Thursday, October 2, 2014

12/28/2007 2007 Wrap Up *

For the week, the Dow dipped 0.6% (up 7.24% y-t-d), and the S&P500 fell 0.4% (up 4.24%). The Transports slipped 0.4% (up 1.43%) and the Utilities 0.5% (up 16.32%). The Morgan Stanley Cyclical index declined 0.5% (up 11.93%), and the Morgan Stanley Consumer index lost 0.6% (up 7.01%). The small cap Russell 2000 declined 1.8% (down 2.01%), and the S&P400 Mid-Caps fell 0.7% (up 7.31%). The NASDAQ100 dipped 0.2%, reducing 2007 gains to 19.93%. The Morgan Stanley High Tech index slipped 0.2% (up 10.75%), and the Semiconductors dropped 1.5% (down 12.38%). The Internet Index declined 0.8% (up 15.47%), and the NASDAQ Telecommunications index sank 2.5% (up 10.68%). The Broker/Dealers fell 1.3% (down 14.58%), and the Banks sank 2.1% (down 24.85%). With Bullion surging $27.60, the HUI Gold index jumped 2.7% (up 22.40%).

Three-month Treasury bill rates jumped 15 bps this week to 3.14%. Two-year government yields fell 9 bps to 3.11%. Five-year T-Note yields declined 8 bps to 3.50%, and ten-year yields dropped 10 bps to 4.08%. Long-bond yields fell 9 bps to 4.49%. The 2yr/10yr spread ended the week at 97 bps, after beginning the year at a negative 11 bps. The implied yield on 3-month December ’08 Eurodollars sank 14 bps to 3.425%. Benchmark Fannie MBS yields fell 14 bps to 5.56%, this week outperforming Treasuries. The spread on Fannie’s 5% 2017 note was little changed at 49 bps, and the spread on Freddie’s 5% 2017 note was slightly wider at 49 bps. The 10-year dollar swap spread declined 0.8 bps to 64.7. Corporate bond spreads were again mixed, with the spread on an index of junk bonds ending the week about 25 bps narrower.

December 24 – Bloomberg (Jeremy R. Cooke): “U.S. state and local government borrowing will drop to about $100 million during this holiday-shortened week…after municipal-bond sales reached an all-time high during 2007… Issuance of state and local bonds due in more than 13 months reached about $428 billion for the year through last week, based on Thomson Financial data… The preliminary total is 5% more than the $408 billion record set in 2005.”

There were no corporate debt issues this week..

December 28 – Bloomberg (Junko Fujita): “Citigroup Inc., Bank of America Corp. and 30 other issuers from Iceland to Australia drove yen-denominated bond sales in Japan to a seven-year high as they took advantage of the lowest rates in the industrialized world. Sales of samurai bonds, debt sold by overseas borrowers mainly to Japanese investors, tripled to 2.2 trillion yen ($19.3bn) this year, from 741 billion yen in 2006, according to data compiled by Bloomberg.”

German 10-year bund yields were unchanged for the week at 4.30%, while the DAX equities index jumped 2.8% (up 22.3% y-t-d). Japanese “JGB” yields dropped 5 bps to 1.50%. The Nikkei 225 gained 1.8%, cutting 2007 losses to 11.1%. Emerging equities and debt markets were mixed to higher. Brazil’s benchmark dollar bond yields rose 6 bps to 5.71%. Brazil’s Bovespa equities index jumped 3.5% (up 43.7% y-t-d). The Mexican Bolsa gained 1.9% (up 12.3% y-t-d). Mexico’s 10-year $ yields declined 6 bps to 5.41%. Russia’s RTS equities index slipped 0.2% (up 19.2% y-t-d). India’s Sensex equities index surged 5.8% (up 46.6% y-t-d). China’s Shanghai Exchange rose 3.1%, increasing y-t-d gains to 97%.

Freddie Mac posted 30-year fixed mortgage rates added 3 bps this week to 6.17% (down 1 bp y-o-y). Fifteen-year fixed rates were unchanged at 5.79% (down 14bps y-o-y). One-year adjustable rates dipped 2 bps to 5.53% (up 6bps y-o-y).

Bank Credit surged $71.6bn during the week (12/19) to a record $9.165 TN. Bank Credit has posted a 22-week gain of $593bn (16.2% annualized) and a y-t-d rise of $943bn, an 11.6% pace. For the week, Securities Credit jumped $37bn. Loans & Leases rose $34.7bn to a record $6.787 TN (22-wk gain of $462bn). C&I loans gained $8.8bn (2007 growth rate of 20.7%). Real Estate loans jumped $16.7bn, increasing 2007 growth to 7.8%. Consumer loans increased $2.9bn. Securities loans dipped $3.0bn, while Other loans jumped $10.2bn. On the liability side, (previous M3) Large Time Deposits declined $2.9bn.

M2 (narrow) “money” supply increased $3.6bn to a record $7.460 TN (week of 12/17). Narrow “money” has expanded $417bn y-t-d, or 6.0% annualized. For the week, Currency dipped $0.4bn, and Demand & Checkable Deposits fell $9.8bn. Savings Deposits increased $9.7bn, and Small Denominated Deposits grew $2.4bn. Retail Money Fund assets added $1.5bn.

Total Money Market Fund Assets (from Invest. Co Inst) declined $5.7bn last week to $3.110 TN. Money Fund Assets have posted a 22-week surge of $527bn (48% annualized) and a one-year increase of $729bn (30.6%).

Total Commercial Paper added $1.2bn to $1.785 TN. CP is now down $438bn over the past 20 weeks. Asset-backed CP dropped another $15.9bn (20-wk drop of $448bn) last week to $764bn. Year-to-date, total CP has contracted $189bn, or 9.6%, with ABCP down $307bn (29%).

Fed Foreign Holdings of Treasury, Agency Debt last week (ended 12/26) jumped $8.5bn to a record $2.056 TN. “Custody holdings” were up $304bn y-t-d (17.4% annualized). Federal Reserve Credit expanded $2.6bn last week to $874bn. Fed Credit has increased $21.3bn y-t-d (2.5%).

International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $1.251 TN y-t-d, or 26%, to $6.061 TN.
Credit Market Dislocation Watch:

December 27 – International Herald Tribune (Floyd Norris): “‘The severity of the subprime debacle may be only a prologue to the main act, a tragedy on the grand stage in the corporate credit markets,’ wrote Ted Seides, the director of investments at Protégé Partners, a hedge fund of funds, in Economics and Portfolio Strategy. ‘Over the past decade, the exponential growth of credit derivatives has created unprecedented amounts of financial leverage on corporate credit,’ he added. ‘Similar to the growth of subprime mortgages, the rapid rise of credit products required ideal economic conditions and disconnected the assessors of risk from those bearing it.’”

December 27 – Bloomberg (Elizabeth Hester and Adam Haigh): “Citigroup Inc., JPMorgan Chase & Co. and Merrill Lynch & Co. may write down an additional $34 billion in securities linked to the collapse of the subprime mortgage market, according to Goldman Sachs Group Inc. Citigroup, the biggest U.S. bank, may reduce the value of its holdings by $18.7 billion in the fourth quarter and cut its dividend 40%, Goldman analyst William Tanona said…”

December 28 – Bloomberg (Bryan Keogh and Pierre Paulden): “Citigroup Inc., Goldman Sachs Group Inc., Morgan Stanley and JPMorgan Chase & Co. are offering discounts of as much as 10 cents on the dollar to clear a $231 billion backlog of high-yield bonds and loans… While lenders reduced the overhang by 32% since July, they are struggling to unload debt from this year’s record $438 billion of leveraged buyouts after losses from securities linked to subprime mortgages reduced demand for higher-yielding assets…”

December 28 – The Wall Street Journal (Gregory Zuckerman and Alistair MacDonald): “It isn’t just consumers who are having a harder time getting credit from lenders. It’s hedge funds, too. Investment banks are cutting back on loans to hedge funds, eliminating some clients and raising borrowing fees for others… ‘Banks aren’t in a position to be accommodating at the moment,’ said Michael Hintze, chief executive of CQS, a…hedge fund with $9bn under management. If the change continues, it could put some pressure on the profits of the prime-brokerage units of the major banks, which make big money by lending to hedge funds… The move also could put pressure on the returns of some hedge funds, which often rely on healthy doses of borrowed money, or leverage, to boost their returns. ‘Leverage definitely drives returns,’ says David Gold, an executive at Watson Wyatt Worldwide… In particular, Mr. Gold says quantitative funds -- those that trade using certain computer models -- are seeing their borrowing ability reduced… He says the move by the banks will have the biggest impact on smaller hedge funds.”

December 28 - Bloomberg (Sree Vidya Bhaktavatsalam): “Legg Mason Inc. pumped $1.12 billion into two non-U.S. cash funds to prevent losses, the biggest bailout by a money manager tied to asset-backed debt sold by structured investment vehicles.”

December 27 – Financial Times (Deborah Brewster): “More than 10 North American banks and fund managers have collectively injected $3bn into their money market and cash funds since October to stem losses. Janus, the fund manager, this week became the latest to bail out its money market funds. It put in $109m to buy troubled asset-backed securities from its funds. Half a dozen firms have made similar moves. The bail-outs, in the form of guarantees, credit lines and the buying out of troubled securities, are intended to stop funds falling below the $1 a share promised to investors. They show how seriously the parent companies take the reputational risk of ‘breaking the buck’.”

December 28 – The Wall Street Journal (Sudeep Reddy): “The Federal Reserve’s first auction of $20 billion in loans to banks under an initiative aimed at unfreezing money markets drew 93 bidders, indicating interest from all sorts of banks across the country. But the first details of where the money went suggest the biggest borrowers are near Wall Street. The central bank said $16.5 billion of loans under its ‘term auction facility’ went to institutions in the New York district, where many of the nation’s largest banks have their headquarters.”

December 27 – Bloomberg (Cecile Gutscher and Christine Richard): “ACA Capital Holdings Inc., the bond insurer that lost its investment-grade credit rating last week, agreed to give control to regulators to avert bankruptcy. ACA Financial Guaranty Corp., a unit of ACA Capital, will seek approval from the Maryland Insurance Administration before pledging or assigning assets or paying dividends, the…company said… S&P sliced ACA’s rating 12 levels to CCC, casting doubt on more than $75 billion of debt the company guarantees, including $69 billion of securities such as collateralized debt obligations. ACA reached agreements to avoid posting collateral until Jan. 18 against credit derivatives it uses to insure the debt.”

December 28 – The Wall Street Journal (John Hechinger): “SLM Corp. cited potentially grim prospects for its main federally guaranteed student-loan business, and indicated it was accelerating its push into private loans that aren’t backed by the U.S. government. The biggest student lender…also disclosed that it faced a federal inquiry into its billing practices for high-return loans and a recent lawsuit from customers alleging racial discrimination. Sallie Mae disclosed both its strategy and the actions it faced in a securities filing yesterday detailing $2.5 billion in stock offerings. The company is using the proceeds to pay off a soured bet on its stock price and shore up its credit rating. Sallie Mae's stock has plunged this year after Congress slashed subsidies to student lenders and a $25 billion takeover bid by a group of investors, led by private-equity firm J.C. Flowers & Co., fell through.”

