01/30/2004 Ruse. 'A crafty stratagem, a subterfuge' *

There was no considerable period of calm or relaxation, but the Fed did keep things interesting.  For the week, the Dow and S&P500 declined less than 1%.  The Morgan Stanley Consumer index added 1%, with the Utilities up less than 1%.  The Transports were hammered for 6%, while the Morgan Stanley Cyclical index dropped 3%. The highflying broader market suffered a setback.  The small cap Russell 2000 declined 2.5%, and the S&P400 Mid-caps were down 2%.  The NASDAQ100 lost 2% and the Morgan Stanley High Tech index dipped 1%.  The Semiconductor, The Street.com Internet, and NASDAQ Telecom indices declined 2%.  The Biotechs declined 1%.  The financial stocks were especially volatile, with the Broker/Dealers ending the week down 2% and the Banks less than 1%.  With bullion down $5.50, the HUI gold index dropped 3%.   The Fed had the bond market unsteady as well.  For the week, two-year Treasury yields jumped 10 basis points to 1.77%, and five-year yields rose 9 basis points to 3.15%.  Curiously, 10-year yields gained only 6 basis points to 4.13%.  Long-bond yields were only 2 basis points higher at 4.97%.  The mortgage market was not as composed, as benchmark Fannie Mae MBS yields jumped 13 basis points.  The spread on Fannie’s 4 3/8% 2013 note widened 5 to 35, and the spread on Freddie’s 4 ½ 2013 note widened 4 to 34.  The benchmark 10-year dollar swap spread gained 2.25 to 39.5.  December 2004 Eurdollars were hit, with implied yields jumping 17 basis points to 2.05%.  Corporate spreads appear to have made it through a volatile week in decent shape, although junk bonds were hit today. Some emerging equity markets came under pressure.  The Brazil Bovespa sank 7%, more than wiping out y-t-d gains.  The Thai stock exchange index sank better than 7%.  More pain was felt throughout emerging bond markets from Mexico to India.  Benchmark Brazilian bond yields surged 80 basis points following the Fed announcement, suffering Wednesday the worst one-day loss since July.  It was a slow week of debt sales, although lower-rated issuance remains significant.  Investment grade issuers included Pfizer $1.45 billion, Freeport-McMoran $350 million, ASIF Global $300 million, ING $300 million, Florida P&L $240 million, Lincoln National $200 million, New Plan Realty $150 million, and Mack-Cali Reality $100 million.  Junk bond funds reported inflows of $251.9 million last week (from AMG).  Junk bond issuers included Dex Media $451 million, Northwest Airlines $300 million, American Tower $225 million, Petro Stopping Center $225 million, Town Sports Intl. $200 million, Thermadyne Holdings $175 million, Nectar Merger Corp $175 million, William Lyon $150 million, Atlantic Broadband $150 million, Carmike Cinemas $150 million, Interface $135 million, and Haights Cross $135 million. Convert issuers included AAR Corp. $75 million. International dollar issuers included Panama $750 million and Inmarsat Finance $375 million. Freddie Mac posted 30-year fixed mortgage rates increased 4 basis points last week to 5.68%.  Fifteen year adjustable-rates rose 2 basis points to 4.97%, and one-year adjustable-rate mortgages could be had for 3.59%, up 3 basis points for the week. The Mortgage Bankers Association Purchase application index dropped 10% last week. Yet Purchase applications remain up 22% from one year ago, with dollar volume up 38.5%.  Refi applications declined 5% last week and were down more than 40% from a year earlier.  The average Purchase application was for $207,000, with the average adjustable-rate mortgage at $313,800. Broad money supply (M3) expanded $17.1 billion (week of Jan. 19), with three-week gains of $78.6 billion.  Demand and Checkable Deposits rose $19.1 billion.  Savings Deposits added $4.3 billion ($35.7bn over two weeks), and Small Denominated Deposits were about unchanged.  Retail Money Fund deposits declined $10.2 billion, and Institutional Money Fund deposits dipped $6.7 billion.  Large Denominated Deposits increased $9.0 billion, with three-week gains of $70.1 billion.  Repurchase Agreements increased $9.8 billion, while Eurodollar deposits declined $6.6 billion.   Total Bank Credit jumped another $32.4 billion, with three-week gains of a notable $75.9 billion.  Security holdings rose $15.6 billion, with Treasury and Agency positions up $20.3 billion.  Loans & Leases expanded $16.9 billion ($55.5 billion over three weeks!), with gains broad-based.  Commercial & Industrial loans added $4.5 billion and Real Estate loans gained $6.7 billion.  Consumer loans were up $4.0 billion and Security loans added $0.7 billion.  Elsewhere, Total Commercial Paper (CP) gained $7.7 billion.  Non-financial CP added $1.6 billion and Financial CP gained $6.1 billion.  Over four weeks, CP is up a notable $31.7 billion (Financial CP up $23.3 billion).  The Fed’s Foreign “Custody” Holdings of U.S. Debt increased $7.4 billion to $1.113 Trillion, with 11-week gains of $110 billion. Currency Watch:  The Fed provided speculators in Latin American currencies a bit of a scare.  Brazil’s real dropped 3.3% this week.  Chile’s peso declined almost 2%, suffering Wednesday its worst one-day decline in more than two years.  Asian currencies generally outperformed, with the Japanese yen, South Korean won and Taiwan dollar rising just under 1%.  For the week, the dollar index added about one-half percent.  Currency markets were generally treacherous, with eye-opening volatility.  The euro dipped just under 1%.  Commodities Watch: Many commodity markets were as treacherous as currency markets.  For the week, the CRB declined about 2%.  With energy prices giving back some of recent gains, the Goldman Sachs Commodity index sank almost 5%.  Copper this week traded to a new six-year high January 30 – Bloomberg:  “China said cotton imports rose fivefold last year and exports fell by a quarter as a domestic shortage made textile mills boost purchases from the U.S.  Imports rose to 870,059 metric tons in the period, from 171,389 tons in 2002, when the country’s imports of the fiber tripled… Imports in December rose fourfold to 162,767 tons.” Asia Inflation Watch: January 29 – Bloomberg:  “Thailand’s central bank said it expects the economy to expand 7.3 percent this year as rising demand for the country’s goods and services at home and abroad prompts it to raise its growth forecast.” January 29 – Bloomberg:  “Hong Kong’s exports grew in December at their fastest pace in 11 months as U.S. and European consumers bought more Chinese-made computers, clothes and cell phones shipped via the city’s ports. Exports rose 16 percent from a year earlier to HK$156.7 billion ($20 billion), after climbing 9 percent in November…” January 28 – Bloomberg:  “India’s exports rose 42 percent from a year earlier to $5.4 billion, boosted by Christmas demand in the U.S. and overseas markets.  Imports rose 45 percent to $7.2 billion, and the trade deficit widened to $1.7 billion from $1.1 billion…Exports rose 14 percent to $42.4 billion in the nine months through December…” Global Reflation Watch: Japanese financial authorities added a record $67.5 billion to their dollar reserves during January (Dec. 27-Jan. 28).  This was about one-third of total 2003 purchases.  And over the past five months, the Japanese have increased reserves by a stunning $185 billion, or 55% annualized.  The dollar declined slightly against the yen in the face of January’s unprecedented interventions. January 30 – Bloomberg:  “The weak dollar is one of the reasons the Bank of Japan last week decided to pump more money into the world’s second-largest economy even though it is recovering, said Toshiro Muto, a BOJ deputy governor. ‘The dollar has been declining on the back of the U.S. twin deficits and the Iraq situation’ and financial and currency market moves warrant caution, Muto said. ‘So the BOJ implemented additional policy-easing steps to show clearly its determination to defeat deflation and shore up the current economic recovery.’”     January 30 – Bloomberg:  “(Japanese) Housing starts rose a seasonally adjusted 8.3 percent last month from November, the Ministry of Land, Infrastructure and Transport said in Tokyo. From a year earlier, starts rose 9.4 percent…” January 27 – Bloomberg:  “German business confidence unexpectedly advanced in January to a three-year high, suggesting executives in Europe’s largest economy are optimistic they will overcome the effects of the euro’s appreciation.” January 27 – Bloomberg:  “U.K. manufacturers’ confidence rose to the highest in almost two years this month while factory orders increased the most since October 1996, suggesting industry's recovery is taking hold, the Confederation of British Industry said.” January 29 – Bloomberg:  “U.K. consumer confidence in January rose to the highest in more than a year, a survey showed, as Britons became more optimistic about the economic outlook… Higher consumer confidence along with faster economic growth add to the case for raising U.K. interest rates next week.” January 30 – Bloomberg:  “Spanish banks increased home loans and other mortgages 24 percent in 2003, the biggest gain in 14 years, as lower interest rates let borrowers keep pace with spiraling home prices.” January 30 – Bloomberg:  “Irish mortgage lending rose 25.7 percent in December from the year before, an almost record pace, as the lowest interest rates more than five decades encouraged more people to buy property.” January 27 – Bloomberg:  “An index measuring sales, earnings and employment in Australia rose to a nine-year high last quarter as accelerating global economic growth stoked demand for exports and farmers recovered from drought…” January 29 – Bloomberg:  “Russia’s foreign currency and gold reserves rose $3.6 billion to a record, the biggest weekly increase since July 1998, as the central bank bought dollars to slow the appreciation of the ruble, traders and economists said.  Russia’s reserves climbed to a record $82.7 billion in the week to Jan. 23, the central bank said. That is the biggest weekly gain since July 1998, when an International Monetary Fund loan helped swell reserves by $5.6 billion ahead of the August 1998 domestic debt default and ruble devaluation.”     January 28 – Bloomberg:  “Brazil’s private banks boosted lending to the highest level in at least three years in December as interest-rate cuts by the central bank reduced financing costs, prompting consumers and manufacturers to borrow.”   January 28 – Bloomberg:  “Chile’s December unemployment rate was the lowest since 1998 as record-low interest rates helped manufacturers boost production and powered new construction. The jobless rate fell to 7.4 percent in the three months through December from 8.1 percent in the three-months through November…” Domestic Credit Inflation Watch: January 29 – Bloomberg:  “The Bush administration projects this year’s budget deficit will reach a record $520 billion, about 10 percent more than previous estimates, because of the cost of rebuilding Iraq, according to a congressional aide and a White House official.” January 27 – MarketNews (Joseph Plocek):  “Detailed state data on Q3 Personal Income showed widespread growth, as net earnings increased in all states and the District of Columbia, the U.S. Commerce Department reported Tuesday.  