Saturday, September 20, 2014

10/31/2007 Road to Ruin *

For the week, the Dow declined 1.5% (up 9.1% y-t-d), and the S&P500 fell 1.7% (up 6.4%). The Utilities added 0.6% (up 13.2%), while the Morgan Stanley Consumer index dipped 0.8% (up 6.0%). The Transports declined 1.3% (up 5.3%), and the Morgan Stanley Cyclical index gave up 0.9% (up 16.9%). The small cap Russell 2000 was hit for 2.9% (up 1.3%), and the S&P400 Mid-Cap index declined 1.0% (up 10.2%). The NASDAQ100 gained 0.9% (up 26%), and the Morgan Stanley High Tech index added 0.6% (up 18.5%). The Semiconductors rallied 1.3% (down 2.1%). The Internet Index was about unchanged (up 22.4%), while the NASDAQ Telecommunications index gained 1.5% (up 24.7%). The Biotechs declined 1.2% (up 9.6%). Financial stocks were under heavy selling pressure. The Broker/Dealers sank 5.7% (down 9%), and the Banks were clobbered for 6.7% (down 17.9%). With bullion surging $19.95 to a 27-year high, the HUI Gold index jumped 4.5% (up 29.9%).

Short-term perceived safe debt was under intense demand. Three-month Treasury bill rates sank 38.5 bps this week to 3.60%. Two-year government yields fell 10 bps to 3.67%. Five-year yields dropped 11 bps to 3.95%. Ten-year Treasury yields declined 9 bps to 4.315%, and long-bond yields fell 8 bps to 4.62%. The 2yr/10yr spread ended the week at 64.5. The implied yield on 3-month December ’08 Eurodollars dipped 2 bps to 4.085%. Benchmark Fannie Mae MBS yields declined 3 bps to 5.756%, this week notably under-performing Treasuries. The spread on Fannie’s 5% 2017 note widened 3.5 to 50.6, and the spread on Freddie’s 5% 2017 note widened 2 to 50. The 10-year dollar swap spread increased a notable 4.4 to 68.5. Corporate bond spreads were mixed, as the spread on an index of junk bonds ended the week 15 bps narrower.

Investment grade debt issuers included Coca-Cola $1.75bn, Motorola $1.2bn, McGraw-Hill $1.2bn, and Textron $400 million.

Junk issuers included Nuveen Investment $785 million, Wynn Las Vegas $400 million, Tenneco $250 million, and CII Carbon $235 million.

Convert issuers included Prologis $1.0bn, and Champion Enterprises $160 million.

Foreign dollar bond issuance included Tesco $2.0bn, Commonwealth Bank $1.0bn, Petrobras $1.0bn, and Panama Canal $100 million.

German 10-year bund yields were unchanged at 4.17%, while the DAX equities index slipped 1.5% for the week (up 18.7% y-t-d). The Japanese “JGB” market was volatile, with 10-year yields ending the week down 3.5 bps to 1.58%. The Nikkei 225 was little changed (down 4.1% y-t-d). Emerging equities were mixed, while debt markets were for the most part surprisingly quiet. Brazil’s benchmark dollar bond yields added one basis point to 5.73%. Brazil’s Bovespa equities index rose another 2.7% (up 44% y-t-d). The Mexican Bolsa fell 3.4% (up 16.5% y-t-d). Mexico’s 10-year $ yields dipped 2 bps to 5.39%. Russia’s RTS equities index gained 1.6% (up 16% y-t-d). India’s Sensex equites index rose another 3.8% (up 44.9% y-t-d). China’s Shanghai Exchange added 3.4%, increasing y-t-d gains to 116% and 52-week gains to 212%.

Freddie Mac posted 30-year fixed mortgage rates declined 7 bps this week to 6.26% (down 5 bps y-o-y). Fifteen-year fixed rates fell 8 bps to 5.91% (down 11bps y-o-y). One-year adjustable rates sank 9 bps to 5.57% (up 4bps y-o-y).

Bank Credit increased $20.9bn during the week (10/24) to a record $9.067 TN. Bank Credit has now posted a 14-week gain of $423bn (18.2% annualized) and y-t-d rise of $770bn, a 11.2% pace. For the week, Securities Credit increased $16.6bn. Loans & Leases rose $4.3bn to a record $6.667 TN (14-wk gain of $342bn). C&I loans declined $11bn, reducing 2007's growth rate to 20.7%. Real Estate loans jumped $15.4bn. Consumer loans added $1.5bn. Securities loans declined $4.0bn, while Other loans increased $2.3bn. On the liability side, (previous M3) Large Time Deposits jumped $18bn.

M2 (narrow) “money” rose $9.9bn to $7.383 TN (week of 10/22). Narrow “money” has expanded $339bn y-t-d, or 5.8% annualized, and $437bn, or 6.3%, over the past year. For the week, Currency added $0.6bn, while Demand & Checkable Deposits declined $18.3bn. Savings Deposits jumped $21.6bn, and Small Denominated Deposits added $0.4bn. Retail Money Fund assets increased $4.1bn.

Total Money Market Fund Assets (from Invest. Co Inst) declined $23.8bn last week to $2.946 TN. Money Fund Assets have now posted a 14-week gain of $3,362bn (56% annualized) and a y-t-d increase of $564bn (28.0% annualized). Money fund asset have posted a 52-week gain of $681bn, or 30.1%.

Total Commercial Paper rose $9.9bn to $1.882 TN. CP is down $341bn over the past 12 weeks. Yet asset-backed CP fell another $8.5bn (12-wk drop of $288bn) to $886bn. Year-to-date, total CP has dropped $92bn, with ABCP down $198bn. Over the past year, Total CP has declined $18bn, or 0.9%.

Asset-Backed Securities (ABS) issuance slowed to $4.5bn this week. Year-to-date total US ABS issuance of $502bn (tallied by JPMorgan) is running a third behind comparable 2006. At $216bn, y-t-d Home Equity ABS sales are 55% off last year’s pace. Year-to-date US CDO issuance of $278 billion is running 7% below 2006.

Fed Foreign Holdings of Treasury, Agency Debt last week (ended 10/30) increased $1.6bn to a record $2.032 TN. “Custody holdings” were up $280bn y-t-d (18.9% annualized) and $338bn during the past year, or 20%. Federal Reserve Credit expanded $3.9bn to $862.7bn. Fed Credit has increased $10.5bn y-t-d and $29.3bn over the past year (3.5%).

International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $1.090 TN y-t-d (27% annualized) and $1.219 TN year-over-year (26%) to $5.901TN.

Credit Market Dislocation Watch:

November 2 – Financial Times (Gillian Tett): “The mood in credit derivatives markets turned ugly on Thursday, with the cost of insuring corporate debt hitting multi-week highs on both sides of the Atlantic. Speculation was rife that leading major investment banks were facing additional losses linked to complex mortgage-backed securities, while worries mounted over the health of major financial guarantors. ‘It’s scary out there – there’s blood on the streets,’ a trader at a US brokerage said. ‘It’s a real mess.’ Five-year credit default swaps tied to Citigroup widened to 60 bps, meaning it cost $60,000 annually to insure Citigroup's debt against default for five years. A couple of weeks ago, that figure stood at $27,000. Contracts on Merrill Lynch…rose $18,000 to $103,000…. Bond insurers, or monolines, were also hit hard. ‘[These triple-A rated companies are] exposed to the crumbling housing market,’ said Gavan Nolan, an analyst at derivatives data provider Markit… CDS on MBIA Insurance rocketed to a four-year high, of 345bp... Ambac Financial climbed to a five-year high of 310bp. In Europe, the iTraxx Crossover index of 50 mostly high-yield companies widened by 18 bp to 338bp, the biggest rise since August…”

November 2 – Bloomberg (Christine Richard): “Ambac Financial Group Inc. and MBIA Inc. were cut to ‘in-line’ from ‘attractive’ by Morgan Stanley, which raised the possibility that the bond insurers could face a ‘downward spiral’ if defaults on mortgages and home equity loans worsen.”

November 1 – Financial Times (Stacy-Marie Ishmael and Gillian Tett): “The ongoing crisis in the US housing market is pushing a key mortgage-linked derivatives index to new lows, threatening to unleash a further bout of credit market upheaval. The price swing in the index, known as the ABX, is particularly significant, since it is starting to reduce the value of credit instruments that carried high credit ratings, and were therefore supposed to be ultra-safe… Until a couple of months ago, the part of the ABX index that tracks AAA debt was trading almost at face value. However, in the past three weeks it has fallen sharply due to downgrades by credit rating agencies and a slew of bad data from the housing sector… The swing could create real pain for investors, since in recent years numerous firms have created trading strategies which have loaded large debt levels onto these ‘safe’ securities, precisely because they assumed these instruments would never fluctuate in price. ‘The last week has seen some of the worst falls in the ABX market this year, especially higher up the capital structure [with highly rated debt],’ said Jim Reid, head of fundamental credit strategy at Deutsche Bank.”

November 2 – Bloomberg (Shannon D. Harrington): “The risk of owning the debt of Merrill Lynch & Co. and Citigroup Inc. rose to the highest in at least five years on speculation that losses from the mortgage-market collapse will worsen.”

November 1 – Bloomberg (Shannon D. Harrington and Hamish Risk): “The risk of owning corporate debt reached the highest in seven weeks as credit-default swap traders bet that companies, including Citigroup Inc., will further reduce the value of securities tied to subprime mortgages. The CDX North America Investment Grade Series 9 Index, a benchmark for the cost to protect debt that rises as investor confidence deteriorates, rose 5.75 basis points to 66.25 bps… Credit-default swaps tied to Citigroup and Merrill Lynch & Co. are at three-month highs, while those on bond insurers Ambac Financial Group Inc. and MBIA Inc. rose to the most in at least four years.”

October 30 – Financial Times (Stacy-Marie Ishmael and Paul J Davies): “Investor worries are mounting that the next big casualties from the credit squeeze might be the specialist companies that act as guarantors for bond issuers. These companies, which write insurance to boost the credit ratings of various kinds of bonds, have seen their share prices pummelled and the cost of protecting their debt against default soar. Over the past week, sector leaders such as MBIA, Ambac, XL Capital Assurance, Radian and MGIC have all been hit hard. In recent years, these companies, known as monolines, have moved away from their role of guaranteeing, or wrapping, bonds issued by US municipalities towards writing business related to structured asset-backed finance deals, such as mortgage-backed bonds and collateralised debt obligations… ‘Our conclusion is that MBIA and the rest of the financial guarantors are facing a prolonged period of stress,’ said Rob Haines, an analyst at CreditSights…”

November 2 – Financial Times (Gillian Tett): “This week, a banking friend made a startling confession. In recent weeks he has been furtively unwinding some large investment portfolios linked to subprime securities. But as he has embarked on this sordid task, he has discovered that the only effective way to get rid of these distressed assets is to avoid putting any tangible price on the trade. Instead, he has resorted to using a tactic more normally associated with third world markets than the supposedly sophisticated arena of high finance: barter. Barter is the only thing that works right,’ he chuckles grimly. ‘It is like the Dark Ages.’ …Never mind the fact that the risky tranches of subprime-linked debt (the so-called BBB ABX series) have fallen 80 per cent since the start of the year; in a sense, such declines are only natural for risky assets in a credit storm. Instead, what is really alarming is that the assets which were supposed to be ultra-safe - namely AAA and AA rated tranches of debt - have collapsed in value by 20% and 50% odd respectively. This is dangerous, given that financial institutions of all stripes have been merrily leveraging up AAA and AA paper in recent years, precisely because it was supposed to be ultra-safe and thus, er, never lose value.”

October 30 – Dow Jones (Anusha Shrivastava): “The higher-rated tranches of the subprime mortgage-based ABX index were being clobbered Monday after Fitch Ratings said the credit ratings of $23.9 billion of the highest-rated collateralized debt obligations could be downgraded. The AAA-rated slice of the index based on home loans from the second half of 2006 was quoted at 80.5 cents, according to one primary dealer. It had closed at 83.39 cents Friday, according to index administrator Markit. Its AA-rated slice hit 47.5 cents, down from a close of 52.04 cents Friday.”

