06/14/2007 For the Twenty-First Century *

For the week, the Dow gained 1.6% (up 9.4% y-t-d) and the S&P500 1.7% (up 8.1%).  The Transports gained 1.1% (up 13.5%), and the Utilities jumped 3.4% (up 9.4%).  The Morgan Stanley Cyclical index rose 1.8% (up 22%), and the Morgan Stanley Consumer index added 0.6% (up 6.3%).  The small cap Russell 2000 gained 1.5% (up 7.7%) and the S&P400 Mid-Cap index 1.4% (up 13.4%).  Technology stocks were strong.  The NASDAQ100 jumped 1.9% (up 10.6%) and the Morgan Stanley High Tech index 1.8% (9.7%).  The Semiconductors rose 2.9% (up 7.4%).  The Street.com Internet Index gained 1.0% (up 9.7%), and the NASDAQ Telecommunications index surged 2.9% (up 8.8%).  The Biotechs increased 2.1% (up 7.1%).  The volatile Broker/Dealers managed a rise of 0.7% (up 9.7%), while the Banks rallied 1.2% (down 0.8%).  With Bullion rallying $6.30, the HUI Gold index recovered 3.1%.

June 13 – Dow Jones (Emily Barrett):  “In the last few decades, overseas investors used to get up in the middle of the night to check the news on the U.S. economy.  These days, it may be the other way around.  In today’s financial market environment, with Treasurys testing their weakest levels in more than five years, U.S. investors can hardly afford to be parochial. Stock and bond trading in Asia and Europe is increasingly setting the scene for the U.S. market, and international growth and inflation indicators have become compelling reading for investors sweating the global trend toward higher interest rates.”

Two-year U.S. government yields increased 2 bps to 5.01%.  Five-year yields gained 3 bps to 5.08%.  Ten-year Treasury yields rose 4.5 bps to 5.15%, after trading above 5.30% Tuesday.  Long-bond yields ended the week up 4 bps to 5.25%.  The 2yr/10yr spread ended the week at 14 bps.  The implied yield on 3-month December ’07 Eurodollars rose another 2.5 bps to 5.38%.  Benchmark Fannie Mae MBS yields added 2 bps to 6.29%, recovering some of last week’s underperformance to Treasuries.  The spread on Fannie’s 5% 2017 note narrowed 2 to 41, and the spread on Freddie’s 5% 2017 note narrowed 2 to 40.  The 10-year dollar swap spread declined 0.75 to 59.25.  Corporate bond spreads were mixed this week, with the spread on a junk index 8 bps wider.    

Investment grade issuers included Hewlett-Packard $2.0bn, Weatherford $1.5bn, HSBC $1.0bn, National Semiconductor $1.0bn, Mellon Capital $500 million, Union Electric $425 million, Cooper $300 million, Mackinaw Power $290 million, Atmos Energy $250 million, Webster Capital $200 million, and Indianapolis P&L $165 million.

Junk issuers included El Paso Corp $1.25bn, Plains Exploration $600 million, and Algoma Acquisition $450 million.

This week’s convert issuers included Molson Coors $500 million, Iconix Brand $250 million, Sunstone Hotel $220 million, Northstar Realty $150 million, Blackboard $150 million, Aspect Medical $110 million, and Trex $85 million.

International dollar bond issuers included Clondalkin $150 million, and Banco Hipotecario $150 million.

June 11– Bloomberg (Tony Barrett):  “Emerging markets received $341 billion of new credit inflows in 2006, up 47% from a year earlier as borrowing increased to a record in developing Europe, according to the Bank for International Settlements.  Investment and lending have boomed in eastern Europe, pushing up wages and spurring consumer spending, as eight nations joined the European Union in 2004 and a further two followed this year. More than 60% of new credit to emerging markets went to European countries in the last three months of 2006, the BIS said…”

German 10-year bund yields jumped 8.5 bps to 4.65%, while the DAX equities index increased y-t-d gains to 21.7%.  Japanese 10-year “JGB” yields rose 4.5 bps to 1.93%.  The Nikkei 225 rallied 1.1%, increasing y-t-d gains to 4.3%.  Many emerging equities markets traded to new record highs, as debt markets regained their composure.  Brazil’s benchmark dollar bond yields declined 6 bps this week to 6.06%.  Brazil’s Bovespa equities index surged 4.2% to a new record, in the process increasing y-t-d gains to 22.6%.  The Mexican Bolsa rose 2.1%, increasing 2007 gains to 21.5%.  Mexico’s 10-year $ yields added 3 bps to 5.93%.  Russia’s RTS equities index jumped 4.4% (down 2.0% y-t-d).  India’s Sensex equities index added 0.7% (up 2.7% y-t-d).  China’s Shanghai Composite index rose 5.6%, increasing y-t-d gains to 54% and 52-week gains to 169%.

Freddie Mac posted 30-year fixed mortgage rates surged 21 bps to 6.74% (up 11bps y-o-y), a jump of 59 bps in five weeks to the highest borrowing rate since last July.  Fifteen-year fixed rates jumped 21 bps to 6.43% (up 18bps y-o-y).  One-year adjustable rates rose 10 bps to 5.75% (up 9bps y-o-y).  Curiously, the Mortgage Bankers Association Purchase Applications Index jumped 7.2% this week to the highest level since the first week of January.  Purchase Applications were up 11.9% from one year ago, with dollar volume 19.6% higher.  Refi applications gained 5.6% for the week, with dollar volume up 27.7% from a year earlier.  The average new Purchase mortgage jumped to $242,500 (up 6.9% y-o-y), while the average ARM rose to $407,600 (up 19.5% y-o-y).  

Bank Credit declined $18.5bn (week of 6/6) to $8.56 TN.  For the week, Securities Credit declined $7.9bn.  Loans & Leases dropped $10.5bn to $6.270 TN.  C&I loans actually jumped $12.2bn, and Real Estate loans gained $5.0bn.  Consumer loans were virtually unchanged.  Securities loans sank $17.7bn, and Other loans fell $10.1bn.  On the liability side, (previous M3) Large Time Deposits rose $2.8bn.     

M2 (narrow) “money” dipped $1.6bn to $7.240 TN (week of 6/4).  Narrow “money” has expanded $197bn y-t-d, or 6.3% annualized, and $448bn, or 6.6%, over the past year.  For the week, Currency added $0.3bn, and Demand & Checkable Deposits jumped $27.8bn.  Savings Deposits dropped $32.2bn, and Small Denominated Deposits slipped $0.5bn.  Retail Money Fund assets gained $3.1bn.       

Total Money Market Fund Assets (from Invest. Co Inst) rose $4.1bn last week to a record $2.530 TN.  Money Fund Assets have increased $148bn y-t-d, a 13.5% rate, and $424bn over 52 weeks, or 20.1%.     

Total Commercial Paper rose $5.7bn last week to a record $2.121 TN, with a y-t-d gain of $146bn (16.1% annualized).  CP has increased $344bn, or 19.3%, over the past 52 weeks.  
Asset-backed Securities (ABS) issuance slowed to $11bn.  Year-to-date total US ABS issuance of $326bn (tallied by JPMorgan) is running about 1% behind comparable 2006.  At $155bn, y-t-d Home Equity ABS sales are 34% below last year’s pace.  Meanwhile, y-t-d US CDO issuance of $167 billion is running 19% ahead of record 2006 sales.  

Fed Foreign Holdings of Treasury, Agency Debt last week (ended 6/13) were about unchanged at $1.955 TN.  “Custody holdings” were up $203bn y-t-d (25% annualized) and $323bn during the past year, or 19.8%.  Federal Reserve Credit last week dropped $7.9bn to $850bn.  Fed Credit has declined $2.2bn y-t-d, or 0.6% annualized, with one-year growth of $25.2bn (3.1%).    

International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $607bn y-t-d (27% annualized) and $962bn y-o-y (22%) to a record $5.417 TN.  

Currency Watch:

The dollar index added 0.2% to 82.60.  On the upside, the Iceland krona gained 2.3%, the Brazilian real 1.9%, the Turkish lira 1.9%, the Hungarian forint 1.6%, and the Bolivian boliviano 1.5%.  On the downside, the Japanese yen declined 1.4%, the Canadian dollar 0.7%, the Swedish krona 0.6%, and the Taiwan dollar 0.5%.  

Commodities Watch

June 14 - Bloomberg (Tony C. Dreibus):  “Wheat rose in Chicago and Kansas City, extending its rally to the highest price since 1996, as overnight storms delayed the harvest of U.S. crops already diminished by an earlier cold spell.”

For the week, Gold gained 1.0% to $655.15 and Silver 1.7% to $13.26.  Copper rallied 5.0%.  July crude surged $3.24 to a 9-month high $68.00.  July gasoline jumped 6.3%, and July Natural Gas advanced 3.3%.  For the week, the CRB index rose 3.8% (up 3.9% y-t-d), and the Goldman Sachs Commodities Index (GSCI) jumped 5.2% (up 14.2% y-t-d). 

Japan Watch:

June 11– Bloomberg (Lily Nonomiya):  “Japan’s economy expanded more than the government initially reported in the first quarter after higher-than-expected spending by companies.  The world’s second-largest economy grew at an annual 3.3% rate in the three months ended March 31…”

June 13 – Bloomberg (Toru Fujioka):  “Japan’s current account surplus widened in April as exports to Asia and Europe helped counter slower growth in shipments to the U.S.  The surplus expanded 50.3% to 1.99 trillion yen ($16 billion) from a year earlier…” 

June 15 – Bloomberg (Kathleen Chu):  “Condominium prices in Tokyo and its surrounds jumped 20 percent in May from a year earlier as the number of units available for sale declined for a fifth-straight month, the Real Estate Economic Research Institute said.”

June 12 – Market News International (Yoji Inata):  “The La Nina effect is expected to hit Japan with heat waves this summer, boosting sales of air conditioners, beverages and clothing and spending on leisure, but a water shortage would stifle production of steel, semiconductors and paper, analysts said…”
  
China Watch:

June 14 - Bloomberg (Zhang Dingmin):  “China’s economy will grow 10.6% this year, boosted by consumption, and its trade surplus may widen 48% to $260 billion, the Bank of Communications said in a report published in the China Securities Journal.”