December 27 – Bloomberg (Laura Cochrane): “Westfield Group, the world’s biggest shopping center owner, scrapped plans to sell A$700 million ($611 million) of U.K. and New Zealand assets after failing to find buyers following the slump in the U.S. subprime market. The sale of the remaining third of a 530 million pound ($1.05bn) U.K. Shopping Centre Fund has been stopped, Chief Financial Officer Peter Allen said… The Sydney-based company also canceled the sale of two shopping centers in New Zealand…”

December 24 – Bloomberg (Sean B. Pasternak): “The market for non-bank asset-backed commercial paper will reopen after a group of investors holding about C$33 billion ($33.3 billion) of the short-term debt struck a deal to restructure the securities. The group, led by Toronto lawyer Purdy Crawford, agreed yesterday to swap the commercial paper for longer-term notes, ending a four-month freeze in trading of the securities.”

December 28 – Bloomberg (Laura Cochrane): “Centro Properties Group, the owner of U.S. malls that lost 80% of its market value last week, said two of its funds will pay reduced dividends for the fourth quarter. The A$2.4 billion ($2.1 billion) Centro Direct Property Fund and the A$1.9 billion Centro Direct Property Fund International will pay unit holders less than in the three months to September because they are majority invested in other Centro managed funds, Alan Hayden, manager of the domestic fund, said…”

December 28 – Bloomberg (Stuart Kelly): “Rams Home Loans Group Ltd., the Australian mortgage company that failed to refinance more than A$6 billion ($5.3 billion) in short-term loans this year, today extended the maturity of two of its funding facilities. Rams extended a A$500 million loan to May 2 from Dec. 31, the Sydney-based non-bank lender said in a statement to the Australian stock exchange. A separate A$250 million facility was extended to Jan. 31 from Dec. 31, Rams said.”
Currency Watch:

December 28 – Bloomberg (Christopher Swann and Kevin Carmichael): “The dollar’s share of global foreign-exchange reserves fell to a record low in the third quarter as demand for U.S. assets waned after the subprime-mortgage market collapsed. The U.S. currency accounted for 63.8% of reserves at the end of September, down from 65% at the end of June, the International Monetary Fund said… The share of euros increased to 26.4%, from 25.5%. The figures suggest central banks diversified out of the dollar as it fell to the lowest level in a decade. Investors sold a record amount of U.S. securities in August when defaults on subprime mortgages rippled through financial markets and the Federal Reserve signaled it would cut interest rates.”

December 27 – Financial Times (Daniel Dombey): “At the end of a year in which the dollar has endured a marked decline against other currencies, an unsettling question is beginning to be voiced: can the troubles of the US currency be confined to the financial world or are they set to undermine Washington’s place on the international stage? ‘This is the neglected dimension of the dollar’s decline,’ says Flynt Leverett, a former senior National Security Council official under President George W. Bush. ‘What has been said about the fall of the dollar is almost all couched in economic terms. But currency politics is very, very powerful and is part of what has made the US a hegemon for so long, like Britain before it.’ Along with some other commentators, Mr Leverett brackets the dollar’s recent fragility with related phenomena, such as the greater international use of rival currencies… ‘Americans will certainly find global hegemony a lot more expensive if the dollar falls off its perch,’ adds Kenneth Rogoff, former chief economist of the International Monetary Fund…”

The greenback rally ended abruptly, with the dollar index suffering a 1.9% loss this week to 76.22. Over the past five sessions, the Swedish krona increased 2.9%, the Norwegian krone 2.9%, the Swiss franc 2.7%, the South African rand 2.4%, the Danish krone 2.4%, the euro 2.3%, and the Japanese yen 1.8%. On the downside, the Mexican peso declined 0.9%.
Commodities Watch:

December 28 – Bloomberg (Pham-Duy Nguyen): “Gold rose, heading for the biggest annual gain since 1979, as a decline in the dollar boosts demand for the precious metal as an alternative investment. Gold has gained 31% this year as a weaker U.S. currency, record energy costs and continuing conflict in the Middle East sparked demand for the metal. Investment in the StreetTracks Gold Trust, an exchange-traded fund backed by bullion, has climbed to a record 628 metric tons. ‘Gold currently has such a strong supporting cast in the dollar, energy prices and geopolitical tensions,’ said Matt Zeman, metals trader at LaSalle Futures Group in Chicago. ‘One would be hard-pressed to find a reason for gold not to continue to rally at this point.’”

December 28 – Bloomberg (Halia Pavliva): “Platinum, little changed, headed for the biggest annual gain since 2003 after the slumping dollar enhanced the appeal of the precious metal as a hedge against rising consumer prices. Palladium rose. Platinum was up 34% this year… ‘Platinum is behaving more and more as a hedge against inflation, just like gold and silver,’ said Ralph Preston, a strategist at Heritage West Financial Inc. in San Diego. ‘It will go much higher, as the weakening dollar is continuing to support platinum.’”

December 28 – Bloomberg (William Bi): “Soybean futures in Chicago rose to the highest in 34 years and corn reached an 11-year high as a jump in crude oil prices may increase demand for the crops to make biofuels at a time of reduced supplies… ‘We haven't seen signs that the recent rallies are curbing demand’ for either corn or soybeans, said Sun Rui, a Beijing-based trader at Cofco Ltd., China’s largest grain trader.”

December 26 – Bloomberg (William Bi): “Soybean futures in China, the world’s biggest consumer of the commodity, surged to a record as traders speculated vegetable oil demand may outstrip supplies resulting from government efforts to control food prices. The price of soybean oil…also rose to a record… The government has tried to lower vegetable oil prices by selling from state reserves and allowing soybean imports at reduced tariffs until the end of March.”

December 26 – Bloomberg (Halia Pavliva): “Copper rose for a fifth straight session, the longest rally in four months, on speculation demand will climb in China, the world’s largest consumer of the metal. China will eliminate a 2% import duty on copper cathodes and anodes next month… Copper prices have more than doubled in the past three years as usage surged in China… China’s imports of refined copper in the 11 months ended Nov. 31 surged 89% to 1.4 million tons from a year earlier…”

December 26 – Bloomberg (Aya Takada): “Natural rubber futures in Tokyo, the global benchmark, rose to the highest in seven weeks on expectations output in Thailand, the world’ largest producer, will start declining early next year… Rubber for June delivery gained as much as…0.8%... The contract has gained 23% this year, heading for the third straight annual gain…”

Commodities ended an exceptional year strongly. For the week, Gold surged 3.4% to $839.30 (up 31.8% y-t-d), and Silver jumped 2.8% to $14.895 (up 15.2%). March Copper declined 0.8% (up approx. 7%). February Crude jumped $2.78 to $96.09 (up approx. 57%). February Gasoline rose 3.6% (up approx. 49%), and January Natural Gas increased 1.1%. (up approx. 17%) March Wheat sank 6.7% (up approx. 77%). For the week, the CRB index gained 1.1%, with a y-t-d gain of 16.5%. The Goldman Sachs Commodities Index (GSCI) inflated 1.5%, increasing 2007 gains to 40.6%.
China Watch:

December 25 – Bloomberg (Tian Ying): “China’s tax revenue is expected to rise 30% in 2007 from a year earlier as economic growth boosts companies’ and individuals’ incomes, the state-run Xinhua News Agency reported.”

December 27 – Bloomberg (Li Yanping): “Chinese industrial companies’ profits rose 36.7% in the first 11 months, outpacing the gain a year earlier and making it harder for the government to tame investment and prevent economic overheating… That’s more than the almost 31% increase through November 2006. Sales jumped 27.6% to 35.5 trillion yuan.”

December 27 – The Wall Street Journal (David Winning and Sherry Su): “China unleashed a string of metal-export tax increases and import-duty cuts aimed at shifting its economy away from energy-intensive industries. It also announced steps intended to ease the country’s worst fuel crisis in years. The moves by the Ministry of Finance were signaled last week when the government said 600 kinds of products would carry temporary export levies in 2008, while import tariffs on other goods would be overhauled.”

December 26 – The Wall Street Journal (Kaja Whitehouse): “The latest year-to-date performance numbers from hedge funds that invest in China’s red-hot market appear impressive… The average China-focused hedge fund is reporting a double-digit percentage gain for the 11 months ended in November, with a few up more than 100%.”

December 26 – Bloomberg (Feiwen Rong and William Bi): “Pork prices in China, the world’s biggest producer and consumer of the meat, rose for an 11th week as demand and higher livestock farming costs thwarted government efforts to boost supply and tame inflation… The wholesale price of pork…gained 1.4% to 20.97 yuan ($2.86) a kilogram, up 53% in the past year…”

December 27 – Bloomberg (Chia-Peck Wong): “The value of new mortgages in Hong Kong rose 76% from a year ago to the most since July 1997, as economic growth and low interest rates fueled demand for loans.”
Japan Watch:

December 26 - Dow Jones Newswire: “A cautious view of Japan’s economy is spreading among business leaders, with the percentage of corporate chiefs who said the economy is expanding plunging to 64% in a recent Nikkei Inc. survey from 79% in October, The Nikkei reported…”

December 28 – Bloomberg (Mayumi Otsuma): “Japan’s inflation rose at the fastest pace in more than nine years in November and industrial production and household spending fell, signaling rising oil costs may derail the economy's longest postwar expansion. Core consumer prices, which exclude fresh food, climbed 0.4% from a year earlier…”
Asian Bubble Watch:

December 24 – Bloomberg (Shamim Adam): “Singapore’s inflation accelerated in November to the highest in 25 years as consumers paid more for food and transportation. The consumer price index jumped 4.2% from a year earlier…”

December 26 – Bloomberg (Nguyen Dieu Tu Uyen): “Vietnam’s inflation may reach a 10-year high of more than 12.6% this year, Saigon Giai Phong newspaper reported, citing Vo Hong Phuc, minister of planning and investment.”
Unbalanced Global Economy Watch:

December 26 – The Wall Street Journal (Alex Frangos): “Some of the biggest cities in the world are proposing the most ambitious real-estate projects in a generation… The list is long and expensive, with more than 15 ventures, some of which are expected to cost as much as $30 billion: Four in New York City, at least three in Dubai, two in London, Chicago and Milan, and one in Amsterdam, Los Angeles, Paris and Mumbai. Reasons for the projects vary….”

December 26 – Bloomberg (Craig Stirling): “U.K. house prices fell the most in three years in December, and the threat of more declines may cause the property market to seize up in 2008, Hometrack Ltd. said. The average cost of a home in England and Wales slipped for a third month, dropping 0.3% to 175,200 pounds ($348,350)…”

December 27 – Bloomberg (Christian Vits): “Inflation in the German state of Saxony held above 3 percent for a second month in December, driven by higher oil and food costs. Prices rose 3.1% from a year earlier…”

December 26 – Bloomberg (Ben Sills and Todd White): “Producer-price inflation in Spain accelerated for a third month in November as higher oil costs squeezed manufacturers. The price of goods leaving Spain's factories, farms and mines rose 5.4% from the year earlier…”

December 28 - Bloomberg (Aleksandra Nenadovic): “Serbian central bank Governor Radovan Jelasic said inflation is accelerating because of record oil prices and the government’s failure to limit wages and cut costs at state companies. The inflation rate will be ‘about’ 10% this year…”

December 26 – Bloomberg (Henry Meyer): “The Russian government will submit amendments to the federal budget to keep its promise of boosting wages, Prime Minister Viktor Zubkov told newly elected lawmakers. ‘I especially underline the importance of passing amendments to the budget to increase the wages of government employees and military personnel,’ Zubkov said… ‘We should strictly fulfill all our promises to citizens,’ he told the Duma’s opening session… Higher-than-anticipated inflation this year made it necessary to budget extra funds for salaries, Zubkov said.”

