Today's Tidbits

Comments From Jackson Hole Fed Conference
From Lehman: “As expected, Chairman Bernanke did not signal any fundamental change in monetary policy. However, this does not mean the speech was irrelevant. His speech did three things. First, it confirmed that the Fed has a bias to ease. He made clear that the two impediments to easing—inflation and concerns about bailing out risky investors—are now taking a back seat to concerns about growth. The Fed is aware that by adopting an easing bias and reaffirming it in Jackson Hole, it is now under the gun to follow up. Hence, no news is good news: it means the Fed is not trying to dissuade market expectations of rate cuts. Second, Bernanke did a careful rundown of the stresses in capital markets, the Fed's efforts to offset them, and the risks to the economy. This was a "good driver" speech: it shows clearly that the Fed is not asleep at the wheel--it is very aware of the risks and is ready to act as needed. Third, he emphasized that old pre-crisis data are misleading and that the Fed must focus on timely data and anecdotal evidence. It takes time for tighter financial conditions to slow growth, so even August numbers should be considered “old.” We will be keeping a close eye on: jobless claims, a volatile but useful early gauge of the labor market … auto sales, a volatile but useful early gauge of spending on consumer durables...existing home inventories, a leading indicator of both home construction and prices… confidence surveys and business surveys such as the purchasing manager’s index…The bottom line: the Fed has bought some time with its money market interventions and supportive talk, but there are growing downside risks to growth, and the market's recovery is predicated on the idea that the Fed is going to ease. We continue to expect 25 bp eases at each of the next two meetings, and the risk is that the Fed does more rather than less. We believe both the markets and the data will have to be strong in the next few weeks to stop the Fed, and we believe things will have to get much worse to cause either an intermeeting cut or a 50 bp move at the September 18 meeting. Two other themes emerged from the meetings and conversations on the hiking trails. First, there were a lot of bears in Jackson Hole…Even usually optimistic housing experts have thrown in the towel and expect considerable more bad news ahead. Second, the level of uncertainty about both capital markets and the economy is quite high. The spillover effects from housing to consumer and business spending may be small, or they could be considerable. The Fed must have been impressed that people from many disciplines —Wall Street, Main Street, academia, and foreign central banks—were all coming to the same conclusion. Only Marty Feldstein came straight out and suggested rate cuts, but that was the undercurrent in the room.”
From Merrill Lynch: “…Martin Feldstein, who is the head of the National Bureau of Economic Research and as such, is the guy responsible for ultimately determining recessions and expansions, not to mention the fact that he was on the short list two years ago for the Fed chairmanship job, also gave a speech at Jackson Hole over the weekend where he said, in quotes "there is a significant risk of a very serious downturn" and added that "the multiplier effect of home price declines and declines in consumer spending could push the economy into recession". He went on to say "I would be more comfortable if the Fed funds rate was 4-1/4% rather than 5-1/4".”
From Goldman Sachs: “…Governor Mishkin's paper …opens the door to a substantial amount of preemptive monetary easing in response to falling house prices. Using the Fed's model, Mishkin finds that a 20% decline in real house prices requires a 75bp reduction in the funds rate in the standard version of the model, and a 175bp reduction in a version that assumes "magnified" housing transmission channels. He didn't endorse either the 20% house price decline or the magnified housing effects as a baseline forecast, but I thought it was interesting that he presented such large rate cuts as "optimal policy" in a paper that was presumably extensively vetted before publication…John Muellbauer presented a very interesting paper which explicitly modeled the interaction between house prices, credit availability , and spending. He found that the wealth effect has grown sharply in the wake of the recent credit loosening, especially in the US, and that it is now as large as 7 cents on the dollar. Moreover, Muellbauer's results imply that a simultaneous decline in housing wealth and credit availability could have even larger adverse effects on consumption…Meanwhile, the recent data support the view that MEW matters. A standard Fed-style model with equal 3-5 cents/dollar wealth effects for both housing and financial assets implies that consumption should grow more quickly than income as long as the ratio of overall household wealth to disposable income is rising. However, over the last year, real consumer spending has grown 1.3 percentage points more slowly than real disposable income (2.5% vs. 3.8%), despite a rising wealth/income ratio. This supports the idea that, on a per-dollar basis, housing is much more important than financial wealth for spending, probably because of MEW/credit availability channel. Given what's happening to MEW, house prices, and credit availability, the underperformance of consumption is likely to continue…we now expect declines in nominal home prices of 7% in both 2007 and 2008. In such an environment, it is very possible that the Fed will need to ease more than 75bp to keep the economy out of recession.”