November 1 – Bloomberg (Deborah Finestone): “The Federal Reserve added $41 billion in temporary reserves to the banking system, the largest one-day cash infusion since the terrorist attacks of September 2001. The amount reflects the central bank’s effort to push the effective rate lower after policy makers reduced their target yesterday by a quarter-percentage point to 4.50 percent.”

November 1 – New York Times (Eric Dash): “Nearly three weeks after the country’s biggest banks announced a $75 billion fund to help stabilize the credit markets, the reality is sinking in that the plan will provide hospice care to troubled investment funds, not resuscitate them. The reason, market participants say, is that the structured investment vehicles, or SIVs, that helped fuel the Wall Street loan-packaging boom hinged on confidence in the quality of the $400 billion in securities they bought and on easy credit from investors. Now, that trust has been shattered and most of the investors have fled. Many say that the business model is dead, or soon will be.”

October 30 – Bloomberg (Neil Unmack): “Sachsen Funding 1 Ltd., a $2.2 billion debt fund set up by Landesbank Sachsen Girozentrale said the value of its assets fell, preventing it from being able to borrow in the commercial paper markets. The company, a so-called SIV-lite, is now in ‘restricted issuance’ after a ‘recent reduction’ in the market value of its assets… In the ‘restricted issuance’ state, the company is not allowed to sell further debt, or invest in assets other than deposits or short-term investments…”

October 30 – Bloomberg (Sebastian Boyd): “Axon Financial Funding, a $9.5 billion structured investment vehicle or SIV, had its debt ratings cut by Standard & Poor’s after it sold assets at a loss. S&P cut its rating on the company’s debt by eight steps to BBB, two steps above high-risk, high-yield, from the top AAA investment-grade ranking.”

October 30 – Bloomberg (Jacob Greber): “UBS AG, Europe’s largest bank by assets, reported its first quarterly loss in almost five years after declines in the U.S. subprime mortgage market led to $4.4 billion in losses and writedowns on fixed-income securities.”

November 2 – Bloomberg (Allen Wan): “Merrill Lynch & Co., the world's biggest brokerage, may need to write off another $10 billion of losses in collateralized debt obligations, Deutsche Bank Securities said in downgrading the stock today. ‘New CDO writedowns could approach $10 billion given a worse CDO market,’ Deutsche Bank analysts wrote…”

October 30 – Bloomberg (Sebastian Boyd): “At Merrill Lynch & Co., a lot more was lost than the $2.24 billion, or $2.82 a share, Chief Executive Officer Stan O'Neal said would be subtracted from the third quarter. The real damage to shareholders came with Merrill's $8.4 billion writedown. It is the biggest in the history of Wall Street and wiped out four quarters of growth in shareholders’ equity, according to Merrill's published figures. The charge, mostly for collateralized debt obligations and subprime mortgages, left the New York-based company with $38.8 billion of assets minus liabilities. Losing ‘20 percent of shareholders’ equity in one fell swoop is a serious blow,’ said Robert Willens, the accounting analyst at Lehman Brothers…”

November 2 – The Wall Street Journal (Susan Pulliam): “Merrill Lynch & Co., in a bid to slash its exposure to risky mortgage-backed securities, has engaged in deals with hedge funds that may have been designed to delay the day of reckoning on losses, people close to the situation said. The transactions are among the issues likely to be examined by the Securities and Exchange Commission. The SEC is looking into how the Wall Street firm has been valuing, or "marking," its mortgage securities and how it has disclosed its positions to investors, a person familiar with the probe said. Regulators are scrutinizing whether Merrill knew its mortgage-related problem was bigger than what it indicated to investors throughout the summer… In one deal, a hedge fund bought $1 billion in commercial paper issued by a Merrill-related entity containing mortgages, a person close to the situation said. In exchange, the hedge fund had the right to sell back the commercial paper to Merrill itself after one year for a guaranteed minimum return, this person said.”

October 30 – Financial Times (Haig Simonian): “UBS committed itself on Tuesday to improving radically its risk assessment and control procedures as a bank once renowned for its risk awareness admitted it had slipped up grievously in the US credit turmoil… UBS will “de-emphasise” proprietary trading, and introduce measures to reprice capital put at traders’ disposal. Staff in its investment bank will also receive a higher proportion of compensation in UBS shares in a further effort to underline the potential consequences of their decisions.”

October 30 – Bloomberg (Gavin Finch): “The cost of borrowing euros for two months rose the most in eight years as banks sought loans that will cover their commitments through to the start of next year. The London interbank offered rate that banks charge each other for the loans climbed 28 bps to 4.59% today… It was the biggest one-day increase since Oct. 28, 1999, when it soared 54 basis points in the run-up to the new millennium on concern computer systems would crash at the turn of the year.”

October 31 – Bloomberg (Caroline Salas): “Residential Capital LLC, the biggest privately held mortgage lender, is the worst performer of the 50 biggest issuers in the high-yield, high-risk bond market this month, according to index data compiled by Merrill Lynch & Co. ResCap’s bonds lost 9.45% in October…”
Currency Watch:

November 1 – Bloomberg (Liz Capo McCormick): “Currency traders are betting in the forward exchange rate market that the Hong Kong Monetary Authority will abandon its currency’s 24-year peg to the U.S. dollar as overseas investment floods into the city. In the forward currency market, an investor can buy Hong Kong dollars now for delivery in 12 months at HK$7.7096 per U.S. dollar, above the HK$7.75 top of the Hong Kong Monetary Authority’s permitted trading range. The authority sold HK$7.828 billion ($1 billion) to defend the currency yesterday, twice as much as two previous interventions since Oct. 23.”

November 1 – Bloomberg (Patricia Kuo and Aaron Pan): “The Hong Kong Monetary Authority denied market speculation that its officials have asked China to allow the city to revise its fixed exchange rate. Medley Global Advisors, founded in 1997 by Richard Medley, former chief political strategist at Soros Fund Management, said Hong Kong suggested widening the band…”

October 30 – Financial Times (Peter Garnham): “Is the dollar set to join the yen and the Swiss franc as a carry trade funding currency? Both the yen and Swiss franc have been pushed to multi-year lows this year as carry trade investors have sold the low-yielding currencies to fund the purchase of riskier, higher-yielding assets elsewhere. However, the dollar has come under similar pressure in recent weeks, hitting a series of multi-year troughs.”

October 30 – Bloomberg (Abdulla Fardan): “The six-nation Gulf Cooperation Council will decide at a summit in December whether to abide by the proposed start date of 2010 for a single currency in the region, Al-Ayam newspaper said, citing a Bahraini official.”

The dollar index declined 0.9% to 76.34. For the week on the upside, the Canadian dollar increased 2.2% (to an all-time record), the British pound 1.3%, the Swiss franc 1.0%, the Danish krone 0.6%, and the Euro 0.6%. On the downside, the Norwegian krone declined 0.9%, the New Zealand dollar 0.3%, and the Japanese yen 0.2%.
Commodities Watch:

October 31 – Financial Times (Javier Blas and Chris Flood): “For a moment this week, it looked as if a sliding dollar and surging oil prices would drive gold through $800 dollars an ounce for the first time since 1980. Precious metals traders say that a move above this psychologically important level and towards the nominal record high of $850 an ounce reached in January 1980 is likely if an expected cut in interest rates today by the US Federal Reserve leads to further dollar weakness.”

October 31 – Financial Times (Ed Crooks): “Shortages of skilled labour and capital investment mean oil supplies might fail to meet the expected growth in demand over the coming years, the head of the rich countries’ energy watchdog has warned. Nobuo Tanaka, executive director of the International Energy Agency, told the Oil and Money conference in London: ‘Despite five years of high oil prices, market tightness will actually increase from 2009. New capacity additions will not keep up with declines at current fields and the projected increase in demand.’ He said that the IEA had revised up sharply to $5,000bn its estimate of the investment that the world’s energy industries would need by 2030 to meet rising demand.”

October 30 – Bloomberg (Gemma Daley and Jae Hur): “Australia cut its wheat harvest forecast for the third time as the nation’s worst drought damaged crops, adding pressure to shrinking world supplies that drove up prices to a record last month. Output may be 12.1 million metric tons in the current harvest… That is 22% less than the 15.5 million tons estimate from Sept. 18. Last year’s 9.8-million-ton crop was the country’s lowest in 12 years. ‘This is close to the worst case and will lend support to the market,’ Kenji Kobayashi, an analyst at Kanetsu Asset Management Co., said… Still, ‘this is not a big surprise as some had expected wheat harvest estimates to fall close to 10 million tons.’”

November 2 – Bloomberg (Jeff Wilson): “Soybeans rose, capping the 10th weekly gain in 11 weeks, on speculation that rising crude oil prices will boost demand for alternative fuels made from oilseeds including soybeans. Crude oil rose 2.6% to a record close on speculation that fuel consumption will increase after a government report showed higher-than-forecast U.S. employment growth last month. Soybeans have had a correlation of 0.7 against the price of oil in the past two months. A figure of 1 would indicate the two commodities move in lockstep. ‘Crude oil is driving soybeans,’ said Chad Henderson, a market analyst for Prime-Ag Consultants…”

November 1 – Financial Times: “Record-high dairy prices have eaten into margins at companies whose products list dairy as a primary ingredient. The US has stepped up production to counteract supply shocks in Europe and Australia, and prices should ease next year. But milk future prices suggest that the timetable for relief is moving further into 2008… Global population growth and booming consumption in developing countries have strengthened demand for dairy products… Costs have spiked for most commodities, but dairy has led the charge. November prices for the type of milk used to make cheese are up 85% from a year ago, while yoghurt milk is up 141% and skimmed milk powder 155%... Most dairy-dependent companies have responded by raising prices…”

October 29 – Financial Times (Javier Blas): “Rising food prices are likely to force developing countries to follow Russia’s example and impose retail price controls to avoid social unrest, the United Nations’ top agriculture official has warned.”

For the week, Gold jumped 2.5% to $805.15, and Silver 2.2% to $14.60. December Copper sank 6%. December crude surged $4.07 to a record $95.93. December gasoline jumped 7.1%, and December Natural Gas rose 7.8%. December Wheat declined 2.7%. For the week, the CRB index jumped 2.2% (up 15.1% y-t-d). The Goldman Sachs Commodities Index (GSCI) surged 3.2%, increasing 2007 gains to 39.4%. 

Japan Watch:

October 30 – Financial Times (Michiyo Nakamoto): “Three leading Japanese banks have become the latest victims of the US subprime woes, which are proving more trouble to the country’s financial sector than initially expected. Mitsubishi UFJ Financial Group is expected to take a writedown on its subprime exposure of up to six times its initial forecast of Y5bn ($43.6m). Japan’s largest banking group is likely to be forced to write down its subprime exposure by Y20bn-Y30bn as of the end of September…”

October 31 – Bloomberg (Mayumi Otsuma and Lily Nonomiya): “The Bank of Japan forecast slower economic growth and abandoned a prediction that consumer prices will increase this year, making it harder to raise the world’s lowest borrowing costs. ‘Downside risks are increasing,'' Governor Toshihiko Fukui said... He repeated the bank’s commitment to raise rates as long as the economy keeps expanding and prices resume gaining.”

October 31 – Bloomberg (Toru Fujioka): “Japan’s housing starts slumped to the lowest in four decades in September as stricter rules for obtaining building permits threaten to slow economic growth. Annualized starts tumbled 44% from a year earlier to 720,000 in September…”

China Watch:

November 2 – Financial Times (Jamil Anderlini): “The murder of a man who jumped a petrol queue in China’s central Henan province on Wednesday is the stuff of nightmares for the authoritarian Chinese government. Faced with worsening fuel shortages across the country Beijing raised petrol, diesel and jet fuel prices at the pump by almost 10% yesterday, in an effort to boost domestic supplies and exorcise the spectre of social unrest. The policy reversal came as shortages spread to the capital, which is usually immune from the country's periodic supply crunches. But the government is unwilling to allow prices to rise too much because of a morbid fear of spiralling inflation, which has a history of toppling governments in China and is currently running at a 10-year high, above 6%... Soaring global crude oil prices…pose a serious dilemma for Beijing, which last raised its tightly controlled fuel prices in May 2006. China is the second-largest crude oil consumer after the US and although it was a net exporter as recently as 1993 it now relies on imports for nearly 5% of its crude supply. The current shortages, particularly of diesel, result from a combination of high global oil prices and strict government controls, causing huge losses for Chinese refiners that must pay more for oil but cannot raise prices at the pump.”

