Today's Tidbits

Record Drop in Commercial Paper Outstanding as Liquidity Shrinks
From Bank of America: “Huge drop in ABCP in the week ending Aug 15-- $48.4 bln, or 4.1% of the market (old record decline had been $19.5 bln in the week of 9/11). In addition, there was a large drop in finanical CP outstanding that pushed overall CP down $91.1 bln, or 4.1% of outstandings (another record-- previous decline was $60.9 bn in the 9/11 week). It is not a surprise that CP outstandings are down, but the size of the decline is surprising-- we are seeing a much more rapid transition from financing in the
CP market to financing elsewhere (repo, bank credit lines, collateral sales,
etc) than we saw in past disruptions in the CP market.”
From Bloomberg: “Investors are scooping up U.S. Treasury bills like few times in history as an expanding credit crunch makes it hard for companies to roll over short-term debt. The yield on the three-month Treasury bill fell 0.72 percentage point today to 3.38 percent, the lowest since July 2005 and the biggest drop in yield since the stock market crashed on Oct. 20, 1987. Lenders are so concerned about the fallout from rising
delinquencies on subprime mortgages that rates on commercial paper have shot up to 5.90 percent from 5.36 percent a month ago, data compiled by the Federal Reserve show. Commercial paper is debt due in nine months or less and is bought by money-market
funds… Money funds that had been buying corporate commercial paper ``have all switched to the safe side,'' …``I'm sure their managers have all given them a Treasury-
only mandate, at least until the dust settles.''”

Fed Adding Liquidity to Help Reduce Short-Term Funding Problems
From Barclays: “This morning's 8:20 operation is a direct signal by the Fed that they will continue to provide abundant liquidity to the market. This operation is a 14 day operation and should address the concern by many that the Fed had been providing o/n liquidity but that term liquidity was hard to come by.”
From Deutsche Bank: “The Fed is likely to continue to oversupply reserves to the overnight borrowing market, which will have the effect of keeping the funds rate soft relative to target. For instance, the last four days the Fed effective rate has been well under 5%, representing in some sense a de facto (albeit temporary) easing of policy. This may continue into the new reserve maintenance period which begins today. Additionally, the Fed could conceivably build confidence as a liquidity provider in the Fed funds market by extending the length of term repos as it did back in 1999 ahead of Y2K when the maximum maturity of repos was extended from 60 to 90 days. (Longer dated repos may cause financial intermediaries to be more willing, at the margin, to extend credit beyond the very short term.) It has just now announced a $5B 14-day repo operation. But the NY Fed also explicitly emphasized that its operating objective is a 5.25% funds rate. Unfortunately, to this point the added liquidity the Fed has provided has not helped other parts of the money markets, such as asset-backed commercial paper. It is highly unlikely the Fed would change the types of collateral it accepts in open market operations. Nonetheless, to the extent the Fed can come up with innovative ways to provide liquidity to the markets, this would minimize in the short term the need to cut interest rates.
The likelihood of a rate cut by the September FOMC meeting has risen markedly-the market is currently pricing one in-but not sufficiently for us to change our Fed call. Despite severe dislocations in various parts of the financial markets, the Fed does not want to be perceived as bailing out Wall Street unless there is systemic risk from a major financial institution failure, or economic growth slows. As such, the Countrywide situation - this morning it announced that it is tapping an $11.5 bn bank credit line - bears monitoring. The exit out of the commercial paper by money market funds has caused a squeeze in the Treasury bill market. This is likely to continue, as the money markets are in a crisis mode. There is also the possibility that repo liquidity will dry up, so relative value relationships could start to move out of line.”

Likelihood of a Fed Ease
From RBSGC: “The market continues to price in a Fed ease (4.87% October Fed Funds), but I would point out that the market view is quite binary, with some investors thinking the Fed will cut 50 bp before the September meeting and others thinking no rate cuts will happen in 2007. The Fed's apparent position, from Poole's comments, is that so far the credit crunch has not impacted business or consumer spending, and thus any slowdown in economic growth will be minor. They do not want to appear to be bailing out investors (rather than the economy) by lowering interest rates. They are looking for a "calamity", such as a major financial failure, before they step in to lower interest rates.”
From Citi: “The rapid deterioration in financial conditions in recent days is tilting the balance of risks decisively toward economic weakness. We think these developments will prompt the FOMC to cut rates no later than the September 18 FOMC meeting. While officials would no doubt prefer to monitor developments and act on the regular policy cycle, events may compel them to move more urgently over the next few days or weeks. The unprecedented aspects of the current situation may make it difficult for the Committee to reach consensus on a course of action. But it also complicates market participants’ abilities to anticipate what they will do. Nonetheless, in the context of a subpar economy with tentative easing in price pressures, a sharp turn toward restrictive financial conditions and disruptive markets would be undesirable. Moreover, in judging the potential cost of no action, policymakers must weigh the fact that forward markets see a compelling case to move. As a result, we would anticipate an initial reduction of 25 basis points coupled with a statement acknowledging the shift in risk assessments and a readiness to do more. The breadth and depth of tightening in financial conditions is reaching a critical stage that warrants policy action. In just a few days the erosion has spread across the globe and across a wide array of financial instruments. The most basic market making in even modest size and among a range of standard products appears to be breaking down, while liquidity preference and the associated withdrawal from risk taking even over short horizons introduces serious questions about financial stability that could undermine economic activity. The fact that the effective funds rate averaged just 4.79% in the latest statement week suggests officials are sensitive to the risks.”[target is 5.25%]
From RBSGC: “…this is not the Greenspan Fed and we expect they're still concerned with inflation-fighting credibility and so will prove more reluctant to ease than perhaps the Greenspan Fed might have been. And, in any event, we're not sure what a single, say 25 bp, ease would do at the moment that other liquidity provisions are doing. Steepen the curve, yes. Affirm the rates rally, yes. Get investors to move down the credit curve? No. The credit risk premium is a story of restoration and the Fed can perhaps smooth the process, but not reverse it. It's the process that we think will generate deeper repercussions as time goes on, putting eases off for a little while.”