December 27 – Bloomberg (Steve Bryant): “Turkey’s central bank said it’s closely watching food and energy prices for signs they could upset the slowdown in inflation the bank forecasts. The government plans to boost household electricity prices by 15% in early 2008… A summer drought pushed up grocery prices and helped accelerate inflation to 8.4% in November.”
Bubble Economy Watch:

December 27 – The Wall Street Journal (James R. Hagerty and Kelly Evans): “A closely watched gauge of U.S. home prices shows they are falling sharply across most of the nation, as a deepening slump in the housing market threatens to damp consumer spending. Home prices in 10 major metropolitan areas in October were down 6.7% from a year earlier, according to the S&P/Case-Shiller home-price indexes… That exceeded the previous record year-to-year decline of 6.3% in April 1991… New statistics from the Census Bureau…indicate a slowdown in the number of Americans moving to states that led the housing boom Nevada, Florida and Arizona.”

December 28 – Bloomberg (Bob Willis): “Sales of new homes in the U.S. fell to a 12-year low in November, pointing to bigger declines in construction that will hobble economic growth throughout 2008. Purchases dropped 9% to an annual pace of 647,000 and October sales were revised down to a 711,000 rate… The deepest housing recession in 16 years will worsen as discounts fail to lure buyers and mounting foreclosures swell the glut of unsold properties.”

December 25 – Associated Press: “Americans are falling behind on their credit card payments at an alarming rate, sending delinquencies and defaults surging by double-digit percentages in the last year and prompting warnings of worse to come… Experts say these signs of the deterioration of finances of many households are partly a byproduct of the sub-prime mortgage crisis and could spell more trouble ahead for an already sputtering economy… The value of credit card accounts at least 30 days late jumped 26% to $17.3 billion in October from a year earlier at 17 large credit card trusts… At the same time, defaults… rose 18% to almost $961 million in October… Some of the nation’s biggest lenders -- including Advanta, GE Money Bank and HSBC -- reported increases of 50% or more in the value of accounts that were at least 90 days delinquent when compared with the same period a year ago.”

December 27 – Dow Jones (Chia-Peck Wong): “U.S. retail foot traffic for the week ended Dec. 22 fell ‘a significant’ 10.6%, contributing to a sales drop of 2.2% during the same period, according to ShopperTrak… which gauges mall traffic. Total U.S. foot traffic for the month of December through Christmas Eve declined 4.36%, while total holiday season foot traffic… was expected to decline 2.5%...”

December 28 – The Wall Street Journal (Kelly Evans): “Business demand for big-ticket goods has softened in recent months, a sign that stress from the housing and credit markets is damaging other sectors of the slowing U.S. economy. New orders for durable goods…rose just 0.1% in November from the previous month after falling three months in a row… Shipments of Manufactured goods dropped, and inventories rose, offering evidence of faltering demand… Orders for nondefense capital goods excluding aircraft, a gauge of business investment, dropped 0.4% after falling 2.9% in October. So far this year, orders are 1.8% below last year’s level. ‘This evidence reinforces the likelihood that the economy will slow dramatically in the fourth quarter,’ Nigel Gault, U.S. economist at forecaster Global Insight…”
Latin America Watch:

December 26 – Bloomberg (Telma Marotto and Andre Soliani): “Brazilian bank lending rose 3.1% in November from a month earlier as record low interest rates and higher employment encouraged consumers to borrow more. State and non-state bank loans increased to 908.8bn reais ($509.3bn)… Lending climbed 26.7% from November ‘06”

December 28 - Bloomberg (Carlos Barletta and Lester Pimentel): “The Costa Rican central bank’s 23-year hold on the country’s currency may be coming to an end as surging inflation puts pressure on the government to abandon its policy of fixing the colon's exchange rate. Higher oil prices have pushed up annual inflation to 10%, the highest in Central America, and forced the central bank to allow the colon to gain against the dollar for the first time since 1984.”
MBS/ABS/CDO/CP/Money Funds and Derivatives Watch:

December 27 – Market News International (Theodore Kim): “The deterioration in the performance of non-Agency Residential Mortgage Backed Securities started initially in subprime and, at least in terms of market volatility and spread widening, spilled quickly over into most other structured credit products. While the jury still may be out on whether the credit quality of commercial real estate or consumer credit card collateral backing ABS is turning for the worse, according to Standard and Poor’s, many Alt-A mortgage deals are already showing signs that they may be the next domino to fall. Alt-A severe delinquencies…have been increasing in recent months. The rate of delinquencies for 2006 originated deals is now running at more than double those of the 2005 vintage and more than four times those of 2004 and 2003. By far the worst vintage may be 2007.”

December 28 – The Wall Street Journal (Karen Richardson): “Warren Buffett, seizing a chance to profit from turmoil in the nation's credit markets, is starting up a bond insurer that aims to make it cheaper for local governments to borrow and promises to be a tough competitor for the industry’s embattled incumbents. The billionaire investor’s Berkshire Hathaway Assurance Corp., set to open for business today in New York state, will guarantee the bonds that cities, counties and states use to finance sewer systems, schools, hospitals and other public projects.”
Mortgage Finance Bust Watch:

December 26 – The Wall Street Journal (Kemba J. Dunham and Jennifer S. Forsyth): “The credit crunch triggered by the downturn in the housing market is creating problems in commercial real estate, driving down prices of office buildings, shopping malls and apartment complexes, and leaving some owners scrambling for cash. One victim is Centro Properties Group, the fifth-largest owner of shopping centers in the U.S. The Australian real-estate company saw its share price fall by 90% in two days last week as it struggled to refinance short-term debt it took on to fund its $6.2 billion acquisition of New Plan Excel, one of the biggest owners of strip malls in the U.S. Centro had planned to pay off the short-term loans by selling long-term debt via the commercial mortgage-backed securities market, but the lack of buyers forced it to get a two-month extension from its creditors.”
Real Estate Bubbles Watch:

December 26 – Bloomberg (James Kraus): “U.S. commercial real estate sales have halved in the past few months, driving down prices and leaving banks with $65 billion of loans they can’t sell to investors, the Wall Street Journal reported. Sales of major U.S. office properties fell 55% to $7 billion in November from a year earlier, the Journal said today, citing Real Capital Analytics.”

December 23 – Bloomberg (Sebastian Boyd): “Property funds may seek to sell a record 43 billion euros ($62 billion) of European commercial real estate in the next three years, the Sunday Telegraph said, citing a report by an industry group. U.K. fund managers may struggle to persuade investors to agree to extend the life of funds as they mature, according to the report from the European Association for Investors…”
Financial Sphere Bubble Watch:

December 28 – Bloomberg (Alison Vekshin): “U.S. bank revenue from trading derivatives and other contracts fell 62% in the third quarter, driven by the recent tightening of credit markets… The lost derivatives revenue will affect five U.S. commercial banks the most, the [OCC] said. JPMorgan Chase & Co., Bank of America Corp., Citigroup Inc., Wachovia Corp. and HSBC Bank USA accounted for 97% of the industry’s total derivatives trading revenue, according to the report.”

December 28 – OCC’s Quarterly Report on Bank Derivatives Activities: “Insured U.S. commercial banks generated $2.3 billion in trading revenues during the third quarter of 2007, down 48% from a year earlier… ‘The third quarter trading numbers reflect the effects of the recent turmoil in the credit markets,’ said Kathryn E. Dick, Deputy Comptroller for Credit and Market Risk. ‘Credit trading books were adversely impacted by rising credit spreads, poor liquidity, and ineffective hedging during the quarter.’ The OCC reported that revenues from credit intermediation declined $3.5 billion to a loss of $2.7 billion. Revenues from interest rate contracts increased $102 million to a record $3.1 billion, and revenues from foreign exchange transactions increased 59% to $2.0 billion. ‘Strong client demand for both interest rate and foreign exchange products boosted revenues in these sectors and helped to soften the impact of the poor performance of credit products,’ Ms. Dick said. The OCC also reported that the notional amount of derivatives held by insured U.S. commercial banks increased $19.7 trillion in the quarter to a record $172 trillion. The third quarter derivatives total is 36% higher than in the same period in 2006. Credit derivatives, the fastest growing product in the derivatives market, increased 19% during the quarter to a notional level of $14.0 trillion, 77% higher than a year ago. The OCC reported that the net current credit exposure, the primary metric the OCC uses to measure credit risk in derivatives activities, rose $53 billion during the quarter to $252 billion.”
California Watch:

December 28 - Los Angeles Times (Christopher Thornberg): “In 2002, the median price of a single-family home in Los Angeles was $270,000 and the median homeowner’s income was $65,000. With a $50,000 down payment, the annual cost of that house (taxes, insurance and payment on a 30-year fixed-rate conventional mortgage) would add up to about 33% of the median household's income -- just under the 35% mark that the Federal Housing Administration calls the upper limit of ‘affordable.’ By 2006, the cost of that same house doubled, to $540,000 -- pushed by unbridled speculation fueled by unparalleled access to mortgage capital. But median income rose a paltry 15%. So today that same set of costs come to 60% of gross income. That might be a manageable burden when home prices are rising at double-digit rates, creating new equity that can be accessed to support spending -- but not when prices are flat and the home-equity ATM is closed… The cold, hard truth is that foreclosures are serving only to hasten the painful process of shifting housing prices back to a level the market can sustain. Prices must and will fall. Everywhere. Probably 25% to 30% from their peak. 2008 is the year when gravity will reassert itself.”
Speculator Watch:

December 28 - Bloomberg (Katherine Burton): “Drake Management LLC suspended most redemptions from its largest hedge fund after losing 23.7% through November, according to a letter sent to investors… Drake will meet about 25% of requested withdrawals from its $3 billion Global Opportunities Fund… The partial redemptions were made possible by an agreement with Drake’s banks, the letter said. The firm’s lenders would have been allowed to terminate transactions and seize collateral if net assets had fallen by 30%.”
Crude Liquidity Watch:

December 27 – Bloomberg (Arif Sharif and Will McSheehy): “United Arab Emirates’ banks will report a 25% increase in combined profit to 24.8 billion dirhams ($6.75 billion) for this year, the Persian Gulf federation’s central bank governor said.”

2007 Wrap-Up:

There’s still Monday’s trading session to officially end the year. I thought I would get my 2007 Wrap-Up out of the way a little prematurely. This will be a work-in-progress, as I plan on editing and amending as year-end data come available.