Net earnings grew faster in 38 states, versus an acceleration in 23 states and the District of Columbia in Q2, the data showed. In addition, the states in the highest quintile for income gains were located in the Plains and Southwestern parts of the country, though good gains continued in the middle of the U.S. down through Texas.  Personal income for the nation grew 1.1% in the third quarter, compared with 1.0% in the second. Earnings for the nation grew in every industry for the first time in more than two years, the Commerce Department said.” January 26 – Dow Jones:  “The global hedge fund industry attracted a record $60 billion in net assets in 2003, almost quadrupling the $16.3 billion inflows of 2002, research firm Tass said Monday.  Hedge funds now have between $725 billion and $750 billion under management worldwide, Tass said.” The Chicago Purchasing Managers index rose a stronger-than-expected 6.7 points to 65.9, the strongest level in almost ten years.  The Production index surged 7.6 points to 76.5, the highest since 1983.  The Production index jumped 19.4 points in only four months. Prices surged 10.5 points last month to a strong 67.8, reversing December’s sharp decline.  However, Employment declined 1.2 points to an unimpressive 48.3. January 29 - Dow Jones (John Conner):  “A Federal Home Loan Bank mortgage purchase program that competes with Fannie Mae and Freddie Mac in the secondary mortgage market registered a 158% volume rise in 2003. ‘By all measures, the MPF (Mortgage Partnership Finance) program is rapidly gaining market share,’ said Alex Pollock, president and chief executive of the FHLB of Chicago… According to a progress report on the program issued by the Chicago FHLB, more than $72.1 billion in MPF loans were funded through the FHLBs during 2003, up 158% from 2002 volumes. By comparison, the total volume of mortgage originations grew by about 35% from 2002 levels. Total MPF assets outstanding stood at $86.7 billion at the end of 2003, up 108% from $41.7 billion a year earlier…” While it doesn’t make for entertaining reading, I will nonetheless again this week note some of the earnings highlights from major U.S. financial institutions.  I remain focused on asset growth and the nature of liabilities created in the process of Credit expansion.  It appears that non-bank liabilities are expanding at a much more rapid pace than bank liabilities.  At this point, I would suggest that the end of the refi boom has been somewhat of a drag on bank assets, while a plus for the “non-bank” sector.  Looking ahead, we should expect the “non-banks” to play an even more instrumental role in providing the Credit to sustain the California Housing Bubble and the national Mortgage Finance Bubble. SallieMae recorded Total Managed Student Loan Acquisitions for the year of $20.7 billion, up 25% from 2002.  Fourth quarter acquisitions were up better than 50% from Q4 2002.  Total Assets expanded by $4.7 billion, or 31% annualized, during the fourth quarter to $64.6 billion.  Total assets were up 21.5% y-o-y.  At American Express, “The 17% increase in worldwide billed business (card usage) resulted from a 13% increase in spending per basis cardmember and 6% growth in cards in force.  U.S. billed business was up 15% reflecting growth of 15% within the consumer card business, a 20% increase in small business activity and a 10% improvement in Corporate Services volume.”  During the quarter, American Express expanded Total Assets by $11.0 billion, or 27% annualized, to $175 billion.  Total Assets were up 20% over the past five quarters.  Freddie Mac’s Total Book of Business increased $12.4 billion during December, a 10.6% annualized rate.  For the quarter, the company’s Book of Business increased $58.9 billion, or 17.4%, the strongest growth since 2002’s second quarter.  Freddie’s Retained Portfolio increased by $2.5 billion (1.6% annualized), following the third quarter’s extraordinary $55.6 billion (38% annualized) expansion.  For the year, Freddie’s Book of Business expanded $98.8 billion, or 7.5%. Combined Fannie and Freddie Book of Business increased $129.3 billion during the fourth quarter (14.9% annualized) to $3.61 Trillion, the second biggest gain on record (up almost $233 billion, or 16.4% annualized, during the final five months of 2003).  For the year, Combined Book of Business was up a record $477.1 billion, or 15.2%.  Combined Book of Business was up 34% over two years (up $906.4bn), 67% over three years (up $1.332 Trillion) and 135% over six years (up $2.07 Trillion).     Countrywide Financial “consolidated net earnings reached $564 million, advancing 121 percent over fourth quarter last year.”  Total Assets expanded at a 24% annualized rate to $97.9 billion during the fourth quarter.  Total Assets were up 69% y-o-y and a stunning 520% over three years.  It is worth noting the liabilities created to fund this ballooning balance sheet: Notes Payable increased $19.63 billion to $38.92 billion; Repurchase Agreements increased $9.38 billion to $32.01 billion; and Deposits increased $6.12 billion to $9.23 billion.  For the month of December, Purchase fundings were up 23% from November and were 38% above December 2002.  December Home Equity and Subprime fundings were both up 11% from November, with one-year gains of 55% and 93%, respectively.  Non-purchase/refi fundings were up about 6% from November but down 51% from December 2002. Southern California bank/mortgage company IndyMac posted “earnings of $43.3 million, up 22% over the fourth quarter of 2002.”  To compensate for a significant decline in mortgage originations, the company has dramatically increased its lending portfolio (Loans up 100% y-o-y).  During the quarter, Total Assets expanded $1.2 billion, or 39% annualized, to $13.24 billion.  Total Assets were up 38% y-o-y.  On the liability side, Advances from Federal Home Loan Bank were up 81% over twelve months to $4.93 billion. Mortgage REIT Impac Mortgage Holdings reported fourth quarter Net Earnings of $38.6 million, up 79% from Q4 2002.  Total Assets expanded by $1.65 billion, or 73% annualized during the quarter, to $10.67 billion.  Total Assets were up 63% y-o-y.  Impac issues CMO (collateralized mortgage obligations) liabilities to fund its mortgage holdings, with CMOs up 69% y-o-y to $8.52 billion.  It is worth noting that, according to Bloomberg, total 2003 CMO issuance was up 26% from the previous year’s record to $1.053 Trillion.  CMO issuance totaled $187 billion during 2000, $306 billion during 2001, and $838 billion during 2002. December Existing Home Sales were reported at a stronger-than-expected rate of 6.47 million units.  This was an impressive 8.9% above a strong December 2002.  Average (mean) Prices were up 8.7% y-o-y to $222,500.  Calculated Annualized Transaction Value (CTV) was up 18.5% y-o-y to $1.44 Trillion, with two-year gains of 44% (prices up 16% and volume up 24%), three-year gains of 64% (prices up 25% and volume up 31%), and six-year gains of 101% (prices up 44% and volume up 39%). December New Home Sales were reported at a somewhat less-than-expected annual rate of 1.06 million units (although November sales were revised higher).  Sales were about unchanged from a strong December 2002, as Average (mean) Prices jumped almost 10%.  Interestingly, the Inventory of New Homes was up 10% y-o-y, with the dollar value of inventory likely up about 20% (up about 40% over two years).  Combined December Existing and New Homes Sales were at a 7.53 million annualized rate, up about 8% y-o-y to the third strongest sales month on record.  Existing and New combined CTV was up 17% y-o-y to $1.716 Trillion, up 40% from two years ago, 58% from three years ago, and double the level from December 1997.  The ballooning Mortgage Finance Bubble fueled a banner year for our nation’s housing markets.  The year saw 6.1 million Existing Homes sold, up 9.5% from 2002’s record.  New Home Sales were up 11.5% to a record 1.085 million.  A combined 7.185 million Existing and New Homes were sold during 2003, up 9.8% from a record 2002.  For comparison, there were total homes sales of 2.402 million during 1982, 3.754 million during 1990, and 5.184 million during (pre-Bubble) 1997. This week from the California Association of Realtors (CAR):  “The median price of an existing, single-family detached home in California during December 2003 was $404,520, a 19.4 percent increase over the revised $338,840 median for December 2002, C.A.R. reported. The December 2003 median price increased 5.1 percent compared to a revised $384,930 median price in November… Statewide home resale activity increased 11 percent from the 573,790 sales pace recorded in December 2002… C.A.R.’s Unsold Inventory Index for existing, single-family detached homes in December 2003 was 1.8 months (compared to 4.3 months nationally).   “Nearly every region in the state posted double-digit increases in the median price, with the Riverside-San Bernardino region reporting a gain of more than 32%,” said …CAR chief economist Leslie Appleton-Young.   The average (median) price for single-family homes throughout the entire state inflated $65,680 during 2003 and is up $87,400 (28%) in 20 months.  Average condo prices surged $52,210, or 20.6%, to $305,770 (also up 28% in 20 months).  Home Prices were up 26.8% in greater Los Angeles, 28.8% in Monterey County, 23.8% in the High Desert, 21.8% in Northern California, 22.8% in Palm Springs/Lower Desert, 22.2% in San Diego, 22% in Ventura, and 18.5% in Sacramento.  Even the San Francisco Bay Area posted a 13.6% y-o-y price gain to $582,320, with Santa Clara up 5.9% to $570,000.    It is worth noting that average (median) California Single-family Home Prices were up 44% over two years, 66% over three years, and doubled in just six years.  Median prices inflated $19,390 during 1999, $25,880 during 2000, $37,940 during 2001, $57,510 during 2002, and $65,680 during 2003.  Golden State Condo prices were up 43% in two years, 70% in three years, and 116% since December 1997.  Condo prices inflated $6,530 during 1999, $18,560 during 2000, $34,150 during 2001, $39,460 during 2002, and $52,210 during 2003.  One of history’s great asset inflations runs unabated, while receiving scant attention from the financial or economic community. Central Banking by Ruse: After a few days of strained fixation and rumination over a few little words, it seems appropriate to take a step back and attempt to again coax our tired eyes to focus on the hazy big picture.  And while blurry eyesight does allow one’s prejudiced imaginations to conjure up seemingly appealing visions, I do not waver in my view that we are witnessing an especially unseemly ongoing effort by the Fed and Administration to Sustain Unsustainable Financial and Economic Bubbles.  