October 31 – Bloomberg (Nipa Piboontanasawat): “China's current-account surplus widened 78% in the first six months of 2007 to $162.86 billion on increased overseas sales.”

October 30 – UK Telegraph (Richard Spencer): “Wages in China’s cities have risen by almost 20% since the start of the year, the government in Beijing said…adding to fears that the country’s economy is overheating and might export inflation round the world… Rising prices and inflation are putting pressure on the government to rein in the economy.”

November 1 – Bloomberg (Wendy Leung): “Hong Kong’s retail sales rose by the most since May 2004 as a buoyant stock market stoked consumer confidence and spending. Retail sales by value climbed 15.8% in September from a year earlier…”
India Watch:

October 30 – Bloomberg (Cherian Thomas): “India’s central bank unexpectedly ordered lenders to set aside more reserves for a fourth time this year to prevent 'unacceptably high' inflows of foreign cash from reigniting inflation. The Reserve Bank of India raised the ratio of deposits lenders must put aside by half a point to 7.5%, up from 5.25% at the start of the year…. Governor Yaga Venugopal Reddy said inflows rose after the U.S. Federal Reserve cut rates to stem subprime mortgage defaults, increasing the risk of ‘financial contagion.’ ‘The move is to ensure the liquidity situation doesn’t get out of control,’ said Shuchita Mehta, senior economist at Standard Chartered Bank in Mumbai. ‘India is still very attractive for foreign investors.’”

November 1 – Bloomberg (Kartik Goyal): “India’s export of gems, textiles and other manufactured products rose at the fastest pace in five months in September. Exports rose 19.2% to $12.8 billion, while imports rose 2.3% to $17.2 billion…”
Asia Boom Watch:

October 31 – Bloomberg (Cherian Thomas and Nipa Piboontanasawat): “India and China may be forced to further restrict bank lending as declining U.S. interest rates prompt investors to pump record cash into the world’s two fastest-growing economies. ‘If the U.S. cuts rates, it will have Asia’s blood on its hands,’ said Marc Faber… ‘The Fed is pursuing an easy monetary policy that is creating massive bubbles outside the U.S.’ The Fed’s actions threaten to spur inflation in India and China, where stocks have soared to records as a stampede of foreign money stokes share and property prices. Chinese and Indian shares have added $882 billion since the U.S. reduced rates on Sept. 18, almost a third of the $3 trillion gain in their combined market capitalization this year.”

November 1 – Bloomberg (Seyoon Kim): “South Korean exports rose to a record in October as higher shipments to China and Europe helped the nation weather a slowdown in demand from the U.S. Exports climbed 24.2% from a year earlier…”'

October 31 – Bloomberg (Shamim Adam): “Singapore’s jobless rate fell to the lowest in 9 1/2 years in the third quarter as the island’s economic growth encouraged companies to increase hiring to meet demand for goods and services.”
Unbalanced Global Economy Watch:

October 30 – Bloomberg (Ambereen Choudhury): “Mergers and acquisitions overtook last year’s record as companies picked up the slack from private-equity firms hobbled by rising borrowing costs. The value of transactions inched ahead of last year’s $3.55 trillion total this week, according to…Bloomberg. October was the busiest month in the past three, with $262 billion of deals…”

October 31 – Financial Times (Ralph Atkins): “Eurozone inflation lurched sharply higher in October and runs a significant risk of soon hitting 3%, putting pressure on the European Central Bank as growth in the 13-country economy starts to slow. The risk of soaring oil prices driving inflation higher while economic growth slides, yesterday prompted a warning of possible 'stagflation conditions' by Vitor Constancio, the Portuguese central bank governor. Energy and food prices drove annual inflation to a higher-than-expected 2.6% in October, from 2.1% in September... That was the fastest rate of price increases for more than two years.”

October 28 – Bloomberg (Svenja O’Donnell): “U.K. house prices fell for the first time in two years in October, and mortgage approvals dropped to a 26-month low, signs the country’s decade-long housing boom is coming to an end. The average cost of a home in England and Wales dropped 0.1 percent to 176,100 pounds ($361,462) from September, research group Hometrack Ltd. said today. Central London led the declines. Separately, the Bank of England said banks granted 102,000 loans for house purchase in September, the fewest since July 2005. A jump in credit costs is threatening to slow London’s financial services industry and is adding to the debt burden on British homeowners.”

October 31 – Bloomberg (Dara Doyle): “Irish mortgage lending grew at the slowest pace in a decade in September as rising borrowing costs and concerns about a property slump deterred homebuyers. Home loans rose an annual 16.1%...”

November 1 – Bloomberg (Dara Doyle): “Irish house prices fell the most in a decade in September as rising borrowing costs and concerns about a property slump deterred homebuyers. Prices fell 2.8% from a year earlier…”

November 1 – Bloomberg (Tasneem Brogger): “Denmark’s jobless rate fell in September, setting a new 33-year low and threatening to push wages and prices higher as a shortage of workers crimps production. Unemployment fell to 3.1% from 3.3%...”

October 30 – Bloomberg (Ben Sills): “The inflation rate in Spain jumped to the highest in more than a year in October as the price of oil reached a record. Consumer prices rose 3.6 percent from a year earlier using European Union methods, compared with a 2.7% rate in September…”

November 1 – Bloomberg (Robin Wigglesworth): “Norway’s jobless rate fell to 1.7% in October, the lowest in 20 years, adding to concern falling unemployment will drive wages higher and stoke inflation. The rate dropped from 1.8% in September…”

October 31 – Bloomberg (Robin Wigglesworth): “Norway’s domestic credit growth slowed to 14.3% in September as six interest rate increases this year crimped people's willingness to take on more debt.”

October 30 – Bloomberg (Maria Kolesnikova): “Russia’s demand for food surged after producers agreed last week to introduce price caps on some products to help the government fight inflation, Kommersant said. Russians have trebled their purchases of sunflower oil, flour, cereals and canned meats from last week on anticipation prices…”

November 1 – Bloomberg (Steve Bryant): “Turkey's exports rose 37.1% in October from a year earlier, the Turkish Exporters’ Assembly said.”

Latin America Watch:

October 30 – Bloomberg (Thomas Black): “Mexico’s government and private companies need to invest $50 billion over the next 10 years to meet the country’s demand for power, an official with the state-owned electricity company said.” 

Bubble Economy Watch:

October 30 – Financial Times (David Wighton and Ben White): “Merrill Lynch on Tuesday boosted Stan O’Neal’s departure package by almost $90m – taking it to $160m – by letting him retire as chairman and chief executive rather than sacking him… By casting his departure as a retirement, the board allows Mr O’Neal, who was paid $48m last year, to retain deferred compensation in the form of unvested stock worth $90m, giving him a total exit package of about $160m, including other compensation, shares and benefits." 

Central Banker Watch:

November 1 – Bloomberg (Matthew Brown): “Gulf Arab oil producers Saudi Arabia, the United Arab Emirates, Kuwait, Bahrain and Qatar lowered interest rates today, following a cut by the U.S. Federal Reserve.”

October 30 – Bloomberg (Jonas Bergman): “Sweden’s central bank raised its benchmark interest rate to a five-year high and said it will lift it once more in the first half of next year on concern falling unemployment and surging wages will stoke inflation. The benchmark repurchase rate was raised by a quarter-point to 4%, the 10th increase from a record low in January 2006…”

November 1 – Bloomberg (Tasneem Brogger): “Iceland’s central bank unexpectedly raised its key interest rate to a record 13.75% as the lowest unemployment rate in almost two decades and climbing house prices keep inflation above the target.”

October 31 – Bloomberg (Jeffrey T. Lewis): “European Central Bank governing council member and Bank of Portugal Governor Vitor Constancio comments on the decline of the dollar against the euro: ‘The risks related to the exchange rate are significant. There is in fact a situation of a continuing, ordered and gradual decline of the dollar, but it has risks because it’s very dependent on financing from the exterior… One of the risks weighing on the world economy is if the fall of the dollar and the correction of imbalance will be gradual or if there will be surprises.’”
Structured Finance Earnings Watch:

November 1 – Bloomberg (Hugh Son and Josh P. Hamilton): “Radian Group Inc., the third-biggest U.S. mortgage insurer, reported a loss of $703.9 million, the largest yet in an industry roiled by claims from failed home loans…joining larger rivals, MGIC Investment Corp. and PMI Group Inc. in reporting its first quarterly loss as a publicly traded company. Radian…wrote down its $468 million stake in a unit jointly owned with MGIC that invested in subprime mortgages…” 

GSE Watch:

October 31 – Bloomberg (Jody Shenn): “Fannie Mae, the government-chartered company that finances one-sixth of U.S. apartment-building debt, this month loosened its review process for multifamily-property loans it will buy, allowing lenders to act faster in a potentially weaker market. The first ‘significant’ changes to the Delegated Underwriting and Servicing program in 20 years will enable lenders to make more loans that Fannie Mae will buy without first looking at their details, said Michele Evans, vice president of multifamily corporate affairs at [Fannie]…”

October 30 – Bloomberg (James Tyson and Jody Shenn): “Banks shut out of the market for short-term loans are finding salvation in a government lending program set up to revive housing during the Great Depression. Countrywide Financial Corp., Washington Mutual Inc., Hudson City Bancorp Inc. and hundreds of other lenders borrowed a record $163 billion from the 12 Federal Home Loan Banks in August and September as interest rates on asset-backed commercial paper rose as high as 5.6%. The government-sponsored companies were able to make loans at about 4.9%, saving the private banks about $1 billion in annual interest. To meet the sudden demand, the institutions sold $143 billion of short-term debt in August and September…” 

MBS/ABS/CDO/CP/Money Funds and Derivatives Watch:

October 30 – Dow Jones (Rex Nutting): “Home prices in 20 major U.S. cities fell 4.4% in the past year as of August, according to the Case-Shiller price index released Tuesday by Standard & Poor’s. Prices fell 0.8% in the 20 cities between July and August, the fastest monthly decline in the seven-year history of the 20-city index. Prices in the original 10-city index had fallen 5% since August 2006, the fastest annual decline since 1991. Prices have been down on a year-over-year basis for eight straight months. ‘The fall in home prices is showing no real signs of a slowdown or turnaround,’ said Robert J. Shiller, co-creator of the index and chief economist for MacroMarkets LLC.”

November 2 – Bloomberg (Pierre Paulden): “Issuance of commercial mortgage-backed securities will fall 50% in 2008 from $220 billion this year as investors seek less complex securities, according to an analyst at Moody's... Collateralized debt obligations based on commercial real estate loans will decline from $30 billion this year to $10 billion next year, Tad Philipp, a managing director at Moody’s…said...” 

Mortgage Finance Bust Watch:

October 31 – The Wall Street Journal (Kemba J. Dunham): “Although underwriting standards in commercial lending have improved since April, the credit quality of the underlying loans that were issued in the third quarter was worse than ever, according to a new report by Moody’s… Moody’s in April issued a warning about commercial mortgage-backed securities, or pools of loans that are sliced up and sold to investors as bonds, stating that underwriting standards had become too lax during the real-estate frenzy.”

October 31 – The Wall Street Journal (Jennifer S. Forsyth): “The amount of sublease office space available to tenants increased nationally for the first time in five years, an indication that commercial leasing is slowing in many markets across the U.S. The increase demonstrates that many businesses related to home-mortgage lending have returned space to the market.” 

