Today's Tidbits

Recession Risks Rising
From Fortune: “After years of living happily beyond their means, Americans are finally facing financial reality. A persistent rise in energy prices will mean bigger heating bills this winter and heftier tabs at the gas pump. Job growth is slowing and wage gains have been anemic. House prices are sliding, diminishing the value of the asset that's the biggest factor in Americans' personal wealth. Even the stock market, which has been resilient for so long in the face of eroding consumer sentiment, has begun pulling back amid signs of deep distress in the financial sector… Rosenberg said the low rates and easy underwriting meant loans were available to just about anyone with a pulse, so recent economic gains were more credit-induced "by a factor of four" than any other U.S. expansion on record. Now many of those loans are going bad, which is why investors are fleeing any debt riskier than U.S. Treasury securities. Making matters worse, the banking system is coming under severe strain. Wall Street has recognized more than $40 billion in losses this year on souring subprime mortgages and a related problem, the toxic debt known as collateralized debt obligations. The losses could constrain the economy by forcing banks and brokerages to sock money away rather than lending it out to businesses and individuals…Northern Trust chief economist Paul Kasriel… says banks are extremely vulnerable to the defaults and foreclosures now sweeping American neighborhoods, with mortgage exposure amounting to 63% of U.S. banks' earning assets … But with banks choking on bad loans, Kasriel doesn't expect to see the return of the easy lending standards that fueled the housing boom. Instead, he expects to see "greater risk aversion" that will slow credit growth and reduce the value of assets like property. He says the median U.S. house price would need to fall 17% to return to its 2001 level, which he notes was hardly at the bottom of the house-price cycle. A decline of that magnitude will further erode home-equity borrowing by Americans and, presumably, deliver one more blow to consumers' wallets. The American consumer seems to grasp the risks. A growing number of Americans expect the economy to tip into recession in the next year -- 40% last week, up from 31% in October, going by a Reuters/Zogby poll released last week. Rosenberg said government statistics show that 500,000 self-employed workers have lost their jobs since July -- a greater loss than was seen in all of 2001. Reported unemployment figures remain low, but Kasriel says those numbers "smell worse than a week-old fish." The combination of an emerging consumer recession and a heavily stressed financial system has some experts suggesting that a financial meltdown looms. "In short, the financial markets are at a critical point," fund manager John Hussman of the Hussman Funds wrote last week in a Web site post devoted to discussing a possible financial crisis. "It's possible that investors will somehow adopt a fresh willingness to speculate, but my impression is that in the weeks ahead, investors will be forced to recognize that the recession risk has tipped."”

Rules for Determining a Recession
From Wachovia: “Although many economic textbooks define a recession as two consecutive quarters of declining real GDP, this is not the true definition of a recession. The most recent downturn did not meet this definition, with three nonconsecutive quarters of declining GDP mixed in with three quarters of increases. A more accurate description of a recession is that it is a pronounced, long-lived, broad based decline in aggregate economic activity. The National Bureau of Economic Research (NBER) is the official arbiter of determining that a recession has begun in the U.S. and their pronouncements usually lag significantly behind the actual start of a downturn. The NBER has a Business Cycle Dating Committee, which provides the generally accepted dates that recessions begin and end. The NBER defines a recession as: A significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. A recession begins just after the economy reaches a peak of activity and ends as the economy reaches its trough. Between trough and peak, the economy is in an expansion. Expansion is the normal state of the economy; most recessions are brief and they have been rare in recent decades. The NBER follows a whole host of monthly economic indicators to determine whether or not there has been a turn in the business cycle. The four “most important measures” considered by the NBER are nonfarm employment, industrial production, manufacturing and trade sales, and real personal income minus transfer payments. The NBER also noted that there is “no fixed rule” about if and how other economic measures contribute to the business-cycle dating process.

Dealer Estimates of Total Home Price Declines for This Cycle
From Merrill Lynch: “From the Case-Shiller HPI peak in July 2006, the index has corrected 5.28%. We look for that correction to extend to closer to -15.0% by year end 2008, or 1Q-2009.”
From Lehman: “We judge the recent decline in home prices to be the beginning of an extended decline. We look for home prices to fall well into 2009 as excess inventory is slowly cleared and foreclosed homes return to the market at a discounted price. We expect this to translate to a 15% decline in national home prices from peak to trough.”
From JP Morgan: “The national composite index peaked in 2Q06 and has since fallen 5.0%. We estimate that national home prices will fall close to 15% peak-to-trough, with the trough coming around the end of 2008.”
From Goldman Sachs: “No one wants to buy a house. The percent of [consumer confidence] respondents considering buying a house sunk to 2.5%, the lowest since 1994. Before that, you have to go back to 1983 to find this few people looking at buying a home.”