The year was remarkable for the unusual divergences between bursting Bubbles and others continuing to inflate. This was the case both domestically and globally. As an example, the U.S. KBW Bank index sank 24.8%, while the NASDAQ100 surged 19.9%. The AMEX oil index surged 32.8%, while the S&P500 Homebuilding index collapsed 60%. Globally, major Chinese stock indices about doubled in price, while Japan’s Nikkei 225 fell 11%. In Europe, Britain’s FTSE mustered a 4.1% gain, while Germany’s DAX posted a 22.3% rise.

“Decoupled” Asian Bubbles inflated dangerously. The Chinese Shanghai Composite surged 96.7%, inflating 2-year gains to 355%. China’s CSI 300 index, which includes stocks on the Shenzhen Stock Exchange, gained 162% this year. The Shenzhen Composite was up 420% in two years. Hong Kong’s Hang Seng index rose 37.1% this year, with 2-year gains of 81.2%.

Taiwan’s TAIEX index gained 5.7%, increasing 2-year gains to 28.7%. South Korea’s KOSPI index gained 32.3% (up 39% in 2yrs). Singapore’s Straits Times index advanced 15.4%, increasing 2-year gains to 47.4% (up 156% in 5yrs). Thailand’s Bangkok SET index rose 26.2% (2yr gain of 22%). Malaysia’s Kuala Lumpur Composite index rose 32%, with 2-year gains of 61.6%. Indonesia’s Jakarta index surged 52.1%, with 2-year gains of 136% and 5-year gains of 546%. The major Philippine index posted a 21.4% gain (2yr gain 75.2%). The Vietnam Stock Index gained 23.3%, increasing 2-year gains to 202%.

India’s Sensex index jumped 46.6%, increasing 2-year gains to 118% and 5-year gains to 495%. The Karachi Stock Exchange 100 rose 47.1% (2-yr gain of 56%).

Fourth quarter losses (3.5%) reduced 2007 gains in Australia’s S&P/ASX index to 11.8% (2-year gain 33%). The New Zealand Exchange 50 dipped 0.5%, reducing 2-year gains to 20.7%.

Latin America certainly participated in the Global Bubble Phenomenon. Brazil’s Bovespa index surged 43.7% (2yr gain of 93%). The Mexican Bolsa rose 12.3% (2yr 68%) and Chile’s Select index 13.3% (2yr 56.8%). Argentina’s Merval gained 2.9% (2yr 40%), and Peru’s Lima General index jumped 36.0% (2yr 263%).

While December numbers have yet to be reported, better than 25% year-over-year growth pushed International Reserve (central bank) Assets to $6.06 TN. Through September, China’s reserves were up 45% y-o-y to $949bn. Russian reserves were up 56% this year to $466bn, with India’s reserves increasing 56% to $264bn. Brazil’s reserve assets almost doubled to $162bn. OPEC reserves were up 36% y-o-y to $421bn. “Sovereign Wealth Fund” was added to financial market vernacular. The dollar drifted further away from reserve currency status.

Despite the significant fourth quarter U.S. slowdown, 2007 will post only a modest decline from last year's record total global debt issuance. The global IPO market enjoyed a record year approaching $275bn, up from the previous record $242bn set last year. Although second-half deal flow slowed sharply, global M&A activity was still 20% ahead of 2006 (according to Dealogic), led by Asia and the emerging markets.

Gold gained 31.8%, its largest annual gain since the tumultuous year 1979 (when its price doubled) and its seventh straight year of positive returns. Crude oil surged 59%. Heating oil gained 62%, gasoline 54% and natural gas 17%. Despite declining 10% from its recent high, Wheat prices inflated 77% this year. Soybeans prices rose a record 79% this year to the highest level since 1973. After gaining 80% last year, corn climbed another 16% in 2007. Cotton prices rose 20%. The CRB index inflated 16.5% this year, and the more energy-weighted Goldman Sachs Commodities index surged 40.6%. It was the year when the markets came to recognize that significantly higher energy and commodities prices were having only minimal impact on demand.

During the year 2007, it became clear that the Federal Reserve had lost control of inflationary forces. The year ended with Import Prices up 11.4% y-o-y; the Producer Price index up 7.2% y-o-y; and the Consumer Price index up 4.3% y-o-y. Despite a weakened economy and another year of dollar devaluation (and booming exports!), the U.S. Current Account Deficit remained in the neighborhood of $800bn. Coupled with huge speculative outflows seeking profits from global inflation, the world was absolutely inundated with dollar liquidity.

It was, as well, a year of shattered myths: That astute global central bankers have inflation in check; that contemporary finance effectively disburses risk to the marketplace, in the process shielding the banking system from Credit and market risk; that “AAA” stands for safety and liquidity; that nationwide home prices won’t decline; that the Federal Reserve controls marketplace liquidity; that commercial paper is safe; that CDOs make sense; that the financial guarantors face minimal risk. Indeed, the entire bullish notion of contemporary risk modeling, structuring, hedging, and financial guarantees (“Credit insurance”) is now in serious jeopardy.

2007 saw the initial bursting of the Great U.S. Credit Bubble. To be sure, the enormous Bubble in Wall Street-backed finance abruptly went from runaway boom to astounding bust. Much of the mortgage origination market collapsed spectacularly. Thirty percent annualized broker/dealer balance sheet growth came to an abrupt halt during this year’s second half. Booming “private-label” MBS issuance ground to an immediate halt. Mortgage Credit Availability was reduced radically, especially in subprime, "jumbos" and riskier loan categories. The booming asset-backed securities and CDO markets faltered badly. The banking system’s off-balance sheet structured “vehicles” collapsed in illiquidity, another factor forcing the major lending institutions to balloon their balance sheets. The global inter-bank lending market seized up. The hedge fund industry waited anxiously for redemption notices. Counter-party risk became a very serious systemic issue, as did speculative leveraging. The global financial system ends the year on the precipice.

Meantime, U.S. Bank Credit expanded almost 12% during the year, with Commercial & Industrial loans ballooning almost 21%. With Risk Embracement turning to Risk Aversion, the marketplace called upon the Money Fund Complex to Intermediate Risk. Money Fund assets expanded an unprecedented $729bn, or 30.6%. And as liquidity disappeared for Wall Street-backed mortgages, Fannie and Freddie’s Combined Books of Business inflated an unprecedented $600bn (or so). The Federal Home Loan Banking system ballooned its balance sheet by more than $200bn, in the process becoming Lender of Last resort to some very troubled financial institutions. Global central bankers engaged in unparalleled concerted marketplace interventions and liquidity injections, sustaining global Bubbles in the process.

From the Fed’s Q3 “flow of funds,” total (non-financial and financial) U.S. system Credit growth expanded at an annualized $4.99 TN, sustaining the U.S. Bubble Economy but in an Unsustainable Manner – unsustainable in the quantity and structure of Credit and Risk Intermediation, as well as with the nature of economic (Bubble) activity. Financial sector debt expanded at an alarming 15.6% annualized pace, with Bank Credit, GSE, agency MBS, and Money Funds all expanding at double-digit rates. Of late, the Wall Street Credit crunch and severe tightening in risky debt markets have instigated recessionary forces. Many housing markets have gone from bad to worse – on the way to much worse. Florida is a mess, while California is an unfolding disaster. Some analysts have begun to recognize that U.S. asset and debt markets have not faced such precarious dynamics since The Great Depression. Meanwhile, collapsing U.S. and international interest-rates fuel myriad global Bubbles and inflationary pressures. In short, 2007 has been a continuation of the unfolding “worst-case-scenario.”

12/21/2007 Wall Street-Backed Finance *

For the week, the Dow advanced 0.8% (up 7.9% y-t-d), and the S&P500 gained 1.1% (up 4.7%). The Transports slipped 0.7% (up 1.8%), while the Utilities added 0.2% (up 16.9%). The Morgan Stanley Cyclical index jumped 1.7% (up 12.5%), and the Morgan Stanley Consumer index added 0.3% (up 7.7%). The broader market rallied strongly. The small cap Russell 2000 surged 4.2% (down 0.3%), and the S&P400 Mid-cap index rose 1.7% (up 8.1%). The NASDAQ100 jumped 1.9%, increasing 2007 gains to 20.2%. The Morgan Stanley High Tech index gained 1.5% (up 11.3%), and the Semiconductors recovered 0.5% (down 11.1%). The Internet Index jumped 2.5% (up 16.4%), and the NASDAQ Telecommunications index rose 3.1% (up 13.4%). The Biotechs gained 1.3% (up 7.5%). The Broker/Dealers increased 1.4% (down 13.5%), and the Banks added 0.4% (down 23%). With Bullion jumping $16.60, the HUI Gold index rose 2.8% (up 17.6%). 

Three-month Treasury bill rates rose 7 bps this week to 2.97%. Two-year government yields sank 11 bps to 3.20%. Five-year T-Note yields declined 5 bps to 3.59%, and ten-year yields fell 6 bps to 4.17%. Long-bond yields dropped 8 bps to 4.58%. The 2yr/10yr spread ended the week at 97 bps. The implied yield on 3-month December ’08 Eurodollars dropped 19 bps to 3.57%. Benchmark Fannie MBS yields fell 6 bps to 5.70%, this week trading in line with Treasuries. The spread on Fannie’s 5% 2017 note was little changed at 49, and the spread on Freddie’s 5% 2017 note was also little changed at 49. The 10-year dollar swap spread declined 3 bps to 65.5. Corporate bond spreads were mixed, with the spread on an index of junk bonds ending the week 30 bps wider.

December 19 - Dow Jones (Kellie Geressy): “Investment-grade companies broke new barriers in 2007, issuing a record amount of debt in the bond market despite the year's volatile second half. And although companies with riskier, more speculative credit profiles also got caught in the mid-year credit crunch, they still managed to post robust new issuance figures as well… According to Thomson Financial, $964.9 billion of high-grade debt has been sold in 2007 year-to-date, nudging out 2006’s $936.6 billion… Despite a major selloff in the second half, the high-yield bond market still saw about $135 billion of new supply this year, beating last year’s $131 billion, according to KDP Investment Advisors…”

December 21 – Financial Times (Lina Saigol and James Politi): “The volume of mergers and acquisitions worldwide suffered a dramatic fall in the second half of the year as credit dried up for private equity deals and many chief executives scrapped plans for bold takeovers. Global M&A in the year to date reached $4,740 bn, surpassing last year’s record of $3,910bn. But volume in the second half dropped 26% and September was the lowest month since November 2005, according to Dealogic…”

December 18 – Bloomberg (Fabio Alves): “U.S. corporate defaults probably will quadruple next year after the number of companies that lost their investment-grade credit ratings rose at the fastest pace since 2003. Moody’s… predicts companies will default on 4.7% of their bonds in 2008 as the economy slows, up from 1% this year. Jones Apparel Group Inc., the Bristol, Pennsylvania-based maker of Nine West shoes, mortgage lender Residential Capital LLC and 31 other companies with a combined $52 billion of debt were downgraded to junk by Moody’s this year.”

December 20 – Financial Times (Paul J Davies): “The outlook for European corporate and financial debt will turn distinctly more negative next year with credit ratings downgrades set to outnumber upgrades by two to one, according to S&P. This would be the first time in more than three years that downgrades have outnumbered upgrades. Default rates are also expected to pick up from their record low levels, the agency said, although they should remain below the long-term European junk-rated average of 3.5%.”