It is the increasingly precarious dynamics of sustaining ballooning U.S. Bubbles, worsening economic maladjustments, and out-of-control financial markets that remain the focal point for our analysis.  As such, we must be cognizant of the fact that historic Credit inflation is intensifying and broadening.  And while this extraordinary degree of excess fosters various temporarily advantageous manifestations (heightened borrowing and spending, economic expansion, and seductive asset inflation), more aged manifestations are losing their luster and turning unwieldy.  I am reminded of an old juggling act that used an orange, an egg and a bowling ball. In the face of an expanding (imbalanced) economy and wildly speculative financial markets, the Fed has installed a long-term peg of 1% short-term interest rates.  The Greenspan Fed plays games, entertains and bewitches.  All the while, the Fed valiantly covers its ineptness and resulting policy straightjacket in a loose cloak of moxie and flexibility.  It is one hell of an act performed to a most affected and accommodative audience.  What an amazing spectacle is has all become, most unfortunately. And now, more than two years out of a mild recession, our Federal government is set to run a half trillion dollar deficit.  The presidential election cycle dovetails all too well with the blow-off stage of the Credit cycle.  So the capable spinmeisters play games, entertain and enthrall with heartening prognostications that deficits will be dissolved by the magic elixir of future growth.  This is, at the same time, a pipedream and a con.  It is a dupe not to recognize that the late-nineties’ budget surpluses were an anomaly borne out of a major acceleration in private-sector debt growth, along with the attendant runaway stock market inflation and massive recognized capital gains (stock options!).  Booming government revenues (federal and state – California!) were but a classic – and, as always – fleeting mirage of inflationary prosperity.  Yet the nature of future inflation ensures troubling structural deficits.  First, with Household borrowings having run at near double-digit growth rates for several years now, there will be no major private sector debt expansion sufficient to fill expansive federal coffers.  Furthermore, the nature of the ballooning Great Mortgage Finance Bubble fosters relatively low federal receipts (lots of tax-free capital gains!).  Second, and I would argue that this point is not today generally appreciated, the character of inflation has evolved over the past few years:  government expenditures are and will continue to be pushed higher by generally rising prices (energy, defense procurements, wages, benefits, medical costs, services, etc.).  Not only were late-nineties surpluses buoyed by artificially inflated revenues, expenditures were for a time held back by the lagging nature of general inflationary pressures.  Or, stated differently, revenues were inflated immediately, while it took some time for costs to catch up – but they have.  Going forward, unrelenting Credit inflation and key demographic developments ensure that general cost pressures – and government expenditures - surprise on the upside.  Then later, when the Bubble economy inevitably loses air, government deficits will shock as they spiral completely out of control (and plan on throwing in a run of bank failures… perhaps a GSE bailout or pension system nationalization).  As such, there was an important time and place for the eighties’ tax-cut crusaders.  These tough mavericks provided a wonderful public service that has evolved to undiscerning disservice.  You know, one can see truly marvelous results after administering moisture to a parched potted plant.  But overstating the medicinal properties of common tap water becomes increasingly risky business.  And one of the dilemmas associated with stubbornly refusing to study and appreciate underlying issues – while mindlessly sustaining Bubbles – is that the system just keeps on pouring water.  All the while, it is much too easy to convince oneself that things are looking better; after all, long ago it was proved that water was a lifesaver.  Excessive moisture, however, will eventually nurture “black mold.”  In the midst of 20% housing inflation, California home buyers are today afforded 3.6% borrowing rates.  The resulting Credit excess, fraud and gross misallocation of resources is momentous and self-reinforcing.  It is interesting to again note that 10-year Treasury yields increased only 6 basis points this week.  Yields are down 12 basis points year-to-date.  And while there was certainly a violent initial market response to the extinction of “considerable period,” the bond market appears notably less than intimidated.  The Credit market’s complacency can be forgiven.  It was more than a decade ago that James Carville commented, “I used to think if there was reincarnation I wanted to come back as the President or the Pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everyone.”  The intimidation factor has surely doubled over the past ten years, although this wouldn’t come close to keeping up with the expansion of total Credit market debt. Curiously, the biggest reactions to the Fed’s pronouncement were in the currency, gold and commodity markets, along with many emerging debt markets.  My own view is that the surprising move away from “considerable period” was, as much as anything, the Fed seeking to use a rubber bullet to instill the fear of death in those speculating against the dollar.  The hope is to incite a reversal of dollar fortunes by crafting perceptions that there is an approaching end to flagrant “benign neglect.” And if a hopeful Fed can somewhat calm speculative juices in the stock market, all the better.  Attempting to place myself in the cogitating, machinating mind of Dr. Greenspan, I can envisage how he would seek to use his sham bullets for selectively meting out speculator punishment.  Surely the last thing he wants to do is to scare the itchy crowd with real projectiles.  If there were only a way to dish out some comeuppance to those selling the dollar, fleeing the U.S. to play foreign markets, buying gold, or manipulating the small caps, while pardoning the cardinal players with their leveraged positions buttressing the U.S. Credit system.  Now that would be the type of clever, sordid central banking which would bring a smile to John Law. As far as I am concerned, Fed policy has regressed only further toward the abyss of playing games and manipulating the markets.  And market participants – skilled from years of practice and remuneration – ardently play right along.  The Greenspan Fed entertains itself with the illusion that it can positively impact market behavior, and the markets slyly cultivate this fantasy. And, similar to so many things in this extraordinary environment, the whole process has a semblance of functioning absolutely splendidly.  Mr. Greenspan can adroitly manage speculative excess with little rubber bullets and leave the real ammo locked securely in the basement.  And as long as market participants roll to the ground and moan a little bit when hit, the charade of a capable central bank and sound marketplace can continue to enthrall the world.     But there are some major, inescapable problems with all this majestic chicanery.  The markets are hopelessly unsound, and they demonstrate zero proclivity whatsoever toward soundness.  And the Greenspan Fed is a farce.  I have simply a very difficult time believing that any of the sophisticated players would today have even an inkling of trepidation that the Fed would venture anywhere near risking the piercing of the massive bond market Bubble.  The Fed has repeatedly promised as much, and the risks grow only more untenable by the week.  Secure in their prominence, most of the bond “masters” would even look askance at playing along with the rubber bullet ruse – leave that to those wannabes diddling with stocks, credit default swaps, or the emerging markets.    And, hopefully, I am coming with a little substance to conclude my latest rant:  The bottom line, as I see things this evening, is that the Fed avoids doing anything to assuage runaway Credit market leveraged speculation or systemic lending excess.  Indeed, one could proffer the argument that the Fed’s rubber bullet Ruse dampens stock market speculation and, perhaps, even temporally lends support to the beleaguered dollar (but I wouldn’t bet on it!).  But these dynamics could actually prove, somewhat ironically, constructive for bond market speculation and Credit excess.  Yet, the only hope for the dollar is to rein in out of control Credit and liquidity creation.  It today appears especially unlikely.     Back during King Dollar, the Fed had considerable leeway in managing “reflation.”  But, with repeated reflationary manipulations, the Credit Bubble became so enormous and all-encompassing.  There were deemed no acceptable alternatives but to open the floodgates and sacrifice the value of our currency to Sustain U.S. Bubbles.   In the process, Bubbles were set loose globally, engulfing emerging debt and equity markets.  At home, these dynamics enticed the speculating community back to the stock market – The Return of the Bubble.  Meanwhile, unconstrained and ultra-cheap finance sparked the parabolic blow-off stage for the California Housing and National Mortgage Finance Bubbles.  The resulting surge in Credit inflation – both domestically and internationally – has been especially seductive, pleasing and provocative.  I would argue strongly that it is without historical parallel.  And there is today no managing the degree of excess or its inflationary manifestations.  Increasingly, we sense an important “breaking of the ranks” for global central bankers.  A few are responding to heightened risk and instability by cutting rates.  Others have moved in the opposite direction, commencing the process of returning to less accommodative yields.  Some central banks are buying dollars (in at least one case in stunning quantities); others are supporting their own currencies as global speculative flows turn erratic.  No longer must global central bankers feel like they are all winners - all part of a cohesive and content group.  Perhaps there has been a concerted behind-the-scenes call for the Fed to act, providing the impetus for this week’s Ruse. Clearly, things have evolved a long way toward the Fed losing complete control of the inflationary process.  It will be fascinating to measure the half-life of Greenspan’s recent Ruse.  Especially in merciless currency markets, traders tend to be keen to expose weak hands.  And while I don’t at this point view Fed rate hikes as imminent, I would expect continued dollar weakness to force the Fed’s hand.  The Ruse would be over and things would turn decidedly interesting.

