hold billions of dollars of high-yield debt.”

June 29 - Dow Jones (Natasha Brereton ):  “The global financial system may have become more vulnerable to potentially large financial crises, a senior Bank of England official said… While financial innovation has allowed better management and wider dispersal of risks, the greater integration of capital markets means that were a major problem to occur, it would be more likely to spread quickly across borders, Executive Director for Financial Stability Nigel Jenkinson said… ‘The flip side to increased resilience of the financial system to small and medium-sized shocks may be a greater vulnerability to less frequent but potentially larger financial crises,’ Jenkinson said.”

Mortgage Finance Bubble Watch:

June 27 – The Wall Street Journal (Michael Hudson):  “Twelve years ago, Lehman Brothers…sent a vice president to California to check out First Alliance Mortgage Co. Lehman was thinking about tapping into First Alliance’s lucrative business of making ‘subprime’ home loans to consumers with sketchy credit.  The vice president, Eric Hibbert, wrote a memo describing First Alliance as a financial ‘sweat shop’ specializing in ‘high pressure sales for people who are in a weak state.’ At First Alliance, he said, employees leave their ‘ethics at the door.’  The big Wall Street investment bank decided First Alliance wasn’t breaking any laws. Lehman went on to lend the mortgage company roughly $500 million and helped sell more than $700 million in bonds backed by First Alliance customers’ loans…  Today, Lehman is a prime example of how Wall Street’s money and expertise have helped transform subprime lending into a major force in the U.S. financial markets. Lehman says it is proud of its role in helping provide credit to consumers who might otherwise have been unable to buy a home, and proud of the controls it has brought to a sometimes-unruly business.”

Foreclosure Watch:

June 26 – Bloomberg (Jody Shenn):  “Delinquencies and defaults on U.S. subprime mortgages made last year rose in May, cementing their record of being the worst-performing in their category ever…  Late payments, foreclosures and already seized property among bonds from the second half of last year used for ‘ABX’ credit derivatives rose 2.15 percentage points to 14.51%... That’s the biggest increase this year…”

MBS/ABS/CDO/Derivatives Watch:

June 29 – Bloomberg (Shannon D. Harrington):  “U.S. bank revenue from trading derivatives and other contracts jumped 24% to a record $7 billion in the first quarter as low yields from bond markets prompted more investors to turn to derivatives that can boost returns… Trading in derivatives contracts by banks including JPMorgan Chase & Co. and Citigroup Inc. rose 10% to cover a record $145 trillion in securities, up 31% from last year’s first quarter, the U.S. Office of the Comptroller of the Currency said… ‘Because investors have faced very tight credit spreads and a flat-to-inverted yield curve for some time now, they have increasingly turned to more complicated and highly structured products,’ Kathryn Dick, the agency’s deputy comptroller for credit and market risk, said… Trading in credit derivatives, the fastest growing part of the derivatives market, surged 86% to cover $10.2 trillion in debt securities.”

June 29 - Dow Jones:  “The OCC…said federally insured U.S. commercial banks earned a record $7.0 billion in trading revenues in the first quarter, up 24% from the same quarter last year.”

June 26 – The Wall Street Journal (Serena Ng and Henny Sender:  “The corporate buyout boom of the 1980s was funded in large part by high-yield ‘junk’ bonds. This time around, another financial product is supplying much of the fuel -- collateralized loan obligations.  CLOs…are giant pools of bank loans bundled together by Wall Street and sold off to investors in slices. They aim to spread default risk an inch deep and a mile wide. Last year, more than half of the loans behind the record wave of buyouts were parceled out to investors as CLOs, bankers say.   As corporate borrowing soars, however, concerns are growing that CLOs have made it too easy for shaky or debt-laden companies to borrow money.”

June 28 – Financial Times (Saskia Scholtes and Gillian Tett):  “As head of the financial stability unit at the Banque de France, Imène Rahmouni-Rousseau traveled to America this month to look at the current turmoil in the US subprime mortgage world.  Although initially that had seemed an all-American saga, Ms Rahmouni suspected that French and other European investors also held assets linked to subprime securities. So on behalf of her central bank she wanted to assess the risks.  What she discovered surprised her. There was little confidence about how to value the holdings. ‘Pricing data are difficult to obtain,’ she says.  It is a discovery being shared by numerous other policymakers and investors around the world as the fallout widens from a subprime lending boom… unlike stocks listed on an exchange or US Treasury bonds, CDOs are rarely traded. Indeed, a distinct irony of the 21st-century financial world is that, while many bankers hail them as the epitome of modern capitalism, many of these new-fangled instruments have never been priced through market trading. Instead, products such as CDOs, which are designed to be held until they mature, have often been valued in investor portfolios or on the books of investment banks according to complex mathematical models and other non-market techniques.”

June 26 – Bloomberg (Darrell Hassler):  “Fitch Ratings and Standard & Poor’s today warned investors that subprime-mortgage securities similar to those responsible for the near collapse of hedge funds run by Bear Stearns Cos. are deteriorating quickly.  Fitch said it may cut ratings on four collateralized debt obligations valued at about $3.1 billion that are linked to some second-lien subprime loans. S&P downgraded 45 bonds backed by subprime mortgages and said it may reduce ratings on 88 more, following similar action by Moody’s…last week.”

Real Estate Bubbles Watch:

June 25 – California Association of Realtors (CAR):  “Home sales decreased 25% in May in California compared with the same period a year ago, while the median price of an existing home increased 4.8 percent… The median price of an existing, single-family detached home in California during May 2007 was $591,180, a 4.8% increase over the revised $563,860 median for May 2006… ‘The decline in sales continues to be driven by both tighter underwriting standards since the start of the year and the adverse psychological impact of news regarding foreclosures and the subprime situation,’ said C.A.R. Vice President and Chief Economist Leslie Appleton-Young. ‘In particular, the lower end of the market…has seen greater declines in sales and weaker prices than the higher end of the market…”  Highlights of C.A.R.’s resale housing figures for May 2007: . C.A.R.’s Unsold Inventory Index for existing, single-family detached homes in May 2007 was 10.7 months, compared with 6 months for the same period a year ago.”

June 26 – Bloomberg (Courtney Schlisserman and Joe Richter):  “Home values in 20 U.S. cities fell the most in at least six years as higher mortgage rates and a record supply of properties for sale deepen the housing slump.  The S&P/Case-Shiller index of 20 metropolitan areas declined 2.1% in April from the same month a year earlier, led by
Detroit and Miami…”

Fiscal Watch:

June 28 – Bloomberg (Stacie Servetah and Terrence Dopp):  “New Jersey Governor Jon Corzine today signed a $33.5 billion state budget for fiscal 2008…  The signed budget is $2.4 billion, or nearly 8% above last year’s plan…”

Speculator Watch:

June 26 – Bloomberg (Jody Shenn and Bradley Keoun):  “Bear Stearns Cos. is getting a taste of its own medicine.  It was Bear Stearns, the biggest broker to hedge funds, that nine years ago declined to join 14 other investment banks in the bailout of Long-Term Capital Management LP. Then last week, as…Bear Stearns pleaded for help to rescue two of its hedge funds teetering on the brink of collapse, many of the same firms refused to come to its aid.”

June 26 – Bloomberg (Matthew Leising):  “Amaranth Advisors LLC held natural gas trades worth more than $18 billion and exploited loopholes to evade regulators who tried to limit the firm's speculation on its way to becoming the biggest-ever hedge fund collapse, a Senate investigation found.”