Countrywide
From Bloomberg: “… yesterday … Merrill Lynch … lowered its rating on … Countrywide Financial Corp., the biggest U.S. mortgage lender, to ``sell'' from ``buy'' and raised the possibility of bankruptcy. That would happen if creditors force Countrywide to sell assets at depressed prices or investors lose confidence in its ability to raise cash, New York-based Merrill Lynch said. Rates for Countrywide's overnight corporate commercial paper were quoted yesterday at 6 percent and 6.5 percent for 30 days…Countrywide tapped an $11.5 billion credit line today to shore up its available cash. The unsecured credit line is with a group of 40 of the world's largest banks, Countrywide said …Last week, Countrywide said it had access to about $187 billion in credit… The perceived risk of owning Countrywide's bonds increased yesterday, according to prices of credit-default swaps. Credit-default swaps on Countrywide soared as much as 425 basis points to 1,025 basis points before rebounding to 705…”
From Morgan Stanley (at 3pm): “CFC Countrwide 5y CDS 600 off the wides..Traded 1050 this a.m, and is currently offered @ 500...”
From LEHC: “In addition to reporting that it had drawn on the “entire amount” of an $11.5 billion credit facility, Countrywide also noted in its press release today that (1) “the Company's primary strategy going forward is to fund its production through Countrywide Bank, FSB. We are already originating in excess of 70 percent of our total origination volume through the Bank, and expect to accelerate our strategy so that nearly all of our volume will be originated in our Bank by the end of September”; and that (2) “Countrywide has materially tightened its underwriting standards for (non-GSE-eligible) loans, and, we now expect that 90 percent of the loans we originate will be GSE-eligible or will meet our Bank's investment criteria.””
From Citi: “…Moody's cut its ratings by three notches…”[to lowest investment grade rating of Baa3]

Consumer Borrowing Correction Overdue
From Merrill Lynch: “The debt binge was never sustainable As Bob Farrell (former dean of Merrill Lynch research) put it in his "Market Rules to Remember", "Exponentially rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways". Just in case you are into picking the bottom, rule #4 should not be ruled out. Bob also said (Rule #10) that "Bull markets are more fun than bear markets". How true. I know we've developed the reputation of being perma-bears. But we're not. We have a well developed and heartily enforced ethic about being bullish on America. We embrace the history. But, at the same time, we need to preserve the Merrill Lynch edge, if at all possible. We want to make sure that our clients' interests are always well served and at times this has meant telling people "stuff" they didn't want to hear - what we are seeing above the surface today has been building for a year if not more. The amount of leverage, especially geared to the consumer sector, that was being added relative to the income required to service the debt had become increasingly untenable - the debt binge was never sustainable, in our opinion, and it ultimately took the payment shock following 17 Fed rate hikes and corroding real estate values as inventory excess gathered apace, to generate a period of rising delinquencies, defaults and foreclosures.”

Unwind of Carry Trade Pushes Yen to One Year High
From Bloomberg: “The yen advanced the most against the dollar since 1998 as a global rout of stocks and credit markets pushed investors to sell riskier assets funded by loans in Japan. The yen is the strongest most-actively traded currency today as the carry trades unwound. Global stocks tumbled and companies from Australia to Canada sought emergency funds as they were unable to refinance debt. The last time the carry trade crashed was in 1998 after Russia's debt default in August. The yen gained 20 percent in less than two months… The Japanese currency advanced 3.9 percent [today]”

MISC

From RBSGC: “We are now approaching "panic" levels in mortgage pass-throughs, about +190/UST for the current coupon now, the widest print since October 2004. We reached +245/UST in August 2003 briefly as a large commercial bank sold a large stake in 30Y conventional 5s.”

From RBSGC: “We would argue that credit is in the process of getting squeezed even for "good" credits. This will almost eliminate any Mortgage Equity Withdrawal we have seen over the past few years. More importantly, with stocks and home prices falling simultaneously (for the first time in decades), there will be a very negative wealth effect on the consumer. That may take a while to show up in the data.”