Comments on the U.S. Government’s Plans to Help Subprime Borrowers
From Bear Stearns: “The FHAsecure mortgage program is a refinance product targeted exclusively to borrowers that are delinquent because of payment reset. The Bush administration estimates that 240,000 families (representing approximately $53 BB in subprime debt) will be saved from foreclosure by the new program. This program requires no congressional approval and is scheduled for immediate implementation…Based on preliminary specifications released by the FHA, under the new program the FHA will guarantee a first lien mortgage that meets the following requirements: 1.Borrower has a recent clean payment history (probably 12-months) 2. Borrower has at least 3% equity in the home 3.Verification of employment and income (i.e. full documentation) 4.The lender may execute a second mortgage to cover closing costs and arrearages in excess of the 97% LTV limit…If we look at the roughly $450 BB of subprime resets scheduled for Q3 2007 through Q4 2009, we find that 28% ($130 BB) qualify under the preliminary guidelines (<97% LTV, full documentation, 12-month clean pay history). In this group we expect borrowers with LTVs between 85% and 97% to be the heaviest users of this program since they currently have very limited or no refinancing alternatives. This group represents approximately 270,000 borrowers ($55 BB)- a level that is roughly consistent with the Bush administration number. The remaining 384,000 borrowers ($ 75 BB) with LTVs less than or equal to 85% will likely qualify under the expanded approval programs set up by the GSEs or for some other form of financing…From a performance perspective a refinance is much preferred to a loan modification since it cures and removes the loan from the mortgage pool. In contrast, history has shown that a significant percentage of loan modifications still end in default. Thus, if we assume in our previous analysis of loan modifications …that current pay, high LTV loans are refinanced instead of modified we find that our projected cumulative default for the 2006 vintage of 2/28 loans declines by nearly 10% (from 36.5% to 27.8%). Thus, it is clear that the program has the potential to lower losses significantly… Of course the true impact of the program will be determined by how rigorous the underwriting process really is and the path of home prices. Some of these details will be revealed in this week’s FHA Mortgagee Letter. In particular, any relaxation in documentation requirements or payment history requirements could broaden the scope of the program significantly. However, it is clear that the Bush administration must walk a fine line between offering a prudent underwriting alternative for deserving subprime borrowers and a program that could be viewed as a bailout to subprime borrowers.”
From RBSGC: “Even borrowers who are 90+ days delinquent would be eligible to refinance into an FHA loan. Note that the borrower would still have to qualify for the loan under the normal process, which often takes another 90 days or so. The borrower would pay the FHA insurance fees, which are typically 1.5 points up front and 50 bp per annum. The FHA estimates this will add 80,000 borrowers to the program next year, or roughly $13 bn in additional production. This is obviously a pretty small event from a macroeconomic point of view (a small portion of even one major city in the US), but will significantly increase GNMA issuance. Net issuance should go from negative to positive. Gross issuance should increase by roughly 18% to $7 bn per month from $6 bn on average, including GNMA IIs. GNMAs are down significantly versus conventionals this morning, reflecting this already. The maximum loan balance for FHA loans would remain in place, currently $362,790. This issue would exclude wide areas of the country with subprime borrowers, including New York and California, where the average mortgage balance is much higher. Note that GNMA has announced they will accept jumbo VA loans and Congress may push the FHA limit to match the conforming loan limit of $417,000.”
From Bloomberg: “U.S. bank regulators urged mortgage lenders to ease terms on the subprime loans they packaged into bonds, seeking to stem foreclosures that may aggravate what's already the worst housing slump in 16 years. The Federal Reserve and other bank regulators asked lenders to review their authority under pooling and servicing agreements to identify borrowers at risk of default and offer to refinance to help them keep their homes, the agencies said in a joint statement released today in Washington. ``We encourage servicers of securitized mortgages to reach out to financially stressed homeowners,'' Fed Governor Randall Kroszner said in a statement. The regulators' recommendation is part of a broader push by the federal government to stem the growing rate of foreclosures among borrowers with weak credit or high debt and to quell the recent turmoil in the credit markets. Last week, President George W. Bush unveiled his plan to help homeowners avoid foreclosure, including a new initiative that would allow the Federal Housing Administration to help borrowers facing rising mortgage payments stay in their homes. The number of U.S. homes under foreclosure almost doubled in
July from a year earlier as property owners with adjustable-rate mortgages faced larger monthly payments, according to RealtyTrac Inc., the Irvine, California-based seller of foreclosure data. The regulators urged lenders to use their authority under the securitization documents to identify borrowers at risk of delinquency or default, including those facing interest-rate increases on their loans, and contact them to assess their ability to repay. They should consider helping borrowers avoid foreclosure by deferring payments, converting loans to a fixed-rate mortgages and other ways that help homeowners manage payments, the regulators said.”
From Dow Jones: “Federal regulators are encouraging financial institutions to determine the full extent of their authority under pooling and servicing agreements to identify borrowers at risk of default. A joint statement was issued Tuesday by the Federal Deposit Insurance Corp., Federal Reserve, the Office of the Comptroller of the Currency, the office of Thrift Supervision, the National Credit Union Administration and the Conference of State Bank Supervisors. The statement is significant because it shows the heightened concern among regulators that problems in subprime markets will likely worsen before improving. “More and more consumers with subprime and hybrid mortgage products are facing the very real prospect of losing their homes through foreclosure as their payments reset and become unaffordable,” Federal Deposit Insurance Corp. Chairman Sheila Bair said. “With declines in housing prices in some areas and tighter credit for subprime loans, it is vital that mortgage servicers work proactively with borrowers facing much higher payments as their interest rates reset.”