First-Half Global Liquidity Watch:

June 29 – Reuters (Natalie Harrison) – “The credit market has had a strong run so far this year, with global corporate bond issuance, for both high-yield and investment grade, up around 30% in the first half from the same period a year ago.  Overall, global debt capital market deals are up 11% in the first half of 2007, compared with the first six months of last year, totalling $3.7 trillion, according to…Dealogic…  Of the $1.26 trillion global investment-grade deals done since January, $626 billion were in the European, Middle East and Africa (EMEA) region, and $502 billion in the Americas. The latter was a 36% increase on the period from January to end-June 2006.  In terms of size, Asia Pacific and Japan trailed behind, but still saw a 26% and 42% respective jump in deals.  The Americas accounted for the vast majority of high-yield deals too, with a 40% jump in the value of issuance to $109 billion, followed by EMEA, where deal values rose to $48 billion… Global asset and mortgage-backed securities were also dominated by the Americas, which generated $1 trillion of them, though that was down 4% from the first half of 2006.  EMEA saw the strongest pick-up, with a 39% rise in issuance to almost $311 billion.”

June 29 – Financial Times (Anuj Gangahar and Joanna Chung):  “Riskier types of debt accounted for a higher portion of global corporate fundraising in the first half of this year than last, underlining investors’ robust appetite for low-quality paper.  Leveraged loans, highly leveraged loans and high-yield bonds made up 29% of the total global corporate fundraising, up from 22% during the same period last year, according to Dealogic. The amount of cash raised through the debt capital markets as a whole - including bonds of both investment grade and lower-quality junk-rated paper - reached $1,450bn, the highest volume on record, and up 32% over the same period last year.” 

June 29 – Financial Times (Lina Saigol):  “The volume of merger and acquisition activity worldwide surged 50% to reach $2,780bn during the first six months of the year, despite growing concerns among companies about a turn in the credit markets and fears that the cycle has reached its peak.  Since 2003, chief executives and private equity investors have been fuelling the M&A boom by taking advantage of cheap debt and strong cash flows to bid for companies… Buy-outs by private equity groups reached a record high of $568.7bn, a rise of 23% on the previous high of $459.2bn in the second half of 2006… Private equity represented 20% of total announced M&A this year, according to Dealogic…  Europe, the Middle East and Africa accounted for 44% of global volume during the first six months of the year to reach $1,230bn.  In the US, the volume of deals increased by 37% over the same period, while the pace of activity in the Asia-Pacific region reached $353.4bn.  In emerging markets, volume rose 17% to $356bn, with Russia the most targeted nation, followed by China and India.”

June 29 – Reuters (Jessica Hall):  “Merger activity in the United States hit a new record in the first half of the year, fueled by deep-pocketed private equity firms and low borrowing costs, even as the pace of deals began to slow in June… The U.S. broke through the $1 trillion level for total mergers, marking the first time that mergers have hit that level in the first six months of any year, according to…Dealogic.  So far this year, U.S. merger volume totaled $1.005 trillion, up 36% from the same period a year ago. The number of deals, however, dropped 12%...  April was the busiest month of the year in the U.S., with $210.5 billion in deals, while June was the slowest month with $124.2 billion in deals, Dealogic said.”

June 29 – The Wall Street Journal (Ellen Sheng):  “Chinese and Indian companies raised the most money from the stock market during the first half, according to a ranking of Asian countries excluding Japan, Australia and New Zealand, from…Dealogic… Fueled by the booming economy, the number of Chinese initial public offerings nearly doubled in the January-June period from a year ago and helped push the number of stock deals in Asia, excluding Japan, up 55% from year-earlier levels.  In all of Asia, there were 838 deals raising $99.5 billion in the first half, compared with 723 deals, which raised $64.1 billion, last year.  Chinese companies launched 85 IPOs, raising $21.5 billion in total, up from 46 IPOs raising $15.6 billion a year ago. Including secondary offerings and convertible deals, mainland Chinese companies did 177 deals and raised $47.1 billion in the year to date, up from 100 deals and $25 billion a year ago.”

June 29 – Reuters (Brian Kelleher):  “Asia Pacific mergers and acquisitions excluding Japan surged 50% in the first half to a record $253 billion, with Australian buyout deals and an overseas push by Indian firms expected to keep activity at high levels. Australia accounted for $76 billion worth of deals in the half, followed by China ($55 billion) and India ($39 billion), according to…Dealogic.”

June 29 – Reuters (Brian Kelleher) - Privately owned Chinese companies helped drive a 42% increase in Asia Pacific stock issuance in the first half, and a recent wave of Indian activity will keep bankers busy through the rest of 2007.  Asia Pacific equity capital markets volume, excluding Japan, was $105.1 billion in the first half, according to…Dealogic, and bankers expect the strong activity to continue through the second half.”

June 29 – Reuters (Daisy Ku):  “More listings from Russia and the Middle East are expected to keep markets buoyant after Europe set the global pace for IPOs in the first half with a 51% gain and topped the United States in total issuance.  Equity capital markets activity reached $445 billion over the first six months of 2007 on 3,000 deals, the highest dollar volume since the record set in 2000, according to…Dealogic.  It was a 19% gain from $375 billion in the first half of 2006.”

Runaway global Credit and liquidity excesses fuelled major global equities indexes to solid – and in some cases spectacular - first-half gains.  The German DAX surged 21.4%, France’s CAC40 9.3%, Britain’s FTSE 6.2%, Amsterdam’s Exchanges index 10.7%, Stockholm’s OMX index 9.4%, and the Swiss Market Index 4.8%.  The Nikkei rose 5.3% and Hong Kong’s Hang Seng jumped 9.1%.  Here at home, the Dow Jones Industrials gained 7.6%, the S&P500 6.0%, the S&P400 Mid-Cap index 11.3%, the Russell 2000 5.8%, and the NASDAQ100 10.1%.

The emerging markets boom hardly missed a beat throughout the first half.  China’s Shanghai Composite index jumped 42.8%, South Korea’s Kospi 21.6%, Taiwan’s Taiex index 13.5%, Brazil Bovespa 22%, Mexico’s Bolsa 17%, and Chile’s Stock Market Select index 29%.  Winners in European emerging equities indices included Prague’s major index up 17.0%, Budapest up 16.4%, Poland’s WIG20 14.4%, and Istanbul’s XU100 index 20.4%.  Most markets in the Middle East and Africa also posted strong gains.  Global (non-U.S.) real estate and art inflation were in full force.

As for global securities issuance and M&A – the fuel for the equities Bubble - the first half was one for the record book.  Record total global debt market issuance of $3.7 TN was up 11% from comparable 2006.  Leveraged loans and junk bonds rose to almost a third of total corporate issuance.  Announced global M&A jumped 50% to $2.78 TN.  It was certainly a case of global financial players working overtime to reap once-in-a-lifetime bounties, in the process ensuring future financial crisis.

The liquidity theme for most of the first half was one of unprecedented global M&A activity financed by increasingly complex and risky debt structures, all made possible by even more astounding financial sector leveraging.  Looking back, February’s subprime implosion provided only a brief setback (respite) for a desperately overheated global Credit and speculation infrastructure.  The global M&A and securities leveraging booms had already attained critical mass, while Wall Street and the leveraged speculating community had some time back achieved a full head of steam.  