Investment grade debt issuers included Citigroup $3.5bn, Morgan Stanley $2.5bn, Lehman Brothers $1.5bn, and Con-Way $425 million.

Junk issuers included Helix Energy Solutions $550 million.

Convertible issuance included ADC Telecom $400 million.

December 18 – Financial Times (Joanna Chung): “A surge in activity by companies in emerging markets has helped to set a new record for capital raised with initial public offerings this year, according to…Ernst & Young… New share issues raised $255bn by the end of November, surpassing the previous record of $246bn set last year.”

German 10-year bund yields were unchanged at 4.30%, while the DAX equities index added 0.7% for the week (up 21.3% y-t-d). Japanese “JGB” yields were little changed at 1.55%. The Nikkei 225 declined 1.7%, boosting 2007 losses to 11.4%. Emerging equities and debt markets were mixed. Brazil’s benchmark dollar bond yields dropped 9 bps to 5.65%. Brazil’s Bovespa equities index added 1.0% (up 41.9% y-t-d). The Mexican Bolsa declined 1.2% (up 12.1% y-t-d). Mexico’s 10-year $ yields rose 8 bps to 5.50%. Russia’s RTS equities index gained 1.2% (up 19.5% y-t-d). India’s Sensex equities index sank 4.7% (up 39% y-t-d). China’s Shanghai Exchange rose 1.9%, increasing y-t-d gains to 90.7%.

Freddie Mac posted 30-year fixed mortgage rates increased 3 bps this week to 6.14% (up 1 bp y-o-y). Fifteen-year fixed rates increased 1 basis point to 5.79% (down 10bps y-o-y). One-year adjustable rates added 1 basis point to 5.51% (up 7bps y-o-y).

Bank Credit dropped $44.2bn during the week (12/12) to $9.163 TN. Bank Credit has posted a 21-week gain of $520 bn (14.9% annualized) and a y-t-d rise of $866bn, a 10.9% pace. For the week, Securities Credit sank $45bn. Loans & Leases added $0.7bn to $6.751 TN (21-wk gain of $426bn). C&I loans declined $9.3bn (2007 growth rate of 20.7%). Real Estate loans fell $9.9bn. Consumer loans added $2.8bn. Securities loans rose $16.6bn, and Other loans added $0.6bn. On the liability side, (previous M3) Large Time Deposits dropped $10.5bn.

M2 (narrow) “money” supply increased $17bn to $7.457 TN (week of 12/10). Narrow “money” has expanded $413bn y-t-d, or 6.1% annualized. For the week, Currency added $0.5bn, while Demand & Checkable Deposits dipped $2.6bn. Savings Deposits rose $14.3bn, and Small Denominated Deposits increased $1.5bn. Retail Money Fund assets rose $3.1bn.

Total Money Market Fund Assets (from Invest. Co Inst) slipped $6.1bn last week to $3.116 TN. Money Fund Assets have posted a 21-week surge of $533bn (51% annualized) and a y-t-d increase of $734bn (31.4% annualized)..

Total Commercial Paper sank a remarkable $54.7bn to $1.784 TN. CP is now down $439bn over the past 19 weeks. Asset-backed CP dropped $27.5bn (19-wk drop of $432bn) last week to $764bn. Year-to-date, total CP has contracted $190bn, or 9.8%, with ABCP down $291bn.

Fed Foreign Holdings of Treasury, Agency Debt last week (ended 12/19) jumped $7.6bn to a record $2.048 TN. “Custody holdings” were up $296bn y-t-d (17.2% annualized). Federal Reserve Credit expanded $7.2bn last week to $871bn. Fed Credit has increased $18.7bn y-t-d (2.2%).

International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $1.250 TN y-t-d (26.5% annualized) to $6.061 TN.

December 20 – Bloomberg (Maria Levitov): “Russia’s foreign currency and gold reserves, the world’s third largest, rose… by $6.2 billion to $467.4 billion in the week ended Dec. 14…”
Credit Market Dislocation Watch:

December 18 – Financial Times (Ralph Atkins, Dave Shellock and Gillian Tett): “Short-term market interest rates in the eurozone plunged at their fastest rate for more than a decade on Tuesday after the European Central Bank stunned investors by pumping a record €348.6bn worth of funds into the markets. The size of the injection – which was intended to calm the markets over the critical year-end period – was twice as big as the ECB had indicated would have been needed in normal circumstances. The bank said some 390 private sector banks in the eurozone had requested funds, which have been offered for two weeks at 4.21 per cent, well below the previous prevailing market rate. ‘The sheer magnitude of the operation caught the market off guard,’ said Win Thin, Brown Brothers Harriman’s senior currency strategist…”

December 18 – Bloomberg (John Fraher): “Bank of England Governor Mervyn King said the coordinated effort by central banks last week to ease a credit squeeze was aimed at persuading financial institutions they would do whatever is necessary to protect the world economy. The actions ‘demonstrate that central banks are working together to try to forestall any prospective sharp tightening of credit conditions that might lead to a downturn in the world economy,’ said King in testimony to lawmakers… Still, ‘a painful adjustment faces the global banking sector over the next few months,’ King said.”

December 19 – Financial Times (Ralph Atkins): “The massive amount of liquidity pumped into financial markets by the European Central Bank appeared yesterday finally to have exceeded demand - but Jean-Claude Trichet, its president, insisted that there had been ‘no bail-outs’. Demand in an auction of three-month money by the ECB yesterday fell short of the €50bn ($72bn, £36bn) that the central bank was prepared to offer… At the same time, the Frankfurt-based institution was able to mop-up €133.6bn of overnight money. The latest moves suggested that the series of measures announced by the ECB in recent weeks had eased banks' fears about the year-end, when financial institutions are under severe pressure to show strong liquidity on their books.”

December 21 – Financial Times (Aline van Duyn): “The crisis of confidence surrounding the creditworthiness of bond insurers deepened yesterday after MBIA revealed larger-than-expected exposure to complex bonds linked to faulty mortgages. Shares in MBIA, which guarantees payments on almost $700bn of debt, fell 26 per cent to close below $20 after the details came to light on the insurer’s website… Fitch…added pressure by warning it could cut MBIA’s triple-A rating unless it raised $1bn in capital in the next four to six weeks.”

December 21 – Financial Times (Aline van Duyn): “With their credit ratings affirmed at triple-A this week, it seemed the world’s biggest bond insurers were at last reaching a period of relative calm which could allow them to get on with boosting their capital positions and building some cushioning for the future. Instead, the lull lasted only a day. MBIA…triggered a near panic after it revealed higher-than-anticipated exposure to some of the riskiest types of structured debt linked to mortgages… For MBIA, this could make its round of capital raising more difficult… David Veno, director at S&P, said: ‘This could have some hindrance on its ability to raise capital. It is all a question of perception.’ Even if the capital raising is successful – and some analysts expect banks and others exposed to some of the hundreds of billions of dollars of bonds backed by insurers to step in if need be – the present crisis could have a longer-term effect on this sector of the market.”

December 21 – Financial Times: “MBIA gets top prize for understatement. When an insurer delicately refers to ‘supplementing’ its list of collateralised debt obligation exposures, that can only be bad news. It is. It turns out that MBIA has an $8bn exposure to CDOs of CDOs (or so called "CDOs-squared"). This is a critical nugget of information, to which the market had an allergic reaction… CDOs-squared are scary because they compound the leverage and complexity of original CDOs, already in the dog house. MBIA can claim that the collateral in the ‘inner’ CDOs is overwhelmingly AAA and AA. Nobody is listening. Markets have had enough of supposedly armour-plated securities tanking…. If MBIA’s capital position is not strengthened sufficiently, the rating agencies could have another go at reviewing the credit rating. A downgrade would hit all the securities MBIA insures, including the vast municipal market.”

December 21 – Financial Times (Ben White): “Trouble at Bear Stearns intensified yesterday when the investment bank reported a quarterly loss - the first in its 84-year history as a public company - that was nearly four times what analysts had forecast. Bear surprised investors with a $1.9bn writedown on its holdings of mortgage assets in its fourth-quarter results, a far larger decline than it forecast only a month ago.”

December 18 – Bloomberg (Jody Shenn): “More than $174 billion of collateralized debt obligations tied to U.S. mortgages were under review for downgrades by Moody's Investors Service at the start of this month, according to the ratings company, suggesting the subprime crisis may deepen. Moody’s downgraded $50.9 billion of CDOs made up of structured-finance securities in November, or about 9.4% of the total… Standard & Poor’s…has so far downgraded or placed under review $57 billion of the debt.”

December 17 – Bloomberg (Neil Unmack): “Sales of U.S. collateralized debt obligations, securities that pool bonds and loans, will fall by about 50% next year as defaults increase, Lehman Brothers Holdings Inc. analysts said. Collateralized loan obligations, CDOs based on loans, will decline 55 to 60% from this year’s estimated $81 billion of sales… Sales of CDOs that bundle credit-default swaps will decrease by about 40 to 50% from $53 billion in 2007.”

December 21 - Bloomberg (Elizabeth Hester and Shannon D. Harrington): "Citigroup Inc., Bank of America Corp., and JPMorgan Chase & Co. abandoned a U.S. Treasury-sponsored plan to buy assets from cash-strapped structured investment vehicles. The 'SuperSiv' fund brokered by Treasury Secretary Henry Paulson, slated to be about $80 billion when it was announced in October, 'is not needed at this time,' the banks said..."

December 20 – Financial Times: “John Mack wants investors to know he feels their pain. But forget the bonus Mr. Mack will forgo. The Morgan Stanley boss is lucky to hang on to his job after the bank disclosed a total writedown of $9.4bn for the quarter and its first ever loss… As for the writedown, it is jaw-dropping, even by subprime standards. A dozen or so traders laid on a position to offset the cost of shorting subprime. Had things worked out, the short could have netted the bank at most about $2bn. Instead, it cost the bank more than $7bn, as the traders’ correct hunch was overwhelmed by a deteriorating long position in top-rated collateralised debt obligation securities. How could that have happened?”

December 21 – Financial Times (Saskia Scholtes): “Hedge funds are scrutinising their levels of exposure to bank defaults, in a telling reversal of conventional risk management concerns. While bank exposure to the hedge funds they trade with has been in sharp focus since the 1998 collapse of Long Term Capital Management, a run of record-breaking losses and bailouts in banking has hedge funds re-examining how much they can be hurt by a bank collapse… In this environment, some hedge funds have found they are more exposed to the risk of bank failure because they agreed to trading terms that did not require banks to post collateral against certain derivatives trades, said Lauren Tiegland-Hunt, managing partner at law firm Tiegland-Hunt. ‘When the credit crunch took hold, many firms were surprised to discover they had entered ‘one-way’ collateral agreements that not only left money on the table, but also left them exposed to increased counter-party credit risk,’ she said. ‘In the current era of falling credit ratings and banks announcing huge...writedowns, this kind of risk is a real and pressing concern.’”