June 15 – Bloomberg (Nipa Piboontanasawat):  “China’s factory and property investment surged, fueling speculation that an interest-rate increase is imminent after inflation accelerated and export and industrial production growth jumped. Fixed-asset investment in urban areas rose 25.9% in the first five months from a year earlier…”

June 11– Bloomberg (Nipa Piboontanasawat):  “China’s trade surplus swelled a bigger-than-estimated 73% in May, increasing pressure on the government to allow faster currency gains.  The gap widened to $22.45 billion…”

June 12 – Market News International:  “Chinese broad money supply decelarated slightly last month following a slew of recent monetary tightening measures… M2 rose 16.7% year-over-year at the end of May compared with April’s 17.1% rate.”

June 13 – Financial Times (Jamil Anderlini and Sky Canaves):  “China’s banks are laden with cash and ready to take on the world - just as the Japanese banks were half a generation ago.  The parallels are not lost on regulators in China or those in the developed world, who are wary about allowing banks that were insolvent just a few years ago into their domestic markets.  Beijing issues regular warnings to Chinese lenders to improve their risk management and has so far only approved a handful of small offshore acquisitions.”

June 12 – Bloomberg (Nipa Piboontanasawat):  “China’s inflation accelerated at the fastest pace in more than two years in May as pork prices soared, increasing the likelihood that interest rates will be raised.  Consumer prices rose 3.4% from a year earlier…”

June 14 - Bloomberg (Nipa Piboontanasawat and Li Yanping):  “China’s government reported industrial production growth unexpectedly accelerated in May, hours after Premier Wen Jiabao said further steps are needed to cool the world’s fastest-growing major economy.  Production by factories, mines and utilities rose 18.1% in May from a year earlier…”

June 13 – Bloomberg (Li Yanping and William Bi):  “The soaring pork prices that pushed China’s inflation rate to the highest in more than two years aren’t all bad news: Farmers’ incomes are getting a boost and that may increase consumer spending and lower dependence on exports.  Meat prices surged 26.5% in May from a year earlier because of a pig shortage linked to increased grain prices.”

June 13 – Bloomberg (Nipa Piboontanasawat):  “China’s retail sales unexpectedly accelerated at the fastest pace in three years, buoyed by rising incomes and a stock market that’s doubled this year.  Sales rose 15.9% from a year earlier to 715.8 billion yuan ($94 billion) after gaining 15.5% in April…”


India Watch:

June 12 – Bloomberg (Cherian Thomas):  “India’s industrial production growth beat expectations in April, suggesting the central bank may need to raise borrowing costs further to contain inflation stoked by consumer demand.  Output gained 13.6% from a year earlier…”

Asia Boom Watch:

June 14 - Bloomberg (Chen Shiyin):  “An apartment unit at City Developments Ltd.’s downtown St. Regis Residences in Singapore was sold at a record price as demand for luxury homes rises… The two-floor penthouse was sold for S$28 million ($18 million), or S$4,653.50 a square foot, to a foreign buyer last month…”

Unbalanced Global Economy Watch:

June 14 - Bloomberg (Simon Packard):  “Luxury home prices in London, the world’s most expensive city, may increase at a slower pace this year as more properties come onto a market with fewer buyers, real estate broker Knight Frank LLC said.  The average price of London’s costliest houses and apartments probably will climb about 20% this year after an almost 29% gain in 2006…”

June 14 - Bloomberg (Brian Parkin):  “Germany’s IfW Kiel institute, one of five that advise the government, said it expects Europe’s biggest economy to expand this year at the fastest pace since 2000, spurred on by exports and growing consumer demand at home.  The IfW raised its economic-growth forecast for 2007 to 3.2%...”

June 12 – Bloomberg (Rainer Buergin):  “German business confidence rose in April and May to the highest level since the country’s re-unification in 1990 as managers stepped up investment and hiring plans, a survey of more than 20,000 companies showed…”

June 14 - Bloomberg (Beate Evensen and Vibeke Laroi):  “Norway’s global pension fund, the largest savings plan in Europe, increased its assets by 2.9% in May, the country’s central bank said.  The fund held 1.96 trillion kroner ($322 billion) at the end of May…”

June 13 – Bloomberg (Diana ben-Aaron):  “Finland’s economy grew an annual 5.5% in the first three months of the year, more than expected and the fifth consecutive quarter above 4%.  Growth accelerated from 4.5% in the fourth quarter…”

June 14 - Bloomberg (Adam Brown):  “Romania’s unemployment rate fell to a 15-year low in May…  Unemployment fell to 4.1% in May from 4.5% in April…”

June 14 - Bloomberg (Maria Levitov):  “Russia’s economy expanded in the first quarter at the fastest pace in six years as production of building materials and electronics increased.  Gross domestic product grew an annual 7.9% in the first quarter…”

June 14 - Bloomberg (Maria Levitov):  “Russia increased imports from countries outside of the former Soviet Union by 53% in the first five months of this year from the year-earlier period, the Federal Customs Service said…  Imports totaled $56.54 billion from January through May…”

Latin American Boom Watch:

June 13 – Bloomberg (Katia Cortes):  “Brazil’s economy expanded in the first quarter as 16 straight cuts to the benchmark lending rate spurred consumer demand and encouraged companies to boost local production.  Brazil’s economy grew 4.3% in the first quarter from the same period a year earlier…”

June 14 - Bloomberg (Bill Faries):  “Argentina’s economy slowed in the first quarter of the year as construction, financial services and the production of manufactured goods moderated.  Argentina’s gross domestic product, the broadest measure of a country’s output of goods and services, grew 8% in the first quarter of 2007…”

Central Banker Watch:

June 14 - Bloomberg (Simone Meier):  “The Swiss central bank raised its benchmark interest rate to a six-year high today and said more increases are likely to prevent an expanding economy and a weaker franc from stoking inflation.  The Swiss National Bank increased the three-month Libor target rate by a quarter-point to 2.5 percent, the highest since September 2001.”

Bubble Economy Watch:

At 4.1%, May’s stronger-than-expected y-o-y increase in Producer Prices is the highest since June ’06.  May Retail Sales were up a stronger-than-expected 1.4%, with y-o-y sales up 5.4%.  May Consumer Prices were up 2.7% from one year ago.

June 13 – Bloomberg (Alan Bjerga and Carol Massar):  “U.S. consumers are paying 8% to 10% more for breakfast foods than a year ago because of rising prices for corn, wheat, milk and other commodities, a Department of Agriculture economist said.  Commodity inflation ‘is starting to work its way through the system,’ Ephraim Leibtag of the USDA’s Economic Research Service said… ‘The last few months we’ve seen it rise.’”

June 14 - BusinessWire:  “While confidence in the U.S. economy continues to fluctuate, affluent consumers remain committed to maintaining their luxury lifestyles. In 2006 American affluent consumers continued to spend significant amounts of money indulging in luxury goods and services.  The typical luxury consumer’s spending on luxuries rose 6.6% to reach $56,065, following an increase of 3.8% in spending in 2005…”
  
Mortgage Finance Bubble Watch:

June 14 - Bloomberg (Jody Shenn and Yalman Onaran):  “Bear Stearns Cos., the second-biggest U.S. underwriter of mortgage bonds, is liquidating holdings from one of its hedge funds after making money-losing bets on subprime home loans, said three people with knowledge of the decision.”

Foreclosure Watch:
June 12 – Bloomberg (Kathleen M. Howley):  “U.S. foreclosure filings surged 90% in May from a year earlier as more homeowners fell behind on their monthly mortgage payments, RealtyTrac Inc. said.  There were 176,137 notices of default, scheduled auctions and bank repossessions last month, led by California, Florida and Ohio…”

June 14 - Bloomberg (Kathleen M. Howley):  “The number of U.S. homeowners who face possible eviction because of late mortgage payments rose to an all-time high in the first quarter, led by subprime borrowers, as the economy grew at the slowest pace in four years.  The share of mortgages entering foreclosure rose to 0.58%, including so-called prime loans made to the most credit-worthy borrowers, from 0.54% in the fourth quarter, the Mortgage Bankers Association said… Subprime loans entering foreclosure rose to a record 2.43%, up from 2% in the prior quarter…”

MBS/ABS/CDO/Derivatives Watch:

June 11– Bloomberg (Darrell Hassler):  “Derivatives traded on global exchanges rose 24% in the first quarter to a record $533 trillion on growing use of interest rate futures, currency futures and stock index options, the Bank for International Settlements said…”

June 14 – Market News International:  “The latest BIS quarterly report…has shown strong ongoing growth in the CDO market, with the overall global issuance for 1Q 2007 standing at $251bn, another record level.   Issuance in CDS backed by ABS rose to $58bln from $48bln in the last quarter of 2006. Significantly though the growth in synthetic CDO’s or CDO’s which are backed by CDS, grew to $121bln, up from $92bln in the previous quarter.  The BIS cited the strong growth in synthetic CDO issuance as being behind the divergence of spreads and premia of CDS to comparable corporate bonds…”

June 12 – Bloomberg (Jody Shenn):  “The perceived risk of owning low-rated subprime-mortgage bonds created in the second half of 2006 rose to a near record today as loan delinquencies and mortgage rates climb, according to an index of credit derivatives.”

June 12 – Bloomberg (Jody Shenn):  “Moody’s…so far this year has cut or considered lowering ratings on 139 classes of securitizations in 2006 of U.S. subprime second mortgages.  The ratings actions, which compares with 29 for 2005 issues, comprise 14% of the classes of subprime second-mortgage bonds sold last year…”

June 12 – Financial Times (Stacy-Marie Ishmael ):  “Investors should demand more transparency and accountability from managers of collateralised loan obligations, according to…Standard & Poor’s.  The rating agency said the rising popularity of so-called covenant-lite loans imposed significant risks on investors in the opaque CLO market.  Demand for CLOs, complex financial instruments which repackage portfolios of loans, has surged recently...  In the first quarter of 2007, global covenant-lite loan volume reached $48bn, compared with $24bn recorded for the whole of last year. The use of these loans to fund buy-outs is already well-established in the US and becoming more accepted in Europe.”