Foreclosure Watch:

November 1 – Associated Press: “A soaring number of U.S. homeowners struggled to make mortgage payments in the third quarter, with properties in some stage of foreclosure more than doubling from the same time last year… A total of 446,726 homes nationwide were targeted by some sort of foreclosure activity from July to September, up 100.1% from…the year-ago period, according to…RealtyTrac Inc. The current figure was 33.9% higher than the 333,731 properties in foreclosure in the second quarter of this year… There was one foreclosure filing for every 196 households in the nation during the most recent quarter, RealtyTrac said…”

November 1 – Bloomberg (Dan Levy): “U.S. home foreclosures doubled in the third quarter from a year earlier as subprime borrowers failed to make higher payments on adjustable-rate mortgages, RealtyTrac Inc. said. There were 635,159 foreclosure filings in the quarter, or one for every 196 households, including default notices, auction notices and bank repossessions. California, Florida and Ohio accounted for 44% of the total… Forty-five of 50 states had increases. ‘Given the number of loans due to reset through the middle of 2008, and the continuing weakness in home sales, we would expect foreclosure activity to remain high and even increase over the next year in many markets,’ James Saccacio, chief executive officer at…RealtyTrac…”
Fiscal Watch:

October 30 – Bloomberg (Michael Quint): “New York state faces a budget gap of $4.3 billion next year, up from $3.6 billion estimated three months ago, as Wall Street job cuts and losses reduce tax revenue, the Division of Budget said. The state normally collects about 20% of its revenue from taxes on Wall Street companies and employees.”

October 30 – Bloomberg (Henry Goldman): “New York Mayor Michael Bloomberg ordered agency heads to freeze all city hiring and cut their budgets this year and next, anticipating less revenue as Wall Street profits drop and real estate sales slow.” 

Speculator Watch:

November 1 – Bloomberg (Alison Fitzgerald and Ryan J. Donmoyer): “The Internal Revenue Service has begun an inquiry into suspected tax abuses at hedge funds and private-equity firms after determining many firm partners don’t file returns and may have improperly characterized transactions. The tax-collection agency is studying whether funds improperly structured stock swaps to avoid withholding taxes, whether they dictated loan terms to banks before agreeing to buy loan portfolios, and whether they improperly classified income as capital gains to take advantage of the lower rate.” 

Crude Liquidity Watch:

October 29 – Financial Times (Andrew England): “An unprecedented construction boom is gaining momentum in Saudi Arabia as highly ambitious, multi-billion-dollar projects to upgrade infrastructure and meet pressing social challenges begin to have an effect. The boom may be less visible than in the kingdom’s smaller Gulf neighbours, such as Dubai and Qatar, but the needs and the numbers are massive – thousands of kilometres of new roads and railways; billions of dollars of water, sewerage and electricity plants; and 4m new housing units over the next decade, with investment of $320bn estimated to be required in housing through to 2020, according to Sagia, the kingdom’s investment authority.”

October 30 – Bloomberg (Theophilos Argitis and Greg Quinn): “Canadian Finance Minister Jim Flaherty announced C$60 billion ($63 billion) in tax cuts through 2013, as surging oil prices and record corporate profits led to higher-than-expected revenue growth.”

Road to Ruin:

The gentlemen at Pimco are, once again, the leading cheerleaders for another round of easier “money.” Calling for the Fed to cut rates to 3.5%, Bill Gross commented Wednesday on Bloomberg television: “The nominal [third quarter] GDP number was 4.7%. Any time you get a nominal GDP growth less than 5% the economy is basically struggling. The U.S. needs at least 5% nominal growth in order to pay its bills on a longer term basis.”

I will, once again, take the other side of their analysis. First of all, 4.7% traditional nominal GDP growth would have easily in the past “paid its bills.” It doesn’t get it done today – even with 4.7% unemployment – specifically because of a long period of gross monetary excess. For some time now, the U.S. economy has been hopelessly finance-driven, and the greater and more protracted the Credit excesses the greater the “transformation” of the economic structure. And it is the underlying real economy that today cannot “pay its bills” and is therefore hooked on ever increasing Credit inflation. This should by now be recognized as the Road to Ruin. Contemporary finance and its operators should be held accountable.

The majority of contemporary “services” economic “output” is intangible in nature. The system creates various types of new financial claims (Credit), and this new purchasing power spins today’s economic wheels. It seemingly works wonders during the boom, but the end result is an endless mountain of financial claims backed by insufficient real economic wealth-creating capacity. Nominal GDP would “pay it bills” today only in the context of monetizing additional debt – or inflating the quantity of Credit to inflate “purchasing power” to inflate incomes and earnings – all in order to service previous borrowing excesses.

Admittedly, the Fed has opportunely administered several bouts of “reflation.” We have, however, reached the point where another round will be self-defeating. To throw out some numbers, from the Fed’s Z.1 “flow of funds” report we know that Total Credit Market Borrowings (non-financial and financial) expanded at a $3.75 TN annualized rate during the first half. To put the immense scope of recent Credit inflation into perspective, Credit Market Borrowings expanded on average $1.233 TN annually during the nineties (see chart above). Total borrowings accelerated to $1.694 TN in 2000, $2.013 TN in 2001, $2.365 TN in 2002, $2.767 TN in 2003, $3.085 TN in 2003, $3.380 TN in 2003, and $3.825 TN last year. It is this degree of Credit creation - and the associated Risk Intermediation - that is today untenable and unsustainable at any interest rate.

Before I dive into the U.S. Credit system fiasco, I was struck by a story by Jamil Anderlini from today’s Financial Times:

“The murder of a man who jumped a petrol queue in China’s central Henan province on Wednesday is the stuff of nightmares for the authoritarian Chinese government. Faced with worsening fuel shortages across the country Beijing raised petrol, diesel and jet fuel prices at the pump by almost 10% yesterday, in an effort to boost domestic supplies and exorcise the spectre of social unrest. The policy reversal came as shortages spread to the capital, which is usually immune from the country's periodic supply crunches. But the government is unwilling to allow prices to rise too much because of a morbid fear of spiralling inflation, which has a history of toppling governments in China and is currently running at a 10-year high, above 6%... Soaring global crude oil prices…pose a serious dilemma for Beijing, which last raised its tightly controlled fuel prices in May 2006. China is the second-largest crude oil consumer after the US and although it was a net exporter as recently as 1993 it now relies on imports for nearly 5% of its crude supply. The current shortages, particularly of diesel, result from a combination of high global oil prices and strict government controls, causing huge losses for Chinese refiners that must pay more for oil but cannot raise prices at the pump.”

I pose the following question for contemplation: How much would the Chinese government, with their $1.4 TN stockpile of chiefly dollar reserves, be willing these days to pay for the necessary energy resources to sustain their economic boom and stem social unrest?

The legacy of years of runaway U.S. Credit excess includes many trillions of dollar liquidity balances circulating around the globe. Chinese reserves, for example, have inflated almost seven-fold in just five years. On the back of unprecedented global Credit and liquidity excess, energy, food, precious metals and other commodities now attract intense demand and virtually unlimited purchasing power. Our economy – our financially stretched consumers and vulnerable businesses - will now have no option other than to bid against highly liquefied competitors for a lengthening list of resources. Failure to recognize that this situation is a major inflationary problem is disregarding reality. The same can be said for suggesting that we can continue on this current course - with massive Current Account Deficits and rampant speculative financial outflows to the world fueling myriad dangerous Bubbles and maladjustment on an unprecedented global scale.

Today’s backdrop is unique. There are literally trillions of dollars of liquidity slushing around the world keen to hold “things” of value. Liquidity sources include the massive central bank reserve holdings as well as funds at the disposal of the sovereign wealth funds. Importantly, the more apparent becomes U.S. financial fragility, the keener they are to stockpile real “things”. There is as well a global leveraged speculating community, in control of trillions of liquid purchasing power. The speculators are also keen to acquire (non-dollar) “things” as opposed to our securities. Indeed, it should be noted that this is the Federal Reserve’s first attempt at reflation where U.S. securities are not the speculators’ or foreign central banks’ asset class of choice.

Not only is the pool of potential global buying power unparalleled in scope. It is fervidly attracted to tangible assets - as opposed to U.S. securities - and is highly speculative in character. At the same time, an unwieldy global boom is stoking unprecedented demand in China, India, Asia generally, and the other “emerging” markets including Russia and Brazil. Throw in various weather related issues and energy production constraints and the prospect for some very serious bottlenecks and shortages has developed.

Granted, these dynamics have been evolving for some time now. What has changed is the speed and breadth of financial crisis enveloping the U.S. financial system. When I read of mounting energy and food shortages and witness the unfolding run on the U.S. financial sector, as an analyst I must contemplate the likelihood we have entered a uniquely unstable monetary environment at home and abroad. In short, the backdrop exists where incredible dollar liquidity flows could be released (from myriad sources) upon key things (notably energy, food, metals and commodities) already in severe supply and demand imbalance. Again, how much are the Chinese willing to pay for energy? The Russians for food? The Indians for commodities in general? How much will investors be willing to pay for precious metals as a store of value? How aggressively will the speculators “front run” all of them? Can the Fed afford to continue fueling this bonfire?

I have so far this evening purposely avoided the unfolding U.S. financial crisis, a historic fiasco that took a decided turn-for-the-worst this week. I’ll admit that I am rather amazed that key financial stocks – including the financial guarantors, “money center banks”, and Wall Street firms – were hammered yet the market maintained its composure. NASDAQ was actually up on the week, as major technology indexes added to their robust y-t-d gains. I’ll assume there is a confluence of great complacency and gamesmanship, with operators determined to play aggressively through year-end (bonuses and payouts).

I wouldn’t bet on the stock market holding 2007 gains for another eight weeks. The Credit meltdown is now moving too fast and furious. Importantly, confidence is faltering for the entire Credit insurance industry, including the mortgage insurers and the financial guarantors. This is a devastating blow for the securitization marketplace, already reeling from pricing, liquidity and trust issues. The Credit system has lurched to the edge of meltdown, while the economy hasn’t even as yet succumbed to recession. It's absolutely scary. Last week I wrote that subprime and the SIVs were “peanuts” in comparison to the CDO market. Well, the CDO marketplace is chump change compared to Credit Default Swaps and other over-the-counter (OTC) Credit derivatives that, by the way, have never been tested in a Credit or economic downturn.

The scale of the Credit “insurance” problem is astounding. According to the Bank of International Settlements, the OTC market for Credit default swaps (CDS) jumped from $4.7 TN at the end of 2004 to $22.6 TN to end 2006. From the International Swaps and Derivatives Association we know that the total notional volume of credit derivatives jumped about 30% during the first half to $45.5 TN. And from the Comptroller of the Currency, total U.S. commercial bank Credit derivative positions ballooned from $492bn to begin 2003 to $11.8 TN as of this past June. It today goes without saying that this explosion of Credit insurance occurred concurrently with the expansion of the riskiest mortgage (and other) lending imaginable. It’s got “counter-party fiasco” written all over it.

The stocks of Ambac and MBIA collapsed this week. I can only surmise that part of the selling pressure emanated from players caught on the wrong side of rapidly widening Credit default swap prices. Since these companies have limited amounts of bonds trading in the markets – in debt markets generally suffering acute illiquidity – those needing to hedge rising default risk in this industry had little alternative than to aggressively short the stocks. And the faster the stocks declined, the wider the CDS spreads and the more “dynamic” hedge-related selling required. This dynamic could play out throughout the financial sector and beyond. The "dynamic hedging" (shorting securities to offset increasing risk on derivatives written) of Credit risk today poses a very serious systemic issue.

The general inability to hedge escalating default and market risk has become and will remain a major systemic problem. Liquidity has disappeared, and there now exists an untenable overhang of risky securities and derivatives to be liquidated and/or hedged. Most playing in the Credit derivatives market lack the wherewithal to deliver on their obligations in the (now likely) event of a systemic Credit bust. The vast majority were “writing flood insurance during a drought, happy to book annual premiums while expecting to purchase reinsurance/hedge if and when heavy rains ever developed.” Well, it all happened at a pace so much faster than anyone ever contemplated. So abruptly, the flood is now poised to wreak bloody havoc the scope of which was unimaginable – and there’s no functioning reinsurance market.

Unlike this summer, this week saw the Credit crisis engulf the epicenter of the U.S. Credit system. Not surprisingly, the Fed rate cut only seemed to exacerbate market tension, with oil, gold and commodities spiking and the dollar faltering. Those arguing that the Fed needs to cut rates aggressively to avoid recession are disregarding the much higher stakes involved. There is today no alternative to a wrenching recession. The economy is terribly maladjusted, while the financial sector is at this point incapable of intermediating the massive amount of ongoing Credit necessary to keep this Bubble Economy inflated. Wall Street “structured finance” is today faltering badly, now leaving the highly vulnerable banking system with the task of sustaining the ill-fated boom. The least bad course for the Federal Reserve at this point would have a primary focus on supporting the dollar and global financial stability.