Yet late-June’s hedge fund and CDO problems appear more all-encompassing and ominous.  February was about U.S. subprime mortgages, while the issue gravitated toward the heart of “contemporary finance” as the second quarter winded down.  To be sure, the story of the historic first half concludes with serious questions with respect to the sustainability of Global Credit Bubble excess.  It has “inflection point” written all over it.

“Repo Agreements,” as reported by the New York Fed, ballooned $455bn during the first half (28% annualized) to $3.904 TN.  Inflating Wall Street balance sheets have directly and, by financing clients, indirectly played a major role in financing the M&A boom.  To what degree the leveraged strategies we’ve seen turn problematic in subprime have been used to lever up corporate Credits will be a crucial issue going forward.  Importantly, the CDO marketplace is now under the microscope and will likely be so for some time to come.  

The Financial Times Saskia Scholtes penned an excellent article in yesterday’s edition, titled “Does it all add up?”  

“These elaborately constructed securities, called collateralised debt obligations (CDOs), are designed to yield juicy returns while also carrying high credit ratings. They have proved popular with hedge funds as well as with longer-term investors such as pension funds and insurance companies, many of which have bought billions of dollars of such securities in recent years - thus providing the liquidity that was then channelled into mortgage loans.  But heavy losses incurred at the two Bear Stearns hedge funds as a result of such financial haute couture have prompted fears that the CDO emperor may turn out to have no clothes. Such a revelation could threaten the value of investor portfolios around the globe - not just in the mortgage sector but in the way many sorts of company fund themselves.  This is because unlike stocks listed on an exchange or US Treasury bonds, CDOs are rarely traded.  Indeed, a distinct irony of the 21st-century financial world is that, while many bankers hail them as the epitome of modern capitalism, many of these new-fangled instruments have never been priced through market trading.”

It is rather ironic that this so-called “golden age of Capitalism” has increasingly been financed by obscure “marketable” Credit instruments and derivatives that only rarely trade in the marketplace.  Moreover, in a marketable securities-based Credit system where gains on securities holdings have come to play such a prominent role, there has been a major shift to instruments, structures and strategies specifically to avoid “marking” to actual market prices (in case those prices actually do decline).  Or, from another angle, the CDO market represents some of the potentially weakest debt structures imaginable:  lend in gross excess to the weakest Credits; bundle them in esoteric structures; have these structures be illiquid and difficult to price; sell them for the purpose of speculation/“Credit arbitrage”; and then have highly leveraged securities firms financing the speculators enormous leverage.

It is not by happenstance that risk intermediation practices have turned increasingly to gimmicks, obfuscation and worse.  By their very nature, Credit booms demand progressively more challenging risk “intermediation”.  The current Global Credit Bubble requires the transformation of unprecedented amounts of risk into “top-rated” securities - in keeping with the highly leveraged portfolios where much of today’s risk is domiciled.  Over the past couple of years, the now arduous intermediation process forced all the major players to push the envelope – the investment bankers, the rating agencies, the leveraged speculators, the derivative players, the banks, and the regulators/policymakers.

It was really not that difficult back in February for the bulls to proclaim that mortgage problems were isolated to subprime.  This will simply no longer suffice, not now that attention has been focused on CDOs, liquidity, pricing, leveraging and unrecognized risks.  Is subprime risk in CDOs the proverbial “tip of the iceberg?”  Of course it is.  The central issues of problematic liquidity dynamics, fair and accurate pricing, and speculative leveraging excesses today permeate the entire global Credit system.  

To be sure, the CDO market is the tip of a derivatives iceberg when it comes to risk obfuscation and market pricing issues.  Arcane instruments, lack of transparency, and tainted markets can (and did) remain non-issues for quite some time.  Yet the longer the period of chicanery the more abruptly greed will inevitably succumb to fear.  Today, markets are turning fearful.  They are fearful of the quality of assets supporting the massive securitization marketplace.  They are fearful of mispricing.  They are fearful of leverage and liquidity.  And, importantly, they are fearful of the ramifications of – in today’s overheated financial environment - any meaningful movement away from risk assets.  All the fears are justified.

Subprime imploded specifically because of “Ponzi Finance” dynamics.  As long as Credit was readily available, individuals could borrow and/or refinance to a more accommodating mortgage.  But the day the music stops is the day Credit losses begin to explode.  And when it comes to runaway Credit booms, subprime was no anomaly.  The perpetuation of the subprime boom was the (only) means for an overheated Credit system to finance the marginal borrower - in order to sustain the housing/mortgage finance Bubbles.  Enormous festering risks were well-concealed by the illusion of perpetually rising asset prices and limitless market liquidity.

I won’t attempt to make the case that the global M&A Bubble is (quite) as acutely vulnerable to “Ponzi” dynamics as subprime.  But we do know that a proliferation of deals has created a current pipeline of hundreds of billions of risky corporate loans that will need to be sold into an increasingly risk-challenged marketplace.  Additionally, the M&A boom has been instrumental in inflating global equities markets, both by bidding up prices and fostering general liquidity and speculative excess.  A reversal of these dynamics is now a distinct possibility.  A serious market liquidity problem will commence with any move by the leveraged speculators to aggressively hedge risk and/or place bearish bets. 

In “Ponzi” fashion, problems getting debt sold would pierce a susceptible M&A Bubble, likely initiating a powerfully recursive cycle of declining equity prices, speculator angst,  further debt market stress and the specter of deleveraging.  This is an inherent predicament of Credit and leveraged speculation-induced asset Bubbles.  And while the corporate debt Bubble may not be “subprime,” there are certainly scores of less than prime borrowers, dangerous speculative dynamics, and latent Credit losses vulnerable to any tightening of the Credit and liquidity landscape.      

Returning briefly to the “distinct irony of the 21st-century financial world…and the epitome of modern capitalism,” I can comfortably state that Capitalism has never generated such a seductively contemptible boom, one financed by a Credit system so captivatingly free-market challenged.  Global central bank reserves will soon surpass $5.5 TN.  Fannie and Freddie’s combined “books of business” today exceed $4.1 TN.  Untold Trillions of leveraged securities holdings have evolved specifically because the Federal Reserve (and global central bankers) “pegs” short-term interest rates, promises advanced warning of any rate increases, and basically guarantees that markets will remain liquid.  Too many guarantees and promises are to blame for securitization and derivatives markets thoroughly perverting global risk markets.  

How anyone really could have expected such a system to effectively regulate Credit, price risk, and allocate resources is beyond me.  Subprime CDOs – yes, the tip of the iceberg.  And today’s surging oil prices, widening Credit spreads and weak dollar wouldn’t appear to portend bullishness.  It’s official, we’re now on Second-Half Liquidity Problem Watch.

06/21/2007 Uncertainty reigns supreme *

CDO and hedge fund worries pressured U.S. stocks, with the Dow (up 7.2% y-t-d) and S&P500 (up 5.9%) both declining 2% this week.  The Transports declined 1.3% (up 12%), and the Utilities were hammered for 4.1%.  Interestingly, the Morgan Stanley Cyclical index declined only 0.7%, reducing 2007 gains to 21.2%.  The Morgan Stanley Consumer index fell 1.8% (up 4.4%).  The small cap Russell 2000 declined 1.6% (up 6.0%) and the S&P400 Mid-Cap index 1.7% (up 11.4%).  Technology stocks generally outperformed.  The NASDAQ100 declined 1.1% (up 9.4%), while the Morgan Stanley High Tech index actually posted a slight gain (up 9.7%).  The Semiconductors added 0.4% (up 7.9%).  The Internet Index declined 1.2% (up 8.4%), and the NASDAQ Telecommunications index dipped 0.9% (up 7.9%).  The Biotechs were hit for 4.4%, reducing y-t-d gains to 2.4%.  Financial stocks were under pressure.  The Broker/Dealers dropped 3.6% (up 5.8%), and the Banks declined 2.6% (3.4%).  With Bullion down $1.20, the HUI gold index slipped 0.1%.