June 12 – Bloomberg (Darrell Hassler):  “Goldman Sachs Group Inc. sold the first security backed by so-called catastrophe bonds as more insurance companies seek to spread the risk of potential losses from hurricanes, earthquakes and other natural disasters.  The $310 million collateralized debt obligation was sold on May 29 and will be managed by Bermuda-based Nephila Capital Ltd….”

Real Estate Bubbles Watch:

June 13 – Bloomberg (Daniel Taub):  “The number of homes sold in Southern California fell 34 percent last month to the lowest level in 12 years even as prices matched a record, DataQuick…said.  A total of 19,874 new and existing single-family homes and condominium units were sold in Los Angeles, Riverside, San Diego, Ventura, San Bernardino and Orange counties last month, down from 30,303 a year earlier…  It was the lowest sales count for any May since 1995, when 17,712 homes changed owners.”

June 13 – Bloomberg (Daniel Taub):  “U.S. commercial real estate investment reached a record $157 billion in the first four months of 2007, up 62% from a year earlier, due to a surge in office purchases, the National Association of Realtors said.  Office-building transactions from January through April totaled $95 billion, a record for the period…”

M&A and Private-Equity Bubble Watch:

June 12 – Financial Times (James Politi, Ben White and Francesco Guerrera):  “Blackstone co-founders Pete Peterson and Steve Schwarzman will together reap as much as $2.5bn from the US buy-out group’s initial public offering… The sum highlights the extraordinary wealth private equity executives have created for themselves during the industry’s recent boom years. This has both elevated their status and influence in global business and attracted increasing scrutiny from politicians and regulators.  Mr Peterson…will be selling 59.9% of his stake in the company, for a sum of $1.88bn… He will only own 4% of Blackstone after the stock market listing… Mr Schwarzman…will be selling a 5.7% stake for $677m. After the IPO, Mr Schwarzman will be by far the biggest shareholder in Blackstone, with a stake of 23% worth more than $7bn.”

June 15 – Bloomberg (Ryan J. Donmoyer and Elizabeth Hester):  “Blackstone Group LP’s planned initial public offering this month may be undermined by Senate legislation that would more than double taxes for the company after five years.  The legislation, introduced late yesterday by the Democratic chairman and ranking Republican on the Senate Finance Committee, would force Blackstone Group LP and Fortress Investment Group LLC to organize as corporations instead of partnerships for federal tax purposes beginning in 2012.  They, and other firms that would copy their tax strategy, would be prevented from taking advantage of a 20-year-old tax provision that allows investors in publicly traded partnerships to pay capital-gains taxes of 15 percent on their share of the
firm's income.”

Energy Boom and Crude Liquidity Watch:

June 12 – The Wall Street Journal (Ana Campoy and Russell Gold):  “The cost of building or expanding oil refineries is rising rapidly, contributing to delays in increasing the U.S. gasoline supply at a time of near-record prices.  The oil industry is blaming cost escalation -- driven by shortages of skilled labor and construction services, along with higher materials prices -- for a spate of pushed-back or scrapped expansion projects. Valero Energy Corp., the U.S.’s largest refiner in terms of the amount of crude it can refine, has delayed expansions in Quebec, Canada, and in Texas.  ConocoPhillips has put off projects at refineries in Texas and in Louisiana, while Tesoro Corp. canceled the installation of new equipment to process cheaper crude at a facility in Anacortes, Wash.”

June 12 – Bloomberg (A. Craig Copetas):  “It’s molting season in the Kingdom of Saudi Arabia and change is in the air… Tabouk Regional Governor Prince Fahd bin Sultan, this year will begin construction on what is intended as a showcase for a new Saudi Arabia: a $300 billion multicultural metropolis designed to lure 700,000 inhabitants from around the globe.  The construction of this and five other megacities scheduled for completion by 2020 will be funded by oil revenue.”

June 11– Bloomberg (Ian McKinnon and Reg Curren):  “Alberta’s oil-based economy is forecast to expand almost twice as fast as the rest of Canada’s this year, pushing unemployment to a 30-year low. The growth is bringing surging housing costs, a shortage of hospital beds, and a lack of schools and recreation facilities for a population that has gained 10% in five years.”

June 14 - Bloomberg (Matthew Brown):  “Increased lending to Kuwaiti residents by commercial banks’ may increase inflation in the oil rich Gulf state, HSBC Holdings Plc. said.  Commercial banks in Kuwait increased lending to residents by 4.3% in May from a month earlier to 17 billion dinars ($59 billion), an annual increase of 29%, the Central Bank of Kuwait said…”

Climate Watch:

June 12 – Bloomberg (Demian McLean):  “A key weather satellite could fail soon, leaving U.S. hurricane forecasters blinded and coastal cities in danger, the Associated Press said, citing scientists including the head of the National Oceanographic and Atmospheric Administration.  The QuikScat satellite, which isn’t scheduled for replacement till 2016, lost its main transmitter last year and is using a backup, the news service said.”

Fiscal Watch:

June 11 – New York Times (Jennifer Steinhauer):  “State lawmakers across the country, their coffers unexpectedly full of cash, have been handing out tax cuts, spending money on fixing roads, schools and public buildings, and socking something away for less fruitful years.  Budget surpluses have largely stemmed from higher than expected tax collections — corporate tax revenues alone were 11% higher than budget estimates — and booming local economies… More than 40 states have found themselves with more money than they planned as they wound down their regular sessions. Governors in 23 of those states proposed tax cuts, and a majority of states with surpluses chose to shore up their roads, schools and rainy day funds… The extra cash over the last two budget sessions (many states work on a two-year cycle) is at the highest level since 2000, state budget experts say.”

Speculator Watch:

June 12 – Financial Times (Martin Arnold):  “Europe’s venture capital market recovered sharply last year, as money raised by funds investing in start-ups and early-stage companies rose 60% to the highest level since the peak of the internet bubble in 2000.  The findings, published in a report by the European Venture Capital Association today, suggest investors are regaining their appetite for the riskier end of the private equity market.”

Financial Sphere Earnings Watch:

Lehman Brothers reported fiscal 2nd quarter earnings of $1.3bn, up 27% from Q2 2006.  Net Revenues were up 25% y-o-y to $5.512bn.  Capital Markets net revenues were up 17% from Q2 ’06 to $3.6bn.  “Equities Capital Markets reported net revenues of $1.7 billion, nearly double the $878 million reported” in Q2 ’06.  “Investment Banking reported record revenues of $1.2bn, an increase of 55%...   This increase was driven by record debt origination revenues, which rose 87% to $540 million… Investment Management reported record net revenues of $768 million, an increase of 30%...”  The company’s M&A pipeline ended the quarter at an astounding $584bn, with record pipelines in all major businesses.  “Fixed Income Capital Markets reported net revenues of $1.9 billion, a decrease of 14%..., as strong client demand across most products and increased real estate and credit product revenue were more than offset by continued weakness in the U.S. residential mortgage business…”  While U.S. mortgage finance struggled, international finance boomed.  “Non-U.S. net revenues represented 48% of the Firm’s quarterly net revenues…”  Combined Europe and Asia revenues were up 62% y-o-y to a record $2.6bn.  Lehman’s Total Assets jumped $44.3bn during the quarter to $605bn (36% pace).  This increased first-half growth to $101bn, or 40% annualized.  The company repurchased 7.2 million shares during the quarter.

Macro comments from Lehman’s earnings conference call:  “Global equity trading volumes rose approximately 13% in dollar value terms…  High grade credit spreads widened very slightly during the quarter, while high yield and emerging market credit spreads tightened significantly to their all time narrowest levels…  The volume of announced M&A transactions was a record $1.7 TN for the period, rising 69% sequentially and surpassing the prior record set in year 2000.  In equity underwriting, volumes increased 23% versus the prior period, driven by an increase in IPO and convertible activity.  Debt underwriting volumes grew by 8% compared to the sequential period.”  “...Global liquidity remained strong with considerable corporate cash on hand, large pools of un-invested capital from financial sponsors, a growing allocation of assets to hedge funds, cash consideration from M&A, proceeds from share buybacks that need to be invested, and continued inflows from regions such as Asian and the Middle East.  If anything, these trends are accelerating…  This pool of liquidity continues to provide a strong underpinning for the global capital markets and for our own client-focused business model.”

Goldman Sachs reported Net Revenues of $10.18bn for the second quarter, about in line with the year ago period.  Earnings were flat y-o-y at $2.287bn.  Compensation expense was down 4% to $4.887bn.  “Net revenues in Investment Banking were $1.72bn, 13% higher than the second quarter of 2006…as mergers and acquisitions and financing activity remained strong.”  “Underwriting revenues were $1.0bn, 18% above the first quarter.  Debt underwriting revenues grew 11%...and equity underwriting revenues grew 35%...”  The investment banking backlog reached a new record during the quarter.  At the same time, “Net revenues in Fixed Income, Currency and Commodities (FICC) were $3.37bn, 24% lower than the second quarter of 2006, primarily reflecting lower net revenues in commodities and weak results in mortgages, principally attributable to continued weakness in the subprime sector… Net revenues in Equities were $2.50bn, 6% higher…” “Asset under management increased 28% from a year ago to a record $758bn, with net asset inflows of $18bn during the quarter.”  International accounted for approximately 52% of revenues.  The company repurchased 5.4 million shares during the quarter, at a cost of $1.13bn.  Goldman does not release balance sheet data with its earnings release.

For the Twenty-First Century:

Today, Chairman Bernanke presented a paper, The Financial Accelerator and the Credit Channel, at the Federal Reserve of Atlanta’s conference on The Credit Channel of Monetary Policy in the Twenty-First Century.  It is a technical discussion of issues near and dear to my analytical heart – and worth plodding through.  I’ll excerpt and attempt an argument against conventional doctrine.