From Wachovia: “…foreign holdings of U.S. securities totaled a bit more than $9 trillion. Consequently, foreigners own about 20% of the roughly $43 trillion of U.S. fixed-income securities and corporate equities outstanding. However, foreign holdings as a percentage of total holdings vary widely by type of security. Foreigners currently own about 45% of outstanding Treasury securities, but only 18% and 15% of agency securities and corporate equities, respectively.1 Foreign holdings of corporate bonds and miscellaneous bonds constitute 28% of the total.2 ...1 The percentage for Treasury securities includes the holding of the Federal Reserve System. If only marketable Treasury debt is considered, foreign holdings account for 50% of the total. 2 Not only are debt securities issued by corporations included in the category of “corporate bonds”, but so also are privately originated mortgage-backed securities and other types of asset-backed securities.”

From The Wall Street Journal: “…First American CoreLogic, a housing and mortgage data supplier…recently found that 7% of 32 million U.S. households studied as of December owed more than their homes were worth, based on computer estimates of the property values. An additional 4% had home equity of 55 or less. Since then, house prices have edged down in much of the country, erasing more home equity.”

From The Wall Street Journal: “U.S. lenders originated about $600 billion of subprime home loans in 2006, or 20% of all home mortgages, according to Inside Mortgage Finance…About 56% of those subprime loans were 2/28 mortgages...”

From Bloomberg: “Manufacturing in the Philadelphia region stalled in August, as orders and sales cooled. The Federal Reserve Bank of Philadelphia's general economic
index dropped to zero in August, the dividing line between expansion and contraction, from 9.2 in July…” (consensus was +8.6)

From Bloomberg: “First Magnus Financial Corp., the second-largest privately held U.S. mortgage lender, will stop funding new mortgages, according to a recorded message on a
customer-service line…First Magnus was the 16th-largest U.S. home lender in the
first half of this year, making $17.1 billion in loans…”

From Citi: “Amazing intraday volatility. The high low for 2 months of this year in UST 2Y was 20bps. We moved that and back again in the span of 2 hours this afternoon.”

From Dow Jones: “Analysts at Moody’s Investors Service warned that the credit crunch roiling global markets has the potential to cause the collapse of a major hedge fund that could further disrupt markets. As investors try to unload illiquid investments such as collateralized debt obligations, hedge funds that are unable to exit their positions could run into trouble, Chris Mahoney, vice chairman of Moody’s, said during a conference call with investors. The result could be the “failure and disorderly liquidation of a hedge fund of sufficient size to disrupt markets as (Long Term Capital Management) threatened to do,” he said during the call. Mahoney said the risk of such hedge fund failures will exist
for the next three to six months.”

End-of-Day Market Update

From Suntrust [at 3pm]: “If today doesn't fit Fed's Poole's definition of "calamity", woe be it unto the markets when calamity hits. Markets around the globe are haywire on the unwind of levered trades. The yen is almost 4 figures higher against the dollar and other currencies today from reversals in yen carry trades, where investors borrow the yen and invest in higher yielding assets. The unwind has hit commodities too. The slump in housing starts kicked lumber down $7 at one point. Gold is down $21 (3%), copper almost 7%, oil over
3%. Equities were lower by over 300 points, but have recovered some. Large liquidations were rumored in the 30 yr MBS sector today. Spreads blew out 20-25 bp, then narrowed back in by 10 or so. 2 yr notes traded at 3.96 before talk of a large curve steepener unwind pushed the yield back to 4.08. Rumors of a seller of $1 bln 2's to buy 10 yr notes along with a huge seller of 2's to buy MBS were around. Then the "FED is holding an emergency meeting" rumor swirled, but to no avail. Perhaps capitulation is here and the dust can settle long enough to at least pick up a few pieces.”

From RBSGC [at 4pm]: “More importantly was the pounding in stocks and widening of credit spreads and Fed's recognition of the liquidity crisis with a 12 bn overnight repo, 17 bn in 14-day system repo, and Funds trading at 5 1/16% (i.e. under target). The front end took aggressive action with 2s at one point testing 3.97% and challenging the Fed in the process. The violent action was panicky -- 2s at one point were 31 bp below the day's high -- and rather a 'leveraged' reaction to activity in other markets. There are a few things going on here. First, there is quarter end for a few large financial houses in two weeks which is likely to keep liquidity at a premium and risk appetites lows -- this should keep the market bid, albeit volatility. Second, month end will generate a big Tsy index extension…”

Yesterday’s Today’s Change
Close Low High Close
Dow 12861 12518 12885 12846 -15.7
S&P 1407 1371 1416 1411 +4.6

2y T 4.288 3.97 4.287 4.212 -7.6
5y T 4.451 4.184 4.451 4.348 -10.2
10y T 4.724 4.565 4.724 4.653 -7.1
30y T 5.026 4.911 5.026 4.956 -7

Swap spreads widened 1.5 to 3bp as of 4pm

Yen 116.6 112 116.75 114.4 -2.25
$Index 81.82 81.63 82.13 81.74 -.08

Oil 73.33 70.10 73.14 71.28 -2.05
Gold 667.6 642.3 668.2 653 -14.6

FNM 61.45 59.5 66.1 65.15 +3.7