December 21 – The Wall Street Journal (Susan Pulliam and Kara Scannell): “Regulatory investigations into mortgage-securities pricing are examining whether financial firms should have told the public earlier about the declining value of such securities and how they priced them on their books, people close to the matter say. The regulators, led by the Securities and Exchange Commission, also are delving into whether Wall Street firms placed higher values on their own securities than those they placed on customer holdings, the people say. ‘As in most investigations, the issue comes down to what did people know and when did they know it,’ said Mark Schonfeld, director of the SEC’s New York office.”

December 21 – Bloomberg (Martin Z. Braun): “Florida Governor Charlie Crist called for outside lawyers to review the activities of an investment pool whose local government investors withdrew half of their deposits after learning the fund held downgraded and defaulted debt tied to subprime mortgages.”

December 18 – Financial Times (Jane Croft and Chris Giles): “Nationalisation moved a step closer for Northern Rock yesterday after the Treasury extended further guarantees to the stricken bank. Two months ago the government said it would provide cast iron guarantees to all Northern Rock’s retail savers and for wholesale deposits and borrowings. Yesterday’s additional guarantee means the government is mired even deeper in the Northern Rock crisis. The taxpayer is, in effect, backing exotic instruments at Northern Rock such as covered bonds - an ultra-safe type of bond - and derivatives that are not backed by mortgage collateral.”

December 20 – Bloomberg (Sebastian Boyd and Gregory Viscusi): “Credit Agricole SA, France’s second-biggest bank by assets, will write down the value of holdings by 2.5 billion euros ($3.6 billion) before tax as the U.S. subprime crash roils debt markets. The bank decided to take the writedowns after S&P yesterday cut its rating on bond insurer ACA Financial Guaranty Corp. to junk…”

December 18 – Bloomberg (Jenny Strasburg and Christine Harper): “Goldman Sachs Group Inc. said clients pulled about $3 billion from quantitative hedge funds including Global Alpha in the fiscal fourth quarter and withdrawals will increase over the next three months. ‘We are OK with those funds being smaller, especially Global Alpha, because the funds have gotten too big,’ Chief Financial Officer David Viniar said… Global Alpha, which started 2007 with more than $10 billion, declined 37% through November…”

December 19 – Bloomberg (Shannon D. Harrington): “A so-called structured investment vehicle-lite managed by a unit of Ellington Management Group LLC failed to pay interest due on three classes of notes, according to S&P. Ratings on the A-2, B-1 and B-2 notes sold by Duke Funding High Grade II-S/EGAM I Ltd.’s were cut to D…”

December 17 – Financial Times (Peter Smith): “The residents of Tumbarumba, an outback town in the foothills of the Snowy Mountains, have little contact with the exotic world of structured debt. But at one point this year their local council had invested close to 70% of its investment portfolio in collateralised debt obligations. Tumbarumba is not alone. Dozens of Australian councils, charities and a public hospital operator invested heavily in high-risk CDOs actively marketed by Grange Securities, a fixed income specialist owned by Lehman Brothers… Similar pain afflicts communities across the world, from Norway to the US, as a result of direct and indirect exposure to exotic and complex debt instruments that failed to price risk accurately in the run-up to the credit meltdown.”
Currency Watch:

The dollar index rallied 0.4% to 77.72. For the week on the upside, the Brazilian real gained 1.5%, the Canadian dollar 1.4%, the Australian dollar 1.2%, the New Zealand dollar 1.2% and the Singapore dollar 0.5%. On the downside, the British pound declined 1.8%, the South African rand 1.5%, the Japanese yen 1.0%, and the Swiss franc 0.5%.
Commodities Watch:

December 17 – Financial Times (Javier Blas, Chris Giles, and Hal Weitzman): “Global food prices will come under further pressure today as benchmark prices for cereals at much higher levels kick in, making it almost inevitable that a second wave of food price inflation will hit the world's leading economies. In Chicago wheat and rice prices for delivery in March 2008 have jumped to an all-time record, soyabean prices are at a 34-year high and corn prices at an 11-year peak. Knock-on price rises are set to hit consumers in coming months, raising inflationary pressure and constraining the ability of central banks to mitigate the slowdown in their economies.”

For the week, Gold jumped 2.1% to $811, while Silver gained 3.6% to $14.49. March Copper surged 4.8%. February Crude gained $2.02 to $93.57. January Gasoline added 1.7%, and January Natural Gas rose 2.8%. December Wheat declined 3.1%. For the week, the CRB index gained 1.6% (up 15.3% y-t-d). The Goldman Sachs Commodities Index (GSCI) added 1.1%, increasing 2007 gains of 38.5%.
China Watch:

December 20 – Bloomberg (Nipa Piboontanasawat and Li Yanping): “China raised interest rates for a sixth time this year to cool decade-high inflation in the world’s fastest-growing major economy. The benchmark one-year lending rate will increase to 7.47%, a nine-year high, from 7.29%…”

December 20 – Market News International (Joe Richter): “Chinese economic growth faces a host of challenges in the new year including dollar weakness and the ongoing subprime crisis in the US credit markets, an official with the country’s planning agency said… Guo Lanfeng, deputy director of the National Economy Department…also told a forum here that the economy faces risks from domestic factors… Guo highlighted dollar depreciation and the subprime crisis as risk factors. ‘We have been studying the US subprime crisis for half a year. We can’t see clearly what’s going to happen to US GDP growth... but one thing that’s certain is that subprime hasn’t finished making its impact felt and the US economy is generally on a downwards track.’ He said that ‘you can’t overstate how much emphasis to place on dollar depreciation,’ noting the impact on global financial markets and raw materials prices. But Guo also said that China should ignore the concerns of others in managing its exchange rate, noting that the Chinese unit’s proper name is ‘people’s currency.’”

December 18 – Bloomberg (Belinda Cao and Li Yanping): “China is studying extra lending curbs to prevent overheating in the world's fastest-growing major economy, according to a central bank official. The People’s Bank of China is considering requiring a larger proportion of new deposits to be set aside as reserves, said a central bank official who declined to be named because he’s not authorized to speak publicly. It’s also studying larger reserve requirements for bigger banks with faster loan growth, he said.”

December 18 – Bloomberg (Luo Jun): “China should cap expansion of loans by commercial banks at between 14% and 14.5% in 2008, the Shanghai Securities News reported… Chinese banks’ outstanding loans stood at 26.1 trillion yuan in the first 11 months of the year, 17% higher than the same period in 2006…”

December 17 – Bloomberg (Winnie Zhu): “China, the world’s second-largest energy consumer, increased diesel imports to the highest in almost three years as the government ordered refiners to avoid fuel shortages. Purchases of the fuel from overseas climbed to 200,000 metric tons in November, the highest since Jan. 2005, while exports declined to 30,000 tons, the lowest since July, customs data released in Beijing today show. In the first 11 months, diesel imports jumped 55% to 800,000 tons and exports fell 14.5% to 640,000 tons.”

December 20 – Bloomberg (Li Yanping and Zhang Dingmin): “Chinese households’ concern about inflation is at the highest level since a central bank survey began… Of 20,000 urban households, 48% said prices are too high, according to the quarterly survey… About 65% expect prices to rise in 2008, also the largest number yet. The central bank began collecting the survey in 1999.”

December 20 – Bloomberg (Nipa Piboontanasawat and Wendy Leung): “Hong Kong’s inflation rose at the fastest pace in nine years as food from China became more costly and lower borrowing costs drove up property prices and rents. Consumer prices rose 3.4% in November from a year Earlier…”
Japan Watch:

December 20 – Bloomberg (Megumi Yamanaka and Shigeru Sato): “Imports of crude oil by Japan, the world’s largest consumer after the U.S. and China, rose for the second month in November, up 15.6% from a year earlier.”

December 20 – Financial Times: “It’s official: Japan’s economic recovery is running out of steam. A spate of consumer and business surveys said as much; several private sector economists are flagging the possibility of recession. The government has slashed its estimates. It expects the economy to grow 1.3% in the year to March, down from earlier forecasts of 2.1%. The numbers…highlight the extent of the gloom in the world’s second biggest economy. Even with a lower base, the next fiscal year’s economic growth is forecast to be 2%... New rules have extended the [homebuilding] approval process, with insufficient staff adding to the bottlenecks. The government reckons the private housing element of gross domestic product will drop 12.7% this year…”

December 20 – Bloomberg (Kathleen Chu): “The condominium supply in Tokyo and the surrounding area will fall to the lowest since 1993 this year and may decline further in 2008 as stricter rules for obtaining building permits has slowed housing starts, the Real Estate Economic Research Institute said.”
Unbalanced Global Economy Watch:

December 17 – Bloomberg (Rich Miller): “The world economy is facing the risk of both recession and faster inflation. Global growth this quarter and next may be the slowest in four years, while inflation might be the fastest in a decade, say economists at JPMorgan Chase & Co… ‘What lies ahead is a period of stagflation -- slow or no growth combined with rising inflation -- in the advanced economies,’ says Joachim Fels, co-chief global economist at Morgan Stanley…”

December 20 – Bloomberg (Andreas Scholz and Simone Meier): “Bert Ruerup, head of German Chancellor Angela Merkel’s council of economic advisers, said the European Central Bank is adding ‘way too much liquidity’ to money markets to try and push down credit costs at year-end. Central banks are ‘fueling moral hazard through the permanent availability of liquidity… It shows that the ECB governing council is under pressure and nervous. Banks are absorbing liquidity like vacuum cleaners.’”

December 20 – Financial Times (Ralph Atkins): “German business confidence tumbled this month to its lowest for almost two years… The Ifo institute’s ‘business climate’ index for the eurozone’s largest economy dropped unexpectedly sharply from 104.2 to 103.0 in November - the weakest since January 2006. ‘The economic cycle is -losing dynamism,’ said Hans-Werner Sinn, the… institute’s president. But the decline reflected greater pessimism about the current situation rather than declining expectations for the future.”

December 20 – Bloomberg (Svenja O’Donnell): “U.K. money supply growth slowed in November to the lowest since August 2005… M4…rose 11.1% from a year earlier, compared with 11.8% in October…”

December 20 – Bloomberg (Tasneem Brogger): “Icelandic wage growth accelerated to 8.3% in November, suggesting record-high interest rates are having a limited impact on pay.”

December 21 – Bloomberg (Maria Levitov): “Russia’s inflation rate rose to a two-year high in November as fruit, vegetables and other food prices surged. The rate rose to 11.5%... ‘Inflation is a serious problem,’ Economy Minister Elvira Nabiullina said… Consumer prices will probably increase an annual 12% this year… [he] said.”

December 21 – Bloomberg (Alex Nicholson): “The cost of goods leaving Russian factories and mines rose at the fastest annual pace in almost three years in November because of record global energy prices. Producer prices in the world’s biggest energy exporter rose 22.2%, up from 14.2% in October and 8.6% in September…”

December 20 – Bloomberg (Tracy Withers): “New Zealand’s economy grew at the slowest pace in a year in the third quarter as record-high interest rates curbed consumer spending and a rising currency crimped exports. Gross domestic product increased 0.5% from the second quarter…”

December 19 – Bloomberg (Nasreen Seria): “South African inflation accelerated to an annual 7.9% in November, the highest in more than four years, adding to pressure on the central bank to raise interest rates further.”
Bubble Economy Watch:

December 20 – Bloomberg (Joe Richter): “Manufacturing in the Philadelphia region contracted in December to the lowest level since April 2003, adding to evidence that a weakening economy is making companies more reluctant to spend.”
Central Banker Watch:

December 21 – Bloomberg (Liz Capo McCormick): “The Federal Reserve will conduct emergency auctions of loans as ‘long as necessary’ every two weeks as part of a global attempt by central bankers to restore faith in the money markets.”