From Dr. Bernanke:

“Economic growth and prosperity are created primarily by what economists call ‘real’ factors--the productivity of the workforce, the quantity and quality of the capital stock, the availability of land and natural resources, the state of technical knowledge, and the creativity and skills of entrepreneurs and managers.  But extensive practical experience as well as much formal research highlights the crucial supporting role that financial factors play in the economy…  In the United States, a deep and liquid financial system has promoted growth by effectively allocating capital and has increased economic resilience by increasing our ability to share and diversify risks both domestically and globally.”

My comment:  The dilemma today is that current forces supporting “economic growth and prosperity” are primarily of a financial nature.  Credit growth and resulting asset inflation and financial flows dictate the nature of economic activity to a greater degree each passing year.  The pricing mechanism and incentive structure have been debauched.  To be sure, financial “profits” have come to command system behavior.  Yet as long as sufficient system Credit creation is maintained – readily providing ample new purchasing power throughout – the “services”-based U.S. economy plows right along, emboldening the New Era crowd and aggressive risk-takers in the process.  Traditional frameworks and conventional thinking are in large part worthless, at best.

And it is certainly not, as Greenspan and Bernanke insist, a case of  “effectively allocating capital.”  Instead, today’s (global) prosperity is the upshot of an unrelenting boom in new Credit powering myriad Bubble processes and dynamics.  As such, Dr. Bernanke’s analysis is hopelessly archaic.  Today, new Credit is so readily available that the “effectiveness” of its allocation is beside the point.  Contemporary Credit systems have so far proved remarkably resilient.  This dynamic is misinterpreted as economic “resiliency,” when in fact economic systems have become precariously dependent upon (addicted to) uninterrupted rampant Credit creation and flows of speculative-based liquidity.  We delude ourselves with fanciful notions of our newfound “ability to share and diversity risks,” when the issue is actually the postponement of the day of reckoning through ever greater risk-taking.

It is curious how Dr. Bernanke can offer an extensive discussion - where he highlights academic work related to “financial accelerators” and “Credit channels” – without addressing Wall Street firms, hedge funds, private equity, securitizations, “repos,” derivatives and foreign financial flows (certainly including the central banks).  His approach remains little tweaks to the traditional bank centric analytical approach, conveniently chucking the heart of contemporary finance into the nondescript category “non-banks.”  Old paradigm frameworks won’t suffice for the New Credit Paradigm.  

“Just as a healthy financial system promotes growth, adverse financial conditions may prevent an economy from reaching its potential.  A weak banking system grappling with nonperforming loans and insufficient capital or firms whose creditworthiness has eroded because of high leverage or declining asset values are examples of financial conditions that could undermine growth.  Japan faced just this kind of challenge when the financial problems of banks and corporations contributed substantially to sub-par growth during the so-called ‘lost decade.’” 

The critical flaws in Dr. Bernanke’s framework at times shine through in this presentation.  He instinctively sees the boom period as sound and, apparently with astute policymaking, sustainable.  There is no recognition that a so-called “healthy financial system” may over time sow the seeds of boom/bust dynamics and inevitable financial and economic impairment.  The primary role of activist policymaking revolves around rectifying “adverse financial conditions” that occasionally hold prosperity at bay.  He believes “weak banking system” can and should be avoided by manipulating the inflationary process.  Post-Bubble policy errors were to blame for Japan’s “lost decade” - not spectacular inflationary Bubble excesses.  More grievous policy blunders – and not a more reckless boom – were to blame for the Great Depression.   

“Putting the issue in the context of U.S. economic history, I laid out, in a 1983 article, two channels by which the financial problems of the 1930s may have worsened the Great Depression).  

The first channel worked through the banking system.  As emphasized by the information-theoretic approach to finance, a central function of banks is to screen and monitor borrowers, thereby overcoming information and incentive problems.  By developing expertise in gathering relevant information, as well as by maintaining ongoing relationships with customers, banks and similar intermediaries develop ‘informational capital.’  The widespread banking panics of the 1930s caused many banks to shut their doors; facing the risk of runs by depositors, even those who remained open were forced to constrain lending to keep their balance sheets as liquid as possible.  Banks were thus prevented from making use of their informational capital in normal lending activities.  The resulting reduction in the availability of bank credit inhibited consumer spending and capital investment, worsening the contraction.”

My comment:  Banks were “prevented from making use of their informational capital” because the “marketplace” had lost faith in their (deposits) and others’ liabilities.  Boom-time Credit and speculative excess and resulting Monetary Disorder had precariously distorted asset prices, earnings, incomes and the flow of finance throughout the U.S. and global economies.  The scope of the preceding Bubble excesses ensured Credit system impairment, “runs” from risky assets, and rather deep-seated disillusionment.  The inflationary boom had severely corrupted the financial intermediation process.



“The second channel through which financial crises affected the real economy in the 1930s operated through the creditworthiness of borrowers. In general, the availability of collateral facilitates credit extension. The ability of a financially healthy borrower to post collateral reduces the lender's risks and aligns the borrower's incentives with those of the lender. However, in the 1930s, declining output and falling prices (which increased real debt burdens) led to widespread financial distress among borrowers, lessening their capacity to pledge collateral or to otherwise retain significant equity interests in their proposed investments. Borrowers’ cash flows and liquidity were also impaired, which likewise increased the risks to lenders. Overall, the decline in the financial health of potential borrowers during the Depression decade further impeded the efficient allocation of credit. Incidentally, this information-based explanation of how the sharp deflation in prices in the 1930s may have had real effects was closely related to, and provided a formal rationale for, the idea of ‘debt-deflation,’ advanced by Irving Fisher in the early 1930s (Fisher, 1933).”

It is fundamental Macro Credit Theory that “the availability of collateral facilitates Credit extension.” Surely, an increase in Credit Availability and the flow of marketplace liquidity will tend to support asset inflation. Higher asset (“collateral”) prices, then, foster further augmented Credit expansion and, almost certainly, greater speculative activity.

“Collateral” can actually be a bigger issue during the boom, and I disagree with Dr. Bernanke’s contention that “The ability of a financially healthy borrower to post collateral reduces the lender’s risks and aligns the borrower's incentives with those of the lender.”

In reality, Credit booms inherently inflate asset prices, incomes and business “cash flows”, in the process creating a steady flow of so-called “healthy borrowers” willing to perpetuate an increasingly unwieldy Bubble – surreptitiously increasing lender risk throughout the life of the boom. Moreover, it is the nature of Credit “blow-offs” that lender risk grows exponentially as collateral values inflate most spectacularly. Only careful analysis of the underlying Credit process will provide an informed view of the true health of most borrowers. And, as far as the alignment of incentives, the further into Bubble excess the greater the incentive for the financing community to loosen lending standards sufficiently in order to perpetuate the boom (think telecom ’99 or subprime ’06). Seemingly robust “borrowers’ cash flows and liquidity” abruptly turn suspect with the arrival of the inevitable bust.

“The ideas I have been discussing today have also been useful in understanding the nature of the monetary policy transmission process. Some evidence suggests that the influence of monetary policy on real variables is greater than can be explained by the traditional ‘cost-of-capital’ channel, which holds that monetary policy affects borrowing, investment, and spending decisions solely through its effect on the level of market interest rates. This finding has led researchers to look for supplementary channels through which monetary policy may affect the economy. One such supplementary channel, the so-called credit channel, holds that monetary policy has additional effects because interest-rate decisions affect the cost and availability of credit by more than would be implied by the associated movement in risk-free interest rates… The credit channel, in turn, has traditionally been broken down into two components or channels of policy influence: the balance-sheet channel and the bank-lending channel (Bernanke and Gertler, 1995). The balance-sheet channel of monetary policy is closely related to the idea of the financial accelerator that I have already discussed. That theory builds from the premise that changes in interest rates engineered by the central bank affect the values of the assets and the cash flows of potential borrowers and thus their creditworthiness, which in turn affects the external finance premium that borrowers face…

Historically, monetary policy did appear to affect the supply of bank loans… In the 1960s and 1970s, when reserve requirements were higher and more comprehensive than they are today, Federal Reserve open market operations that drained reserves from the banking system tended to force a contraction in deposits. Regulation Q, which capped interest rates payable on deposits, prevented banks from offsetting the decline in deposits by offering higher interest rates. Moreover, banks had limited alternatives to deposits as a funding source. Thus, monetary tightening typically resulted in a shrinking of banks' balance sheets and a diversion of funds away from the banking system… The extension of credit to bank-dependent borrowers, which included many firms as well as households, was consequently reduced, with implications for spending and economic activity.

Of course, much has changed in U.S. banking and financial markets since the 1960s and 1970s. Reserve requirements are lower and apply to a smaller share of deposits than in the past. Regulation Q is gone. And the capital markets have become deep, liquid, and easily accessible, either directly or indirectly, to almost all depository institutions.

This is not to say, however, that financial intermediation no longer matters for monetary policy and the transmission of economic shocks. For example, although banks and other intermediaries no longer depend exclusively on insured deposits for funding, nondeposit sources of funding are likely to be relatively more expensive than deposits, reflecting the credit risks associated with uninsured lending. Moreover, the cost and availability of nondeposit funds for any given bank will depend on the perceived creditworthiness of the institution…

Like banks, nonbank lenders have to raise funds in order to lend, and the cost at which they raise those funds will depend on their financial condition--their net worth, their leverage, and their liquidity, for example. Thus, nonbank lenders also face an external finance premium that presumably can be influenced by economic developments or monetary policy. The level of the premium they pay will in turn affect the rates that they can offer borrowers. Thus, the ideas underlying the bank-lending channel might reasonably extend to all private providers of credit.”