Funding Issues Persist Causing Further Market Dislocations
From Barclays: “In contrast to other assets, the money markets are signaling deepening problems as liquidity is increasingly confined to overnight rates. If the term deposit
market continues to malfunction, a second sell-off in equities and other asset markets is increasingly probable. However, common sense suggests that central banks will eventually find a successful way of returning liquidity to the money markets - and by extension to the interest rate swap and FX forward markets. Longer run, current events may serve to influence the way central banks react to speculative bubbles.”
From Deutsche: “Libor continues to remain the most volatile instrument in US rates as funding pressures continue to cause 3mL to press higher [5.70% this morning]. The term markets continue to remain dysfunctional and expectations for increased demand for short term funding (CP rolls over the next few weeks) has moved spot Libor up nearly 20bps since last week. This phenomenon is unique to Libor as Fed Funds effective
continues to remain low due to expectations for a 25bp cut - the result is that FedFunds / Libor basis continues to blow out.”
From Bloomberg: “The Federal Home Loan Bank system, the cooperatives chartered by Congress to promote home ownership, said its lending rose 14 percent in August to $769 billion as other sources of financing for mortgages dwindled…The 12 Federal Home Loan banks lend money to 8,100 thrifts, credit unions, insurance companies and commercial banks at below- market rates in order to finance their holdings of mortgages. The banks in the system, which was formed 75 years ago, also buy and hold mortgage-related assets themselves. They're owned by their borrowers, and raise money as a group in the so-called agency bond market, like government-chartered mortgage companies Fannie Mae and Freddie Mac. The system's borrowing rose by $110 billion in August to $1.087 trillion. Discount notes increased by $82 billion to $249 billion; longer-term bonds rose $28 billion to $838 billion.”
From Citi: “Swap players having real issues dealing with resets, and this impacting bank players in general. Also, between the Libor resets and effective Fed Funds continuing to trade well below the official rate, it makes trying to gauge what the market really anticipates or hedge what the Fed may or may not do extremely difficult.”
From Dow Jones: “Daily issuance volumes of asset-backed commercial paper hit a new high in the week to Friday, according to Federal Reserve data, a sign that the rush to sell ever-shorter-term maturity debt amid the current credit crisis has yet to diminish. The Fed’s data showed that in the week to Friday, asset-backed commercial paper sold averaged a daily $90.6 billion, up from $88.6 billion the prior week. By way of comparison, an average of around $70 billion was sold in June and July, while average daily issuance last year was just $51.2 billion. More than three-quarters of the total issued was concentrated in the maturity range of one to four days, with only $938 million issued in the 81-plus-days category. The numbers reflect all sales of asset-backed commercial paper to investors by dealers or direct issuers, but they exclude secondary issues and repurchase agreement and financing issuance of commercial paper. Last week’s numbers were the highest since the Fed started keeping records on commercial paper in 2000. The commercial paper market, which is where companies and banks go to fund short-term financing needs, has been at the heart of the recent credit crunch. Asset-backed commercial paper was one of the most popular funding instruments for purchases
of higher-yielding, longer-term mortgage products. When mortgage products started to hit trouble earlier in the summer, asset-backed commercial paper rates spiked as issuers
found it increasingly hard to borrow. With some issuers being forced out of the market, the amount of outstanding commercial paper has dropped sharply in recent weeks, with total volumes falling by 11% in the three weeks to Wednesday, while the outstanding amount of asset-backed CP has declined by more than 15%. However, even while the total outstanding has declined, the daily volume of commercial paper - and asset-backed CP in particular - has jumped. That’s because issuers are having to sell increasingly
short-term paper and roll it over much more frequently. That’s led to a massive pile-up in commercial paper which matures over a very short time period.”

