Today's Tidbits

Credit Crunch Continues as LIBOR [London Inter-Bank Offered Rate] Rises
From Bloomberg: “The three-month rate banks charge each other for dollars held at a seven-year high, indicating central bank efforts to free up cash in money markets are
misfiring. The overnight rate declined. The three-month London interbank offered rate, or Libor, for dollars was unchanged at 5.72 percent, the highest since January 2001, the British Bankers Association said today. It was at 5.36 percent on July 31. The overnight rate dropped 4 basis points to 5.47 percent… The U.S. benchmark overnight lending rate is 5.25 percent.”
From Merrill Lynch: “We are certainly experiencing extraordinary times in the capital markets when, despite the Federal Reserve's best efforts to provide liquidity to the money markets, the key short-term LIBOR rates keep rising. The unprecedented scope of the credit crunch in the money markets does not bode well for the real economy… Despite the Fed's large injections of liquidity into the money markets and its pledges to do more, the 3-month LIBOR (inter-bank offer rate) rate has risen to 5.85%, up 50bps from early August and the highest level since January 3, 2001, the start of the Fed's previous easing campaign. The LIBOR curve is inverted as 1-month and 3-month rates (5.85%) are higher than 1-year rates (5.30%). The spread of 3-month LIBOR less the targeted Fed funds rate is a wide 60bps, typically such a widening in spread would be associated with Fed tightening, not easing. On average, going back to 1990, the spread between the 3-month LIBOR and the Fed funds rate is just around 16bps. LIBOR, the London Inter-bank Offered Rate, is an important global benchmark rate for everything from large global corporate loans to US mortgages to corporate deals. It is calculated daily based on the interest rates at which banks offer to lend unsecured funds to other banks in the London interbank market for periods as short as overnight and as long as one year. More specifically LIBOR is used in determining the price of variable-rate government and corporate loans and widely used financial derivatives, including interest rate futures, interest rate swaps and Eurodollars, as well as floating rate notes, syndicate loans, and adjustable rate mortgages. Interest rate swaps are reported to be the largest component of the global OTC derivative market, with a notional amount outstanding at a sizeable $230 trillion at the end of 2006. This represents 55% of the entire OTC - over the counter - derivative market. Interest rate swaps are also extremely important in providing a liquid secondary market for residential mortgages, which in turn allows lower interest rates on US mortgages.”
From Dow Jones: “The Federal Reserve added far more reserves to the system than expected, matching similar liquidity injections carried out by overseas central banks.
The Fed supplied a total of $31.25 billion in three separate operations, following several days of more meager injections…“This surge in reserve supplies suggests that the Desk
feels that it is far behind its add-job for the period.” The Fed invited bids backed by Treasurys, agency bonds and mortgage bonds, resorting to the widest scope of acceptable collateral.”
From SunTrust: “The FED announced CP issuance fell by another $54 bln in the last
reporting week, $31 bln of which was ABCP. That brings total CP issuance down
by $298 bln in the last 4 weeks.”

European Central Banks Stopped Tightening
From Bloomberg: “The European Central Bank and Bank of England left their key interest rates unchanged, putting anti- inflation campaigns on hold as policy makers sought to calm markets roiled by the collapse of subprime mortgages in the U.S. Hours before its rate decision today, the ECB pumped 42.25 billion euros ($57.7 billion) into money markets, providing emergency cash to reduce borrowing costs that reached their highest in six years yesterday… Both banks pointed to market turmoil in explaining their decisions. Concern that defaults on U.S. home loans would spread losses through the European banking system pushed up the interest rate on interbank loans the past month, forcing lenders to borrow from the central banks. ``At whatever price, at whatever interest rates, the market has to function,'' Trichet said. ``The functioning of the market - - the money market, the commercial-paper market – is significantly hampered by an absence of confidence.'' The turmoil in credit markets will likely damp economic growth next year, with the U.S. economy suffering the most, International Monetary Fund spokesman… Today's ECB cash injection sent overnight borrowing costs to 3.7 percent from as much as 4.68 percent yesterday.”