10/24/2007 Structured Finance Under Duress *

For the week, the Dow gained 2.1% (up 10.8% y-t-d), and the S&P500 rose 2.3% (up 8.2%). The Utilities surged 4.8% (up 12.5%), and the Morgan Stanley Consumer index gained 2.0% (up 6.8%). The Morgan Stanley Cyclical index advanced 1.5% (up 18%) and the Transports 1.4% (up 6.7%). The broader market rallied sharply. The small cap Russell 2000 jumped 2.8% (up 4.3%), and the S&P400 Mid-Cap index gained 1.8% (up 11.3%). On the back of Microsoft's strong earnings, the NASDAQ100 rose 3.0%, increasing y-t-d gains to 24.9%. The Morgan Stanley High Tech index added 0.6% (up 17.8%). The Internet Index gained 2.7% (up 22.4%), and the NASDAQ Telecommunications index increased 1.3% (up 22.9%). The lagging Semiconductors dropped 4.9% (down 3.4%). Not lagging this week, the Broker/Dealers rallied 4.2% (down 3.5%), and the Banks recovered 3.1% (down 11.9%). With bullion surging $20 to $785.36, the HUI Gold index jumped 3.9% (up 24.3%). 

Three-month Treasury bill rates increased 3 bps this week to 3.95%. Two-year government yields slipped 2 bps to 3.76%. Five-year yields added one basis point to 4.04%. Ten-year Treasury yields were unchanged at 4.39%, and long-bond yields were little changed at 4.69%. The 2yr/10yr spread ended the week at 63. The implied yield on 3-month December ’08 Eurodollars dropped 5.5 bps to 4.115%. Benchmark Fannie Mae MBS yields declined 2 bps to 5.77%, this week somewhat outperforming Treasuries. The spread on Fannie’s 5% 2017 note widened one to 47, and the spread on Freddie’s 5% 2017 note widened 1 to 48. The 10-year dollar swap spread declined 0.4 to 64.1. Corporate bond spreads generally widened, as the spread on an index of junk bonds ended the week 23 bps wider.

Investment grade debt issuers included Agilent Tech $600 million, Washington Mutual $500 million, Union Pacific $500 million, and Panhandle Eastern $300 million.

Junk issuers included TXU $3.0bn, Energy Future Holdings $4.5bn, and Alliant Holdings $265 million.

Convert issuers included Lincare Holdings $500 million.

Foreign dollar bond issuance included VTB Capital $2.0bn, EDP Finance $2.0bn, Diageo Cap $1.5bn, American Movil $1.0bn, and EEB International $610 million.

German 10-year bund yields declined 3bps to 4.19%, as the DAX equities index added 0.7% for the week (up 20.4% y-t-d). Japanese 10-year “JGB” yields increased 1.5bps to 1.615%. The Nikkei 225 dropped 1.8% (down 4.2% y-t-d). Emerging equities were mostly higher, while their debt markets posted another solid performance. Brazil’s benchmark dollar bond yields dipped one basis point to 5.71%. Brazil’s Bovespa equities index surged 5.6% (up 44.5% y-t-d). The Mexican Bolsa added 1.0% (up 21.5% y-t-d). Mexico’s 10-year $ yields fell 5 bps to 5.42%. Russia’s RTS equities index gained 2.4% (up 14.2% y-t-d). India’s Sensex equites index surged 9.5% (up 40% y-t-d). China’s Shanghai Exchange fell 3.9%, reducing y-t-d gains to 109% and 52-week gains to 209%.

Freddie Mac posted 30-year fixed mortgage rates declined 7 bps this week to 6.33% (down 7bps y-o-y). Fifteen-year fixed rates fell 9 bps to 5.99% (down 11bps y-o-y). One-year adjustable rates dropped 10 bps to 5.66% (up 6bps y-o-y).

Bank Credit expanded $14.5bn during the week (10/17) to a record $9.026 TN. Bank Credit has now posted a 13-week gain of $382bn (17.7% annualized) and y-t-d rise of $729bn, a 10.9% pace. For the week, Securities Credit declined $18bn. Loans & Leases surged $32.5bn to a record $6.640 TN (13-wk gain of $316bn). C&I loans rose $2.0bn, increasing 2007's growth rate to 22%. Real Estate loans jumped $54.5bn, led by an unusual $52.3bn increase in "other" RE loans. Consumer loans declined $4.0bn. Securities loans fell $9.1bn, while Other loans dropped $11.0bn. On the liability side, (previous M3) Large Time Deposits surged $55.4bn (5-wk gain of $123bn).

M2 (narrow) “money” declined $12.5bn to $7.373 TN (week of 10/15). Narrow “money” has expanded $329bn y-t-d, or 5.8% annualized, and $436bn, or 6.3%, over the past year. For the week, Currency was unchanged, and Demand & Checkable Deposits were little changed. Savings Deposits declined $9.0bn, while Small Denominated Deposits added $1.0bn. Retail Money Fund assets fell $4.5bn.

Total Money Market Fund Assets (from Invest. Co Inst) surged another $50bn last week to a record $2.970 TN. Money Fund Assets have now posted a 13-week gain of $387bn (60% annualized) and a y-t-d increase of $588bn (30% annualized). Money fund asset have surged $716bn over 52 weeks, or 32%.

Total Commercial Paper increased $6.2bn to $1.872 TN. CP is down $351bn over the past 11 weeks. Asset-backed CP dipped $300 million (11-wk drop of $279bn) to $894bn. Year-to-date, total CP has dropped $102bn, with ABCP down $190bn. Over the past year, Total CP has declined $27bn, or 1.4%.

Asset-backed Securities (ABS) issuance increased to $9bn this week. Year-to-date total US ABS issuance of $496bn (tallied by JPMorgan) is running 32% behind comparable 2006. At $214bn, y-t-d Home Equity ABS sales are 54% off last year’s pace. Year-to-date US CDO issuance of $272 billion is running 5% below 2006.

Fed Foreign Holdings of Treasury, Agency Debt last week (ended 10/23) jumped $12.4bn to $2.031 TN. “Custody holdings” were up $279bn y-t-d (19.2% annualized) and $345bn during the past year, or 20.5%. Federal Reserve Credit increased $0.8bn to $859bn. Fed Credit has increased $6.6bn y-t-d and $28.0bn over the past year (3.4%).

International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $1.077 TN y-t-d (27% annualized) and $1.215 TN year-over-year (26%) to $5.888 TN.
Credit Market Dislocation Watch:

October 24 – Financial Times: “A few weeks ago, investors were in masochistic mode. A string of hefty writedowns from investment banks were greeted with rising share prices, on the assumption that the worst was now out in the open. Merrill Lynch appeared to take a ‘kitchen sink’ approach, with a massive $4.5bn writedown on collateralised debt obligations and subprime mortgages. Now it is clear that a large bathtub would have been more appropriate. Merrill on Wednesday increased the writedown to $7.9bn. That is shocking. How could Merrill have got the scale of its exposure to losses so wrong? Was it not conservative enough the first time round, factoring in instead some sort of price recovery in these illiquid instruments? Or was it simply unaware of the true depth of its problem?”

October 26 – Financial Times (Ben White and Michael Mackenzie): “Subprime mortgage anxiety continued to spread on Thursday as a leading derivatives index hit a new low and fears grew that Merrill Lynch and other banks could be forced into even bigger asset writedowns. Trading in the riskiest slice of the ABX index of bonds backed by home loans made in the second half of last year hit a new low of 18 cents. The risky slice of the index is down about 30% since the end of September when banks closed their books for the third quarter… The ABX decline has helped fuel speculation of further big asset writedowns by banks and insurance groups… William Tanona, Goldman Sachs analyst, said he expected [Merrill Lynch] to take an additional $4.5bn of writedowns in the fourth quarter on its remaining $20.9bn portfolio of CDOs and subprime mortgages. His estimate was based on movements in indices tracking the value of subprime mortgages and securities made up of those mortgages. ‘While only a proxy, we believe this price action does not bode well for the firm’s existing $5.7bn exposure in subprime mortgages,’ Mr Tanona said. ‘Second, the TABX index, which we have been using as a proxy for CDO assets, has also deteriorated 18-35% across all of the tranches with the most significant deterioration coming at the most senior levels.’”

October 25 – Dow Jones (Anusha Shrivastava): “Fresh evidence that the subprime mortgage problems are growing worse pummeled a leading derivative index Thursday, and caused investors to grow much more cautious about the prospects of bond insurers and financial institution American International Group Inc. Troubling data on subprime mortgage delinquencies and defaults released Thursday pushed the riskiest, BBB- portion of the closely watched ABX index based on mortgages made in the second half of 2006 to record lows…Even the less risky tranches of the index are much weaker, with the A and AA tranches hit the most. The single A slice of the index based on loans from the second half of 2006 is quoted at 28.5 cents, down from a close of 32.42 cents… ‘After seeing the remit reports, people are saying it’s time to go back into bomb shelters because the war continues unabated,’ said Dan Nigro, ABS portfolio manager at Dynamic Credit Partners…”

October 26 – Associated Press: “Moody’s…expects to complete a report by the middle of next week assessing how much damage decaying mortgage quality will wreak upon a type of investment known as a collateralized debt obligation, a person familiar with the review said… In the meantime, reports cutting credit ratings on CDOs will trickle out as they are completed, according to the person, who spoke on condition of anonymity… When Merrill Lynch wrote down the value of its portfolio by $7.9 billion this week, much of that was from investments in CDOs that lost value during the credit crisis this summer. At least 40 reports downgrading or considering downgrading billions of dollars in CDOs were issued Friday, though the agency declined to estimate the value of downgraded CDOs.”

October 26 – Bloomberg (Jody Shenn and Shannon D. Harrington): “Moody’s…cut the ratings of collateralized debt obligations tied to $33 billion of subprime mortgage securities that were downgraded this month, a decision that may force owners to mark down the value of their holdings. Securities with ratings as high as AAA from at least 45 CDOs were either cut or put on review for a downgrade…”

October 22 – Wall Street Journal Europe: “Vulture fund, bailout, stopgap, savior -- the super-SIV meant to reopen the short-term debt markets is being called a lot of things. What if the best way to describe it turns out to be ‘failure’? That’s not too far-fetched. Only Wachovia has publicly committed to back the fund since Citigroup, J.P. Morgan Chase and Bank of America unveiled it last Monday. It turns out that there is no easy way to drum up guarantees for a boatload of hard-to-price mortgage bonds and collateralized debt obligations, which are backed by pools of mortgage and other assets. Also, bankers are questioning the logic of the fund, which seems especially helpful to Citigroup, the sponsor of more than its share of SIVs, or structured investment vehicles.”

October 24 – Dow Jones (Carrick Mollenkamp, Ian McDonald and Valerie bauerlein): “As three of the world’s biggest banks try to finalize a rescue plan for some shaky investment funds, the funds themselves face mounting problems. The outlines of a new superfund - an effort led by Citigroup Inc., Bank of America Corp. and J.P. Morgan Chase & Co. that may include at least seven other banks - are still being hashed out, according to a person familiar with the situation. The three banks could present a formal structure to potential bank partners and funds as soon as next week. Meanwhile, the funds at the heart of the situation - known as structured investment vehicles, or SIVs - need to find investors for $100 billion in debt coming due in the next six to nine months, even as ratings firms continue to come out with reports that lower the ratings of securities in moves that could further depress the value of SIV holdings.”

October 25 – Bloomberg (Shannon D. Harrington): “A U.S. Treasury-led effort to keep structured investment vehicles afloat ‘has low odds of success’ in part because investors are conflicted about whether to participate in the plan, according to Bear Stearns Cos. Investors are torn between whether to go along or hold out and ‘ride along for free,’ speculating it will improve the market enough that the SIVs can raise money through asset sales to repay debt holders, Bear Stearns strategist Steven Abrahams wrote…”

October 26 – Financial Times (Saskia Scholtes and Francesco Guerrera): “US companies are becoming increasingly risk-averse with their investments, holding on to record levels of cash as a buffer against turmoil in financial markets, according to a survey of chief financial officers and corporate treasurers. Corporate America’s increased caution with its investments will make it more difficult for banks and hedge funds to restore normality to troubled markets such as the one for asset-backed commercial paper.”

