Today's Tidbits

Fed Study Indicates Low Down Payment Loans Fueled Housing Boom
From BusinessWeek: “…the national rate of homeownership suddenly began rising around 1995. The rush to buy homes fueled an enormous surge in housing construction and home prices…. new research published by the Federal Reserve Bank of Atlanta concludes that the bulk of the increase was caused by innovations in the mortgage market, in particular the explosion of "piggyback" or "combo" loans that made it possible for people to make small or zero down payments. Young families with little savings flocked to those loans to buy first homes… Using math-heavy econometric analysis, the authors conclude that the availability of new kinds of mortgages, mainly ones with low down payments, accounted for 56% to 70% of the decade-long increase in the U.S. homeownership rate, while demographic changes accounted for only 16% to 31% of the effect. A combo loan such as those mentioned in the Atlanta Fed paper consists of two loans, one for 80% of the value of the house and the other for 10%, 15%, or even the entire 20% remaining. The reason for taking two loans instead of one big one is that 80% is ordinarily the maximum loan-to-value ratio for loans that are eligible for purchase by Fannie Mae and Freddie Mac. When the borrower makes little or no down payment, he or she is more likely to walk away from the loan if the house loses value and return to being a renter. But could the homeownership rate actually decline? Yes. In fact, it already has begun to. According to the Census Bureau, it was 68.2% in the second quarter of 2007, down from 69.2% in the fourth quarter of 2004 and 69.1% in the first quarter of 2005. Goldman's Hatzius says that "given the current number of U.S. households of 110 million, the change in the homeownership rate over the past two years has already subtracted almost 500,000 from the underlying demand for new homes."

More on Impact of Housing Market Slowdown on Economy
From Merrill Lynch: “The Flow of Funds report released last month showed that that homeowners' real estate equity declined in 2Q by 0.22% (annualized) from 1Q and is up just 0.9% from one year ago. This is the slowest yearly pace of real estate wealth accumulation since 1993. Clearly the recession in the housing market is taking its toll. However, even these sluggish numbers, which are based on the relatively narrow OFHEO measure of home prices, may be overstating the true state of real estate wealth in our opinion.”
From Market News: “The WSJ carries an article, saying home prices in some of Europe's hottest markets are falling after a decade of double-digit-percentage price increases, noting the reasons resemble those across the Atlantic: higher interest rates, faltering confidence and tighter lending standards.”
From Barclays: “Homebuilders are priced for a depression. Some have price-to-books at below 0.5. It used to be that price-to-books at 1 were considered cheap. The pricing suggests a further decrease (from today) of 205-30% or more in housing rices…financials are priced to a low PE (8-12 range for many) mainly because the market believes that their profit growth is unsustainable and that there will be some giveback…although, if the homebuilders are right on a depression, Wall Street may be expensive.”
From the Financial Times: “Banks are adding to reserves not just for defaults on mortgages, but also on home equity loans, car loans and credit cards.”

From Bloomberg: “Countrywide Financial Corp., IndyMac Bancorp Inc. and Washington Mutual Inc. were downgraded by Lehman Brothers Holdings Inc. analyst Bruce Harting, who said their share prices don't reflect ``the worst of their problems.''”
From Deutsche Bank: “The last time housing starts were as low as they were in Q3 2007, was during a temporary dip in Q2 1995 or on a more sustained basis in the first half of 1993. Residential construction payrolls at those respective times were only 64% and 58% of the current level*, so we will not be surprised to see significant layoffs over the next several months as the size of the construction workforce falls to a level more consistent with the pace of activity. (*It is important to note these figures correspond purely to residential construction, because there was no data on specialty trade contractors in the residential sector published at that time.)”

Estimating Negative Impact of Higher Oil Prices on Economic Growth
From JP Morgan: “We expect higher fuel prices to take a little less than 1% point off annualized real income growth this quarter and, by itself, reduce real consumer spending growth about one half that amount. Combined with the effects of a softening labor
market and tighter credit standards, real consumer spending growth looks set to slow from a projected 3.5% pace at an annual rate in 3Q07 to 1.8% in the current quarter…The slowdown in consumer spending is coming at the same time that the downturn in housing is intensifying and that business spending on fixed investment is moderating. The result is a marked slowing in real GDP growth from an estimated pace of 3.2%q/q, saar last quarter to a forecast 2.0% in the current quarter. At the same time, headline inflation
is increasing. And the combination of passthrough from higher fuel prices and from the weaker dollar threatens to push up core inflation as well.”
From Merrill Lynch: “Ninety dollar oil is going to extract a lot of pain in the coming months… if the new range is $90+ then we are talking about a 1.25 percentage point drag on real GDP growth – at a time when the trend is barely 2%. We have built half that drag into our 1.5% GDP call for next year. But clearly, this oil drag, coupled with the spread of the housing recession, clouds the outlook in a very material way.”