In the case of both the Credit system and monetary policy, developments since the 1960s and 1970s have been nothing short of momentous and historic. Today, asset-based lending (as opposed to financing business investment) and sophisticated (market-based) financial intermediation completely dominate the Credit creation process. Myriad intermediaries issue basically unlimited quantities of myriad Credit instruments - in the unbridled extension of new Credit. Bank deposits are today but a sideshow. As for policy, the Federal Reserve has gone to a system of openly transparent fixed short-term interest rates. Credit growth and asset prices are largely disregarded, while a narrow inflationary focus on an index of "core" consumer prices holds sway over policy. The interplay of these two dynamics – marketable securities-based Credit and highly accommodating monetary policy - has created powerful inflationary dynamics that policymakers are ill-equipped to manage. Conventional doctrine is completely oblivious to prevailing inflation.

In reference to today’s financial intermediation, Dr. Bernanke stated that “nondeposit sources of funding are likely to be relatively more expensive than deposits, reflecting the credit risks associated with uninsured lending. Moreover, the cost and availability of nondeposit funds for any given bank will depend on the perceived creditworthiness of the institution.”

Well, this seemingly innocuous comment approaches the heart of today’s flawed central banking. First of all, it implies that the marketplace accurately assesses and prices risk, an assumption directly at odds with a backdrop of unfettered Credit, marketplace liquidity, and speculation. Importantly, over liquefied and high speculative environments inherently under-price and over-extend risk, and this dynamic tends to only escalate over time. Instead of blind faith in the marketplace’s faculty for accurately pricing and regulating risk, the focus should be on the major systemic risks associated with a Credit apparatus that will by its nature foster reinforcing Credit and speculative excess.

Secondly, today’s securities-based finance juggernaut has evolved into the prevailing source of system Credit and liquidity creation. As such, the creditworthiness of Bernanke’s “borrowing institution” is of minor importance in comparison to the market values (and liquidity) of the securities collateral supporting the borrowing. The booming “repo” market, for example, is dictated by the perceived safety and liquidity of the underlying securities – and not the credit standing of the borrower. And I will suggest that it is a dire predicament when “creditworthiness” for a large part of the Credit system is dependent upon Bubble-induced inflated securities and asset prices, incomes, cash flows and over-liquefied markets generally.

With respect to “financial accelerators” and “Credit channels,” there are some very serious shortcomings inherent in the current regulatory framework. I’ll note a few. First, today’s securities-based Credit knows no bounds (no reserve or capital requirements or natural constraints). Second, the Federal Reserve and global bankers “peg” short-term interest rates and forewarn on policy adjustments. Third, the incentives are simply too enticing for aggressive borrowing at the lower pegged rates (wherever they may be found) to speculate in higher yielding securities and instruments. For one thing, this creates a remarkably powerful inflationary bias in the securities markets overall. And, fourth, the prevailing central banking doctrine disregards asset prices and speculative leveraging.

Dr. Bernanke concludes:

“The critical idea is that the cost of funds to borrowers depends inversely on their creditworthiness, as measured by indicators such as net worth and liquidity. Endogenous changes in creditworthiness may increase the persistence and amplitude of business cycles (the financial accelerator) and strengthen the influence of monetary policy (the credit channel). As I have noted today, what has been called the bank-lending channel--the idea that banks play a special role in the transmission of monetary policy--can be integrated into this same broad logical framework, if we focus on the link between the bank's financial condition and its cost of capital. Nonbank lenders may well be subject to the same forces.”

I’ll conclude by proffering that securitization and asset-based finance have been a radical departure from the traditional Credit mechanism. The proliferation of agency and asset-backed securities, leveraged speculation, derivatives, CDOs and “structured finance” in general has acted as one momentous “financial accelerator.” Developments in monetary policy have aided and abetted the rise of “Wall Street finance” and the empowerment of Credit Bubble dynamics. Monetary “management” has been reduced to telegraphed “baby-step” adjustments to the interest rate “peg.” The Fed allowed itself to become hamstrung by Bubble Fragility and the inoperability of imposing actual system monetary tightening. And when it comes to a working framework for “financial accelerators” and Credit Channels, I suggest that Dr. Bernanke scrap his previous research and have his staff begin anew.

The bottom line is that the Fed is content to let Bubbles run their course, while being ready to implement aggressive “mopping up” strategies. But the potent inherent “financial accelerator” attributes of contemporary asset-based “speculative” finance beckon for a radically different policy approach For the Twenty-First Century.