Speculators and Flippers Fuel Major Increase in Delinquencies
From CNN: “Defaults in non-owner occupied houses are driving defaults in four of the states with the fastest rising default rates in the nation, according to a report released Thursday by the Mortgage Bankers Association…Several sun-belt states were magnets for real estate speculators during the home-price boom…As of June 30, in Nevada, 32 percent of all prime mortgages in default and 24 percent of subprime defaults were on non-owner occupied properties, according to the MBA. The numbers for Arizona were 26 percent prime and 18 percent subprime. In California, they were 21 percent and 15 percent respectively. The default rates in Florida for non-owner occupied homes were 25 percent for prime loans and 14 percent for subprime ones. In the rest of the nation, non-owners accounted for just 13 percent of prime loan defaults and 11 percent of subprime. "California, Nevada, Arizona and Florida were among the states with the fastest home price appreciation over the last five years. This...attracted both speculators and home builders, a volatile combination that led to an over-supply of homes that was beyond the capacity of the local populations to support,"…"When this over-supply became apparent and prices began to fall, many of these investors simply walked away from their mortgages." In Nevada and Arizona, 29 percent of all the prime mortgage loans written in 2005 were for non-owner occupied home purchases. In California, it was 14 percent and in Florida, a whopping 32 percent, according to the MBA. The subprime figures for non-owner occupied home purchases were 14 percent in Nevada and Arizona, 15 percent in Florida and 7 percent in California.”
From Lehman: “The rate of homes entering the foreclosure process jumped to a record high of 0.65% from 0.58% [the highest rate in the MBA's 55-year history]. On a dismal note, we judge the recent deterioration in mortgage performance to be just the beginning. Delinquencies and foreclosures should continue to rise over the next several quarters, particularly as subprime adjustable-rate mortgages reset to higher rates… As of Q2, 14.82% of subprime loans were delinquent, which is a 1.1bp increase from Q1. The bulk of the rise can be attributed to adjustable-rate mortgage delinquencies.”

Credit Bubble Bigger Than Housing Bubble
From Merrill Lynch: “Since this economic expansion began in late 2001, the aggregate household debt-to-disposable income ratio surged from 100% to a record of 136%. In six
years, the personal sector was able to tack on as much as debt to this ratio as the prior forty years combined. This 6 percentage point run-up per year was triple what was “normal” in other economic up-cycles. Most of this, as we are only now finding out, were loans extended to households who were either dramatically expanding their real estate portfolio or tapping home equity through loans for consumer spending in other areas apart from housing…The housing bubble was never about “consumer resilience”. It was about leverage – unfettered access to credit… According to the Fed’s flow-of-funds data, real estate valuations surged 67% since this economic cycle began in late 2001. But the amount of mortgage debt soared by 86%. The amount of debt taken on in the form of mortgage debt exceeded the extraordinary appreciation in existing homes, the cost of newly built homes and presumably the money spent gold plating and otherwise improving existing homes. Homeowners quite satisfied to stay put were more than willing to extract that rising home equity via mortgage cashouts or other lines of credit… So this was an even bigger credit bubble than it was an asset bubble. Individuals opted to use some portion of their home appreciation for consumption by taking on additional debt and tapped it so extensively that aggregate equity, in that prized retirement asset relative to outstanding real estate values, fell this cycle (since the end of 2001) from nearly 58% to an all-time low of 52.7% today. And now the dramatic appreciation of recent years is receding and threatening to drive the ratio much lower.”

Back to School Retail Sales Better Than Expected
From Bloomberg: “Wal-Mart Stores Inc., Macy's Inc. and retailers catering to teenagers reported August sales that topped analysts' estimates on purchases of clothing and
electronics for the new school year. Wal-Mart, the world's largest retailer, said U.S. sales at stores open at least a year increased 3.1 percent, after forecasting a gain of 1 percent to 2 percent. The chain slashed prices on 16,000 back-to-school items such as notebooks and staplers after customers cut back on visits. Retailers benefited from back-to-school shopping, the industry's second-biggest sales period after the December holidays. Consumers, concerned about lower home values and higher borrowing costs, limited spending on non-necessities and hunted for discounts.”

Employment Growth Likely to Slow
From Goldman Sachs: “We are cutting our forecast for August payroll growth to 75,000 and raising our forecast of the unemployment rate to 4.7%.” [Consensus 100k and 4.6%]
From JP Morgan: “The employment index has plunged 7.1-points over the past two months, the largest two-month decline ever for this series which goes back to July 1997. The index now stands at the lowest level since December 2003. Indeed, the last time the index fell below 50 was in July 2004. Nonfarm payroll growth was only 59,000 that July, compared to the May-September 2004 average of 141,000. And when the employment index has been at levels close to this August’s, nonfarm payrolls have always declined. In contrast, the ISM manufacturing employment index rose to 51.3 from 50.2. But that index is less useful for judging payroll trends.”
From JP Morgan: “We are keeping the forecast for nonfarm payrolls unchanged at 125,000. The ADP report and the ISM employment index both suggest a lower number. Two considerations give us pause in revising down the forecast. First, the risk to the government employment forecast (+30K) is geared to the upside, as the projected 30K gain would still leave the July-August average at a mere +1,000; government employment growth was averaging about 20,000 per month prior to July's drop which was caused by seasonal adjustment problems in teachers' employment. Second, neither the ADP nor the ISM nonmanufacturing employment index correlates well with monthly changes in payrolls, although both can provide reasonable guidance on the trend. That said, the risk to our forecast is clearly on the downside and significantly so. We expect the unemployment rate to hold at 4.6%.”