Two-year U.S. government yields declined 11 bps to 4.91%.  Five-year yields fell 7 bps to 5.01%.  Ten-year Treasury yields dipped 3 bps to 5.13%, as the yield curve further steepened.  Long-bond yields ended the week down one basis point to 5.25%.  The 2yr/10yr spread ended the week at 22 bps, with widest since October 2005.  The implied yield on 3-month December ’07 Eurodollars fell 9 bps to 5.29%.  Benchmark Fannie Mae MBS yields were unchanged at 6.29%, this week underperforming Treasuries.  The spread on Fannie’s 5% 2017 note widened one to 42, and the spread on Freddie’s 5% 2017 note widened about 2 to 42.  The 10-year dollar swap spread increased 2.2 to 62.  Corporate bond spreads widened, with the spread on a junk index 16 wider.     

Investment grade issuers included United Healthcare $1.5bn, Great River Energy $1.3bn, Regions Financial $1.1bn, BP AMI Leasing $930 million, Quest Diagnostics $800 million, JP Morgan Chase $750 million, Meridian Funding $750 million, Sprint Nextel $750 million, Lazard Group $600 million, Kinder Morgan Energy $550 million, Northern State Power $350 million, Marriot $350 million, Pactiv $500 million, Idaho Power $140 million, and Partners Healthcare System $100 million.

June 21 – Dow Jones (Michael Aneiro and Cynthia Koons):  “By any account, $300 billion is a lot of money. It should be an especially daunting sum when you’re lending it to someone else, even more of a cause for alarm when it’s going to a borrower with a less-than-stellar credit rating.  This is the amount coming to the risky debt markets in the next six to nine months, much of it to foot the bill for the eye-popping volume of leveraged buyouts announced this year. Yet it seems that after all the hubbub over how large LBOs were getting, investors aren’t that worried about actually ponying up the $300 billion necessary to get the deals done.  About $100 billion in bonds and $200 billion in loans are slated to hit the market through the first quarter of next year, a sizable chunk of which is even expected by the end of June.”

June 22 – Bloomberg (Caroline Salas):  “U.S. high-yield debt investors, after snapping up a record $600 billion in new loans and bonds this year, are starting to push back.  Thomson Learning…this week cut its bond offering to $1.6 billion from $2.14 billion, removed the riskiest portion of the deal and agreed to pay more interest on its planned loan… US Foodservice…also raised the interest on its planned loan to attract lenders…”

Junk issuers included UAL $700 million, Smithfield Foods $500 million, Shingle Springs Tribal Gaming $450 million, CMS Energy $400 million, Surgical Care Affiliates $300 million, Americredit $200 million, and Blaze Recycling and Metals $115 million.

This week’s convert issuers included Verifone Holdings $275 million, Stewart Enterprises $250 million, Dollar Financial $175 million, and Novamed $75 million.

International dollar bond issuers included Dubai Ports $3.25bn, Telefonica Emisiones $2.3bn, Northern Rock $2.2bn, BNP Paribas $1.1bn, Majapahit Holding $1.0bn, Transneft $500 million, Ukraine $500 million, ABH Financial $500 million, BW Group $500 million, Hynix Semiconductor $500 million, and Delhaize Group $450 million.

German 10-year bund yields were little changed at 4.65%, while the high-flying DAX equities index gave up 1.0% (up 20.5% y-t-d).  Japanese 10-year “JGB” yields declined 4 bps to 1.895%.  The Nikkei 225 rose 1.2%, increasing y-t-d gains to 5.6%.  Emerging equities markets mostly held their own, while debt markets remained under moderate pressure.  Brazil’s benchmark dollar bond yields added 2 bps this week to 6.08%.  Brazil’s Bovespa equities index dipped 0.5%, reducing y-t-d gains to 22.0%.  The Mexican Bolsa declined 1.5%, reducing 2007 gains to 19.6%.  Mexico’s 10-year $ yields gained 3 bps to 5.95%.  Russia’s RTS equities index gained 0.7% (down 1.3% y-t-d).  India’s Sensex equities index rallied 2.2%, increasing 2007 gains to 4.9%.  Today’s 3.3% sell off left China’s Shanghai Composite index down 1.0% for the week (up 52.9% y-t-d and 156% over 52-weeks).

Freddie Mac posted 30-year fixed mortgage rates declined 5 bps to 6.69% (down 2bps y-o-y).  Fifteen-year fixed rates fell 6 bps to 6.37% (up one bp y-o-y).  One-year adjustable rates dropped 9 bps to 5.66% (down 9bps y-o-y).  The Mortgage Bankers Association Purchase Applications Index declined 3% this week.  Purchase Applications were up 8.8% from one year ago, with dollar volume 14.7% higher.  Refi applications fell 4.2% for the week, although dollar volume was up 23.3% from a year earlier.  The average new Purchase mortgage dropped to $237,000 (up 5.4% y-o-y), and the average ARM declined to $396,200 (up 16.5% y-o-y). 

Bank Credit jumped $28.9bn (week of 6/13) to a record $8.584 TN.  For the week, Securities Credit rose $32.1bn.  Loans & Leases dipped $3.2bn to $6.266 TN.  C&I loans declined $6.1bn, and Real Estate loans dipped $3.5bn.  Consumer loans added $3.6bn.  Securities loans fell $2.0bn, while Other loans gained $4.7bn.  On the liability side, (previous M3) Large Time Deposits declined $15.9bn.     

M2 (narrow) “money” gained $7.5bn to $7.248 TN (week of 6/11).  Narrow “money” has expanded $204bn y-t-d, or 6.3% annualized, and $448bn, or 6.6%, over the past year.  For the week, Currency dipped $0.2bn, and Demand & Checkable Deposits fell $25.1bn.  Savings Deposits jumped $26.5bn, and Small Denominated Deposits increased $0.4bn.  Retail Money Fund assets gained $6.0bn.       

Total Money Market Fund Assets (from Invest. Co Inst) rose $4.2bn last week to $2.534 TN.  Money Fund Assets have increased $152bn y-t-d, a 13.3% rate, and $428bn over 52 weeks, or 20.3%.     

Total Commercial Paper rose $11.4bn last week to a record $2.132 TN, with a y-t-d gain of $158bn (16.6% annualized).  CP has increased $355bn, or 20.0%, over the past 52 weeks. 

Asset-backed Securities (ABS) issuance rose moderately to $12bn.  Year-to-date total US ABS issuance of $342bn (tallied by JPMorgan) is running slightly behind comparable 2006.  At $162bn, y-t-d Home Equity ABS sales are 35% below last year’s pace.  Meanwhile, y-t-d US CDO issuance of $177 billion is running 17% ahead of record 2006 sales

Fed Foreign Holdings of Treasury, Agency Debt last week (ended 6/20) jumped $11.7bn to a record $1.967 TN.  “Custody holdings” were up $215bn y-t-d (25.5% annualized) and $330bn during the past year, or 20.1%.  Federal Reserve Credit last week increased $2.3bn to $852.3bn.  Fed Credit is about unchanged y-t-d, with one-year growth of $26.4bn (3.2%).    