December 20 – The Wall Street Journal (Nina Koeppen): “European Central Bank President Jean-Claude Trichet warned yesterday that inflation remains a threat, dismissing calls for the ECB to cut interest rates to help overcome the credit crisis. ‘We have to do our job, and our job is to deliver price stability,’ Mr. Trichet told the European Parliament’s committee for economic and monetary affairs. Mr. Trichet said the ECB stands ready to counter inflation risks with interest-rate increases if higher prices for fuel and food result in excessive wage and industrial price spikes. ‘Don’t be surprised if we remain alert and we tell . . . all price setters we wouldn’t hesitate to do whatever would be necessary to avoid those second-round effects,’ he said. Some warning signs are already surfacing. Germany’s public-sector union yesterday called for an 8% pay raise for its 1.3 million employees, as workers in both the public and private sectors have started demanding higher wages ahead of a coming round of salary negotiations in Europe’s largest economy.”

December 18 – Bloomberg (Svenja O’Donnell and Jennifer Ryan): “Bank of England Governor Mervyn King comments on the global credit squeeze… ‘The reason for the rise in spreads was not due to a shortage of cash. The large banks are now awash with cash. The issue is not whether they have enough cash. The issue is whether they’re willing to lend. In recent weeks, what has become evident is that banks are concerned about the capital position of other banks. They do not know where the losses from an array of investments in financial instruments will come to rest. Banks themselves are worried that the impact of their reluctance to lend will lead to a sharper downturn in the United States. That concern is a serious one. Central banks are clearly aware of these problems and will take steps.’”
GSE Watch:

Fannie and Freddie’s combined Books of Business (guaranteed MBS and retained mortgages) ballooned an additional $52.7bn during November, or 13.1% annualized, to $4.895 TN. For comparison, their Books of Business increased $23.0bn during November 2006 and $27.6bn during November 2005. Year-to-date, Fannie and Freddie’s Books of Business have increased a record $541bn, or 13.5% (2006 BofB growth of $352bn and 2005 growth of $166bn). Their retained portfolios have declined $5.0bn y-t-d to $1.423 TN, while the guaranteed MBS exposure has inflated $546bn to $3.472bn.
MBS/ABS/CDO/CP/Money Funds and Derivatives Watch:

December 21 – Financial Times (Paul J Davies): “The volatility in credit markets appears set to claim fresh victims after Moody’s yesterday put a number of complex and highly leveraged products, known as CPDOs, on review for downgrade… CPDOs (constant proportion debt obligations) are essentially highly leveraged bets on a large portfolio of corporate debt exposures, which carry ultra-safe ratings while promising high returns. They are usually created by selling protection on the main European and US indices of investment grade credit default swaps, which provide a kind of insurance against non-payment of corporate debt. The bets made through CPDOs are leveraged by 15 times on average…”

December 19 – Bloomberg (Bradley Keoun): “Citigroup Inc…dismissed about 30 employees in its structured-credit group after record mortgage-related losses… The cuts reduced the division by almost a third, a week after newly appointed Chief Executive Officer Vikram Pandit pledged a ‘front-to-back’ cost review…”

December 18: “Moody’s…downgrades of US structured finance (SF) CDO securities in November totaled US$50.9 billion across 952 tranches of 267 deals… The November downgrades represent roughly 9.4% of the original principal balance of Moody's-rated US SF CDOs outstanding on November 30.”

December 19 – Bloomberg (Dan Levy): “U.S. home foreclosures rose 68% in November from a year earlier as adjustable-rate mortgages left subprime borrowers unable to meet higher payments, according to data compiled by RealtyTrac Inc. There were 201,950 foreclosure filings in November, including default notices, auction letters and bank repossessions, down 10% from October’s total, RealtyTrac reported… California, Florida and Ohio had the most filings and Nevada had the highest foreclosure rate.”
Mortgage Finance Bust Watch:

December 19 – The Australian (Anthony Klan): “The most senior executives at Centro Properties Group - which is facing collapse after suffering a $6 billion meltdown this week - were given 10-year interest-free loans by the company to buy $44 million worth of shares. However, seven of the company's top executives, including Centro's chief executive, Andrew Scott, chief operating officer, Graham Terry, and chief financial officer, Romano Nenna, may never have to pay the money back because of a legal clause in the generous share agreements that says the money does not need to be repaid if the share price collapses.”

December 18 – Bloomberg (Patricia Kuo): “The risk of Australian property trusts defaulting on their debt rose to a record after Centro Properties Group, the owner of 700 U.S. shopping malls, said it has difficulty refinancing debt.”
Real Estate Bubbles Watch:

December 19 – Bloomberg (Saijel Kishan): “Jim Rogers, author of ‘Investment Biker,’ sold his New York townhouse for $1 million more than the asking price, according to Leslie J. Garfield & Co… Rogers, 65, sold the Riverside Drive property for $16 million on Dec. 17, a record for a single-family townhouse in New York’s upper westside…”
Muni Watch:

December 19 – Bloomberg (Michael Quint and Jeremy R. Cooke): “Wall Street’s three-year love affair with debt sold by U.S. states and cities is over. Municipal bonds, whose returns trounced Treasuries and corporate debt from 2004 to 2006, are headed for their worst year since 1999, according to Merrill Lynch & Co. indexes. They may remain laggards after securities firms reduced their holdings at the fastest pace in at least 12 years during the third quarter, data compiled by the Federal Reserve show.”

December 18 – The Wall Street Journal (Amy Merrick): “Falling home values and rising property taxes in many parts of the country are generating the loudest complaints about property levies since the 1970s, forcing state and local officials to address the outcry even as the housing-market slump eats into many sources of their revenue… In California, thousands of homeowners are having their assessments reduced under a decades-old state law, and lower tax revenue due to the weaker housing market is likely to force an emergency budget session. Falling real-estate prices and turmoil in the mortgage market are expected to reduce property values for U.S. homeowners by a total of $1.2 trillion next year, according to Global Insight Inc… Unless tax rates are changed, California could lose $2.96 billion in property taxes over several years because of the housing bust, the firm predicted. New York could lose $686 million; Florida, $589 million.”

December 18 – Bloomberg (Henry Goldman): “New York Mayor Michael Bloomberg said a slowing U.S. economy will reduce Wall Street profits and real estate sales, creating ‘worrisome’ city tax shortfalls… ‘The test of our character as well as our policies is how we handle any long-term downturn headed our way,’ Bloomberg said. The mayor said that while he is optimistic about long-term prospects because of the city’s fundamental economic strengths, ‘We are going to have some very tough times.’ In October, the mayor ordered budget cuts of 2.5% for the remainder of the fiscal year and 5% for the next year, which begins July 1. He sought to reduce the 2009 budget gap that had grown to $2.73 billion from $1.55 billion in June. The mayor said ‘unfunded mandates’ for public employee pensions and benefits and Medicaid had increased by $8.2 billion in the six years he’s been mayor, costing the city 47 cents out of every dollar in the city’s $59.4 billion budget.”

December 20 – Bloomberg (Christopher Condon): “Nuveen Investments Inc.’s John Miller, the No. 2 ranked municipal bond-fund manager of the past five years, may post his first annual loss because he kept almost half his assets in unrated securities as prices sank. Miller invested 48% of the $5.1 billion Nuveen High Yield Municipal Bond Fund in non-rated bonds that finance projects such as schools, hospitals and water-treatment plant… The strategy backfired this year when investors fled all but the highest-rated government bonds as subprime mortgage losses mounted.”
Financial Sphere Bubble Watch:

December 21 - Bloomberg (Christine Harper): "Goldman Sachs Group Inc... awarded Chief Executive Officer loyd Blankfein a record $67.9 million bonus in 2007 as mortgage losses drove his counterparts at Morgan Stanley and Bear Stearns os. to forgo year-end payouts."

December 18 – Bloomberg (Christine Harper): “Goldman Sachs Group Inc.’s 2007 bonus pool rose 23% to a record $12.1 billion as Wall Street’s biggest securities firm made revenue and profit history for a fourth consecutive year. Total compensation, including salaries, benefits and bonuses, climbed to $20.2 billion from $16.5 billion last year… Bonuses, which typically account for about 60% of pay, increased from $9.88 billion in 2006.”

December 18 – Bloomberg (Ambereen Choudhury and Zachary R. Mider): “Even Goldman Sachs…is prepared for a decline in mergers and acquisitions income next year… The value of transactions may fall 20% from a record $3.9 trillion this year, executives at JPMorgan Chase & Co., Lehman Brothers Holdings Inc. and Bank of America Corp. estimate.”
California Watch:

December 18 – Bloomberg (Dan Levy): “Southern California home prices fell a record 10% in November from a year earlier and sales declined the most in at least 20 years as tighter mortgage standards reduced the number of home buyers, DataQuick…said. A total of 13,173 new and existing houses and condominiums were sold in six southern California counties in November, down 43% from a year ago and up 2% from October. The median home price dropped to $435,000 from last November, the largest monthly decline since DataQuick began keeping records in 1988… Southern California home sales financed with so-called jumbo loans, those that exceed $417,000, tumbled 69% in November from a year earlier, DataQuick said… Purchases using jumbo loans accounted for 22% of Southern California home sales in November, down from 40% in the first seven months of the year… The median home price in Los Angeles County fell for the second consecutive month, dropping 3.5% in November from a year earlier to $499,000… Sales fell 46%... The San Diego County median home price dropped 9.7% to $440,000… San Diego prices peaked in November 2005 at $517,000… The Orange County median home price dropped 6.5% in November to $582,750…and sales decreased 45%... Orange County prices peaked in June at $645,000… The biggest Southern California sales decline was in San Bernardino County, which dropped 48.1%... The County’s median fell 13% to $330,000.”

December 20 – San Francisco Chronicle: “The Bay Area’s housing market remained in a bit of deep freeze in November, when sluggish demand kept sales at a two-decade low for the third straight month. Prices continued to hold up best in the region’s core markets, while some outlying areas posted more double-digit annual declines… A total of 5,127 new and resale houses and condos sold in the Bay Area in November. That was down 6.5% from 5,486 in October, and down 36.2% from 8,042 in November 2006, DataQuick…reported… Last month was the slowest November in DataQuick's statistics, which go back to 1988…”

December 21 – Bloomberg (William Selway): “California Governor Arnold Schwarzenegger said he will invoke emergency powers to force lawmakers into a special session to wrestle with a $3.3 billion shortfall in the state’s budget this year. The gap for the current year, ending in June, emerged as the housing market slump curbed tax revenue, wildfires in Southern California increased expenses, and the state was forced to set aside more money for teachers’ pensions… Over the next two fiscal years, the state is forecast to take in $14 billion less than it has committed for programs because spending growth is outpacing revenue.”