October 24 – Financial Times (Ben White): “Poor quarterly results from banks across the US over the past two weeks suggest credit problems once confined to high-risk mortgage borrowers are spreading across the consumer landscape, posing new risks to the economy and weighing heavily on the markets. US banks have raised reserves for loan losses by at least $6bn over the second quarter and by even larger amounts from last year, indicating financial executives believe consumers will be increasingly unable to make payments on a variety of loans. Banks are adding to reserves not just for defaults on mortgages, but also on home equity loans, car loans and credit cards. ‘What started out merely as a subprime problem has expanded more broadly in the mortgage space and problems are getting worse at a faster pace than many had expected,’ said Michael Mayo, Deutsche Bank analyst. ‘On top of this, there is an uptick in auto loan problems, which may or may not be seasonal, and there is more body language from the banks that the state of the consumer was somewhat less strong [than thought].’ Dick Bove, analyst at Punk Ziegel, said bank earnings indicated ‘there are problems with consumer debt that extend beyond the well-known issues in the real estate markets. Auto loans are clearly a new area of concern’.”

October 24 – Financial Times (Henny Sender and Saskia Scholtes): “Turmoil in the market for debt backed by commercial mortgages is hitting some private equity deals hard, raising financing costs and eroding the profitability of buy-outs that depend on cash flows from real estate. Carlyle Group’s planned $6.3bn purchase of US nursing home operator Manor Care is among the deals to have been caught in a swift downdraft in the commercial mortgage-backed securities market… Carlyle…originally intended to raise $4.6bn by selling bonds backed by the value of Manor Care’s real estate. As part of that deal, the private equity group also secured a promise from its bankers to cap interest costs, which meant its banks would be vulnerable to losses on the deal if rates rose for CMBSs. That possibility has grown in recent days as spreads on CMBSs have widened. Since the start of last week, the spreads…have gone up more than one full percentage point.”

October 23 – Bloomberg (Neil Unmack): “The investment fund run by Washington state’s King County, which includes the city of Seattle, may be downgraded by Standard & Poor's because it holds bonds sold by structured investment vehicles. The $4.08 billion King County Investment Pool has 3.8% of its assets in three ‘distressed’ SIVs including Cheyne Finance LLC, Rhinebridge LLC and Mainsail II LLC, S&P said… S&P may cut the fund’s AAAf rating, the highest government investment pool grade.”
Currency Watch:

October 24 – Financial Times (Peter Garnham): “The Hong Kong dollar yesterday hit the upper end of its trading band for the first time, prompting the Hong Kong Monetary Authority to refute speculation that it would abandon its peg against the US dollar. The territory’s currency…rose to HK$7.7500 against the dollar for the first time since its trading band was set in May 2005. The Hong Kong dollar is pegged at HK$7.8 against the dollar, but since May 2005 has been allowed to trade between HK$7.75 and HK$7.85… Analysts said speculation had been increasing that the HKMA might ditch its peg against the dollar, or allow its currency to trade in a wider band, since a strengthening Chinese renminbi and a weakening US dollar were making the territory's imports more expensive.”

October 22 – Bloomberg (Matthew Brown): “Iraq wants to diversify out of dollars to preserve the value of its foreign exchange reserves after the U.S. currency fell, the head of the central bank said. ‘We would like to diversify, definitely,’ Sinan al-Shabibi, governor of the Central Bank of Iraq, said in an interview in Washington today. ‘This is a prudent policy.’ Iraq joins Middle East oil producers, including the United Arab Emirates, Qatar, Kuwait and Syria in reducing dollar holdings or dropping their currency’s peg to the dollar, in the past year. Iraq has about $21.5 billion in foreign reserves…”

October 24 – Bloomberg (Marcel van de Hoef and Danielle Rossingh): “Jim Rogers…said he is shifting all his assets out of the dollar and buying Chinese yuan because the Federal Reserve has eroded the value of the U.S. currency. ‘I’m in the process of -- I hope in the next few months -- getting all of my assets out of U.S. dollars,’ said Rogers, 65, who correctly predicted the commodities rally in 1999. ‘I’m that pessimistic about what's happening in the U.S.’”

The dollar index declined 0.5% to 77.03. For the week on the upside, the South African rand increased 5.4%, the Australian dollar 3.6%, the Brazilian real 2.7%, the New Zealand dollar 2.6%, the Canadian dollar 1.7%, the Swedish krona 1.7%, the Norwegian krone 1.6%, and the Euro 1.5%. On the downside, the Thai baht declined 1.1%. This week the Canadian dollar traded to a new 33-yr high and the Australian dollar a 23-yr high.
Commodities Watch:

October 24 – Financial Times (Javier Blas): “The steel industry is braced for an increase of up to 50% in the contract price of iron ore next year as a result of strong demand from China and lagging supply, industry executives and analysts have warned… The iron ore spot market has already seen price increases of up to 145% over the past year.”

October 22 – Bloomberg (Tan Hwee Ann): “Goldman Sachs JBWere Pty…raised its contract coking coal price forecasts 17%... The annual contract price of coking coal may rise to a record $140 a metric ton in the 12 months from April 1, from $98 this year…”

October 26 – Bloomberg (Halia Pavliva): “Platinum rose to a record and palladium climbed as the dollar fell to the lowest ever against the euro, bolstering the appeal of the precious metals as hedges against inflation.”

October 22 – Wall Street Journal (Robert Guy Matthews): “The cost of shipping raw materials across the world’s oceans has reached an all-time high, pushing up prices of grain, iron ore, coal and other commodities. The average price of renting a ship to carry raw materials from Brazil to China has nearly tripled to $180,000 a day from $65,000 a year ago. In some cases, ocean shipping can be more expensive than the cargo itself. Iron ore, for example, costs about $60 a ton, but ship owners typically are charging about $88 a ton to transport it from Brazil to Asia.”

October 26 – Bloomberg (Tony C. Dreibus): “Corn climbed for a second day and soybeans rose to a three-year high as the weaker dollar encourages overseas buyers to purchase U.S. supplies. The U.S. currency fell to a record against the euro on speculation the Federal Reserve will cut borrowing costs again. The slumping dollar makes U.S. goods, including commodities, more attractive. ‘The weak dollar is definitely a factor in the rally in the corn and beans,’ said Jon Marcus, president of Lakefront Futures & Options LLC in Chicago.”

October 26 – Financial Times (Javier Blas): “Fertiliser prices have surged this week to the highest level in at least a decade as farmers in Europe and North America prepare to plant more crops to cash in on high agricultural commodities prices. The prices of fertilisers have gone up by 50% in the past year and will add significantly to farmers’ costs, helping to sustain record agricultural commodities prices, analysts said.”

For the week, Gold jumped 2.6% to a 27-year high $785, and Silver surged 4.7% to $14.28. December Copper slipped 0.4%. November crude surged $4.91 to a record $91.86. November gasoline jumped 4.9%, and November Natural Gas increased 2.5%. December Wheat dropped 6.5%. For the week, the CRB index rose 1.7% (up 12.6% y-t-d). The Goldman Sachs Commodities Index (GSCI) increased 2.0% (up 33.4% y-t-d).
Japan Watch:

October 24 – Financial Times (David Pilling and Jonathan Soble): “When official figures come out on Friday, they are likely to show that consumer prices in Japan have fallen for the eighth month in a row and fuel talk of the country’s persistent de­flation. But that is not how many hard-pressed Japanese consumers will see it. From their perspective life is getting more expensive, with the price of dozens of everyday items, including coffee, noodles, bread, set lunches, clothes, taxi fares and road tolls all rising. ‘Prices are definitely go­ing up, slowly but surely,’ says Keiko Kikuya, a Tokyo resident… ‘Things like meat and fish are inching up all the time. Clothes, too. And land prices in central Tokyo: there’s a lot just opposite our house that’s shot up in price.” Price rises – a novel phenomenon in a Japan that has been stuck in deflation for 10 years – are stirring anger. In the northern city of Sendai, 1,000 protesters marched recently against a planned 5 per cent rise in the price of kerosene, which is used to heat homes. The disconnect between people’s everyday experiences and those of statistic­ally measured price movements poses a conundrum for the Bank of Japan, the central bank, as it has tried to track inflation. “

October 24 – Bloomberg (Lily Nonomiya): “Japan’s exports grew at the slowest pace in two years in September as shipments to the U.S. fell, a signal that the nation’s economic expansion may cool because of waning demand in its largest market. Exports rose 6.5% from a year earlier…”
China Watch:

October 26 – Financial Times (Richard McGregor): “China’s economy is on target this year to achieve its fastest annual growth rate since 1993 after continued strong expansion in the third quarter in spite of a raft of government measures to control investment and credit growth. The economy grew at an annual rate of 11.5% in the third quarter on the back of robust investment and exports… Growth is now on track to surpass 11% this year, which would be the fastest annual increase in output since the 13.1% achieved in 1993. The figures suggest China’s powerful growth remains unchecked, even after five interest rate rises this year, directives to state banks to cool lending, and repeated calls by the central government for tighter enforcement of environmental rules.”

October 25 – Bloomberg (Nipa Piboontanasawat and Li Yanping): “China’s economy, the biggest contributor to global growth, expanded 11.5% in the third quarter, adding pressure for faster currency appreciation and higher borrowing costs to curb inflation… A record trade surplus helped drive a 26.4% surge in factory and property spending in the first nine months, raising the risk of idle plants and bad loans as the global economy slows.”

October 26 – Bloomberg (Wang Ying): “China, the world’s second-biggest energy user, increased electricity consumption by 15% to 2.395 trillion kilowatt-hours, as the nation's economy expanded.”

October 26 – Dow Jones: “Property prices in 70 of China’s large and medium-sized cities rose 8.9% from a year earlier in September, the fastest pace of increase so far this year… The increase in prices accelerated from 8.2% in August…”

October 22 – Bloomberg (Li Yanping): “China’s economy may expand 11.5% and the inflation rate will be 4.3% this year, said Wang Xiaoguang, an economist at the National Development and Reform Commission… Gross domestic product will likely be 11% in 2008 with inflation at 3.5 percent, Wang said. China may have a $257 billion trade surplus this year, as exports expand by 24%, outpacing import growth by 4 percentage points…”

October 22 – China Knowledge: “According to the latest statistics from the General Administration of Customs, China’s imports of iron ore fines went up by 14.5% year-on-year to reach 250 million tons in the first eight months of this year. The import of 250 million tons iron ore fines worth US$19.61 billion, up 43.8% compared with the same period last year.”

October 26 – Bloomberg (Kelvin Wong and Chia-Peck Wong): “Prices of luxury apartments in Hong Kong almost doubled in the past four years, according to an index compiled by real estate agency Midland Holdings Ltd… The average price of luxury apartments…has risen 90% to HK$9,800 ($1,264) a square foot…”
India Watch:

October 24 – Bloomberg (Robin Wigglesworth): “India’s Finance Minister Palaniappan Chidambaram said planned curbs on offshore derivatives are aimed at improving disclosure in the stock market and not an outright ban on types of funds. ‘All we are trying to do is ensure that there is greater transparency in the manner in which funds flow into India, and that investors are subject to some kind of due diligence,’ Chidambaram told reporters… ‘We are not imposing capital controls, we are not against any kinds of inflows, or discriminating between one flow or the other.’”
Unbalanced Global Economy Watch:

October 26 – Bloomberg (Simone Meier): “Money-supply growth in the euro region remained near a 28-year high in September, adding to signs inflation may accelerate. M3 money supply…rose 11.3% from a year earlier, after gaining 11.6% in August… The rate reached 11.7% in July, the highest since August 1979.”