01/23/2004 Financial Bubbles Rage On *

The Dow and S&P500 were about unchanged this holiday-shortened week. The Transports added 1.2% and the Utilities were up 1.7%. The Morgan Stanley Cyclical index was up 0.5%, and the Morgan Stanley Consumer index was down 0.6%. The broader market speculative surge continues. The Russell 2000 added 1% this week. The Russell is already up 7% y-t-d, with a 52-week gain of 55.4%. The S&P400 Mid-cap index added almost 1%, increasing y-t-d gains to 4%. The highflying technology sector came under some selling pressure this week, following last week’s surge. The NASDAQ100 declined 1.5% and the Morgan Stanley High Tech index fell 2.4%. The Semiconductors dropped 5.7% (up 4% y-t-d). The Street.com Internet index was slightly positive (up 9% y-t-d), while the NASDAQ Telecommunications index declined almost 2% (up 9% y-t-d). The Biotechs gained 1%, increasing 2004 gains to almost 7%. Financial stocks were this week’s speculative vehicle of choice. The Broker/Dealers’ 1.3% rise increased y-t-d gains to 9%. The Banks added 1% (up 2.4% y-t-d). The NASDAQ Financial index is up 3.4% y-t-d and the NASDAQ insurance index 5.4%. Small cap financial stocks are on fire, with the NASDAQ Other Financial Index’s almost 3% rise increasing 2004 gains to 11% (up 91% over 52 weeks!). With bullion rising $1.33, the HUI Gold index was up less than 1%. Today’s abrupt reversal at least temporarily halted what appeared an incipient bond market melt-up. For the week, 2-year Treasury yields were unchanged at 1.66%. Five-year yields rose 3 basis points to 3.06%, and 10-year Treasury yields rose 4 basis points to 4.07%. Fannie Mae benchmark mortgage-backed yields rose 2 basis points. Agency spreads generally widened one basis point. The 10-year dollar swap spread added 1 to 37.25. The implied yield on December Eurodollar declined 2 basis points to 1.885%. Corporate spreads were generally little changed to slightly wider on the week. Bloomberg tallied about $8 billion corporate issuance during the shortened week. Investment grade issuers included Morgan Stanley $1.6 billion, Goldman Sachs EUR 1.5 billion, Bank of America $1 billion, Allied Waste $825 million, Procter & Gamble $500 million, Fifth Third Bank $375 million, Nationwide Building Society $400 million, MBIA $150 million, Halliburton $500 million, John Hancock $300 million, Jefferson-Pilot Corp $300 million, and Developers Diversified Realty $275 million. January 22 – Dow Jones (Simona Covel): “Drive-by deals are in the driver’s seat in the junk bond market. With investors desperate for yield, even jumbo offerings can forgo the cost and hassle of a roadshow and instead be announced, shopped and priced in a single day. ‘We’re in a strange environment where a lot of the deals can get done without a roadshow,’ said Kevin McCormick, a high-yield portfolio manager with Weiss, Peck & Greer, which has $18 billion in assets under management. A combination of high demand and limited new issuance is fueling investors’ urgency.” And today from Bloomberg: “U.S. high-yield, or ‘junk’ bond sales…totaled $8.4 billion in January... In the same three-week period a year ago, sales totaled $2.2 billion.” Junk bond funds received $220 million this week (from AMG), in what has been a steady stream of inflows. Junk bond issuers included United Rentals $1.375 billion, Mail Well $320 million, Portola Packaging $180 million, UAP Holding Corp $125 million, and Kingsway America $100 million. Convert issuers included Teva Pharmaceutical $1 billion and Komag $70 million. Foreign dollar debt issuers included Chile $600 million, Republic of Panama $250 million, Corp Andina De Fomento $200 million, and Cosipa $175 million. Freddie posted 30-year fixed mortgage rates declined 2 basis points last week to 5.64% (down 23 basis points in two weeks!). Fifteen-year fixed mortgage rates declined two basis points to 4.95%. One year adjustable-rate mortgages could be had at 3.56%, down 6 basis points for the week. One year-adjustable rates were down 20 basis points in two weeks to the lowest level since mid-July. Fed Foreign (“Custody”) Holdings of Treasury, Agency Debt surged $22.2 billion last week to $1.105 Trillion. Custody holdings have increased $102.85 billion in 10 weeks, or better than 50% annualized. Over the past 52 weeks, Custody Holdings were up an unprecedented $247 billion, or 29%. Broad money supply (M3) jumped $37 billion for the week of January 12. The two-week gain of $66.9 billion is the strongest since July. For the week, Demand and Checkable Deposits declined by $31.3 billion, while Savings Deposits surged $54.2 billion. Small Denominated Deposits dipped $1.4 billion. Retail Money Fund deposits declined $9.0 billion and Institutional Money Fund deposits dropped $14.4 billion. Large Denominated Deposits jumped $21.5 billion (up $63.4 billion in two weeks!). Repurchase Agreements rose $11.9 billion and Eurodollar deposits gained $5.6 billion. Over the past 20 weeks, Retail Money Fund deposits have declined $87 billion, or 26% annualized, to $791.5 billion. During the same period, Institutional Money Fund deposits contracted $70 billion, or 15% annualized, to $1.1 Trillion. We remain in the heart of a major disintermediation out of low-yielding money fund deposits and into securities. Bank Credit rose $20.1 billion for the week ended January 14 (2-week gains of $43.4 billion). Securities holdings increased $17.3 billion, as “Other” securities surged a noteworthy $19.8 billion. Loans & Leases added $2.8 billion (2-week gain of $38.5bn). Real Estate loans declined $3.2 billion and Consumer loans were about unchanged. Security loans were up $5.8 billion ($24.5 billion in two weeks). On the liability side, Deposits were up $25.6 billion, with two-week gains of $47.9 billion. Bank Credit has increased $100 billion, or 8.4% annualized, over the past ten weeks. Elsewhere, Total Commercial Paper (CP) borrowing rose $4.3 billion, with three-week gains of a notable $24.0 billion. Non-financial CP was up $3.7 billion (up $6.8 billion over three weeks), and Financial sector CP added $0.6 billion. Commodities Watch: The CRB index mustered a small gain for the 4-day trading week. Stronger energy prices led the Goldman Sachs Commodity index to a 1.5% gain. Copper gained 3% this week to a 7-year high. Aluminum prices rose to 3-year highs. Currency Watch: January 21 – Times of London (Leo Lewis): “Japan’s Ministry of Finance has lost more than (pounds) 40 billion ($72bn dollars) in the past financial year trying to bet against currency speculators, The Times has learnt. Cabinet Office insiders admitted yesterday that the currency losses have spiraled out of control, after a renewed attempt by the Finance Ministry to prop up the dollar and talk down the value of the yen… This month the Government has already spent a record sum trying to prevent the yen from rising too high against the dollar… One currency broker in Nomura…said: ‘The (ministry) is like an intervention junkie at the moment. The effect of each shot of dollar buying is getting less and less, which means the shots have to be bigger and bigger…’” Currency markets now appear to have entered a new stage of heightened volatility. No longer is dollar weakness necessarily a one-way bet, a dynamic that will make derivative-related trading strategies all the more challenging. The Canadian dollar today suffered its largest one-day decline since 1987, while the Mexican peso enjoyed its biggest gain in 32 months (both according to Bloomberg). Instability abounds. Global Reflation Watch: January 20 – Bloomberg: “Japan’s central bank unexpectedly decided to add cash to the economy, which may help slow the yen’s 10 percent rise against the dollar the past year and protect an export-led recovery in the world’s second-largest economy. The bank’s policy board decided by a majority vote to raise the upper limit of the reserves it makes available to commercial banks to 35 trillion yen ($326 billion) from 32 trillion yen, the first increase since October.” January 23 – Bloomberg: “Brazil, Mexico and Venezuela are leading Latin American borrowers in selling a record amount of international bonds this month as the outlook for faster global economic growth boosts investors' appetite for riskier assets. The region’s governments and companies have raised $8.63 billion so far this month…That’s more than the $8 billion sold in June 1997. The debt market has become more attractive as the average borrowing rate for Latin American issuers has fallen to 8.69 percent from 12.73 percent a year ago, according to J.P. Morgan Chase & Co. With U.S. interest rates at their lowest in four decades, the yields are attractive to investors.” January 22 – Bloomberg: “Emerging market equity funds received a record amount of money last year as stocks in developing countries set the pace among major global indexes… Investors poured $12.5 billion into funds that invest in regions such as Asia, Latin America and Eastern Europe, surpassing the previous high of $10.9 billion in 1996, according to EmergingPortfolio.com Fund Research… Investors have added $1.32 billion to emerging market stock funds in the first two weeks of 2004…” January 23 – Bloomberg: “Brazil’s jobless rate fell to a 12-month low in December as rising consumer demand prompted companies such as automakers Volkswagen AG and Ford Motor Co. to add staff. The unemployment rate fell to 10.9 percent in December from 12.2 percent the previous month and a two-year high of 13 percent in August…” January 22 – Bloomberg: “Argentina’s economy will expand 6 percent in 2004, because of increased consumer spending and higher exports, the central bank said… Argentina’s central bank expects gross domestic product to rise 2 percentage points more than was set in the 2004 federal budget, powered by record low interest rates, increased trade abroad and higher spending by domestic consumers.” January 22 – Bloomberg: “Chilean retail sales rose at their fastest pace in six years in 2003 as a stronger peso made foreign goods less expensive and falling unemployment spurred spending. Sales rose 3.6 percent from 2002, the biggest increase since 1997.” January 21 – Bloomberg: “Britain’s budget deficit widened to a record 13.1 billion pounds ($24 billion) in December as Prime Minister Tony Blair’s government boosted spending, the statistics office said… The Treasury’s preferred measure, public-sector net borrowing, or PSNB, increased to 5.26 billion pounds from 4.48 billion pounds. Overall spending, including interest payments, climbed 9.3 percent to 39.5 billion pounds, as expenditure by government departments leapt 12.3 percent to 35.7 billion pounds.” January 21 – Bloomberg: “U.K. mortgage lending growth accelerated in December from the previous month, the British Bankers’ Association (BBA) said, suggesting an increase in interest rates hasn’t curtailed consumer demand for home loans. December net mortgage-lending rose 5.41 billion pounds ($9.9 billion), compared with 4.78 billion pounds in November…” January 22 – Bloomberg: “U.K. house-price growth in December was the quickest for more than a year, the Royal Institution of Chartered Surveyors said, suggesting further increases in interest rates may be needed to cool the market.” Asia Watch: January 20 – Bloomberg: “China’s economy grew 9.9 percent in the fourth quarter from a year ago as companies such as Shanghai Automotive Industry Corp. and Motorola Inc. expanded to meet surging consumer demand and export orders. The world’s sixth-largest economy accelerated from a revised 9.6 percent rate in the third quarter, the National Bureau of Statistics said… Gross domestic product for 2003 rose 9.1 percent, the fastest in six years, to 11.7 trillion yuan ($1.41 trillion). China helped drive a global recovery last year, consuming 55 percent of the world’s cement production and 36 percent of its steel, the bureau said. The government forecast slower growth this year and said it has no plans to rein in money supply or allow its currency to strengthen… China’s industrial production rose a record 18 percent in December, which, adjusting for new year holidays in January and February, was the fastest since records began in 1995… Surging investment and production helped create 8.5 million new jobs in China last year, Li said. That’s helping boost incomes in the world’s most-populous