Is China Reducing Treasury Holdings?
From The Telegraph: “A sharp drop in foreign holdings of US Treasury bonds over the last five weeks has raised concerns that China is quietly withdrawing its funds from the United States, leaving the dollar increasingly vulnerable. Data released by the New York Federal Reserve shows that foreign central banks have cut their stash of US Treasuries by $48bn since late July, with falls of $32bn in the last two weeks alone… "We won't know if China is behind this until the Treasury releases its TIC data in November, but what it does show is that world central banks are in a hurry to get out of the US. They don't seem to be switching into other currencies, so it is possible they are moving into gold instead. Gold is now gaining momentum across all currencies and has broken through resistance… While the greenback has been resilient over recent weeks - even regaining something of a 'safe-haven' role as banks scrambled to buy the currency to cover dollar debts - most experts believe that America's $850bn current account deficit will eventually cause the dollar to resume its relentless slide… Two top advisers to the Chinese government gave strong hints in August that Beijing should use its estimated $900bn holdings of US Treasuries and agency bonds as a "bargaining chip", words taken as an implicit threat to trigger as US bond crash if provoked. The Chinese government has since put out an official statement clarifying that it has no intention in taking such an irresponsible step, which would in any case backfire by devaluing China's remaining holding… Any evidence that China was pulling out would risk setting off an unstoppable stampede, which is why such a policy would never be announced. It holds the world's biggest pool of reserves, followed by Japan.”

MISC

From Goldman Sachs: “The overall commercial paper market continues to shrink as has declined in size by about $50bn over the last week. Though the market is very large at $1903bn and the pace of decline has slowed, these declines remain substantial. The asset backed market commercial paper market also continues to shrink, falling to $959.0bn vs. $1173.4bn four weeks ago. Seasonally adjusted, the declines appear to be even larger.”

From Bloomberg: “Countrywide Financial Corp. shares dropped below $18, wiping out the $700 million paper profit Bank of America Corp. made when it invested $2 billion in the nation's biggest mortgage lender two weeks ago.”

From Merrill Lynch: “As all of us were taught, but most of us have long since forgotten, economic change occurs at the margin, where the action takes place... individuals who can think on the margin always have an advantage over those who cannot.”

From Goldman Sachs: “Historically, performance of DJI [the Dow Jones Industrial Average] in October in years ending [in]***7 has been poor (-8.4% average since 1907).”

From Bloomberg: “Gold topped $700 an ounce for the first time since May 2006 on speculation that further declines in the dollar will boost the appeal of precious metals as
alternative investments. Silver also gained. Five of the past six bear markets for the U.S. currency pushed gold prices higher. Investment in the StreetTracks Gold Trust, an exchange-traded fund backed by bullion, reached a record 528 tons yesterday. Before today, the metal climbed 8.3 percent this year, and the dollar had fallen 3.3 percent against the euro.”

From Dow Jones: “Hedge funds are increasingly positioning themselves as direct lenders to companies that are having trouble borrowing money from banks or through the bond market. These investors aren’t strangers to the world of lending, and they’re preparing to play a bigger role by capitalizing on the wave of risk aversion that has swept global markets this summer. Banks are shying away from lending to riskier corporate clients and struggling to find buyers for hundreds of billions of dollars in debt stemming from the leveraged-buyout boom, opening the door for hedge funds and some private equity firms to fill the void.”

From Bloomberg: “For the first time in recorded history, farming is no longer the world’s dominant occupation, having been surpassed by the service sector, a United Nations Report says…Agriculture accounts for 36 percent of global employment…industry’s share has stagnated at about 22 percent of all jobs…”

End-of-Day Market Update
From Lehman: “…stocks made a small rebound, and treasuries sold off in fairly quiet trading… The yield curve flattened [4bp for 2s30s]… Thursday's yield changes were roughly as follows:2 years:+5.0 bp 5 years:+3.8 bp 10 years:+3.0 bp 18 years:+2.0 bp 30 years:+1.7 bp”
From UBS: “Agencies traded in line with swaps. Mortgages saw only moderate activity, tightening 4 ticks to Treasuries and 2 to swaps.

Dow closing up 58 points at 13,363, and S&P up 6 at 1478.5. Dollar index weakens by .15, falling to 80.47. Yen at 115.4 and euro at 1.369. Oil rallies 65 cents, to close at $76.38, after rallying close to the YTD high of $78 reached in early August.