October 24 – Financial Times (Jenny Wiggins and Javier Blas): “When the United Nations held its annual World Food Day last week to publicise the plight of the 854 malnourished people around the world, its warning that there ‘are still too many hungry people’ was a little more anxious than usual. Finding food to feed the hungry is becoming an increasingly difficult task as growing demand for staples such as wheat, corn and rice brings higher prices. That is leading all nations – rich and poor – to compete for food supplies. Food security is not a new concern for countries that have battled political instability, droughts or wars. But for the first time since the early 1970s, when there were global food shortages, it is starting to concern more stable nations as well. ‘The whole global picture is flagging up signals that we’re moving out of a period of abundant food supply into a period in which food is going to be in much shorter supply,’ says Henry Fell, chairman of Britain’s Commercial Farmers Group. As agricultural commodities trade at record high levels, causing one food manufacturer after another to put up prices…countries are starting to question whether they can afford to keep feeding themselves. Wheat and milk prices have surged to all-time highs while those for corn and soya­ beans stand at well above their 1990s averages. Rice and coffee have jumped to 10-year records and meat prices have risen recently by up to 50% in some countries. ‘The world is gradually losing the buffer that it used to have to protect against big swings [in the market],’ says Abdolreza Abbassian, secretary of the grains trading group at the UN’s Food and Agriculture Organisation. ‘There is a sense of panic.’”

October 22 – Bloomberg (Maria Levitov): “The Russian economy expanded an annual 7.4% in the first nine months, Interfax reported, citing the Economy Ministry.”

October 26 – Bloomberg (Maria Levitov): “Consumer prices in Russia have increased 1.5 percentage points more than last year as the government struggles to curb accelerating inflation. Prices rose 8.9% in the year… in comparison with 7.4% in the same period last year…”

October 24 – Financial Times (Neil Buckley and Javier Blas): “Russia is introducing Soviet-style price controls on some basic foods in an effort to prevent spiralling prices from denting the Putin administration’s popularity ahead of parliamentary polls in December. The country’s biggest food retailers and producers have reached an agreement, expected to be signed with the Russian government on Wednesday, to freeze prices at October 15 levels on selected types of bread, cheese, milk, eggs and vegetable oil until the end of the year. Russia’s move is the latest sign of surging agricultural prices becoming an international political issue. Big retailers will limit their mark-up on those goods to 10%. China has also agreed to food price controls; Egypt, Jordan, Bangladesh and Morocco are increasing subsidies or cutting import tariffs to lower domestic prices. Rich countries are not im­mune: Italian consumer groups organised a pasta boycott last month in a protest over prices.”

Latin America Watch:

October 26 – Bloomberg (Lester Pimentel): “The widespread suspicion that the government of President Nestor Kirchner has manipulated inflation data and the likelihood that his wife Cristina Fernandez de Kirchner will succeed him are transforming the Argentine bond market into a financial bloodbath. Argentina’s benchmark inflation-linked bonds have tumbled 24% this year…” 

Bubble Economy Watch:

October 22 – Bloomberg (Thomas R. Keene): “Corporate-tax receipts in the U.S. have slowed along with profit growth, and that means the federal budget deficit is likely to widen next year, according to FTN Financial economists. Job growth may suffer as well, they say. ‘Just when it seemed the federal deficit was melting away to nothing, growth in federal receipts has collapsed,’ writes Christopher Low… Lower corporate tax receipts imply less job creation, he says.”

October 22 – Bloomberg (Poppy Trowbridge): “U.S. banks, burdened by loans they promised prior to the recent liquidity shortage, will curb their lending and may spark a broader credit crisis, the Wall Street journal reported. Banks now use tighter lending criteria as a result of losses suffered from defaults in subprime mortgages and the effect of lending commitments made before the crisis, which they still have to honor, the Journal said, citing Michael Bauer, an executive vice president at MainSource Financial Group Inc…”

October 24 – The Wall Street Journal (Ana Campoy): “Cold weather hasn’t hit the Northeast yet, but record heating-oil prices mean high heating bills are on the way for many residents. About eight million U.S. households -- largely in New England and the Central Atlantic states -- rely on heating oil to run their furnaces each winter. Last week, heating-oil futures hit a record of $2.36 a gallon, up more than 40% since the start of the year.”
Central Banker Watch:

October 25 – Bloomberg (Patrick Harrington): “Mexico’s central bank unexpectedly raised its benchmark interest rate by a quarter percentage point after a report showed core inflation quickened more than expected. The five-member board lifted the benchmark rate to 7.50 percent…” 

California Watch:

October 24 - California Association of Realtors (CAR): "Home sales decreased 38.9% in September in California compared with the same period a year ago, while the median price of an existing home fell 4.7%... this decline -- which was both the largest month-to-month percentage decline on record and the first year-to-year decline in more than 10 years -- was mainly the result of the credit or liquidity crunch...” said C.A.R. President Colleen Badagliacco. ]California’s sales fell more steeply than those of the U.S. as a whole because of its heavy reliance on jumbo loans...” The median price of an existing, single-family detached home in California during September 2007 was $530,830, a 4.7% decrease over...September 2006... The September 2007 median price fell 9.9% compared with August’s $588,970 median price. 'The impact of the credit crunch spread throughout all tiers of the market in September,' said C.A.R. Vice President and Chief Economist Leslie Appleton-Young. 'While the entry-level portion of the market has been adversely affected by the subprime situation and tighter underwriting standards for much of this year, the high end of the market also saw a decline in sales, as even well-qualified buyers were affected by the lack of funds available for jumbo loans.' ...C.A.R.’s Unsold Inventory Index for existing, single-family detached homes in September 2007 was 16.6 months, compared with 6.4 months (revised) for the same period a year ago."

October 24 – Bloomberg (Michael B. Marois): “Four years after Arnold Schwarzenegger was elected governor of California, vowing to ‘tear up the state’s credit card,’ the actor and former body-builder is about to charge $7 billion to taxpayers’ accounts. California is selling notes tomorrow due in eight months to help pay its bills until tax revenue comes in, the largest short-term loan since Schwarzenegger took office and almost five times more than last year. Debt is increasing after cash receipts fell $777 million below the state’s projections during the first three months of the fiscal year that started July 1… The rise in IOUs is an early sign that finances are deteriorating after four years of revenue growth… ‘A California budget crisis is beginning to recur, and the big increase in short-term seasonal borrowing is the classic leading indicator,’ said Richard Larkin, a municipal bond analyst at J.B. Hanauer & Co….a…money manager that oversees $10 billion.”

Structured Finance Earnings Watch:

October 25 – Bloomberg (Christine Richard): “MBIA Inc., the world’s biggest bond insurer, plunged the most in 20 years after the company reported its first loss, ended a share buyback and failed to quell speculation it will write down more of its mortgage portfolio. The company today reported a $36.6 million loss after reducing the value of the securities it guarantees by $342 million… MBIA…and Ambac Financial Group Inc…both reported their first losses… The insurers write derivative contracts promising to pay holders in the event of a default. The value of the securities plummeted after subprime delinquencies soared. ‘People began to question the viability of the business model and the tremendous credit exposure that MBIA has taken on to a wide range of structured credit risks,’ said David Einhorn, president of Greenlight Capital…”

October 24 – Bloomberg (Christine Richard): “Ambac Financial Group Inc., the World’s second-largest bond insurer, reported its first quarterly loss after reducing the value of subprime mortgage-linked securities by $743 million. The shares fell the most in 2 1/2 years after…it had a third-quarter net loss of $360.6 million... Ambac, MBIA Inc. and other bond insurers have guaranteed billions of dollars of AAA rated collateralized debt obligations that are backed by low investment-grade rated portions of mortgage-backed debt… ‘They have to show that they can survive a rough patch,’ said Scott MacDonald, head of research at Aladdin Capital Management… ‘They have to
demonstrate that their business model is sustainable.’”

October 25 – Bloomberg (Christine Richard): “Security Capital Assurance Ltd., the Hamilton, Bermuda-based financial insurer and reinsurer, reported a third-quarter loss because of a $131.7 million markdown on credit derivatives.”
GSE Watch:

Fannie Mae and Freddie Mac’s combined “Book of Business” (mortgages retained and MBS guaranteed) expanded a notable $67.1bn during September, a 17% annualized rate, to $4.784 TN. Through nine months, their “Books of Business” have expanded $430bn, or 13.2% annualized. By category, their combined Retained Portfolio has expanded $8.6bn to $1.437 TN, while their guaranteed MBS exposure has increased $421bn to $3.347 TN.
MBS/ABS/CDO/CP/Money Funds and Derivatives Watch:

October 24 – Bloomberg (Jody Shenn): “European and Asian investors will avoid most U.S. mortgage-backed securities for years without guarantees from government-linked entities, creating ‘an enormous drag on the U.S. housing market,’ according to UBS AG. During the current ‘shutdown’ of the subprime and Alt-A mortgage-securities markets, it’s been ‘virtually impossible’ to find buyers for anything but the safest classes of such bonds…UBS analysts led by Laurie Goodman wrote… Surging losses on the loans will worsen as the credit crunch makes it harder for borrowers with adjustable-rate mortgages to lower their payments by refinancing, they wrote. Foreclosures started on U.S. loans rose at the highest rate on record in the second quarter, the Mortgage Bankers Association says. ‘The `virtuous' cycle of the past few years has evolved into a ‘vicious' cycle,’ the UBS analysts wrote.”

October 22 – Bloomberg (Andrew Blackman): “Californian homes are overvalued by as much as 40% and stricter lending standards will probably contribute to ‘material’ price declines, according to analysts at Goldman Sachs. Prices in the state ‘have proven surprisingly resilient, given the severe curtailment of credit availability and rising unemployment,’ the analysts said… ‘However, we believe that a downturn is imminent.’ In August, the median price for houses in California was $589,000, though economic conditions only support prices of $350,000 to $380,000, the analysts said.”

October 26 - DataQuick Information Systems: “Lenders started formal foreclosure proceedings on a record number of California homeowners last quarter, the result of declining home prices, sluggish sales and subprime mortgage distress, a real estate information service reported. A total of 72,571 Notices of Default (NoDs) were filed during the July-to-September period, up 34.5% from 53,943 during the previous quarter, and up 166.6% from…third-quarter 2006… Last quarter’s default level passed the previous peak of 61,541 reached in first-quarter 1996… ‘We know now, in emerging detail, that a lot of these loans shouldn’t have been made. The issue is whether the real estate market and the economy will digest these over the next year or two, or if housing market distress will bring the economy to its knees.”

Mortgage Finance Bust Watch:

October 24 – The Wall Street Journal (Ruth Simon and James R. Hagerty): “Subprime mortgages aren’t the only challenge facing Countrywide Financial Corp., the nation’s biggest home-mortgage lender. Some loans classified as prime when they were originated are now going bad at a rapid pace. These loans are known as option adjustable-rate mortgages, or option ARMs. They typically have low introductory rates and allow minimal payments in the early years of the mortgage. Multiple payment choices include a minimum payment that covers none of the principal and only part of the interest normally due. If borrowers choose that minimum payment, their loan balances grow – a phenomenon known as ‘negative amortization…’ Among option ARMs held in its own portfolio, 5.7% were at least 30 days past due as of June 30, the measure Countrywide uses. That’s up from 1.6% a year earlier. Countrywide held $27.8 billion of option ARMs as of June 30, accounting for about 41% of the loans held as investments by its savings bank. An additional $122 billion have been packaged into securities sold to investors, according to UBS… It now appears that many borrowers who moved into option ARMs were attracted by the low payments and may have been staving off other financial problems. More than 80% of borrowers who are current on these loans make only the minimum payment, according to UBS… Of the option ARMs it issued last year, 91% were "low-doc" mortgages in which the borrower didn't fully document income or assets, according to UBS, compared with an industry average of 88% that year. In 2004, 78% of Countrywide’s option ARMs carried less than full documentation. Countrywide also allowed borrowers to put down as little as 5% of a home’s price and offered ‘piggyback mortgages,’ which allow borrowers to finance more than 80% of a home’s value without paying for private mortgage insurance. By 2006, nearly 29% of the option ARMs originated by Countrywide and packaged into mortgage securities had a combined loan-to-value of 90% or more, up from just 15% in 2004, according to UBS."