International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $607bn y-t-d (26% annualized) and $965bn y-o-y (22%) to a record $5.418 TN

Currency Watch:

June 18 – Bloomberg (Kosuke Goto):  “Japanese businessmen, housewives and pensioners betting against the yen in their spare time are wrecking the forecasts of the world’s biggest currency traders.  The yen has slumped 4.6% to a 4 1/2-year low against the dollar this quarter, making it the worst performer among 72 major currencies and confounding predictions by strategists… The banks didn’t reckon on the risk appetite of Japanese individuals, who are borrowing money like never before to buy currencies with higher yields. They tripled their trading in the year ended March to a record $11 billion a day…  Globally, currency trading by retail investors rose 54% in 2006, according to research firm Greenwich Associates in Greenwich, Connecticut.”

The dollar index declined 0.6% to 82.13.  On the upside, the Swedish krona gained 2.3%, the Romanian leu 1.6%, the Hungarian forint 1.8%, the Norwegian krone 1.6%, and the New Zealand dollar 1.4%.  The Swiss franc rose 1.0% and the euro 0.6%.  On the downside, the Colombian peso declined 2.0%, the Brazilian real 1.9%, the Indonesian rupiah 1.8%, the Israeli shekel 1.1%, and the Mexican peso 0.6%.  The yen sunk to a record low against the euro and a four and one-half year low against the dollar.

Commodities Watch

June 19 – Bloomberg (Madelene Pearson and Fergus Maguire):  “Australia, the world’s third-largest wheat shipper, cut its production forecast by 10% on concern of dry weather in its main export wheat-growing area, adding to a squeeze that's driven prices to an 11-year high.”

For the week, Gold declined 1.2% to $654 and Silver 1.8% to $13.02.  Copper fell 1.1%.  August crude added 60 cents to $69.14.  July gasoline gained 1.2%, while July Natural Gas sank 10%.  For the week, the CRB index declined 1.4% (up 2.4% y-t-d), and the Goldman Sachs Commodities Index (GSCI) also declined % (up 12.6% y-t-d). 

Japan Watch:

June 21 – Bloomberg (Lily Nonomiya):  “Japan’s trade surplus widened in May as export growth accelerated, indicating the slump in U.S. demand that cooled shipments in April was temporary.  The surplus rose 9.3% to 389.5 billion yen ($3.2 billion) from a year earlier…  Exports rose 15.1% in May, more than the 11.8% median estimate…”

China Watch:

June 19 – Financial Times (Richard McGregor and Jamil Anderlini):  “Chinese housing prices rose in May by 6.4%, the fastest year-on-year monthly increase in 18 months, in the latest sign that the economy is outpacing both the government’s and the market’s expectations.  The World Bank and Morgan Stanley in recent days have revised upwards their growth forecasts for 2007 to above 10%...  ‘The latest data indicate buoyant activity in almost every aspect of the economy, including investment, retail sales, external trade, and industrial production,’ said Qing Wang, of Morgan Stanley.  One of the most disturbing signs for the government has been the surge in power consumption, now rising at about 16% annually, well ahead of overall growth.”

June 19 – Financial Times (Richard McGregor and Jamil Anderlini):  “Eight years ago, China’s technocrats came up with an idea for what to do with the government’s vast stockpile of corn reserves, a stockpile that was going stale.  The plan was to transform the corn into starch, sweeteners or ethanol, which could be blended with gasoline to run cars. The move would create valuable products and potentially reduce China’s oil dependency. Now there is growing concern that creating biochemical and biofuels industries worked too well. The stale corn reserves are used up and there is increasing competition for fresh supplies between rapidly growing industrial processors and livestock farmers who rely on it as feed for animals… In April, the food price index rose 7.1%...  The search for corn sent China, the world’s second-biggest corn producer, back into international markets in 2005 for the first time since the mid-1990s. Only 70,000 tonnes were imported last year but that amount is likely to soar to 24m tonnes by 2020.” 

Asia Boom Watch:

June 20 – Bloomberg (Kim Kyoungwha):  “South Korea’s economic growth will top 4% in the second quarter, central bank Assistant Governor Lee Ju Yeol said.”

June 20 – Bloomberg (Suttinee Yuvejwattana):  “Thailand’s trade surplus widened in May as rice, sugar and electronics pushed exports to a record, outpacing imports, the commerce ministry said.  The trade surplus rose to $800 million in May… ‘All of our export items are rising, especially the agricultural products…’  Exports rose 20.9% from a year earlier to a record $13.1 billion…”

June 20 – Bloomberg (Stephanie Phang and Angus Whitley):  “Malaysia’s economy may expand 6% for a second straight year in 2008, the government said, reducing the need for an interest-rate cut to fuel growth.”

Unbalanced Global Economy Watch:

June 20 – Bloomberg (Gabi Thesing):  “The pace of global economic expansion is the strongest in decades, fueling demand for German goods, Handelsblatt reported, citing an interview with Hans-Werner Sinn, president of the Munich-based Ifo Institute.  Sinn said that if this year proves, as forecast, to be the fourth straight year in which the global economy has grown about 5%, it will be the first time since the 1950s that that has been the case, the newspaper said.”

June 18 – Bloomberg (James Kraus):  “Rising global demand for cranes is slowing the U.S. construction industry and creating a backlog of orders for manufacturers, the Wall Street Journal said.  Manitowoc Co.,  one of the largest crane manufacturers in the world with more than 6,000 people in its crane division, has added about 500 employees in North America in the last three years and a third shift at factories in the U.S. to keep up with demand…”

June 20 – Bloomberg (Svenja O’Donnell):  “U.K. money supply growth accelerated in May to the fastest pace in seven months, suggesting the Bank of England may have room to further increase interest rates.  M4, which is the broadest gauge of U.K. money supply…rose 13.8% from a year earlier, accelerating for a third month…”

June 19 – Bloomberg (Marcel van de Hoef):  “Dutch unemployment fell to 4.7% in the three months ended May 31, the lowest in four years.”

June 20 – Bloomberg (Simone Meier):  “Swiss producer and import prices, an early indicator of consumer price inflation, rose more than expected in May led by higher costs for mineral oil products.  Prices for factory and farm goods as well as imports rose 0.9% from the previous month… In the year, prices increased 2.8%.”

June 18 – Bloomberg (Simone Meier):  “Swiss industrial production rose for an eighth quarter as demand for machines and chemicals increased. Production in the first three months of 2007 increased 7.3% from a year earlier…”

June 19 – Bloomberg (Monika Rozlal):  “Poland’s average corporate wages rose an annual 8.9% in May, boosting the chance that interest rates may be lifted as soon as this month to curb inflation.”