06/07/2007 Q1 2007 Flow of Funds *

In a volatile week for global financial markets, the Dow declined 1.8% (up 7.7% y-t-d) and the S&P500 1.9% (up 6.3%).  The Transports were smacked for 3.9% (up 12.3%), and the Utilities sank 5.6% (up 5.8%).  The Morgan Stanley Cyclical index declined 1.8%, reducing y-t-d gains to 19.8%.  The Morgan Stanley Consumer index fell 2.4% (up 5.7%).  The small cap Russell 2000 fell 2.1% (up 6.1%) and the S&P400 Mid-Cap index 2.5% (up 11.8%).  Technology stocks generally outperformed.  For the week, the NASDAQ100 declined 1.1% (up 8.5%), with the Morgan Stanley High Tech index down only 0.8% (up 7.7%).  The Semiconductors dipped 0.3% (up 4.4%).  The Street.com Internet Index declined 1.5% (up 8.6%), and the NASDAQ Telecommunications index lost 1.7% (up 5.7%).  The Biotechs skidded 4.3% (up 4.9%).  The Broker/Dealers declined 1.7% (up 8.9%) and the Bank fell 2.0% (down 1.9%).  With Bullion sinking $22.80, the HUI gold index sank 4.9%. It was bloody out the curve.  Two-year U.S. government yields increased 3 bps to 5.0%.  Five-year yields jumped 13 bps to 5.05%.  Ten-year Treasury yields surged 16 bps to 5.11% (11-mnth high).  Long-bond yields jumped 16 bps to 5.22%.  The 2yr/10yr spread ended the week at 11 bps – the most positively sloped curve (2/10) since May 2006.  The implied yield on 3-month December ’07 Eurodollars rose 2 bps to 5.355%.  Benchmark Fannie Mae MBS yields surged 20 bps to an 11-month high 6.28%, this week underperforming Treasuries.  The spread on Fannie’s 5% 2017 note widened 3 to 42, and the spread on Freddie’s 5% 2017 note widened 3 to 41.  The 10-year dollar swap spread increased 3 to 60.50.  Corporate bond spreads were mixed to wider, with the spread on a junk index 4 wider.     June 5 – Dow Jones (Laurence Norman):  “Goldman Sachs Tuesday became the latest Wall Street dealer to reverse its call for a Federal Reserve rate cut in 2007, with economists at the firm now seeing growth picking up faster and the jobless rate ticking higher more slowly than they previously expected.  The bank previously saw the federal funds rate falling to 4.50% by year end, with the easing starting in September.  ‘However, although real GDP (gross domestic product) growth has slowed as anticipated, the absence of any tangible evidence of rising unemployment makes it unlikely that Fed officials will cut’ rates, Goldman economists said…” Investment grade issuers included Wachovia $2.25bn, Wellpoint $1.5bn, Valero Energy $2.25bn, Janus Capital $750 million, BB&T $600 million, Cardinal Health $600 million, Jefferies Group $600 million, PNC Funding $500 million, Promise $500 million, FPL Group $400 million, Discover Finance $800 million, Genworth Financial $350 million, AGFirst Farm Credit $250 million, Pepco Holdings $250 million, and Gulf Power $85 million. Junk issuers included Reliant Energy $1.3bn, Hub International $700 million, Sanmina-SCI $600 million, Outback Steakhouse $550 million, W&T Offshore $450 million, Pinnacle Entertainment $385 million, Bristow Group $300 million, and Actuant $250 million. This week’s convert issuers included Amylin Pharmaceuticals $575 million, Ciena Corp $500 million, Noranda Aluminum $220 million, Cogent Communications $200 million, Integra Lifescience $165 million and Dendreon $75 million. International dollar bond issuers included Promise Co. $500 million, Tristan Oil $420 million, Alto Parana $270 million, Willow RE $250 million, Air Jamaica $125 million, and Nelson RE $75 million. German 10-year bund yields jumped 11 bps to 4.57% (high since Oct. ’02).  Japanese 10-year “JGB” yields surged 13 bps to 1.89% (high since 2000).  The Nikkei 225 declined 1.0%, reducing y-t-d gains to 3.2%.  Emerging equities markets were under moderate pressure, while debt markets were slammed by the global yield maelstrom.  Brazil’s benchmark dollar bond yields surged 30 bps this week to 6.10%.  Brazil’s Bovespa equities index declined 2.0%, reducing y-t-d gains to 17.7%.  The Mexican Bolsa declined 1.5%, reducing 2007 gains to 19%.  Mexico’s 10-year $ yields jumped 26 bps to 5.88%.  Russia’s RTS equities index fell 2.2% (down 6.9% y-t-d).  India’s Sensex equities index sank 3.5% (up 2.0% y-t-d).  China’s Shanghai Composite index declined slipped 2.2%, reducing y-t-d gains to 46% and 52-week gains to 146%. Freddie Mac posted 30-year fixed mortgage rates jumped 11 bps to 6.53% (down 9bps y-o-y) - the highest borrowing rate since the week of August 11.  Fifteen-year fixed rates rose 10 bps to 6.22% (down 1bp y-o-y), with a four-week gain of 35bps.  One-year adjustable rates increased 8 bps to 5.65% (up 2bps y-o-y).  The Mortgage Bankers Association Purchase Applications Index rose 1.5% for the week.  Purchase Applications were up 9.8% from one year ago, with dollar volume 15.6% higher.  Refi applications dropped 6.3% for the week, yet dollar volume was still up 33.6% from a year earlier.  The average new Purchase mortgage dipped to $238,600 (up 5.3% y-o-y), while the average ARM declined to $402,400 (up 18.1% y-o-y).  Bank Credit surged $34bn (week of 5/30) to a record $8.575 TN (2-wk gain of $44.2bn).  For the week, Securities Credit decreased $2.0bn.  Loans & Leases jumped $36.1bn to $6.280 TN.  C&I loans rose $6.7bn, and Real Estate loans gained $4.0bn.  Consumer loans jumped $6.8bn, while Securities loans slipped $2.7bn.  Other loans jumped $21.4bn.  On the liability side, (previous M3) Large Time Deposits fell $17.4bn.      M2 (narrow) “money” dipped $2.8bn to $7.241 TN (week of 5/28).  Narrow “money” has expanded $198bn y-t-d, or 6.6% annualized, and $441bn, or 6.5%, over the past year.  For the week, Currency added $0.2bn, and Demand & Checkable Deposits increased $7.4bn.  Savings Deposits dropped $14.1bn, while Small Denominated Deposits rose $1.6bn.  Retail Money Fund assets gained $2.2bn.        Total Money Market Fund Assets (from Invest. Co Inst) surged $37.9bn last week to a record $2.526 TN.  Money Fund Assets have increased $144bn y-t-d, a 13.7% rate, and $431bn over 52 weeks, or 20.6%.      Total Commercial Paper gained $1.6bn last week to a record $2.115 TN, with a y-t-d gain of $140bn (16.1% annualized).  CP has increased $318bn, or 17.7%, over the past 52 weeks.  Asset-backed Securities (ABS) issuance rose to $16bn.  Year-to-date total US ABS issuance of $316bn (tallied by JPMorgan) is running about 1% ahead of comparable 2006.  At $152bn, y-t-d Home Equity ABS sales are 31% below last year’s pace.  Meanwhile, y-t-d US CDO issuance of $152 billion is running 19% ahead of record 2006 sales.  Fed Foreign Holdings of Treasury, Agency Debt last week (ended 6/6) declined $3.9bn to $1.955 TN, with a y-t-d gain of $203bn (26% annualized).  “Custody” holdings expanded $330bn during the past year, or 20%.  Federal Reserve Credit last week expanded $4.1bn to $857.9bn.  Fed Credit has gained $5.7bn y-t-d, or 1.5% annualized, with one-year growth of $28.5bn y-o-y (3.4%).     International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $599bn y-t-d (28% annualized) and $955bn y-o-y (21%) to a record $5.410 TN.  June 8 – Bloomberg (Anoop Agrawal):  “India’s foreign-exchange reserves rose $3.44 billion to $208.37 billion in the week ended June 1, the central bank said.” Currency Watch: June 8 – Bloomberg (Jake Lee):  “Hong Kong’s government and de-facto central bank ‘seriously’ considered scrapping the city’s currency link to the U.S. dollar during a financial crisis in 2002, former Financial Secretary Antony Leung said… Former Hong Kong Chief Executive Tung Chee-Hwa said ditching the peg was considered when ‘financial sharks’ were attacking the link in 2002, the Standard reported today…” June 5 – Bloomberg (Matthew Brown):  “The United Arab Emirates may be the next Middle Eastern country to stop pegging its exchange rate to the U.S. dollar, according to trading in currency forwards.  The second-largest Arab economy may follow Syria and Kuwait, which both said in the past two weeks that they would dump the dollar peg to curb rising import costs and inflation. Middle East currencies have been dragged lower by declines in the dollar, pushing up the cost of imports from Europe and Asia.” The dollar index gained 0.5% to 82.69.  On the upside, the New Zealand dollar gained 2.5%, the Australian dollar 1.4%, the Thai baht 1.3%, and the Belize dollar 1.0%.  On the downside, the Iceland krona declined 4.2%, the Indonesian rupiah 3.1%, the Israeli shekel 2.9%, and the Brazilian real 3.0%.  Commodities Watch June 5 – Bloomberg (Angela Macdonald-Smith):  “Uranium spot prices may reach $200 a pound within the next two years, buoyed by a shortfall in supply and increasing investment in the nuclear fuel by speculators, said Macquarie Bank Ltd., Australia’s biggest securities firm.  The price, which reached $125 a pound in mid-May, will probably average $125 a pound this year…  Uranium prices have jumped 12-fold since early 2003…” For the week, Gold dropped 3.4% to $648.85 and Silver 5.1% to $13.04.  Copper fell 4.3%.  July crude declined 52 cents to $64.56.  July gasoline sank 5.2%, and July Natural Gas fell 2.7%.  For the week, the CRB index declined 2.1% (up 0.1% y-t-d), and the Goldman Sachs Commodities Index (GSCI) dipped 1.1% (up 8.6% y-t-d).  Japan Watch: June 4 – Bloomberg (Lily Nonomiya):  “Spending by Japan’s largest companies rose to a record in the first quarter, indicating the world’s second-largest economy probably grew at a faster pace than the 2.4% initially estimated by the government.  Capital spending climbed 13.6% in the three months ended March 31 from a year earlier…” China Watch: June 6 – Bloomberg (Zhang Dingmin and Josephine Lau):  “China should expand local companies’ fundraising options by letting commercial banks invest in the country’s private-equity funds, the deputy central bank governor said.  ‘Our current capital market is insufficient in meeting the funding needs of our companies,’ Wu Xiaoling said… ‘Banks are institutions that manage risks anyway so they should be in the best position to judge the risks in these instruments.’” June 8 – Bloomberg (Christina Soon):  “China’s inflation rate rose to a more than two-year high last month, Market News International reported… Consumer prices may have climbed to 3.5% in May…” June 6 – Bloomberg (Li Yanping):  “China’s retail sales are expected to grow by about 14% this year, the Ministry of Commerce said… Sales may rise to 8.7 trillion yuan ($1.1 trillion)…” June 4 – Bloomberg (Kelvin Wong):  “Hong Kong’s home sales rose 63.4% in May compared with a year earlier, according to the city’s Land Registry.” India Watch: June 8 – Bloomberg (Anil Varma):  “Money supply in India grew at the slowest pace since December… The M3 measure of money supply increased 19.6% in the two weeks through May 25 from a year earlier…” Asia Boom Watch: June 4 – Bloomberg (Anuchit Nguyen):  “Thailand’s economic growth expanded faster than economists expected in the first quarter as rising exports of rubber, hard disk drives and automobiles countered a slump in consumption and investment.  Southeast Asia’s second-biggest economy expanded 4.3% in the three months…” Unbalanced Global Economy Watch: June 8 – Bloomberg (Greg Quinn):  “Canada’s April trade surplus widened to the biggest since July 2004, as exports fell slower than imports.  The surplus widened to C$5.76 billion ($5.4 billion)…” June 5 – Bloomberg (John Fraher):  “A one-bedroom apartment in London’s affluent Belgravia district has gone on sale for a record price of more than 3 million pounds ($6 million), the Evening Standard reported…” June 8 – Bloomberg (Jennifer Ryan):  “The Bank of England…may have to move faster to curb the U.K.’s worst bout of inflation in a decade.  Manufacturers’ optimism about their pricing power rose to a 12-year high in May… ‘Inflation is high and sticky,’ said Alan Clarke, an economist at BNP Paribas in London.  ‘Underlying prices will continue to accelerate throughout this year. The bank is behind the curve.’” June 6 – Bloomberg (Sharon Smyth and Ricard Alonso):  “Javier Usua and Ruth Graneda never got out of the car when they visited Sanchinarro and Las Tablas, two of Madrid’s biggest new suburban developments. The concrete-block buildings and empty streets were all they needed to see.  ‘We came to look at apartments but found ghost towns,’ said Usua, a 27-year-old taxi driver.  ‘You’d need to drive miles for a loaf of bread or cigarettes and my girlfriend found it creepy and unsafe so we turned around and left.’  The abandoned developments are evidence of a housing glut that will lead to Spain’s first decline in home prices since at least 1992…” June 8 – Bloomberg (Jonas Bergman):  “Swedish unemployment slipped to the lowest in 16 years… The…rate dropped to 3.3%, the lowest since 1991, from 3.7% in April…” June 8 – Bloomberg (Torrey Clark and Michael Heath):  “Russia’s economic growth will accelerate faster than last year, perhaps exceeding 7%, President Vladimir Putin’s  economic adviser said…” June 6 – Bloomberg (Hans van Leeuwen and Gemma Daley):  “Australia’s economy grew at the fastest pace in more than three years, pushing the nation’s currency to the highest since 1989 on expectations the central bank will raise interest rates to ward off inflation.  Gross domestic product rose 1.6% in the three months ended March 31…” Latin American Boom Watch: June 5 – Bloomberg (Eliana Raszewski):  “Argentina’s consumer prices last month rose 8.8% from May last year, the National Statistics Institute reported.” June 8 – Bloomberg (Alex Emery):  “Peru’s economy will expand more than previously expected this year, led by growth in manufacturing and retailing, central bank President Julio Velarde said.  Gross domestic product will expand 7.2%...” June 8 – Bloomberg (Jorge Rebella and Eliana Raszewski):  “Uruguay’s gross domestic product rose 6.7 percent in the first quarter from the same period last year, the country’s Central Bank reported…” Central Banker Watch: June 6 – The Wall Street Journal (Marcus Walker, Greg Ip and Andrew Batson):  “For the past decade, low-priced labor from China, India and Eastern Europe has helped much of the world enjoy economic growth without the sting of inflation. Now that damper on prices is beginning to reverse -- and global inflation pressure is starting to build.  Companies in many countries are operating at close to full capacity, facing shortages of everything from land to equipment. Western workers and their low-cost rivals both are winning higher pay, thanks to rising demand. In some cases, the global links of the economy are increasing costs rather than lowering them, as far-flung businesses compete for the same resources.  Central banks are increasingly worried about spare production capacity running out -- which could force them to raise rates to their highest level in years to stave off inflation.” June 8 – Bloomberg (Tracy Withers):  “New Zealand’s central bank unexpectedly raised its benchmark interest rate a quarter point to a record 8%, saying housing demand and consumer spending are fanning inflation…  ‘A sustained period of slower growth in domestic activity will be required to alleviate inflation pressures,’ Reserve Bank Governor Alan Bollard said… A 60% surge in world prices of dairy products the past six months has boosted farmers' incomes and will stoke inflation next year, he said.” June 5 – Bloomberg (Craig Torres):  “Federal Reserve Chairman Ben S. Bernanke commented on global liquidity and financial risks in a question and answer period…to the International Monetary Conference… On sources of liquidity: ‘One of the fundamental forces driving the so-called wall of liquidity is the amount of gross saving in the world looking for return.’” Bubble Economy Watch: June 5 – Bloomberg (Curtis Eichelberger):  “Jim Balsillie’s $220 million purchase of the Nashville Predators last month may reflect renewed confidence in the future of the National Hockey League.  In selling the Predators, Tennessee businessman Craig Leipold almost tripled the $80 million he paid for the expansion team in 1997, even though the club lost $15 million this season and is ranked in the bottom third of the league in attendance.” Speculator Watch: June 7 – Financial Times (Stacy-Marie Ishmael):  “Hedge funds are helping to fuel a global credit boom, but their growing influence on credit markets is likely to have negative consequences, a new report by Fitch Ratings has found.  Such funds now account for almost 60% of trading volumes in credit default swaps - derivatives that provide a kind of insurance against non-payment on corporate debt. The CDS market has more than doubled in the past four years, according to Markit…  ‘Hedge funds’ willingness to trade frequently, employ leverage, and invest in the more leveraged, risky areas of the credit markets magnifies their importance as a source of liquidity,’ the Fitch report said. Credit-oriented strategies were one of the fastest areas of growth for hedge funds. They now have between $15,000bn and $18,000bn of assets deployed in the credit markets.” Mortgage Finance Bubble Watch: June 5 – Bloomberg (Jody Shenn and James Tyson):  “Fannie Mae and Freddie Mac, the once-derided white elephants of the mortgage market, are benefiting from the subprime lending debacle and trampling just about anything in their way.  The government-chartered companies, the biggest source of money for Americans buying houses, accounted for 46.9% of all mortgage bonds sold through April, newsletter Inside Mortgage Finance says. Their share rose from a record low 37.3% in last year's second quarter.  The biggest slump in U.S. home prices since 1991 is reviving Washington-based Fannie Mae and McLean, Virginia-based Freddie Mac…” Foreclosure Watch: June 8 – Los Angeles Times (Annette Haddad):  “On Kentucky Derby Drive in Moreno Valley, the houses with "for sale" signs on their lawns boast Craftsman-style facades, roomy floor plans and granite-countered kitchens.  Four of the nine have something else in common: They’re owned by lenders.  Saddled with properties the borrowers could no longer afford, banks and mortgage companies have joined the legions of individual homeowners trying to sell on the open market — and at a pace not seen in more than a decade… Currently, nearly 3% of the homes for sale in Southern California are owned by lenders, according to…ZipRealty, up from less than 1% a year ago.   ‘Volumes are increasing, definitely,’ said Patrick Carey, the executive in charge of foreclosed properties at Wells Fargo & Co….”  Real Estate Bubbles Watch: June 6 – The Wall Street Journal (James R. Hagerty):  “Growing inventories of unsold homes continue to weigh on the U.S. housing market, portending more downward pressure on prices, the latest data show.  The number of homes listed for sale in 18 major U.S. metropolitan areas at the end of May was up 5.1% from April, according to figures compiled by ZipRealty Inc….” June 8 – Bloomberg (Sharon L. Crenson):  “Manhattan landlords raised rents last month for studio and one-bedroom apartments by an average of 4% as graduates flocking to the largest U.S. city seeking work boosted demand for housing.” Energy Boom and Crude Liquidity Watch: June 4 – Bloomberg (Grant Smith and Tom Cahill):  “Oil companies including Exxon Mobil Corp., Royal Dutch Shell Plc and Chevron Corp. returned a total of $118 billion to shareholders last year, according to Moody’s…  The 16 integrated oil companies assessed by Moody’s distributed ‘generous’ returns amid rising global energy prices, analysts…said … ‘We expect growth in dividends to continue,’ they said.” Climate Watch: June 7 – Reuters:  “Los Angeles residents were urged…to take shorter showers, reduce lawn sprinklers and stop throwing trash in toilets in a bid to cut water usage by 10% in the driest year on record.  With downtown Los Angeles seeing a record low of 4 inches of rain since July 2006 -- less than a quarter of normal -- and with a hot, dry summer ahead, Mayor Antonio Villaraigosa said the city needed ‘to change course and conserve water to steer clear of this perfect storm.’  It is the driest year since rainfall records began 130 years ago.  The Eastern Sierra mountains, where Los Angeles gets about half of its water supply, marked its second-lowest snowpack on record this year. That and the lack of rainfall could force the nation’s second largest city into full drought mode in coming months, officials said.” June 8 – Financial Times (Alan Cane):  “‘Dirty’ snow, soiled by soot from vehicle exhausts, smoke stacks and forest fires, is a major contributor to warming in the Arctic, investigators have found. Professor Charlie Zender and his group at the University of California at Irvine believe that one third or more of the Arctic warming which had been attributed to greenhouse gases is in fact a consequence of the absorption of heat from the sun by less-than-pristine snow surfaces.  ‘When we inject dirty particles into the atmosphere and they fall on to snow, the net effect is we warm the polar latitudes,’ said Prof Zender. ‘Dark soot can heat up quickly. It’s like placing tiny toaster ovens into the snow pack’” Fiscal Watch: June 5 – The Associated Press:  “States spent freely this year, though worries about tighter times ahead are resulting in more modest plans for the new fiscal year that starts this summer, the nation’s governors reported Tuesday.  Overall state spending rose this year well above average growth - up 8.6% nationally over the previous year, compared with 6.5% growth on average over the past three decades. That heavier spending helped states cover higher costs for health care, education and employee pensions, according to a new survey from the National Governors Association and the National Association of State Budget Officers.  They were able to do so because revenues came in stronger than expected in the current fiscal year…” Q1 2007 Flow of Funds: The latest Federal Reserve Z.1 Report provides its usual interesting and illuminating “read”.  At $3.607, Total SAAR (Seasonally-Adjusted and Annualized Rates) Credit Market Borrowings remain enormous - although somewhat slower than Q4’s SAAR $3.820 TN growth.  For perspective, 2004 was the first year total borrowings surpassed $3.0 Trillion, with total borrowings averaging $2.292 TN annually during the decade 1996 to 2005.  Total borrowings increased $3.706 TN during 2006, $3.463 TN in ’05, $3.232 TN in ’04, $2.896 TN in ’03, $2.495 TN in ’02, and $2.263 TN in ‘03.  The trend of accelerating Credit expansion is unmistakable and, despite the housing slowdown, there’s a legitimate possibility it runs through 2007.  Continuing last year’s trend, Non-Financial Debt growth further moderated, while immoderate Financial Sector expansion gained additional momentum.  Most analysts are focused on the slowdown in Non-Financial Debt and its negative economic implications.  I’ll instead suggest that the historic financial sector expansion is the predominant dynamic.  At this point, sustaining this runaway Credit expansion will be no easy feat.  Yet, as long as it perseveres, unstable financial markets will be buffeted by liquidity overkill - and the Bubble Economy will be further contorted by these unwieldy inflationary forces.  For the first quarter, Total Non-Financial Debt Growth slowed from Q4’s 8.2% to 7.3%, while Financial Sector Credit Market Borrowings jumped from a robust 8.1% rate to a booming 9.3%.  In nominal (SAAR) dollars, Non-Financial Debt growth slowed to $2.084 TN from Q4’s $2.304 TN rate, while Financial Sector Borrowing jumped to $1.354 TN from Q4’s $1.166 TN.  And do keep in mind the mid-quarter subprime meltdown and market turbulence that for at least a few weeks threw some sand in the securities issuance gears.  Although slowing from last year’s blistering pace, Broker/Dealer Assets expanded SAAR $540bn, or about a 20% rate during the quarter, to $2.866 TN.  For perspective, the Broker/Dealers expanded $615bn last year; $282bn in 2005; $232bn in 2004; $278bn in 2003; declined $130bn in 2002; and increased $244bn in 2001 and $220bn in 2000.  Two-year Broker/Dealer growth increased to $919bn, or 47%.  On the Asset side, Misc. Assets expanded at a 27% rate during the quarter to $1.664 TN, with a y-o-y gain of $619bn, or 25%.  