Are Foreign Equity and Commodity Markets Ready for a Correction?
From Credit Suisse: “…emerging market equities hardly noticed the credit crisis, and China related equities have been on a moonshot, with A shares now 40% higher than they were in late July, and the Hang Seng about 20% higher. Reinforcing the message, Baltic Freight (Dry Bulk) has doubled since mid-June, oil and gold have made new highs and copper seems poised to do so…In each of the last two weeks inflows into EM equity funds have been above 5bn dollars, which has never happened before, with about half of that money going into Asian equities. On a 4-week rolling basis, net flows into GEM equity funds have reached an alltime high…the Chinese communist party is holding its crucial five-yearly congress. With inflation expectations and wages in China apparently picking up sharply and accelerated price gains in both equities and property, there must be serious risk of another round of policy tightening once the congress is over. So just when you thought it was safe to go back in the water, it looks as though we are setting ourselves up for another shock in financial markets, as some of the froth comes out of the emerging equity, and most especially, the Asian equity complex.”
From Merrill Lynch: “Europe down more than 1.5% across the board today - Commerzbank's CEO Mueller on the tapes saying that subprime provisions "won't be enough". Asia was very weak, with the Nikkei down 375 points (-2.2%) to 16,438 and the Hang Seng pummeled 1,091 points or 3.7% to 28,374 in the sharpest falloff (point-wise) in seven years. The Korean Kospi lost 3.4% and even the high-flying Chinese market succumbed to the global contagion via a hefty 2.8% slide (Taiwan reported a surprising uptick in its unemployment rate today to a 3-month high). US futures are down size at this moment - the S&P 500 is now down 4.1% after testing that peak back on October 9th. If there is one asset class that is not buckling (outside of high-quality bonds), it is the commodity complex - and for one reason why that is the case, have a look at the front page article in today's WSJ titled "Ship Shortage Pushes Up Prices of Raw Materials". There is a chronic shortage of bulk ships everywhere, which is why the Baltic Dry Index has doubled in just the past four months after hitting a record high on Friday.”
From Barclays: “China is prices as though super-charged GDP growth is here to stay.”

Recent Bank Balance Sheet Changes
From RBSGC: “MBS holdings by US banks decreased $4 bn with pass-through holdings down $3 bn and CMO holdings little changed. MBS holdings were down $38 bn since the start of this year. Deposits increased $30 bn over the past week. Since the start of this year, deposits increased $313 bn. Commercial and industrial loans increased $13 bn for all banks over the week. Since the start of the year, C&I loans increased $178 bn. Whole loan holdings increased $8 bn over the week. Since the beginning of the year, whole loan holdings increased by $117 bn.”

MISC
From Merrill Lynch: “…rare is the day that earnings are heading south and the market isn't doing likewise.”

From Barclays: “…the credit markets remain in need of a real capital infusion.”

From Merrill Lynch: “the G7 does not appear to have the appetite to change FX dynamics. That could well open the door for extended USD weakness.”

Bank of America: “The Treasury seems to be showing a preference for liquidity in 2yr notes than bills.”

From Dow Jones: “Federal Deposit Insurance Corp. Chairman Sheila Bair said that bank regulators are concerned about the damage that the current credit crisis is having on banks’ reputations. Regulators are discussing whether banks may need to boost their capital to guard against depositor concern about off-balance- sheet and other risks, Bair said after a talk in New York. “It needs to go beyond what we’re already doing,” Bair said. The issue is not so much about banks depleting their regulatory capital ratio, which requires certain levels of cash to insulate them from unexpected market turbulence, as it is their need to reassure depositors that they aren’t hiding assets off their balance sheets, she said.”

From Macroeconomic Advisors: “There was a substantial shift in sentiment in financial markets this [past] week…developments led to a massive rally in Treasury securities, as investors revised down their expected path of monetary policy through 2008 by nearly one-half percentage point. That revision resulted in a 43-basis-point decline in the two-year Treasury yield over the week (to 3.80%) and a 29-basis-point decline in the ten-year yield (to 4.41%).”
From Merrill Lynch: “…not since 1960 have we entered a Fed easing cycle and possible recession with inflation – both headline and core – as low as it is today. We see that that the flurry of buying action at the front end has taken the 2-year note yield down to levels not seen since the aftermath of Katrina in September 2005.”

From Merrill Lynch: “A just released NABE (National Association of Business Economists) survey shows there to be more skunks at the picnic: 56% of businesses polled are more pessimistic now – double the share in July – and for the first time since 2002, the majority believe that GDP growth will come below 2% for the USA in the coming year. Net hiring intentions receded to 17% from 24% three months ago. Capex plans slipped from 50% saying “yes” to now just 43%. Fully 36% say that the tightening in credit guidelines is negatively affecting their businesses.”