June 20 – Bloomberg (Mahmoud Kassem):  “Egypt’s economy expanded 7.2% in the third quarter of the fiscal year that ends June 30, Al-Alam al-Yom reported… The economy grew 6.9% in the first nine months of the fiscal year…”

Latin American Boom Watch:

June 21 – Bloomberg (Patrick Harrington):  “Mexico’s unemployment rate fell in May from the previous month.  The jobless rate fell to 3.2% from 3.6% in April…”

June 20 – Dow Jones:  “Brazil’s federal tax receipts rose 18.2% in real terms in May compared with the same month a year ago…”

June 21 – Bloomberg (Bill Faries and Daniel Helft):  “Argentina’s economy, the second-largest in South America, grew faster than expected in April… Argentina’s economy expanded 8.4% in April from the same period a year earlier…”

June 17 – Bloomberg (Daniel Helft):  “Argentina revenue will reach 200 billion pesos ($65 billion) this year as the economy expands at more than 8%, the newspaper Clarin reported, citing economy ministry officials... Tax collections will be 32% higher…”

Central Banker Watch:

June 21 – Financial Times (David Ibison):  “Sweden’s central bank has raised interest rates by a quarter percentage point to 3.5% and adopted a more hawkish stance after indicating there will be two more quarter point increases before the year is over.  The Riksbank also raised its medium-term interest rate forecast to 4.4% by the end of 2009, well above the 3.7% it forecast in February.  The increases are attributable to strong growth domestically and overseas, decreasing unemployment, higher-than-expected wage costs and a buoyant lending and housing market.”

Bubble Economy Watch:

June 20 – Dow Jones (Irwin Kellner):  “Will it take double-digit percentage price increases to convince the markets that inflation is rapidly becoming a major economic problem?  Over the past three months, the annual rate of inflation has been running anywhere from 7% to 9%. That’s no typo, folks: Since March, prices have gone up at a 7% clip at the consumer level and at an 11% pace at the producer, or wholesale, level. By contrast, last year consumer prices rose 2.5%, while producer prices inched up just 1.1%.  Of course, I am referring to the headline figure in each instance; in other words, all the prices that are contained in these indexes.”

Financial Sphere Bubble Watch:

June 21 – Bloomberg (David M. Levitt):  “JPMorgan Chase & Co.’s new trading floors at Manhattan’s World Trade Center site would jut out 127 feet beyond the building’s facade, hovering above a park and a church, according to renderings released today.  The six cantilevered trading floors would extend in a six-story shelf from the north face of the 42-story tower, towards the World Trade Center Memorial. JPMorgan…last week agreed to build a 1.3 million square foot tower just south of Ground Zero.  ‘As a physical matter, it’s very difficult to get a trading floor that big on a 32,000 square-foot site,’ said Anthony Shorris, executive director of the [Port] authority, which controls the site.”

June 19 – Dow Jones:  “The nation’s largest public pension fund is doubling its investment in hedge funds…to $10B from $5B. The California Public Employees’ Retirement System, Calpers, also plans to double to $10B its investment in funds that seek to improve returns by bettering companies’ corporate governance.”

June 19 – Financial Times (Richard McGregor and Jamil Anderlini):  “American regulators may be forced to clamp down on activity in the so-called repurchase, or repo, market involving US government bonds if the industry does not clean up its behaviour, a senior official has warned… The comments will be closely watched by the market since it comes at a time of widespread investor interest in the US government bond sector, which has seen heavy trading volumes in recent days as a result of sharp price swings.  American finance officials attach a huge importance to maintaining the reputation of the $4,000bn-plus Treasury market and the related repo market. In the repo market, traders do not buy or sell bonds but use them as collateral for short-term financing. However, last year there was criticism from the US Treasury and others that traders had been trading to make profits by hoarding specific securities or manipulating the timing of trades.”

Mortgage Finance Bubble Watch:

June 22 – Bloomberg (Jody Shenn and Yalman Onaran):  “Bear Stearns Cos. offered to provide $3.2 billion in loans to bail out one of its money-losing hedge funds, the biggest rescue since 1998, after creditors started seizing assets.  The firm will provide a credit line to the High-Grade Structured Credit Strategies Fund that will be backed by the fund’s assets. Bear Stearns made the offer after creditors including Merrill Lynch… JPMorgan… and Lehman…put some of their collateral up for sale to investors.”
Foreclosure Watch:

June 18 – Bloomberg (John Taddei):  “More New York City homeowners are missing payments on their subprime loans and entering the foreclosure process, the New York Post reported.  In Brooklyn’s Bedford-Stuyvesant, one-fifth of subprime mortgages were more than 60 days in arrears as of April, and 10% of all subprime loans were in foreclosure, The Post said.  In one part of Bedford-Stuyvesant, the percentage of subprime loans 60 days or more in arrears rose from 15% in June 2006 to 23% in April 2007, said The Post.”

MBS/ABS/CDO/Derivatives Watch:

June 21 – Bloomberg (Jody Shenn):  “David Castillo, a senior managing director who trades asset-backed, commercial-mortgage and CDO bonds in San Francisco at Further Lane Securities, comments on the collateralized debt obligation market… On valuations assigned to CDO holdings:  ‘The CDO market is where it’s is happening right now. Subprime isn’t the story’ because the main driver of subprime-mortgage bond prices, and main holders of the securities, are CDOs and, in turn, their owners…  ‘If nothing’s trading and nobody’s pressuring you about it, why would you make it an issue? Nobody wants to look at the truth right now because the truth is pretty ugly.’”

June 21 – Bloomberg (Mark Pittman):  “Scott Simon, head of mortgage- and asset-backed securities… at Pacific Investment Management Co. … comments on the deterioration in the U.S. subprime mortgage bond market and the liquidation of two Bear Stearns Cos. hedge funds…  ‘The question is: Is this the tip of the iceberg?’  ‘When you get nervous is when you have $600 million of money that’s got $15 billion of positions.’  ‘The problem with these bonds is that there’s no market… The bonds are so sensitive to assumption, that little assumptions make an enormous difference in valuation. The difference between 60 and 90 is a very small deviation in path between now and five years from now. The bonds are incredibly levered.’”

June 20 – Bloomberg (Patricia Kuo and Junko Fujita):  “Credit-default swaps linked to loans will be more actively traded in the U.S. than the loans themselves within a year, according to analysts at Citigroup Inc… Trading of loan credit-default swaps now accounts for 50% of the volume of loan trades handled by Citigroup…”

Real Estate Bubbles Watch:

June 20 – Bloomberg (Hui-yong Yu):  “Morgan Stanley and Goldman Sachs Group Inc. raised $12 billion for global real estate funds, tapping a surge in investor demand for high-return assets outside the U.S.”

June 20 – Bloomberg (Will McSheehy and Bradley Keoun):  “Merrill Lynch & Co. plans to raise funds to invest in global real estate and infrastructure, chasing rivals Goldman Sachs Group Inc. and Morgan Stanley in offering clients alternatives to takeover funds.  ‘There’s no doubt the infrastructure space is an opportunity that's evolving,’ Ahmass Fakahany, co-president of Merrill, said…”

June 20 – Bloomberg (Simon Packard):  “Merrill Lynch & Co. Inc., the world’s biggest brokerage, sold its London offices to the government of Singapore for $954 million, and will rent the property back under a 15-year lease at an unspecified rent.”