Credit Market Instruments expanded at a 30% rate, with y-o-y gains of $130bn, or 26%.  Corporate Bond holdings grew at a 24% rate during the quarter, with a y-o-y gain of $68bn, or 19.8%. The Liability Side of the Broker/Dealer balance sheet remains today a focal point of Macro Credit Analysis.  Wall Street-pioneered innovation has profoundly altered contemporary “money” and Credit.  Clearly, the traditional expansion of Deposit Liabilities - during the process of banking sector (loan) expansion – some time back lost its role as the primary source of system liquidity creation.  As analysts, we must take a broad view of financial expansion and examine a wide range of financial sector liabilities created in the process lending as well as securities leveraging.  The Broker/Dealer Liability “Repurchase Agreements” (“repos”) expanded SAAR $372bn (in nominal dollars - 29.3% annualized) during the first quarter to $1.150TN.  “Repo” Liabilities jumped $333bn, or 40.8%, over the past year and have doubled in about two years.  The Liability “Security Credit” increased $30.2bn, or at a 12.6% rate during the quarter, with a one-year gain of $132bn, or 15.5%, to $988bn.  The Liability “Due to Affiliate” was little changed during the quarter at $1.132 TN, with a y-o-y gain of $156bn, or 16.0%.  The Fed’s Z.1 category “Funding Corporations” – “Funding subsidiaries, non-bank financial holding companies, and custodial accounts for reinvested collateral of securities lending operations.” – Assets expanded a notable SAAR $498bn during the quarter to $2.199 TN.  Funding Corp Assets were up $299bn y-o-y, with a 2-year gain of $596bn, or 37.2%.  At $929bn, “Investment in brokers and dealers” was the biggest Funding Corp Asset.  Primarily, these Funding Corps are vehicles used in securities financing operations, including the reinvestment of short sale (debt and equity) proceeds.  And, in large part, it would appear that the “liquidity” acquired from a shorting transaction flows back to the broker/dealer community where it finances asset growth (i.e. securities holdings, lending to hedge fund and other clients, and derivatives operations).     The category “Federal Funds and Security Repurchase Agreements” expanded at a robust SAAR $470bn during Q1 to $2.610 TN.  Over the past year, “Fed Funds and Repos” expanded $483bn, or 22.7%, with a 2-year gain of $828bn, or 46.4%.  For perspective as to the systemic scope of the “repo” boom, total Bank Credit expanded $722bn y-o-y.  Banks ended the quarter with a net “Fed Funds and Repo” Liability of $1.284TN, now only somewhat larger than the Broker/Dealer’s $1.150 TN.  For comparison, at the end of 2002 the Banks net “Fed Funds and repo” Liability of $902bn overshadowed the Broker/Dealers’ $344bn.  Interestingly, Rest of World (ROW) holdings of “Fed Funds and Repos” expanded SAAR $717bn during the quarter to $1.141 TN, having increased 60% over the past five quarters.  ROW holdings have increased from 7.6% of total (net) “Fed funds and Repos” at the end of year 2000 to 43.7% to end the first quarter. The Money Market Fund complex is again playing a prominent role in the ongoing Credit expansion, more recently in helping finance the Wall Street/securities boom.  Money Market Funds expanded SAAR $428bn during the quarter to $2.390 TN.  Money Funds grew $376bn over the past year, or 18.7%, with a 2-yr gain of 30%.  The ongoing boom in Wall Street “structured finance” showed no sign of abating.  “Agency- and GSE-backed Mortgage Pools” expanded SAAR $468bn during the quarter to $4.076 TN, double the fourth quarter’s pace to the strongest expansion in several years.  This took one-year Agency MBS growth to a relatively robust $322bn, or 8.6%.  This sector was bolstered by subprime woes and the resulting newfound appetite for perceived safer mortgage securities.  At SAAR $604bn, the growth in Asset-backed Securities (ABS including "private-label" MBS) remained strong, although down from Q4’s record SAAR $749bn.  ABS increased $673bn, or 18.7%, over the past year to $4.268 TN.  ABS has ballooned 62% over the past nine quarters.  While the boom in their guarantee business has returned, GSE balance sheets remain contained.  Asset growth was about flat for the quarter at $2.839bn, with a one-year gain of $24bn, or 0.9%. A conversion of a commercial bank to a thrift apparently reduced Bank Assets by about $100bn during the quarter, somewhat muddying the analytical waters.  All in all, Bank Assets were about unchanged during the quarter at $10.193 TN.  Bank Credit rose $26bn (1.2% annualized), reducing y-o-y Bank Credit growth to 9.4% (2-yr gain of 20%).  Loans were little changed for the quarter at $6.109 TN.  Mortgage assets actually declined by $24bn, offset by a $24bn increased in Corporate Bonds.   On a year-on-year basis, Total Loans were up $582bn (10.5%); Mortgages $354bn (11.7%); and Corporate Bonds $94.5bn (13.3%). On the Bank Liability side, Total Deposits expanded at a 6.4% rate to $6.113 TN, with a one-year gain of 9.1%.  Bank net “repo” Liabilities expanded at a 14.2% clip to $1.284 TN, increasing y-o-y gains to 13.5%.  Bank Credit Market Borrowings slowed sharply during the quarter to $17bn.  Yet, over the past year borrowings jumped 21.2% to $1.015 TN.  Miscellaneous Liabilities declined $29bn during the quarter to $1.782 TN (up 3.6% y-o-y).  The historic Wall Street securities boom coupled with significantly slower mortgage Credit growth has taken the pressure off of bank Credit to sustain Bubble excess.  Total Mortgage Debt (TMD) expanded SAAR $954bn during the first quarter, down from Q4’s $1.101 TN, Q3’s $1.242 TN, Q2’s $1.236 TN, and Q1 2006’s $1.318 TN.  Yet keep in mind that TMD, on average, expanded $267bn annually during the nineties.  Indeed, it is likely that 2007 will compete with $2003’s $1.00 TN for the fourth largest annual increasing in TMD (trailing only 2004-2006).   And while Household Mortgage Debt growth slowed to a 6.2% pace, Commercial Mortgage debt growth remained in the low double digits.  Over the past year, Home Mortgages increased 8.4% to $10.426bn and Commercial Mortgages jumped 13.9% to $2.261 TN.  In two years, Home Mortgages increased 24% and Commercial 31%.  Home Mortgages have now increased 114% in seven years.    Examining other non-bank sectors, Life Insurance Assets grew at a 5.8% rate during the quarter to $4.764 TN.  Savings Institution Assets gained at a 1.6% rate to $1.667 TN.  Real Estate Investment Trust Assets expanded at an 8.5% pace to $412bn (up 19.2% y-o-y).  Finance Company Assets were little changed at $1.889 TN (up 1.9% y-o-y).  Credit Unions expanded at a 13.9% rate to $741bn (up 5.4% y-o-y).  It’s too bad there are not categories for hedge funds and CDOs. Despite the moderation of both Non-Financial Debt and economic growth, there was little letup in the Rest of World accumulation of U.S. financial assets (not surprising, considering the boom in financial sector growth/liquidity creation).  For the quarter, ROW increased U.S. asset holdings to the amazing tune of SAAR $1.316 TN to $12.931 TN, down only slightly from Q4’s SAAR $1.327 TN.  In just 13 quarters, ROW holdings of U.S. financial assets ballooned $4.343 TN, or 51%. During the first quarter, the ROW accumulation of Credit Market Instruments actually accelerated to SAAR $1.041 TN (to $6.717TN), with Treasuries increasing SAAR $364bn (to $2.219TN); Agencies SAAR $174bn; and Corporate Bonds SAAR $436bn.  ROW purchased more Treasuries during the quarter than were issued (SAAR $326bn), about 30% of Agencies issued (SAAR $516bn) and 40% of new Corporate Bonds (SAAR $1.003TN).  Over the past year, ROW Credit Market holdings increased $892bn, or 15.3%.  During this period, Treasury holdings swelled $193bn (9.5%); Agency $204bn (20%); and Corporate Bonds (including ABS) $442bn (18.3%).  As mentioned above, the ROW “repo” holding jumped SAAR $717bn during the quarter, offsetting a SAAR $528bn decrease in “Net Interbank Assets”.  And, as always, we’ll attempt to glean Credit Bubble insights from the (ballooning) Household (including non-profits) Balance Sheet.  For the quarter, Household Assets increased $725bn (4.2% annualized) to $69.608 TN.  Real Estate Assets increased $212bn (a 3.7% rate) and Financial Assets jumped $463bn (4.4% rate) to $42.522 TN.  And with Liabilities increasing “only” $137bn during the quarter, Household Net Worth rose a respectable $587bn to $56.176 TN.  For the year, Household Asset gains of $3.914 TN (6.0%) were offset by Liability increases of $1.002 TN (8.1%), leaving a $2.912 TN (5.5%) rise in Net Worth.  Over four years, Assets inflated $21.157 TN (44%); Liabilities $4.604 TN (52%); and Net Worth $16.552 TN (42%).  We should not understate the ongoing influence on consumer behavior from the spectacular (4-year plus) inflationary windfall. The windfall is also lining government coffers.  Federal Government first quarter Receipts were up 6.9% from the year ago period, with State & Local Receipts gaining 4.6%.  First quarter spending was up a robust 6.0% at the federal level and 7.6% locally.  Despite booming tax receipts, federal government borrowings increased at a 6.6% rate during the quarter (after growing 3.9% during 2006).  State & Local debt expanded at an 8.6% rate (after 2006’s 8.2%). The ongoing excesses confirmed in the Q1 2007 Flow of Funds leave little confusion with regard to surging global bond yields.  It’s just surprising bonds ignored rampant global liquidity excess for so long.  The abrupt nature of the yield spike is surely problematic for those highly leveraged players (and curve speculators) caught on the wrong side of the market.  Clearly, scores of players had positioned for the imminent start of a Fed easing cycle.  It’s never a smooth process when the crowd rushes to the exit an unsuccessful “crowded trade.”  But to what extent this unwind impacts liquidity (reduces gross excess) is difficult to assess at this point.  The near-term market assumption will likely be that the jump in market yields is sufficient to keep the economy and inflationary pressures in check – holding the Fed at bay. And while it was a painful week for fixed income, for the system as a whole it was anything but the worst case scenario (rates spiking, stocks collapsing, dollar sinking and spreads blowing out).  The yen only rallied slightly, encouraging players that yen carry trade dynamics are still quite favorable.  The dollar rallied and most spreads were only moderately wider for the week.  Emerging market equities were ok.  On a global basis, I doubt recent yield increases will have much influence on overheated Credit systems.      But the week can be viewed as another body blow to a vulnerable marketplace weakened by subprime and heightened volatility.  This yield spike certainly comes at an especially poor time for fragile housing markets and mortgages.  Yet for global equities, securities finance and M&A – today's prevailing booms and sources of new liquidity – the near-term outlook is anything but clear.  I would be somewhat surprised if the current cost of funds meaningfully restrains the overheated M&A Bubble.  I would also expect the equities bulls to play hardball, keen to keep the bears on their heels.  But it should be increasingly obvious that this massive and unwieldy pool of global speculative finance is a serious problem.  As master of the obvious, I’ll predict we’re in store for A Long, Hot Summer of Volatility and Discontent.  The bond market was content for some time to ignore unfolding fundamentals.  The stock market has been gleefully disregarding reality.  From Iraq to the entire Middle East to Russia – the disturbing geopolitical backdrop has curiously remained a non-issue.  The enormous ongoing cost of national security and the global “war on terror” are brushed off as if they are inconsequential.  But, then again, inflating financial markets create their own rationalizations, spin and reality.  The latest round of bullish propaganda has really pushed the envelope, setting the stage for major disappointment and disillusionment.  If history is any guide, expect a period of wild volatility leading to a financial accident.