From Goldman Sachs: “One sector that has helped offset the housing slump so far is nonresidential construction. Both private and government building have been buoyant, offsetting roughly half of the impact of the residential downturn on real GDP growth over the past year. However, many of the same conditions that drove residential housing activity to unsustainable levels—easy credit, financial innovation, an influx of new buyers with investment motives—have contributed to the boom in the nonresidential sector. With these conditions now in retreat, growth in nonresidential construction is apt to slow significantly over the coming year, with negative ramifications for growth, employment, and credit performance.”

From JP Morgan: “The main theme emerging from the BoJ’s September Tankan survey was the widening gap in business conditions between large firms, where conditions are steady, and smaller firms whose situation has deteriorated…The main theme emerging from the BoJ’s September Tankan survey was the widening gap in business conditions between large firms, where conditions are steady, and smaller firms whose situation has deteriorated…”

From Lehman: “The New York Times reported that collateralized debt obligations (CDOs) have begun to shut off payments to holders of low-rated tranches, following recent ratings downgrades of subprime mortgage backed securities. While the move was widely expected by market participants, the macro impact may only take effect with the realization of the losses.”

From Bloomberg: “The annual cost of attending a private four-year college in the U.S. rose 3.9 percent to $32,307 for this school year, the biggest inflation-adjusted increase since 2001… Colleges have raised prices more rapidly than inflation for 30 years… The total cost of attending a public four-year school for in-state students rose to an average of $13,589, a 3.8 percent increase after inflation, the biggest jump since 2004…”

From Bloomberg: “Commodities fell the most in two weeks, led by copper, oil, gold and corn, on concern that slowing economic growth will hurt demand for raw materials… The Group of Seven finance ministers and central bankers said the rising cost of credit will curb economic growth that had sent the cost of metals, grains and energy to record highs this year.”

End-of-Day Market Update

From RBSGC: “The bond market lost some ground Monday, led by the front end, as stocks and credit indices improved… Today's volumes were notably strong, particularly for a Monday…”

From Dow Jones: “The dollar slipped against the yen Monday as risk aversion increased due to a decline in global equity markets, spurring currency investors to unwind their yen carry trades. But the decline in risk appetite also created safe-haven buying of the greenback, allowing the dollar to rebound against the euro, even after the dollar hit a new all-time low versus the euro at the start of Asian session. Monday afternoon, the euro was at $1.4154 from $1.4292 late Friday[dollar index up .59 to 78.00, gold down $11 to $754]… Stocks pulled into positive territory Monday afternoon as selling after Friday’s steep drop abated, led by strength in technology stocks[Dow up 45 to 13567]… Crude oil futures fell under $87 Monday morning, pressured by reports that a Kurdish rebel group that has been attacking Turkish forces will call a ceasefire and by concerns over falling global equities.”[Oil settled down $1.04 at $87.56]

From Bloomberg: “Treasuries declined for the first time in six days as stocks rose and investor demand for the safety of U.S. debt waned with two-year note yields near the
lowest since September 2005. Two-year notes failed to extend the biggest gains last week since the Sept. 11, 2001, terrorist attacks as investors became more willing to take on the risk of corporate debt. Interest-rate swap spreads, a gauge of what companies pay over benchmark lending rates, narrowed the most in more than a week… The yield on two-year notes rose 7 basis points, or 0.07 percentage point, to 3.85 percent… The yield on the benchmark 10-year note gained 4 basis points to 4.43 percent… Two-year notes yield 91 basis points less that the Fed's target rate for overnight lending between banks. The gap reached 97 basis points on Oct. 19, the most since Sept. 17. The Fed on Sept. 18 cut its benchmark interest rate a half-percentage point to 4.75 percent. The two-year interest-rate swap spread narrowed 3 basis points to 68 basis points, the biggest drop since Oct. 11. The spread, an indication of risk aversion in the bond market, rose to as high as 79 basis points on Sept. 5 as investors demanded higher returns for holding corporate debt. Interest-rate futures traded on the Chicago Board of Trade show an 82 percent chance the Fed will lower borrowing costs a quarter-percentage point to 4.5 percent on Oct. 31. The odds were 32 percent on Oct. 15… The gap between the yield on asset-backed commercial paper and the fed funds rate shrank, signaling investors are less
concerned about the short-term debt. Issuers of one-day, asset-backed commercial paper are paying about 4.99 percent, or 24 basis points more than the Fed's funds rate, compared with a one-year average of about 21 basis points more, Bloomberg data show. Three-month bill yields rose for the first time in a week amid lower perceived risks of holding commercial paper. The yield rose 17 basis points to 3.99 percent… The difference between bill yields and the three-month London interbank offered rate, or Libor, shrank 22 basis points to 111 basis points. The difference averaged 39 basis points in the first seven months of the year before widening to 240 basis points on Aug. 20, the highest since the stock market crashed in 1987.”

From HSBC: “MBS pricing static as the world swirls. Pass thru pricing has been disabled for most of the day. MBS went from 4 wider to 2 tighter without moving a tic.”