October 24 – Bloomberg (Laura Cochrane): “Collateralized debt obligations with investments related to U.S. home loans taken out in 2006 and this year will probably have their ratings cut by credit assessors, according to Barclays Capital. Some securities with the highest investment-grade rating of AAA may be lowered by two levels because of the ‘tsunami’ of ratings cuts to U.S. residential mortgage-backed securities that underlie the debt, Barclays’s analysts said…”

October 26 – Bloomberg (Jody Shenn): “Late payments and defaults among subprime mortgages packaged into bonds rose last month as higher loan rates and weaker home prices pushed homeowners to the brink, according to data for loans underlying ABX derivative indexes. After September mortgage payments, 21.3% of the loan balances from 20 deals created in the first half of 2006 were at least 60 days late, in foreclosure, subject to borrower bankruptcy or already turned into seized property, up from 19.7% a month earlier…”

October 24 – Financial Times: “California pension fund Calpers assumed the ground beneath its feet was a safe place to park some of its $250bn of assets. The fund has invested billions of dollars in land and residential housing projects over the past 15 years, often within its home state. Those projects earned Calpers some of its highest returns before the US housing market hit a wall. But the fund now has hundreds of millions of dollars tied up in US ‘land banks’ which are struggling to deal with undeveloped acreage home builders no longer want… Calpers reported $1.12bn of investments in ventures managed by leading land banks Hearthstone, IHP and MacFarlane, as of March 31."

October 24 – Bloomberg (Laura Cochrane): “Standard & Poor’s may cut the credit ratings of 207 Australian and New Zealand residential mortgage-backed securities as turmoil in the U.S. subprime market spreads to home-loan insurers. It’s the first time in five years S&P has put securities backed by Australian and New Zealand mortgages on negative ‘creditwatch.’”
Foreclosure Watch:

October 25 – Bloomberg (Alison Vekshin): “About 2 million subprime borrowers will lose their homes to foreclosure through 2009, costing them $71 billion in housing wealth, a congressional report said. Subprime foreclosure rates will increase as housing prices stagnate or decline, and the effects of the subprime crisis may spill over to the broader economy, according to a report by the Joint Economic Committee…”
Real Estate Bubbles Watch:

October 25 – Bloomberg (Kathleen M. Howley): “A record 17.9 million U.S. homes stood empty in the third quarter as lenders took possession of a growing number of properties in foreclosure. The figure is a 7.8% gain from a year ago…the U.S. Census Bureau said… About 2.07 million empty homes were for sale, compared with 1.94 million a year earlier, the report said.”

October 22 – PRNewswire: “Single-family home sales in September fell 18.7% in Massachusetts, the steepest monthly decline in a year. But the third quarter still experienced less dramatic decreases than the second quarter, according to a report released today by The Warren Group… Single-family home sales fell from 4,593 in September 2006 to 3,735 in September 2007, a decrease of 18.7%.”
Fiscal Watch:

October 24 – Bloomberg (Brian Faler): “The wars in Iraq and Afghanistan would cost almost $2.4 trillion if the U.S. keeps even a reduced number of troops in the two countries for the next decade, according to the Congressional Budget Office. Peter Orszag, head of the nonpartisan agency, told the House Budget Committee that it would cost $1.055 trillion to keep a reduced number of troops in the two theaters -- 75,000, down from the current 200,000 -- through 2017. If the conflicts continue to be funded with borrowed money, interest payments would total $705 billion. Those bills, when combined with the $604 billion Congress has already appropriated for the conflicts, would bring total costs to $2.364 trillion, according to CBO estimates. By comparison, President George W. Bush proposed a federal budget this fiscal year of $2.9 trillion.”
Speculator Watch:

October 23 – Bloomberg (Jenny Strasburg): “Hedge-fund managers attracted $45.2 billion in the third quarter, a decline from record fundraising earlier in the year… New money gathered from investors worldwide fell by more than a fifth from $60 billion and $58.7 billion in the first and second quarters, respectively…Hedge Fund Research Inc. said… Returns averaged 1.36 percent in the third quarter, the smallest gain in a year, Hedge Fund Research said. Year-to-date inflows still surpassed the $126 billion record for all of 2006…”
Crude Liquidity Watch:

October 24 – Financial Times (Simeon Kerr): “Saudi Arabia is turning the home of one of its older industries into a symbol of what the kingdom hopes is its future. Thuwal on the Red Sea coast is a fishing port but, as part of a plan to end the kingdom’s dependence on its petroleum-based economy, the government is turning it into the King Abdullah University for Science and Technology, or Kaust. The project, scheduled to open in 2009, will house up to 15,000 people, based around a graduate research-focused university. Kaust’s mooted $10bn endowment, would make it one of the best funded universities in the world…”

Climate Watch:

October 23 – Bloomberg (Alex Morales): “Carbon dioxide is collecting in the atmosphere faster than forecast as the use of dirtier fuels increases worldwide, an Australian-led team of scientists said. Rising levels of the main gas blamed for climate change threatens to accelerate global warming, the researchers said. The study builds on previous findings and may lead to a change in the way scientists predict climate change.”

Structured Finance Under Duress:

The market may be been perfectly content to brush it aside. It was, however, a brutal week for “contemporary finance.” Merrill Lynch, a kingpin of structured Credit products, shocked the marketplace with a $7.9bn asset write-down – up significantly from the $4.5bn amount discussed just two weeks ago. Much of the write-off related to the company’s CDO (collateralized debt obligations) portfolio, the size of which was reduced in half to $15.2bn during the quarter. But with proxy indices of subprime and CDO exposures down between 15% and 30% since the end of the quarter, Street analysts have already warned of the possibility for an additional $4bn hit. Merrill is not alone.

Also hit by sinking CDO fundamentals, Credit insurer Ambac Financial reported a third-quarter loss of $361 million - it’s first-ever quarter of negative earnings. The company posted a $743 million markdown on its derivative exposures, “primarily the result of unfavorable market pricing of collateralized debt obligations.” Credit insurance compatriot MBIA also reported its first loss ($36.6 million), on the back of a $352 million “mark-to-market” write-down of its “structured Credit derivatives portfolio.” These two Credit insurance behemoths – and the “financial guarantor” industry generally – would have been a whole lot better off these days had they stuck to insuring municipal bonds and fought off the allure of easy (“writing flood insurance during a drought”) profits guaranteeing Wall Street’s endless array of new structured Credit products.

October 26 – Financial Times (Stacy-Marie Ishmael): “The perceived creditworthiness of two of the largest financial guarantors in the US on Thursday plunged to lows not seen since the worst of the credit squeeze in August. MBIA and Ambac are specialist companies that guarantee the repayment of bond principal and interest in the event of an issuer default - including bonds backed by subprime assets. After both companies this week reported third-quarter losses, investors have begun to speculate that the monolines, as they are known, might themselves in default on their outstanding debt. Spreads on five-year credit default swaps written on Ambac’s debt widened by 50 bps to 300bp, according to Credit Derivatives Research… In other words, the annual cost of insuring a $10m portfolio of Ambac’s debt over five years has risen by $50,000 to $300,000. The previous record of $238,000 was set on August 16…”

It is worth noting that MBIA and Ambac combine for about $1.9 Trillion of “net debt service outstanding” – the amount of debt securities and Credit instruments they have guaranteed, at least in part, to make scheduled payments in the event of default. Throw in the Trillions of Credit insurance written by the mortgage guarantors and you’re talking real “money.” Importantly, the marketplace is beginning to question the long-term viability of the Credit insurance industry, placing many Trillions of dollars of debt securities in potential market limbo.

With recent developments - including the monstrous write-down from Merrill Lynch, the implosion in the mortgage insurers, and the losses reported by the “financial guarantors” - in mind, I’ll revisit an excerpt from a January article by the Financial Times’ Gillian Tett: “…Total issuance of CDOs…reached $503bn worldwide last year, 64% up from the year before. Impressive stuff for an asset class that barely existed a decade ago. But that understates the growth. For JPMorgan’s figures do not include all the private CDO deals that bankers are apparently engaged in too. Meanwhile, if you chuck index derivative portfolio numbers into the mix, the zeros get bigger: extrapolating from trends in the first nine months of last year, total CDO issuance was probably around $2,800bn last year, a threefold increase over 2005. These startling numbers will certainly not shake the world outside investment banking. For, as I noted in last week’s column, the CDO explosion is occurring in a relatively opaque part of the financial system, beyond the sight - let alone control - of ordinary household investors, or politicians.”

Subprime and the SIVs are peanuts these days in comparison to the gigantic global CDO and Credit derivatives markets. CDOs may lack transparency, trade infrequently, and operate outside of market pricing (“mark-to-model”). Nonetheless, CDO exposure now permeates the entire global financial system – exposure that regrettably mushroomed in the midst of the most reckless end-of-cycle mortgage excesses imaginable. Rumors this week had major insurance companies suffering huge CDO losses. To what extent the big insurance “conglomerates” have exposure to CDOs and other Credit derivatives is unclear today, but there is no doubt that the global leveraged speculating community is knee deep in the stuff. Importantly, as goes the U.S. mortgage market, so goes the CDOs. I’m not optimistic.

I don’t want to place undue weight on one month’s data, but the California statewide median home price sank $58,140 over the month of September (down 4.7% y-o-y to $530,830). This was by far the largest monthly decline on record and the first year-over-year fall “in more than 10 years.” September California sales were down 39% from a year earlier. Weakness was statewide, led by a 63% y-o-y collapse in the “High Desert.” But even San Francisco “Bay Area” sales dropped 46% y-o-y. Ominously, the California Association of Realtors “Unsold Inventory Index” surged to 16.6 months, almost double the level from just six months earlier and compared to 6.4 months in September ’06. “The impact of the credit crunch spread throughout all tiers of the market in September,” said California Association of Realtors Chief Economist Leslie Appleton-Young. As far as I’m concerned, there is sufficient evidence at this point suggesting the Great California Housing Bust has begun in earnest.

We’ve definitely reached a critical point worthy of the question: Can “structured finance,” as we know it, survive the California and U.S. mortgage/housing busts? I don’t believe so. For one, the historic nature of the Credit Bubble virtually ensures the collapse of the Credit insurance “industry” (companies, markets, and derivative counter-parties). The mortgage insurers are now in the fight for their lives, while the “financial guarantors” today face an implosion of their “structured Credit” insurance business. Worse yet, major problems in municipal finance (certainly including California state and municipalities) are festering and will emerge when the economy sinks into recession. It is worth noting that California revenues were $777 million short of expectations during the first fiscal quarter (see “CA Watch” above).

Returning to the vulnerable CDO market, some key dynamics are in play. With California now at the brink, uncertain but huge losses are in the pipeline for jumbo, “alt-A,” and “option-ARM” mortgages – loans that were for the most part thought sound only weeks ago. The market began to revalue the top-rated CDO tranches this week, a process that should only accelerate. “AAA” is not going to mean much. If things unfold as I expect, a full-fledged run from California mortgage exposure could be in the offing. And as the dimensions of this debacle come into clearer market view, the viability of the Credit insurers will be cast further in doubt – with ramifications for Trillions of securities and derivatives. General Credit Availability would suffer mightily.

With global equities markets in melt-up mode, it might seem absurd to warn that a troubling global financial crisis is poised to worsen. But Structured Finance is Under Duress. The entire daisy-chain of liquidity agreements, securitization structures, Credit insurance and guarantees, derivatives counterparty exposures and, even, the GSEs is increasingly suspect. Trust has been broken and market confidence is not far behind.

The big global equities and commodities surge over the past few months certainly has been instrumental in counteracting what would have surely been a problematic “run” from the leveraged speculating community. How long this spectacle can divert attention from the unfolding mortgage/CDO/“structured finance” debacle is an open question. I can’t think of a period when it has been more critical for stocks to rise - and rise they have. Yet I suspect recent developments will now encourage the more sophisticated players to begin reining in exposure.

The nightmare scenario - where the market abruptly comes to recognize that the leveraged speculating is hopelessly stuck in illiquid CDO, ABS, MBS, derivative and equities positions - doesn’t seem all that outrageous or distant this week. Unfortunately, today’s Ponzi-style acute fragility (as was demonstrated this summer in subprime, asset-backed CP, SIVs and the like) and speculative dynamics dictate that he who panics first panics best. I don’t expect the sophisticated players to hang around and wait for securities to be properly priced and the full extent of illiquidity and the unfolding Credit debacle to be recognized. And while Bubbling markets do delay the inevitable reversal of speculative flows from the leveraged speculating community, they only compound the risk of an inevitable ravaging run from illiquidity. We’ll see to what extent the Fed is willing to spur increasingly destabilizing global stock market speculation and dollar liquidation in false hope that lower rates can somehow mitigate Structured Finance Under Duress.