December 21 – Sacramento Bee (Andy Furillo): “In what may be the largest early release of inmates in U.S. history, Gov. Arnold Schwarzenegger’s administration is proposing to open the prison gates next year for some 22,000 low-risk offenders.

According to details of a budget proposal made available to The Bee, the administration will ask the Legislature to authorize the release of certain non-serious, nonviolent, non-sex offenders who are in the final 20 months of their terms. The proposal would cut the prison population by 22,159 inmates and save the cash-strapped state an estimated $256 million in the fiscal year that begins July 1 and more than $780 million through June 30, 2010.”

December 21 – Los Angeles Times (Sharon Bernstein and Paloma Esquivel): “California’s population continued to grow modestly in the last fiscal year despite a significant exodus of residents to other states, according to a state report… The annual study by the Department of Finance showed that 89,000 more people moved out of California than moved here from elsewhere in the United States. California’s population did grow in fiscal 2007 -- but the growth rested on births and the arrival of more than 200,000 immigrants from other countries. The shift dovetails with the state’s weakening economy and is most likely related, said Howard Roth, chief economist for the Department of Finance. Those who left, Roth said, were fleeing an economy in which just 5,800 jobs per month were created -- down from more than 20,000 per month the previous year. Jobs were lost in housing, finance, construction and other sectors, and key indicators like the number of automobiles sold were also down, he said… ‘If you’re someone in finance and you haven’t already been laid off . . . or if you’ve lost your job here and maybe your house, maybe you’re thinking that there are better prospects out there in other states,’ he said.”
Speculator Watch:

December 21 – Bloomberg (Jenny Strasburg and Jason Kelly): “Blue Wave, the hedge fund started by private-equity firm Carlyle Group in March, fell 6% last month, hurt by losses on structured credit investments backed by fixed-income assets.”
Wall Street-Backed Finance:

It was not a good week for Wall Street finance. Bear Stearns reported its first loss in its 84 year history. “Market conditions during the company’s fourth quarter continued to be very challenging as the global credit crisis that began in July continued to adversely impact global fixed income markets… On November 14th, we announced we would take a $1.2bn write-down on our mortgage securities inventories as a result of continuing deterioration in market conditions through the end of October. During the month of November, market conditions continued to deteriorate, which resulted in additional write-downs – bringing total mortgage related losses to $1.9bn.”

Yet Bear’s total writedown was rather puny in comparison to Morgan Stanley’s bombshell. “During the fourth quarter, the firm recognized a total of $9.4 billion in mortgage related writedowns as a result of the continued deterioration and lack of liquidity in the market for subprime and other mortgage related securities since August 2007. Of this total, $7.8 billion represents writedowns of the firm’s U.S. subprime trading positions…”

Morgan Stanley’s CFO: “As you are aware, over the past year our trading group decided to short the subprime market. The traders were short the lowest tranche of the subprime securities with a notional value of approximately $2.0bn. The traders decided to cover the cost of the negative carry in the short position. To do so they went long approximately $14bn of the super senior AAA or BBB subprime securities we refer to as mezzanine. As the Credit markets declined dramatically, the implied cumulative losses in the subprime market “ate” (unclear) into the value of the super senior AAA tranche we were notionally long. As a result, not withstanding the short position, the implied losses of the notional long generated a major net loss when the position was marked-to-market. The loss was non-linear with the decline of the relevant ABS index, given the long/short structure of this particular trade.”

Analyst question: “I know everyone is dancing around it, but I guess my question would be to help us understand how this could happen – that you could take this large of a loss? I would imagine that you have position limits and risk limits, as such. It behooves me to think that you guys could have one desk that could lose $8 billion?”

CFO: “Look, let’s be clear. One, this trade was recognized and entered into our accounts. Two, it was entered into our risk management system. It is very simple – it’s simple and very painful. So I’m not being glib. When these guys stress-lossed (tested) the scenario on putting on this position, they did not envisage in their stress losses that we could have this degree of defaults, right? It is fair to say that our risk management division did not stress those losses as well. It is as simple as that. There was a big fat tail risk that caught us hard, right? That’s what happened. Now, with hindsight, can you catch these things? We are not unique being long these positions, right? What is unique is that this was a trade that was put on as a proprietary trade and we have learned a very expensive and, by the way, humbling lesson.”

Morgan Stanley’s stock was up 8% for the week, despite reporting the first loss in its 72 year history. Investors were apparently comforted with the news of a $5bn equity infusion from the China Investment Corporation (controlled by the Chinese Finance Ministry).

The marketplace should be petrified with the revelation of an $8bn loss on a single trade that was not “rogue” - nor did it apparently even circumvent risk management processes. Instead, it appears to be a “simple” case of a devastating failure in the models used to structure a highly leveraged “hedged” trade. At the heart of the issue were illiquidity and a collapse in the value of a leveraged position, in a development that is very much systemic in nature. As the CFO stated, the company is “not unique being long these positions.” Morgan Stanley is quite fortunate that they do retain a strong global franchise in what remains a period of extraordinary Global Credit Bubble excess. They still enjoy the capacity to plug part of the hole in their equity base.

The market was rocked Thursday by the revelation of an additional $8bn “CDO-squared” (CDOs of CDOs) exposure at troubled MBIA. The stock’s 25% pounding confirmed that MBIA has reached the point where there’s scant room for error. And while the Credit insurers (“financial guarantors”) are (massively) exposed to Devastating Model Failure similar to that which has hammered Morgan Stanley, Bear Stearns, Merrill Lynch and scores of others, they today lack the fundamental “franchise value” that would be enticing to investors from China, the Middle East or elsewhere.

The financial guarantors suffer today from a confluence of terminal forces. First of all, current and future Credit Insurer losses are unknowable. And it’s not that loss estimates are difficult to reasonably quantify – it’s much more a case of requiring a series of assumptions with respect to the Credit cycle, market environment and economic performance on top of a bunch of guesses as to how various interrelated risk exposures will react to myriad possible scenarios. Such an exercise would require sophisticated models based on various other models, when we know full well today that even basic securities valuation modeling has broken down. Moreover, it is likely that prospects for writing profitable new business will be dismal for years to come. The market has lost trust in the insurance. At this point only a massive and highly-complex multi-government-orchestrated industry bailout would avert a collapse.

Morgan Stanley’s CFO stated that the company was caught hard by “big fat tail risk.” I don’t believe it was a case of “tail risk” at all. Devastating illiquidity and market losses were inevitable, only the timing was unclear. Broker/Dealer assets ballooned 140% in just four and one-half years to $3.2 TN. During this same period, the asset-backed securities market (including “private-label” MBS) inflated 120% to almost $4.3 TN. Myriad sophisticated structures, financial guarantees, liquidity agreements, and leveraging strategies were implemented to perpetuate the greatest financial Bubble in history. As with all great schemes of leveraged speculation, the minute the music stops collapse ensues. Underlying Acute Fragility is exposed with the inevitable reversal of speculative and leverage-based market liquidity.

To keep the music playing required increasingly egregious excesses – ever greater quantities of increasingly risky loans, structures and leveraging. The Credit Insurers came to play a critical role in perpetuating the Bubble. They could not resist the allure of easy “profits” insuring Wall Street’s creative “structured Credit products,” while at the same time aggressively expanding their traditional guarantee business at the top of a Historic Credit Cycle. The Credit insurers destroyed themselves.

December 20 – Bloomberg (Shannon D. Harrington and Christine Richard): “MBIA Inc. fell the most since 1987 in New York trading after the world's biggest bond insurer disclosed that it guarantees $8.1 billion of collateralized debt obligations that investors say have a greater chance of losses. ‘We are shocked management withheld this information for as long as it did,’ Ken Zerbe, an analyst with Morgan Stanley…wrote… ‘MBIA simply did not disclose arguably the riskiest parts of its CDO portfolio to investors.’”

December 21 – Bloomberg (Shannon D. Harrington): “The perceived risk of MBIA Inc. and Ambac Financial Group Inc. defaulting on their bonds rose for a second day after Fitch Ratings said it may cut its rankings on the world’s two largest bond insurers. Credit-default swaps tied to…Ambac, the second-biggest bond insurer, climbed 15 basis points to 598 basis points and contracts tied to MBIA, its larger rival, rose 17 basis points to 590 basis points, a signal of eroding investor confidence.”

December 21 – Bloomberg (Christine Richard): “Credit ratings for Ambac Financial Group Inc. were placed under review for a possible downgrade by Fitch Ratings, which said the world’s second-largest bond insurer needs to raise $1 billion of capital. Fitch cited the…company’s guarantees on about $32.2 billion of collateralized debt obligations with varying degrees of exposure to subprime mortgage assets… The once unquestioned strength of AAA rated bond insurers is being reassessed on concern by Fitch, Moody’s Investors Service and Standard & Poor’s that the companies don’t have enough capital to cover losses stemming from downgrades on securities they guarantee. Fitch gave Ambac, MBIA Inc. and FGIC Corp. four to six weeks to raise at least $1 billion or lose their top ratings.”

December 21 – Bloomberg (Jeremy R. Cooke): “U.S. municipal bonds guaranteed by Ambac Assurance Corp. were placed under review for a possible cut from AAA by Fitch Ratings, which said it may downgrade the insurer because of its backing of subprime-mortgage debt. The ‘rating watch negative’ affects almost 138,000 municipal bonds backed by the financial guarantor, Fitch said… Four of the seven AAA rated companies that insure U.S. state and local government debt are now under review for a downgrade from Fitch. Standard & Poor’s and Moody’s… also are looking into whether the insurers have enough capital to warrant top grades…”

December 21 – Bloomberg (Darrell Preston): “State and local borrowers are discovering that buying municipal bond insurance from MBIA Inc. and Ambac Financial Group Inc. is a waste of money… Wisconsin, California, New York City and about 300 other municipal issuers sold bonds without buying insurance in recent weeks, avoiding premiums that are as high as half a percentage point of the bond issue…”

Wednesday S&P downgraded ACA Financial Guarantee from “A” to “CCC.” The insurance on about $69bn of “structured Credit products” is now essentially worthless, including $26bn or so of CDO guarantees. This is one further blow to the imploding CDO marketplace and a potential tipping point for Credit insurance more generally. To this point, the market has been content to assume that the larger financial guarantors were “too big to fail” – which implies too important in the marketplace to have their debt downgraded. But Fitch today placed Ambac’s ratings on watch for possible downgrade. By the pricing of their Credit default swaps, Ambac and MBIA this summer lost their “AAA” stature and are now quickly losing market confidence in their long-term viability.

We expect further significant and imminent weakness in “structured Credit products” – certainly in the illiquid markets for CDOs and Credit default swaps (CDS). Keep in mind that the economy is only now succumbing to recessionary forces, and we’ve yet to experience the failure of a major financial institution in the U.S. There will be many, and it’s worth noting that Rescap’s CDS prices surged again this week. It’s amazing to watch the massive central bank liquidity injections inflate the value of government and quasi-government backed securities, while having minimal impact on the imploding market for Wall Street-backed securities. It’s impossible to rectify the damage from the bursting Bubble, and there’s today literally trillions of increasingly impaired Wall Street securities overhanging the debt markets.