June 21 – PRNewswire:  “California’s real estate downturn will be deep and long lasting, with home prices falling 15 to 30% during the next 36 to 42 months, according to a prominent real estate expert.  Bruce Norris, who correctly forecast both the real estate boom that began in 1997 and the subsequent doubling of home prices, said the downturn will reflect a perfect storm that includes record numbers of foreclosures, a sharp decline in migration to California, substantial increases in unsold inventory, and, of course, falling prices.  ‘We are in for a very rough ride in California’s real estate market, which is likely to be far more severe than analysts, state officials and real estate industry associations have acknowledged… Foreclosures alone are likely to be more numerous than anything we’ve ever experienced, with bank repossessions ultimately accounting for as high or as many as 25-30% of all homes sold during the next three years. But like any storm, this, too, shall pass’”

M&A and Private-Equity Bubble Watch:

June 22 - Dow Jones (Margot Patrick):  “Volume in European mergers and acquisitions deals will hit a record $1.02 trillion in the first half, according to preliminary figures… [from] Thomson Financial… The activity in Europe puts the region neck and neck with the U.S., where volume was $1.025 trillion as of June 21. It is the fifth consecutive year that first-half M&A volume has risen globally…”

June 21 – Financial Times (Ben White, James Politi, Francesco Guerrera, and Eoin Callan):  “Blackstone’s $7.8bn initial public offering was about seven times subscribed on Wednesday with strong investor demand for the units, especially from Asia, the Middle East and Europe, despite concerns over the US private equity group’s valuation.  People close to the offering said orders for Blackstone units had significantly outstripped supply. However, they added that demand from big US mutual funds had been limited by concern over a possible increase in Blackstone’s tax liability.”

June 19 – Financial Times (Gillian Tett):  “The use of so-called ‘cov-lite’ deals is snowballing in Europe and the US, in spite of warnings from regulators and financiers that these instruments could produce new dangers for investors if the credit cycle turns.  In recent weeks London bankers have sold a flurry of financing packages for European companies that feature reduced use of covenants – stipulations, such as minimum levels of interest coverage, to protect lenders…  In the US, more than a third of all loan issuance this year has been cov-lite, according to Standard and Poor’s Leveraged Commentary Data… ‘Talk is that arrangers [investment banks] are being told not to bother calling [private equity] sponsors for new mandates unless they are prepared to do cov-lite,’ says S&P LCD. The trend has horrified traditional financiers, who warn that it will leave investors exposed to losses if the credit cycle turns. Regulators and central bankers fear it indicates that credit markets are in a bubble.”

June 19 – Financial Times (Richard McGregor and Jamil Anderlini):  “The chief executive of UBS, the Swiss banking group, warned that the growing number of risky loans investment banks are making could lead to lawsuits and damaged reputations.  The warning by Peter Wuffli highlights increasing concern among senior executives that a boom in leveraged finance could drag banks into litigation and damaging disputes with clients if the credit cycle turns.  His comments…are the latest in a series of warnings by investors, bankers and regulators…  Mr Wuffli compared the potential consequences of the lending boom with the fallout from the stock market bubble of the late 1990s, when investment banks became embroiled in a series of accounting scandals and regulatory investigations that proved more damaging than their financial losses.”

June 21 – Financial Times (Jeremy Grant and Eoin Callan):  “The political momentum behind efforts to get private equity to pay more tax gathered pace last night even as Blackstone was pricing its initial public offering, with leading Democrat Barney Frank saying it was ‘an outrage’ that the industry was being ‘under-taxed’.  His comments came as a new bill to increase US taxes on private equity emerged in the House of  Representatives from Vermont congressman Peter Welch, who took aim at a ‘gaping tax loophole’. It also emerged that the Senate finance committee was considering toughening a bill introduced last week that would force listed private equity groups to pay corporation tax.”

Energy Boom and Crude Liquidity Watch:

June 19 – Bloomberg (Daryna Krasnolutska):  “Azerbaijan’s economy, the world’s fastest growing, will probably expand more than 35% this year as oil exports accelerate, Economic Development Minister Heydar Babayev said.”

Climate Watch:

June 20 – Bloomberg (Alex Morales):  “China in 2006 overtook the U.S. as the world’s biggest emitter of carbon dioxide, the greenhouse gas blamed for the bulk of global warming, a policy group that advises the Dutch government said.  China produced 6,200 million metric tons of carbon dioxide from burning fossil fuels and producing cement last year, the Netherlands Environmental Assessment Agency said… That pushed it past the U.S., which produced 5,800 million tons of the gas, the agency said.”
Speculator Watch:

June 19 – Bloomberg (Linda Sandler):  “Claude Monet’s painting of Waterloo Bridge doubled its top estimate while a view of his rose garden in France fell short of its low valuation at a Christie’s International sale last night in London.  The world’s largest auction house took in 121.1 million pounds ($240 million), including commissions, beating its top target. Monet’s 1904 ‘Waterloo Bridge, Temps Couvert’ sold for 17.9 million pounds…”

Uncertainty Reigns Supreme:

This should be an easy Bulletin to write:  The apparent collapse of two hedge funds -highly leveraged (at least 10 to 1) in illiquid collateralized debt obligations (CDOs) and other “structured” instruments.  Escalating losses induce the fund’s (“repo”) lenders to hit The Street with bid lists of CDO collateral apparently loaded with subprime exposure.  The dearth of buyers willing to pay anything close to “market” (“marked”) prices then forces the specter of revaluation and downgrades of similar securities and a possible contagion de-leveraging of CDO exposures throughout.  Smelling blood, scores of enterprising speculators of various stripes move to place assorted bets seeking profits from the expected forced liquidations, generally widening Credit spreads, and the potential snowball unwind of leveraged speculations.  The Wall Street firm that sponsored the funds is forced to step up and loan the funds $3.2 billion, increasing its risk profile in an increasingly Uncertain marketplace.  And with the CDO market having evolved into a critical source of system Credit and liquidity creation, the potentially dire Credit ramifications certainly could have rocked U.S. and global markets.

Yet, even after today’s drubbing the Dow is only about 2% off its record high and the S&P500 only a few percent below its own.  The NASDAQ100 is within a percent or so of its six-year high.  The emerging equities boom hasn’t missed a beat, with Brazil’s Bovespa index up 22% y-t-d, Mexico’s Bolsa almost 20%, and China’s Shanghai Composite up 52%.  Emerging debt spreads remain near record lows.  Junk spreads aren’t far off recent lows.

It would be easy this week to just stick with the obvious:  marketplace complacency has become deeply ingrained.  I’ll shoot for something a bit more thought-provoking, delving deeper into possible reasons behind the markets’ nonchalance. 

First of all, market participants have become conditioned to seek added risk during these occasional periods of “risk” market tumult.  Buying stocks and bonds back in the dark days of the 1994 MBS/bond/interest-rate derivatives rout worked wonderfully.  Ditto for the LTCM debacle in October 1998, the corporate Credit dislocation in 2002, the auto bond/derivatives dislocation in 2005, last year’s Amaranth collapse, or even the February subprime implosion.  It has been a case of each “profit opportunity” emboldening a little deeper.  “Resiliency” is today’s watchword. 

But there is certainly more to market behavior than a simple Pavlovian response.  After all, the global economy is booming and Inflationary Biases proliferate at home and abroad.  For example, Goldman and Morgan Stanley combined to raise $12 billion this week for their latest global real estate funds.  So far, the historic global M&A boom hasn’t missed a beat.  And despite subprime and housing angst, U.S. and global debt issuance runs at or near record pace.  Junk issuance was robust again this week.  Even CDO issuance remains strongly above last year’s unprecedented level.  The bulls (that tend to remain contently oblivious to Credit and speculative dynamics) are comfortable that the U.S. economy is in decent shape; that the global economic boom has a powerful head of steam; and that liquidity remains abundant.  Naturally, they would expect powerful Wall Street to fix problems as they arise.