nation. The average disposable income last year rose 9.3 percent” January 22 – Bloomberg: “China’s finished steel imports rose 52 percent to 37.2 million tons in 2003 from a year earlier, the Tex Report said, citing preliminary data collected by the Japan Iron & Steel Federation from the Chinese customs department.” January 20 – Bloomberg: “Chinese investment in industry and public works projects, which accounts for about a third of the nation’s economy, rose 23 percent in December to 802.5 billion yuan ($97 billion). Fixed-asset investment was up 26.7 percent in 2003… Chinese retail sales last month grew 10.9 percent, the National Statistics Bureau reported today. For 2003, sales were up 9.1 percent.” January 22 – Bloomberg: “India’s long-term foreign-currency rating was raised one level by Moody’s Investors Service to investment grade for the first time in almost six years, a move which may reduce overseas borrowing costs for Indian companies. Moody’s raised the rating to Baa3 from Ba1 with a stable outlook because of increasing foreign-exchange reserves, accelerating economic growth and higher overseas investment…” January 21 – Bloomberg: “Bangkok Bank Pcl, Thailand’s biggest lender, and three of its biggest rivals have reported a surge in 2003 earnings, providing evidence demand for credit is increasing as economic growth accelerates. Bangkok Bank’s 2003 net income rose by a record 81 percent to 11.35 billion baht ($289.8 million) in the year to Dec. 31… Net loans expanded 2.2 percent, exceeding its target, the bank said. ‘We are now confident that the credit cycle is picking up,’ said Thananchai Jittanoon, an analyst at UOB Kay Hian Securities (Thailand) Ltd. ‘The banks have been advancing corporate term loans to companies in the petrochemical, consumer finance and other industries.’” January 20 – Bloomberg: “India’s economy may grow faster than expected in the year to March 31, 2004, as heavier rains boost farm production, raising the incomes of 700 million rural dwellers, the National Council for Applied Economic Research said. Gross domestic product will grow 8 percent, faster than the 7.1 percent it predicted in October, the economic research institute said…” January 20 – Bloomberg: “Taiwan’s export orders rose 20 percent to a record $15.7 billion last month because of higher Chinese and U.S. demand for the island’s computer chips, flat-panel displays and other electronics goods… Orders from Hong Kong rose 25 percent to $3.7 billion in December… Most Taiwanese goods bound for China are shipped via Hong Kong because of transport restrictions between Taiwan and its political rival. Orders from the U.S. rose 15 percent last month to $4.2 billion. Orders from Europe increased 26 percent to $2.6 billion and those from Japan rose 10 percent to $1.6 billion.” Domestic Credit Inflation Watch: The Mortgage Bankers Association Application index surged 36% this past week, the strongest gain in three years (according to Bloomberg). Refi applications shot 52% higher to the strongest reading since early August. Moreover, Purchase applications jumped 19% (25% over two weeks!) to an all-time record high. Purchase application volume was up 40% from a year earlier, with dollar volume up a whopping 62%. The average purchase application was for $211,800. Adjustable-rate applications accounted for almost 28% of total applications, with an average amount of $308,200. December Housing Starts were reported 7% above the consensus estimate to an annualized rate of 2.088 million. This was up 15% from December 2002 to the fastest pace since February 1984. Total Starts of 1.848 million place 2003 as the strongest year since 1978, with Permits issued at the strongest pace since 1972. When compared to December 1997, December 2003 Starts were up 33%, Permits were up 32% and Homes Under Construction were up 34%. January 21 – Los Angeles Times (Roger Vincent): “The O.C. (Orange County) remains hot — when it comes to houses. Orange County home prices continued to climb at a torrid pace last month as the median price jumped 21.3% from a year ago to hit an all-time high of $467,000 during a month that saw a 5.8% increase in sales to 4,693. That is the biggest volume for any December since 5,064 homes sold in 1988, and analysts say the pace shows no signs of letting up. ‘Indications are that sales counts are going to stay strong,’ said John Karevoll, an analyst with DataQuick... appreciation was up across all price categories, from condominiums to high-end luxury homes. ‘It was just a darn strong end of the year,’ Karevoll said. ‘That’s all there is to it.’ The median price of a new single-family house in Orange County was up 8% from a year ago to $594,000. Other increases were more extreme: The median price for a house that was resold was up 24.1% to $490,000, and resold condominiums climbed 25.3% to $324,500.” Other California real estate headlines this week included, “Home Prices in Ventura County Soar – the median price hits $398,000 for 2003, nearly 20% above the figure for the previous year.” “High Desert Home Sales to Remain Hot.” “Santa Clara County Home Sales Jump.” From the LA Daily News: “The median price of a Southern California home jumped 20 percent in December to a record $346,000, but sales remained at all-time highs, thanks to strong demand and affordable mortgage rates…” But it’s not just Southern California. From the Contra Costa Times: “December sales figures for (San Francisco) Bay Area homes show that while prices of homes keep rising, people keep buying. Bay Area home sales last month showed the strongest December performance in 16 years and a 26.3 percent increase over the same period in 2002.” The San Mateo Times – where the county saw December sales up 36% y-o-y and a median price of $570,000 – quoted a local real estate executive: ‘There were so many buyers vying for so few properties that the only thing that was going to happen was prices would go up.’ Let there be no doubt: The Great California Housing and National Mortgage Financial Bubbles Rage On. Interestingly, the Mortgage Bankers Association yesterday raised their 2003 mortgage originations estimate 13% above their December forecast to $3.79 Trillion. January 20 – Wall Street Journal (James Hagerty): “Membership in the NAR (National Association of Realtors), which includes most of the nation’s more active agents and brokers, has surged 27% in the past three years to 977,000. More are on the way: Schools that train people for real-estate licensing exams report booming enrollment. Indeed, the residential real-estate industry has a boom-time mentality reminiscent of the one that pervaded Silicon Valley and Wall Street in the late 1990s. ‘The great thing about real estate is that we upsize, we don’t downsize,’ says Bill Spadea, head of career development at Weichert Realtors, a brokerage that operates on the East Coast.” January 19 – New York Times (Stephanie Strom): “Many nonprofit organizations responding to a new survey managed to increase their revenue in 2003 despite the sputtering economy, but those gains were more than offset by higher costs. While 64 percent of the 236 organizations across the country that responded reported more income, 66 percent said they had higher costs for health and liability insurance as well as for wages and salaries and other expenses. More than half of the respondents reported being in ‘severe’ or ‘very severe’ financial stress.” Weakly bankruptcy filings of 28,094 were down about 3% from the comparable week one year earlier. The ABC News/Money Magazine consumer comfort index rose last week to a 21 month high. The Personal Finances component is up a strong 8 points in three weeks. Financial Sector Earnings Reports: Earnings season is upon us once again (How time flies…). With respect to the financial sector, this reporting period is even more interesting than usual. Earnings are stellar - Fannie 4th quarter Net Income of $2.197 billion vs. Q4 2002’s $952.2 million; Citigroup $4.80 billion vs. $2.46 billion; JPMorganChase $1.864 billion vs. a loss of $387 million; Wells Fargo $1.62 billion vs. $1.47 billion; MBNA Financial $703.5 million vs. $540.1 million; and so on. By “definition,” reported accounting profits should be nothing less than spectacular during one of history’s great lending and speculating follies. Our focus for this quarter is to try to get a gauge on the degree and composition of lending. Additionally – especially considering the fourth quarter’s unusual decline in the monetary aggregates – we should pay special attention to the nature of financial sector liabilities being created. All indications have the mortgage finance sector continuing to play the key role of systemic Credit and liquidity creator. And the financial sector still much prefers consumer lending to commercial lending, although there are signs of life in business lending. It also is clear that signficant credit creation is outside traditional bank lending activities, while non-deposit liabilities play an unusually prominent role in funding lending growth. Fannie Mae posted a strong fourth quarter, with its Book of Business expanding $70.4 billion, or 13.2% annualized, to $2.198 Trillion. Following its spectacular third-quarter $104.7 billion Retained Portfolio expansion (52% annualized!), the Retained Portfolio declined by $18.7 billion (8.1% annualized) during the fourth quarter to $898 billion. But the “action” was found in the expansion of mortgage-backed securities (MBS). Non-retained MBS expanded by $89.1 billion during the quarter, or at a rate of almost 30%, to $1.3 Trillion. It is worth noting that non-retained MBS expanded at a 39.4% rate during December (Book of Business up at a rate of 16.3% during the month). For 2003, Fannie’s Book of Business surged $378.3 billion, or 20%. This was a 44% increase over 2002’s record growth, with the Book of Business up 146% since the beginning of 1998. For 2003, the Retained Portfolio expanded $107.6 billion (13.6%) and non-retained MBS jumped $270.7 billion (26.3%). Fannie repurchased 21 million shares of stock during the year. We must wait for Freddie’s data, but it is possible that combined Fannie and Freddie Books of Business expanded by as much as $140 billion during the fourth quarter. The quantity of MBS sold into the marketplace was similarly enormous. Yet it is not clear today which institutions acquired these securities, as well as what liabilities were created in the process. Bank holdings did not appear to grow substantially during the quarter, although some “trading” positions expanded sharply. The buyers may reside in the leveraged speculating community; perhaps it was the Wall Street firms and hedge funds? Was it the ballooning REITS? Was the household sector buying MBS products in lieu of bank and money fund deposits? And let's not forget the expansive Global central bankers. Likely, it was “all of the above.” Citigroup, the largest U.S. financial institution, expanded Total Assets $55.1 billion, or 18.2% annualized, during the fourth quarter to $1.264 Trillion. Trading assets surged $40 billion during the quarter to $230.9 billion and were up almost 50% from one year ago. Consumer Loans were up $42 billion, or almost 50% annualized, to $380 billion. Year-over-year, Consumer Loans were up 12.5%. Corporate Loans declined by almost $5 billion during the quarter (19% annualized) to $98.1 billion and were down almost 11% y-o-y. On the liability side, Fed Funds increased $13.0 billion (31% annualized) during the fourth quarter, Long-term Borrowings $16.7 billion (46% annualized), and Trading Account Liabilities $7.0 billion (26% annualized). Total U.S. Deposits increased $2.7 billion, or 6.3% annualized. Short-term Debt declined by $4.0 billion to $36.7 billion. For the year, Total U.S. Deposits increased $5.4 billion (3.2%), Long-Term Debt $35.8 billion (28.2%), Trading Account Liabilities $22.6 billion (24.7%), Fed Funds $18.7 billion (11.5%), and foreign deposits $37.2 billion ($14.3%) -- data providing us an excellent example of lending growth financed by non-monetary liabilities. JPMorganChase Investment Banking Fees were up 29% from Q4 2002, with “record earnings of $3.7 billion for the full year, up 183%... Chase Financial Services posted record earnings of $2.5 billion… Record revenues of $14.6 billion were driven primarily by Home Finance revenues which