MISC

From Bloomberg: “While there is no basis for predicting a recession right now, the risks have surely gone up,'' says former Treasury Secretary Lawrence Summers, now a professor at Harvard University in Cambridge, Massachusetts. ``The combination of softness in the housing sector, contractions in credit, increased uncertainty and volatility, and losses in wealth make the chances significantly greater now.''

From Merrill Lynch: “…jobless claims…a key economic barometer to watch for several reasons. First, it is a weekly, and therefore timely, statistic. Second, it is an official leading indicator of the economy and of employment. Third, we thought that employment would be the key to the seriousness of the housing problems because people generally tend not to give back the keys to their homes so long as they are employed… jobless claims have now risen for 5 straight …Significant increases in jobless claims would surely signal that the front end of the US economy (and the global economy for that matter) are starting to weaken more than has been anticipated. Our five investment themes (high quality bonds, large cap stocks, defensive sectors, developed markets, and high quality dividends and income) are likely to gain wide acceptance if these data show more weakness.”

From Dow Jones: “U.S. auto makers, battered by economic headwinds, posted mixed August U.S. sales with General Motors Corp. reporting a surprising increase. Meanwhile, Ford Motor Co. posted a 14% skid in sales for the month and said it sees higher fourth-quarter production. Toyota Motor Corp. posted a 2.8% sales drop. GM said its U.S. sales of cars and light trucks for August rose 6.1% from a year ago, but the company lowered its third-quarter production forecast and sees lower fourth-quarter output.”

From Bloomberg: “Wheat rose the maximum allowed by the CBOT on rising
purchases by India, the second-biggest consumer, and forecasts that global supplies will drop to their lowest in 26 years. Prices have doubled in the past year in Chicago and reached a record high last month.”

From FTN: “Despite the turmoil of the past several weeks, the WSJ reports $71.6bn in investment grade corporate bond issuance in August, the most ever in August and the sixth most in any month ever. Many companies issued bonds rather than commercial paper…”

From The Rutland Herald: “A strong human working hard all day can put out roughly 100 watts of power. Working hard 12 hours per day, six days per year, 50 weeks per year, a human can produce about 1 million BTUs of energy — the amount of energy contained in eight gallons of gasoline.” [Based on per capita oil consumption, this equates to 150 people working full-time on manual labor per person in the U.S.]

From Bloomberg: “…the cheapest stock market in almost 12 years…Software makers in the Standard & Poor's 500 Index are valued at an average 20.8 times estimated profit, the lowest since at least 1995, according to data compiled by Bloomberg. Industrial companies trade at 18.4 times earnings, lower than their average of 23.4 this decade… The S&P 500 Diversified Financials Index last month was valued at 10.6 times earnings, the cheapest since at least 1995, according to Bloomberg data.”

From Dow Jones: “CME Group Inc. posted a 78% increase in trading volume last month, benefiting from a surge in market volatility amid investors’ jitters about deepening problems in the subprime mortgage market and tightening credit conditions.”

End-of-Day Market Update
As of 3:45, ten year Treasury yields are up 2bp to 4.55%. The Dow has rallied 103 points to its highest level in almost a month. The dollar index is up .08 to 80.90, but gold has rallied $10 to $682.7 (its highest level since July). Oil is up over at dollar to $75.08 – its highest level in exactly a month. (Report out early as going into a meeting from 4-5.)