Yet below the surface of mostly impressive market performance there are troubling signs.  Notably, recent risk market turbulence has been noteworthy for failing to ignite aggressive Treasury purchases. Ten-year yields declined only a few basis points this week, and Treasuries outperformed agency debt and MBS.  For years, the Credit market has been bolstered by the awareness that any indication of heightened systemic stress would be met with an immediate rally in Treasuries, agencies, MBS and other “top-tier” securities.  I’ve always seen this predictable drop in yields (increase in bond prices!) as a key dynamic supporting leveraging and risk-taking generally.  A change in this dynamic would be a significant Credit Bubble and market development. 

Clearly, U.S. markets are coming to the realization that global forces these days play a much more prominent role than ever before.  Robust Credit systems globally, general liquidity overabundance, and increasingly determined international central bankers are pressuring global as well as U.S. bond yields.  Importantly, this is forcing participants to rethink how quickly (and freely) the Fed might respond to heightened financial stress, especially if it is largely isolated to a particular segment of the U.S. Credit system. 

I can imagine the manager of Bear Stearns’ troubled hedge funds - and most speculators in risky assets - have for some time built into their thinking (and models) the presumption that any meaningful stress in asset markets (certainly including housing, stocks, and “structured finance”) would quickly impel lower Fed funds rates and sinking market yields.  Today’s scenario of a subprime implosion, faltering U.S. housing markets, an unparalleled global M&A boom, record debt issuance, an escalating global economic boom, $70 crude, heightened inflation pressures, and rising bond yields would have been considered a remote possibility not many months ago.

But things these days move so quickly and unpredictably.  Issues that were not even on the radar screen six months ago are now front and center.  The Blackstone Group as a public company with a $38bn market capitalization?  The prospect for wide-ranging legislation that would significantly raise the tax burdens for hedge funds, private equity firms, and venture capitalists?  “Sovereign wealth funds” that will quite likely prefer the acquisition of companies, resources, and other strategic assets to freshly “minted” debt securities courtesy of our Department of the Treasury and the GSEs? 

June 21 – Financial Times (Krishna Guha):  “The US is growing wary of the new fashion for sovereign wealth funds, amid concern among policymakers about potential negative effects on the international financial system.  Officials worry that the creation of such funds – which invest excess foreign exchange reserves – by non-oil exporters such as China may reduce the incentive for these countries to reform their currency regimes. They are also concerned that the existence of more large state-owned investment vehicles, with opaque holdings and objectives, could create problems for private investors operating in global markets…  A former senior administration official said: ‘A year ago they were not on anyone’s radar screen.’ Now, he said, the US was trying to figure out how to engage with countries eager to set up these funds.  John Taylor, undersecretary for international affairs in the first term of the Bush administration, told the FT ‘it is definitely a concern’.  ‘One of the things clearly is the motivation, rationale and transparency of the funds,’ he said…. the spread of giant public sector funds ran contrary to the longstanding US agenda of promoting a private sector market-based global financial system.  ‘A world where the private sector is making investment decisions is more dispersed, there is less concern about concentration of power. This has worked well,’ he said… The former senior administration official said there was nothing intrinsically ‘villainous’ about sovereign wealth funds. But there were concerns, not just in the US, that ‘China is going to want a device to make strategic acquisitions around the world that will trigger a political backlash’.” He said sovereign wealth funds could operate as ‘a big honeypot’ for governments.”

The subprime implosion, CDO problems, faltering hedge funds, China Bubble worries, the global M&A and securities Bubbles, prospering hedge funds and leveraged speculators, ballooning Wall Street, “tax the rich”, enterprising sovereign wealth funds, wildly inflating global asset markets and heightened uncertainty are anything but random and independent developments.  I hope readers will contemplate that the world economy, financial flows, and markets have been commandeered by Precarious Global Credit Bubble Dynamics - and the pursuit of free-flowing but highly inequitable financial riches.  At its Core, to sustain U.S. Financial and Economic Bubbles requires ever increasing amounts of already colossal Credit creation.  The global effects emanating from this global inundation become more pronounced and unwieldy by the month.

In relation to subprime, CDOs, derivatives, and highly leveraged hedge funds, keep in mind that the task of intermediating (transforming risky Credits into palatable securities) ever rising quantities of increasingly risky debt instruments has become quite a challenging endeavor.  This process – whether in relation to mortgage finance or corporate M&A – implies greater system leveraging, risk-taking, and the implementation of more sophisticated risk instruments and strategies.  Contemporary Credit booms work too magically on the upside, but the enigmatic world of derivatives and aggressive speculative leveraging ensure great Uncertainty at some (turning) point.

How secure is the collateral supporting Bear Stearns’ $3.2bn hedge fund loan?  How great is the risk of an unwind and contagion collapse of leveraged CDO and risky MBS/ABS holdings?  How quickly could tumult in the CDO marketplace spread the fear of risky mortgages to fear for risky corporate Credits and a faltering M&A Bubble?  To what extent will the global “leveraged speculating community” hedge against and/or speculate on widening spreads and heightened Credit system stress?

On several fronts, the Credit Bubble and U.S. Current Account Deficit-induced ballooning pool of global finance was inevitably going to lead to major market Uncertainties.  That day has arrived – the comforting and dependable flow (deluge) of finance into U.S. debt securities can’t now be so mindlessly taken for granted.  Will the global speculator community generally remain cohesive in pursuit of risk assets, or will we look back on the subprime implosion as marking the onset of dog-eat-dog opportunism, forced liquidations, hedging, and de-leveraging?  Does the recent rise of the powerful sovereign wealth funds create, as the bulls believe, an inexhaustible pool of finance for stocks and risk assets?  Or, perhaps, as it seems our government officials fear, does their advent mark an inflection point where a meaningful portion of the global pool of speculative finance abandons automatic Treasury/agency purchases in pursuit of better returns however they may be attained (including shorting, hedging, and bear trading).

Not uncharacteristically, over-zealous financiers and speculators have greatly exacerbated late-stage Bubble risk and Uncertainty.  The M&A boom got too hot.  Global stock, real estate and assets markets turned too hot.  The Chinese, Asian and general global economy became too hot.  Billions were made too effortlessly; the CDO game was too easy.  And robust economies and myriad spectacular asset and debt Bubbles are by their nature gluttons for additional Credit and marketplace liquidity.  Inevitably, things turn tenuous, and the line between runaway boom and unwinding Bubble turns troublingly thin.  For the semblance of order is maintained only as long as speculation and leverage-induced demand for risky debt instruments meets the ever escalating supply.

Most of the ingredients for Credit crisis are within reach, yet heightened volatility is likely still the best short-term bet.  I would expect the gigantic pool of speculative finance to be increasingly keen to short securities and bet on/hedge against systemic stress.  This is a notably unbullish dynamic, one that likely alters that nature of speculative flows - and that could at any point initiate a rush for the exits, market dislocation and panic.  Big down days seem inevitable, the kind that really shake confidence and instill fears that the “wheels are coming off.”   But there will almost surely also be days of panicked short covering and euphoric buying.  And those days will reinvigorate notions of goldilocks, New Eras and unlimited finance.  There will be days when the hedge funds and sovereign wealth funds are perceived as bull market friendly and days when their supporting role is seriously questioned.  Uncertainty Reigns Supreme.