were up 38% from 2002.” For the year, Consumer loans expanded 10.1% to $171.23 billion, while Commercial loans declined 9.2% to $83.1 billion. Total Assets were down $21.8 billion during the quarter, with Other Assets declining almost $18 billion. Trading Assets jumped $22.4 billion to $169.1 billion, while Total Loans declined $16.5 billion to $215.0 billion. On the liability side, Deposits increased 7.1% during 2003 to $326.5 billion. Commercial Paper borrowing declined 14% (to $14.3 billion), while Long-Term Debt jumped 21% (to $48.0 billion). Trading Liabilities rose 17% (to $78.2 billon), while Fed Funds & Repos declined 33% (to $113.5 billion). For the quarter, JPMorgan’s Total Deposit liabilities were up $12.9 billion. Interestingly, the liability Federal Funds and Securities Sold under Repurchase Agreements dropped $18.5 billion at the end of the period to $113.5 billion, although the Average Balance for the quarter was $141.1 billion. Many banks make some major position adjustments to reduce trading assets and repurchase agreement funding agreements for quarter and year-end reporting purposes. In this regard, it is interesting to examine weekly Fed reported “Repo Agreements.” Ending the week of December 24th at $2.704 Trillion, these positions dropped to $2.288 Trillion on January 7th (before rising back to $2.484 Trillion by January 14). At Bank of America, “mortgage banking income increased 39 percent to $292 million”; “Record mortgage originations - $131 billion 2003 vs. $88 billion 2002”; “Card income increased 11 percent to $815 million”; “Investment banking income increased 9 percent to $458 million.” For the year, Total Average Consumer loans expanded 22% to $239.6 billion, with Average Residential Mortgage loans up 32% to $142.5 billion. Average Total Commercial loans contracted by 10% to $131.5 billion. On the liability side, Average Interest Bearing Deposits were up 12% y-o-y to $296.2 billion, while Average Fed funds and Repos were up 23% to $152.0 billion. During the fourth quarter, Average Total Consumer loans expanded at a 27% rate, while Total Average Commercial loans contracted at 4% rate. From Wells Fargo: “The purchase mortgage market continued to be strong (during the fourth quarter). While originations for the quarter were down from the prior year, full year originations of $470 billion eclipsed the industry record of $333 billion we set last year.” “Average loans of $236 billion for the fourth quarter 2003 increased $56.5 billion, or 31 percent, from fourth quarter 2002, and $19.8 billion, or 37 percent (annualized), on a linked-quarter basis. The double-digit growth in loans was generated by continued strong consumer demand for credit including home equity, residential first mortgage products, credit cards and installment loans.” “Average core deposits grew $15 billion, or 8 percent, from fourth quarter 2002, and declined $6 billion on a linked-quarter basis due to a $10 billion decline in mortgage escrow deposits attributable to lower mortgage refinance activity.” Commercial Loans expanded at an 8.5% annualized rate during the quarter, but were up only 3% y-o-y. Real Estate 1-4 Family First Mortgage loans doubled during the year to $83.5 billion. Real Estate Construction Loans expanded at a 22% rate during the final three months of 2003. Credit Card Loans expanded at a 26% rate. Real Estate 1-4 Family First Mortgage jumped $16.8 billion during the quarter, while Mortgages Available For Sale dropped $26.3 billion. Home Equity Loan holdings dropped $4.0 billion, so Wells must have been an active securitizer during the fourth quarter. Overall, Total Assets declined $3.0 billion during the quarter to $387.8 billion (up 11% y-o-y). Washington Mutual ended the year with “Record home loan volume of $384.18 billion,” up $104.73 billion, or 37%, from 2002. “Strong home equity loans and lines of credit volume was a record $29.64 billion,” up 94% from 2002. “Multi-family lending volume was a record $8.07 billion in 2003,” up 38% from 2002.” “During 2003, the company repurchased 65.9 million shares of its common stock…, of which 28.7 million shares were repurchased during the fourth quarter…” And while fourth quarter loan volume was down 36% from Q4 2002, home equity loan volumes were up 68%. Adjustable-rate mortgages accounted for 55% of application volume during the fourth quarter, compared with 38% during the third quarter. On the back of the fourth quarter’s 16% annualized decline, Total Assets were up about 3% for the year. More interesting is the expansion and composition of liabilities. For the first three quarters of the year, Deposits expanded at a 7% rate (to $164.1bn) and Repurchase Agreements increased at a 30% rate (to $20.5 billion). But during the fourth quarter, deposits actually declined by $11.0 billion (27% annualized), while Repurchase Agreements surged $7.9 billion (154% annualized). For the year, deposits declined 2% and Repos rose 30%. California adjustable-rate mortgage powerhouse Golden West Financial expanded total assets at a 44% annualized rate during December to $82.55 billion. Total Assets expanded at a 34% rate during the fourth quarter and were up 21% for the year. It is interesting to examine the type of liabilities expanded to fund this extraordinary lending growth. For the first nine months of the year, Total Deposits expanded $5.1 billion, or 17% annualized, while Federal Home Loan Bank (FHLB) Borrowings increased $1.1 billion, or 8% annualized. But the compositions of liabilities changed markedly later in the year. During December, FHLB Borrowings increased $1.3 billion (76% annualized), while Total Deposits rose $238 million (6% annualized). For the quarter, FHLB Borrowings expanded $2.3 billion, or 47% annualized, to $22.0 billion. Total Deposits increased $582 million, or 5% annualized, to $46.7 billion. What a great example this provides of the atypical dynamics of contemporary finance: aggressive lending growth financed by the expansion of (GSE) non-monetary liabilities! Net Income at Credit Card behemoth MBNA was up 30% y-o-y to $703.5 million. Managed Loans expanded at a 20% annualized rate during the fourth quarter to $118.5 billion. Managed Loans were up 10% y-o-y. “During 2003, the Corporation added 10.7 million new accounts, with 2.7 million new accounts added in the quarter.” Total Assets were up 12% y-o-y to $59.1 billion, although Total Assets expanded at a 3% rate during the fourth quarter. And with loans expanding so rapidly, it is no surprise to see the managed delinquency rate (down 9 basis points to 4.39%) and managed Credit losses (down 16 basis points to 4.97%) improve during the quarter. And the Credit boom lives on... CapitalOne reported 4th quarter Net Income up 11% y-o-y to $266 million. Total Assets expanded at a 26% rate during the quarter to $46.3 billion, with a second-half growth rate of 29%. Total Assets were up 24% y-o-y and were up almost 400% in just five years. Average Loans expanded at a 32% annual rate during the quarter. Total Managed Loans expanded at a 31% during the quarter to $68.7 billion. Perhaps the Credit card lenders are benefiting from significantly reduced mortgage refis. Are fewer consumers paying down card balances with equity extraction? Allowing card balances to grow, while using liquid balances to play the markets? New Age subprime mortgage lender New Century Finance expanded Total Assets by $1.3 billion, or 68% annualized, during the quarter to $8.9 billion. Total Assets were up 270% for the year, with 2-year growth of better than 500%. New Century originated $8.25 billion of mortgages during the fourth quarter, up 85% from Q4 2002 and down only slightly from the previous quarter’s record originations. Mortgage real estate investment trust (REIT) Thornburg Mortgage Inc. expanded Total Assets by $1.8 billion, or 42% annualized, during the quarter to $19.12 billion. Total Assets were up 82% for all of 2003. Total Assets are up 335% over the past 10 quarters. Assets ($18.6 bn) are primarily jumbo Adjustable-rate Mortgages. Liabilities comprise mainly Reverse Repurchase Agreements ($13.9bn) and Collateralized Debt Obligations (CDOs) ($3.1bn). The company ended the year with Shareholder’s Equity of $1.24 billion. It is worth noting that the S&P Thrifts & Mortgage Finance index was one of the strongest groups this week, advancing 5.3% in four sessions (up 6.7% y-t-d). Perhaps the marketplace is coming to the realization that – barring an unforeseen rate spike or some type of financial dislocation – mortgage lending excess is poised to do more than simply endure. But, then again, this is precisely the nature of Credit Bubbles: once commenced, they take on a life of their own and are quite prone to runaway excess. Mortgage finance is, today, in the midst of the blow-off stage for one of history’s Great Credit Bubbles. So we should expect the truly spectacular. And when it comes to the California Housing Bubble, it may be worth recalling that the late-nineties technology stock Bubble saw, by October 1999, prices go to what were at the time almost unimaginable extremes. And then the NASDAQ 100 index almost doubled in six ruinous months.

01/16/2004 Q3 2003 'Flow of Funds' *

Each week these days passes for a peculiar adventure through some serpentine financial jungle.  For the week, the Dow, S&P500, Transports, and Morgan Stanley Cyclical indices advanced about 1.5%.  The Utilities were unchanged, and the Morgan Stanley Consumer index mustered a small gain.  The broader market was on fire, with the small cap Russell 2000 posting a 3% gain (up 6% y-t-d).  The S&P400 Mid-cap index gained 1.5%, increasing 2004 gains to 3% (to a new record).  The NASDAQ100 added 2%, with y-t-d gains of 6%.  The Morgan Stanley High Tech index rose 4%, increasing 2004 gains to almost 10%.  The Semiconductors added 2.5% (up 10% y-t-d) and The Street.com Internet index 5% (up 8.5% y-t-d).  The NASDAQ Telecom index rose 3%, with 2004 gains of 11%.  Since December 17th, the Russell 2000 is up 9.6%, the Morgan Stanley High Tech index 16.7%, the Semiconductors 17.3%, and the NASDAQ Telecom index 19.4%.  For the week, the Biotechs gained 4% (y-t-d up 6%).  The Broker/Dealers surged 6% to an all-time high, while increasing 2004 gains to 7%.  The Banks added 1% this week to a new all-time high.   With gold dropping almost $20, the HUI gold index sank 11%.  Despite inflating equities and strong economic data, fixed-income more than held its own.  For the week, two-year Treasury yields were about unchanged at 1.66%.  Five-year yields declined 1 basis point to 3.03%, while 10-year Treasury yields declined 5 basis points to 4.03%.  Ten-year yields are down 22 basis points so far this year.  The long-bond saw its yield decline 7 basis points to 4.89%.  Benchmark Fannie Mae mortgage-backed yields rose 2 basis points.  The spread on Fannie’s 4 3/8% 2013 note added 3 to 37, while the spread on Freddie’s 4 ½% 2013 note added 2 to 35.5.  The 10-year dollar swap spread narrowed 0.75 to 36.75.  The implied yield on December Eurodollars rose 2 basis points to 1.905%.  Corporate spreads generally widened this week, with junk bonds underperforming (for a change).  Bloomberg’s tally has more than $17 billion of corporate bond issuance for the week.  Investment grade issuers included Nalco Finance $690 million, XTO Energy $500 million, Simon Property Group $500 million, Pulte Homes $500 million, Western & Southern Finance $500 million, United Utilities $350 million, Dominion Resources $300 million, Caterpillar Financial $250 million, Jackson National Life $200 million, Reckson Operating Partnership $150 million, Allstate Finance $150 million, Istar Financial $140 million, and Georgia Power $100 million, Junk bond funds received $396 million over the past week (from AMG), with 11-week inflows of $3.5 billion.  Junk issuers included Station Casino $400 million, Sistema Capital $350 million, Vail Resorts $390 million, Exco Resources $350 million, Centennial Communications $325 million, Alamosa $250 million, Sungard Data $500 million, Primus Telecom $240 million, American Casino $215 million, Premier Entertainment $160 million, New ASAT Finance $150 million, Medianews $150 million, Seminis Vegetable Seeds $140 million, Duke Realty $125 million, and Communications & Power Industries $125 million. Convert issuers included Graftech International $180 million and Gencorp $100 million. Foreign dollar debt issuers included KFW-Kredit Wiederaufbau $3 billion, Abbey National $2.25 billion, Republic of Brazil $1.5 billion, Republic of Colombia $500 million, Banco Nacional $400 million, Excelcomindo Finance $350 million, Braskem SA $250 million, Costa Rica $250 million, and Telemig Celular $120 million. $4 billion of emerging market debt was issued this week. January 16 – Financial Times (Alan Beattie ):  “The rush of investors into emerging markets is in danger of suffering a swift and damaging reversal, the leading association of global financial institutions has warned. In an unusually explicit warning, the Institute of International Finance, which represents more than 300 of the world’s largest banks and finance houses, said asset prices were vulnerable after rising too far, too fast… The institute said net capital flows to emerging markets last year reached $187.5bn, their highest since the Asian financial crisis began in 1997, and forecast a further rise this year.” Freddie Mac posted 30-year mortgage rates sank 21 basis points last week to 5.66%, the lowest level since the week of July 11.   Fifteen-year fixed mortgage rates dropped 20 basis points to 4.97%.  One-year adjustable rate mortgages could be had at 3.62%, down 14 basis points to the lowest rates since the week of July 18th.  In a development to monitor closely, mortgage applications surged last week.  Refi applications were up 25% for the week to the highest level in seven weeks.  Purchase applications jumped 11% to one of the highest levels ever.  Purchase applications were up 23.5% from one year earlier, with purchase dollar volume up a notable 35.4%.  The average purchase mortgage application was for $206,200, with the average adjustable-rate mortgage at $286,900. Global Currency Watch: The elusive dollar rally arrived abruptly this week.  Curiously, the ECB this week decided to “bite the bullet” and make comments supportive of a dollar rally.  This follows (coincidently?) a week of reportedly massive – and minimally effective – Japanese dollar support.  The dollar rallied strongly against the euro over the past three sessions, and the dollar index posted a 3% gain for the week.  Nonetheless, the dollar recorded a slight decline against the yen.  January 15 – Financial Times (David Pilling and Barney Jopson):  “Sadakazu Tanigaki, Japan’s finance minister, urged the US yesterday to take steps to repair its trade and fiscal deficits, saying that concern over the two was driving the dollar lower.  Mr. Tanigaki said the twin deficits were undermining faith in the US currency. ‘It is being said that this is a concern linked to the foreign exchange rate. If that is the case, efforts may be needed to improve that.’  Japan has intervened in foreign exchange markets to try to stop the yen appreciating against the US currency but with limited success. Last year it spent a record Y20,000bn ($188bn), three times the previous high, but failed to hold the yen at Y115… Intervention has continued this year… Some government officials have privately voiced concern over the effectiveness of constant intervention. ‘We can’t continue this intervention policy indefinitely,’ said one official. ‘But if we stop now the yen might soar. It’s a catch-22.’” The strongest currencies for the week included the Brazilian real, Russian ruble, the Argentine peso, Mexican peso and the Indian rupee. Commodities Watch: The CRB index was walloped for 1.5% yesterday on dollar strength but then gained virtually all of it back today (in spite of further dollar gains).  The CRB ended an impressively resilient week about unchanged.  Crude oil closed today above $35 a barrel, rising to the highest price since March. January 16 – Bloomberg:  “Crude oil rose after an Energy Department report showed that U.S. inventories declined to the lowest level since September 1975.”     January 16 – Bloomberg:  “Oil inventories are plunging, leaving consumers vulnerable to rising prices as world demand grows faster than expected, according to the International Energy Agency, an adviser to 26 nations on energy policy. Fuel and crude-oil inventories held in the 30 nations of the Organization for Economic Cooperation and Development declined in November by 860,000 barrels a day from October, to 2.53 billion, the Paris-based agency said in a monthly report. The decline left stockpiles 95 million barrels below the five-year average.      January 12 – Bloomberg:  “China’s crude oil imports last year rose 31 percent to a record, the Ministry of Commerce said. China bought from abroad 91.12 million metric tons (670 million barrels) of crude oil last year… The country’s imports of fuels such as gasoline and diesel gained 39 percent to 28.24 million tons.” Global Reflation Watch: January 12 – UPI:  “China’s total trade volume hit $851.21 billion last year, up 37.1 percent from 2002… Statistics show that in 2003 China had exports of $438.37 billion, up 34.6 percent from the 2002 level, and had imports of $412.84 billion, up 39.9 percent from the 2002 level. Last year’s total increase over 2002 levels -- for both imports and exports -- was $230.4 billion, or 37.1 percent. That makes 2003 the country’s fastest growing year since 1980.” January 12 – Bloomberg:  “India’s industrial production grew at its fastest pace in three years in November as rising farm incomes and the cheapest credit in three decades led consumers to buy homes, vehicles and other goods.” January 15 – Bloomberg:  “Indian equity funds last week had the largest weekly inflow of new funds in at least two years as some overseas investors bet stocks in Asia’s third-biggest economy can extend last year’s 73 percent surge.” January 16 – Bloomberg:  “Argentina’s consumer confidence climbed in December to its highest level since the University Torcuato Di Tella began tracking confidence levels in March 2001.” Domestic Credit Inflation Watch: January 16 – Dow Jones:  “Bond issuance should decline this year from the record levels seen in 2002 and 2003, as the economy heats up and interest rates rise, according to the Bond Market Association.    The BMA sees bond issuance (excluding Treasurys and agencies) totaling $3.05 trillion, compared with $4.96 trillion last year - with the sharpest decline coming in secondary mortgage markets…” January 15 - Dow Jones (Christine Richard and David Feldheim):  “With the giant mortgage market exerting an ever-greater influence on the Treasury market, it’s not surprising that Countrywide Financial Corp.’s securities unit was added this week to the prestigious list of primary dealers for U.S. Treasurys.  As a primary dealer Countrywide Securities Corp. joins 22 other institutions that underwrite Treasury auctions and deal directly with the Federal Reserve Bank of New York’s open market desk.  And with Countrywide’s well-rounded presence in the mortgage market, it’s a unique addition to the roster of primary dealers.  The other 22 institutions on the list are best known either for their securities businesses or for their commercial banking operations… Countrywide sold a record $435 billion in mortgage loans in 2003..." January 14 – Bloomberg:  “A Manhattan apartment’s average price fell 1.5 percent in the last three months of 2003 from a record in the previous quarter, and sales slipped 2.9 percent, as fewer New Yorkers offered their homes for sale, a report showed. Prices declined to $903,259 from $916,959 and sales dropped to 2,256 from 2,324, according to a report from Miller Samuel Inc., a residential appraiser, and Douglas Elliman, the city’s largest brokerage.” January 14 – Dow Jones (Christine Richard and Julie Haviv):  “Cash-out refinancings have been a dream come true for many homeowners and mortgage bankers. But some of the cash individuals took out of their homes may be, in fact, a fantasy as the booming market led some appraisers in the rush for business to overstate home values.  Exaggerated appraisal values have raised concerns at Fannie Mae, the largest buyer of mortgages in the nearly $7 trillion mortgage market. That’s set off a scramble to reappraise property values that could leave banks on the hook for inadequately backed loans sold to Fannie Mae. It also means individuals may have borrowed against equity in their homes that doesn’t exist.  ‘We have seen a trend toward inflated appraisal values on cash-out refinancings,’ said Alfred King, director of communications at Fannie Mae. ’That has resulted in Fannie Mae requiring lenders to review loans for excessive valuation.’” Received this week from Citibank:  “This tax season, make life simpler by paying your taxes with your Citi/AAdvantage Card.  It’s fast, convenient and you’ll earn one AAdvantage mile for every dollar charged.  What could be easier? …So paying your taxes can be simpler, stress-free and rewarding…” Broad money supply (M3) rose $29.8 billion (for the week ended Jan. 5), its first significant gain since early September.  Currency dipped $1.4 billion and Checkable Deposits declined $2.1 billion.  Savings Deposits dipped $1.2 billion (down $32.4 billion over 5 weeks).  Small Denominated Deposits were down $0.6 billion and Retail Money Fund deposits dipped $0.2 billion.  Institutional Money Fund deposits added $13.9 billion and Large Denominated Deposits surged $41.6 billion.  Repurchase Agreements contracted $29.3 billion, while Eurodollars added $8.5 billion. Fed Custody Holdings gained $10.3 billion, with a 24-week rise of $151.2 billion (35% annualized growth rate). Bank Credit increased $28 billion during the first week of the year.  Loans & Leases surged $41 billion.  Commercial & Industrial loans were up $3.1 billion and Other loans added $5.9 billion.  Consumer loans dipped $0.8 billion.  Securities holdings declined $13 billion.  Real Estate loans jumped $10.5 billion and Security loans surged $22.4 billion.  Elsewhere, Commercial Paper increased $11 billion last week to $1.288 Trillion, with two-week gains of a notable $19.7 billion.  Financial CP added $13.3 billion, while Non-financial CP declined $2.3 billion. December Advance Retail Sales were reported up a slightly less-than-expected 0.5% from November.  But don’t let that fool you.  December Retail Sales were up 6.7% from December 2002.  December Producer Prices were up 4% from December 2002.  Year-over-year PPI gains have not been stronger since January 2001.  The New York State Manufacturing index added almost 2 points to a better-than-expected and record 39 points.  The Philadelphia Fed index surged a much stronger-than-expected 6.7 points to 38.3, the strongest reading since December 1993.  Our nation’s Trade Deficit for November improved to $38.0 billion.  Year-over-year, Goods Exports were up 10.5% to $63.82 billion.  Goods Imports were up 5.4% to $107.42 billion.  It would require Goods Exports to increase 68% to match Goods Imports. Interestingly, the University of Michigan survey of preliminary January confidence surged 10.6 points to 103.2, the largest gain since November 1992.  It is also worth noting that the index is up 25.2% from January 2003.  Current Conditions were up 11.9 points to 108.9, and Economic Outlook was up 9.7 points to 99.5. With stock prices up significantly over the past month and mortgage rates down meaningfully, there should be no mystery surrounding the surge in consumer confidence.  I note that some analysts have averred that December’s unimpressive jobs data is indicative of a slowing economy.  I would argue strongly that jobs growth will not be a driving force for either the economy or financial markets.  The financial markets are today the horse and the economy the cart.  As analysts, our focus must remain on financial conditions, general liquidity, Credit availability and lending growth. Analyzing how financial markets respond to the natural ebb and flow of economic activity will keep us on our toes. Q3 2003 “Flow of Funds” While it does require some thinking back, the third quarter was an extraordinary period for the Credit system in several respects.  The period demonstrated exceptional growth; it marked the end of an historic mortgage refi boom; and there was near dislocation within interest rate markets as yields spiked higher and some key spreads and volatilities blew out to the widest levels since LTCM (it today seems like such a long time ago).  There was a major shifting of assets (and liabilities) by players caught in the interest rate tumult.  There was also a marked deceleration and near stagnation of money supply growth, and with it renewed talk of faltering liquidity, deflation and even a collapse in Credit.  With this in mind, I was especially excited by yesterday’s (delayed) arrival of the Fed’s quarterly Z.1 report. First of all, there was certainly no indication of any meaningful slowdown in the historic Credit Bubble.  Total Credit Market Debt (Non-financial and Financial) increased at an 8.6% annualized rate during the third quarter to $33.6 Trillion.  Over the past year, Total Credit Market Debt increased $2.784 Trillion, or 9.0%.  For comparison, Total Credit Market Debt increased $2.22 Trillion during 2002, $1.877 Trillion during 2001 and $1.792 Trillion during 2000.  Since the beginning of 1998 (23 quarters), Total Credit Market Debt is up a whopping 59% ($12.4 Trillion!).  Non-financial Borrowings (NFB) increased at a 7.4% rate to $22.0 Trillion.  Over four quarters, NFB has expanded $1.736 Trillion, or 8.6%.  By sector, Federal Government Debt expanded at an 8.2% rate to $3.95 Trillion, with a 12-month rise of 10.3%.  Total Household Debt increased at an 11.2% rate during the quarter to $9.18 Trillion, with a 12-month rise of 11.2%.  State & Local Governments increased debt at a 10.5% rate during the quarter to $1.542 Trillion, with a 12-month rise of 10.5%.  Lagging, Total Corporate Debt increased at a 3.4% rate during the quarter to $7.33 Trillion, with a 12-month rise of 4.2%.  It is worth noting that when the government and household sectors are borrowing so aggressively, one would expect resulting strong cash-flows (profits) to lessen corporate borrowing requirements. It is one of many curious facets of contemporary economic doctrine that Financial Sector borrowings are deemed basically irrelevant; non-financial debt creation is paramount and to examine Financial Sector debt amounts to mindless “double counting.”  But to ignore financial sector liability creation and asset accumulation is to disregard one of the key aspects of contemporary finance and the Great Credit Bubble.  I strongly argue that financial sector expansion (including foreign institutions’ dollar asset accumulations) is the key liquidity-creating mechanism in today’s financial markets.  It is surely much more useful to focus on financial sector liabilities generally, rather than to fixate exclusively on “bank money” or the money supply aggregates.  In fact, in this environment the analysis of the expansion of a broad range of financial sector liabilities is fundamental for avoiding some rather major blunders.  With this in mind, Financial Sector Borrowings increased at a near record annualized $1.178 Trillion, or 10.9%, to $11.09 Trillion during the third quarter.  Financial Sector Liabilities increased $1.08 Trillion, or 10.8%, over the past four quarters and have now doubled over the past 23 quarters.  This expansion is massive, unrelenting and historic, and goes far in explaining rampant asset inflation and seemingly endless financial market liquidity. However, I’ll begin by noting that Commercial Banking Total Assets expanded at only a 1.2% annualized rate during the third quarter.  This was down sharply from the second quarter’s 10.1% pace of expansion and the weakest growth since the Q1 2002 blip.  Seasonally-adjusted “Net Acquisition of Financial Assets” actually contracted at an adjusted annualized rate of $67.2 billion during the quarter.  And after gorging on Agency Debt for five quarters (up $226.7 billion, or 28%), Commercial Banks reduced holdings by an annualized $268.8 billion during the third quarter (as interest rates rose sharply, albeit temporarily).  Bank Loans expanded at about a 5% rate during the quarter.  Notably, Commercial Loans contracted by an annualized 9.0%, with these loans declining $103.5 billion (7.6%) y-o-y.  Conversely, Mortgage Loans expanded at a 12.9% pace during the quarter and were up $301.9 billion (15.4%) y-o-y.  As for Commercial Bank liabilities, Checkable Deposits contracted at an annualized pace of $152 billion, while Miscellaneous Liabilities expanded by an annualized $219.3 billion.  Foreign Banking Offices in the U.S. reduced financial assets holdings by an annualized $128.2 billion, with the liability Federal Funds and Securities RP (repurchase agreements) contracting by an annualized $100.4 billion. Yet we certainly cannot nowadays associate slow bank asset growth with reduced overall Credit expansion.  Once again “saving the day,” GSE Assets expanded at a 21.4% rate during the quarter to $2.80 Trillion.  At an unprecedented seasonally-adjusted annualized increase of $568.9 billion, this was the strongest rate of GSE growth since the anxious fourth quarter of 1999.  As “Buyers of First and Last Resort” for the banks, brokers, hedge funds and other speculators, the GSEs increased holdings of mortgage-backed securities during the quarter by an annualized $542 billion (45%).  Over 12 months, GSE Assets inflated $345.6 billion, or 14.1%, compared with the 2002 rise of $247 billion.  GSE Assets have ballooned an astonishing 155% over 23 quarters.  Federally-related Mortgage Pools (GSE MBS) increased at a 9.9% rate during the quarter to $3.37 Trillion, the strongest rate of growth in five quarters.  MBS was up 9.3% over the past year (up 85% over 23 quarters).  Asset-backed Securities (ABS) expanded at a 9.3% rate during the quarter to $2.56 Trillion, with 12-month gains of 13.6% (up 159% over 23 quarters).  Total “Structured Finance” (combining GSE, MBS, and ABS assets) expanded during the quarter at an annualized $1.23 Trillion, or 13.4%, to $8.76 Trillion.  Over the past year, “Structured Finance” has ballooned $938.3 billion, or 12.0% (up 123% over 23 quarters).  Security Brokers and Dealers increased assets by an annualized $107 billion (10% growth rate), down sharply from the second quarter’s risky 36.5% growth rate.  Agency Holdings contracted at a notable annualized $214.3 billion, while Treasuries increased by an annualized $174.4 billion.  Security Credit contracted at an annualized $87.6 billion.  Miscellaneous Assets expanded at an annualize $187.9 billion.  On the liability side, Security RPs (repurchase agreements) increased at an annualized $206.1 billion.  Over the past four quarters, Security Broker and Dealer assets have increased 9.3% to $1.55 Trillion. Federal Funds and Security Repurchase Agreements expanded at a 10.1% annualized rate to $1.487 Trillion, with four-quarter gains of 13.2% (up 81% over 23 quarters).  Funding Corporations – “Funding subsidiaries, nonbank financial holding companies, and custodial accounts for reinvested collateral of securities lending operations” – saw asset holdings expand at an annualized $167.6 billion, or a pace of about 11%. Miscellaneous Liabilities increased by an annualized $187.4 billion. Finance Companies (including “captives”) expanded assets during the quarter at a notable annualized $366.9 billion, or 28%.  To fund this expansion, Corporate Bonds increased at an annualized $139.7 billion and Other Miscellaneous Liabilities expanded at an annualized $257.9 billion.  Money Market Funds contracted by an annualized $223.1 billion, with holdings of Open Market Paper (commercial paper) down by an annualized $167.9 billion.  Miscellaneous Assets expanded by an annualized $108.6 billion.  Elsewhere, Real Estate Investment Trusts (REITs) expanded assets at a 27% annualized rate to $108 billion.       The Federal Reserve increased its holdings by $9.9 billion during the quarter to $778.9 billion, or 5.1% annualized.  The Fed’s balance sheet was up $68.7 billion, or 9.7% y-o-y.  Over the past four quarters, Federal Reserve growth has accounted for only about 6% of total financial sector expansion.  .  Examining mortgage lending, Total Mortgage Borrowings increased at a 12.1% rate during the quarter to $9.242 Trillion.  Over four quarters, Total Mortgage Credit surged $1.045 Trillion, or 12.8%.  It is worth noting that Total Mortgage Borrowings increased $288 billion during 1996 and $337 billion during 1997.  Since the beginning of 1998 (23 quarters), Total Mortgage Credit is up $3.98 Trillion (avg. $692 billion annually), or 76%.   Total Household Debt was up 13.8% over the past year to $7.11 Trillion (up 78% over 23 quarters).  Examining third quarter government receipts and expenditures, Federal spending was up 8.6% y-o-y, while receipts were down 4.1% y-o-y.  State & Local government spending was up 5.5% from third quarter 2002, while receipts were up 5.9%.  Total government debt increased at an annualized rate of $557 billion during the quarter.  Federal government debt increased at an annualized rate of $396 billion.  State & Local debt increased at an annual rate of $161.3 billion.     It is also beneficial to take a close look at ballooning household assets and liabilities.  The Balance Sheet of the Household Sector (including non-profit organizations) surpassed $51 Trillion for the first time during the third quarter.  Total Assets increased $802.2 billion, or 6.3% annualized, and were up $4.53 Trillion, or 9.6%, over the past year.  The value of Household Real Estate increased $290.8 billion during the quarter, or 8.2% annualized, to $14.55 Trillion (up $1.07 Trillion, or 7.9%, over four quarters).  And despite massive borrowings, inflating values allowed Owners’ Real Estate Equity to increase $90 billion during the quarter to $7.9 Trillion.  Total Financial Asset values increased $434.7 billion, or 5.4% annualized, to $32.47 Trillion (up $3.224 Trillion, or 11.0% over 4 quarters).  Interestingly, Total Deposit holdings actually contacted $4.4 billion to $5.17 Trillion.  On the other hand, Credit Market Instrument holdings jumped $61.9 billion, or 10.2% annualized, to $2.49 Trillion.  Holdings of Agency securities actually jumped $140 billion (to $291.4 billion), easily the most conspicuous development with respect to household investment preference.    And while we must wait impatiently for the March release of the 4th quarter “Flow of Funds” report, third quarter data provide us some very useful insight.  As for the almost four months of contracting money supply, unfolding during the third quarter were some rather profound developments with regard to the nature of financial sector liability creation.  Commercial Banking Checkable Deposits were in sharp decline ($152.4 billion annualized).  Time and Savings Deposits growth had slowed markedly, from an average annualized $371 billion over the previous six quarters to only $43.9 billion during the three months ended September 30th.  And Money Market Fund deposits were in sharp decline ($223.1 billion annualized).  But we must not allow the stagnation and/or decline of key traditional money supply components to draw our attention away from the continued major expansion of Credit, along with an attendant huge expansion of financial sector liabilities (predominately not elements of the money aggregates).  Foremost, Total Agency Securities (GSE debt and MBS) were issued at an unprecedented annualized rate of $831.2 billion during the quarter.  Treasury Securities were issued at an annualized rate of $317.5 billion and State & Local debt at an annualized $137.1 billion.  Corporate and Foreign Bonds were issued at an annual rate of $466.6 billion; New Equities at a rate of $137.4 billion.  And Asset-backed Securities were issued at an annual rate of $234.1 billion.  It is also worth noting the extraordinary expansion in "Miscellaneous" and "Other" assets and liabilities.  Moreover, it appears – especially in the case of agency securities – that households were increasingly using liquid balances to acquire marketable securities directly, rather than holding money fund or bank deposits.  In conclusion, the third quarter “Flow of Funds” confirms that we remain in the midst of an unprecedented – truly historic - financial sector expansion and security issuance boom.  And as the melee of leveraged speculation and the general flight to risk assets go to dangerous excess, the nature of financial claims inflation and intermediation are altered momentously.  Those today associating the declining “M’s” with deflation are missing profound developments throughout the U.S. Credit system and global financial system.