The Country of Abu Dhabi to Buy 4.9% of Citi
From RBSGC: “Abu Dhabi willing to inject $7.5 bn into Citi for what eventually will be a 4.9% stake. This has relieved stocks, raised the specter of further liquidity from such sources coming to the banking system, and hit bonds hard…it comes a bit late to the 45K rumored layoffs at Citi. We don't expect this to be challenged from a legal or national security perspective a la the ports issues a few months ago (minority stake, banking vs. real goods coming into the country), but we do wonder if sovereign wealth funds face some political heat in an election year. It's one thing for a private firm to buy a US firm, but a foreign government buying a private company is NEW.”
From Morgan Stanley: “The Citi capital raising is big news. Worth about 60bp on tier 1, which is more than enough to bring all the SIVs on balance sheet (which would cost about 40bp of tier 1). This crisis morphed from a liquidity crisis to a capital/solvency crisis in October. Capital raising by banks is therefore a big part of the solution. Note, however, that Citi is only the first to raise capital. Many others will need to do so before this is over.”
From Handelsbanken: “CDS spreads came in on financials after Citigroup announced that it received a cash infusion of $7.5billion.”
From Bloomberg: “Citigroup Inc., the biggest U.S. bank, is paying a ``junk bond'' rate to uphold Chairman Robert Rubin's pledge to preserve the dividend and weather this year's mortgage-market decline. The 11 percent interest rate on $7.5 billion of convertible shares that Citigroup sold to the Abu Dhabi Investment Authority is almost double the rate it offers bond investors. Countrywide Financial Corp. paid 7.25 percent to Bank of America Corp., the second-biggest U.S. bank by assets, for bailout financing three months ago. Citigroup's common stock pays a dividend equivalent to a 7.1 percent yield… The average fixed-rate preferred stock yields 7.7 percent, according to Merrill index data. The average high-yield, high-risk bond yields 9.5 percent”

MISC

From Goldman Sachs: “The worsening housing downturn has pushed the risk of a US recession in 2008 to 40%-45%, from around 30% previously.”

From JP Morgan: “Falling house prices, combined with the weakness in the stock market, point to a probable decline in household net worth this quarter, the first since the middle of 2002.”

From HSBC: “Since October 31 (the date of the last FOMC meeting), the SP500 has
declined by roughly 9%. 9%-plus monthly declines are rare events. Before this November, it has only happened twelve times in the past sixty years, or 1.7% of the time. The last time it happened was over five years ago in September 2002. So short of a big rally in stocks in the last few days of November, the stock market performance this month is shaping up to be a true `outlier' event, reflecting financial system concerns and fears of a credit crunch...”

From The Wall Street Journal: “Yesterday, the three-month Libor, or the London interbank offered rate, quoted on dollar loans between European banks was 5.05%, unusually high relative to the Fed's current 4.5% target interest rate for overnight loans between banks, known as the federal-funds rate. It is even more unusually high when compared with the 4.25% that investors expect to prevail in January…In the U.S., the Libor is an especially important interest rate because it is a benchmark for many other kinds of lending, such as floating-rate mortgages and commercial corporate paper. Its rise may be symptomatic of a more generalized reluctance by banks to lend, which could impair consumer and business spending.”

From Barclays: “Bank holdings of MBS declined sharply in Q3 07 after a smaller decrease in Q207. The decline at the top 10 banks was 4.4% over the quarter. Wells Fargo and Citigroup were the biggest sellers of MBS in Q3 07; their portfolios decreased $18.7bn and $12.6bn, respectively. A number of other banks were net buyers of MBS in Q3 07, but their buying was overshadowed by the deleveraging of Citigroup and Wells Fargo. Bank deposits rose 3.5% over Q3 07. In addition, the cost of deposits for banks probably went up in Q3 07, since non-interest bearing deposits fell 3%. At the margin, this could further weaken the bank bid for MBS.”

From HSBC: “…the spread of jumbo mortgage rates over conventional mortgage rates went from about 25bp in July to up to 108bp in August, before improving to 60bp in late October. However, it has re-widened to 81bp now…In the midst of this doom and gloom, it is important to bear in mind that not everything has gone the wrong way as far as financial conditions are concerned. The 30-year conventional mortgage rate has declined from 6.74% in mid-June to 6.20% now, 54bp lower, although it is tougher now for applicants to be approved, given tighter lending standards.”

From Merrill Lynch: “There have been only two times in the past that consumer confidence fell this much at this time of the year - in 2001 and 1991. Both represented recessionary phases in the economy - maybe it will be different this time but we are not convinced. Holiday shopping pundits should note that both years saw fourth quarter ex-auto retail sales stagnating on a y/y basis.”

From JP Morgan: “Chicago Fed President Evans and Philadelphia Fed President Plosser each delivered speeches today which gave little sense that they are looking for an interest rate cut at the next meeting of the FOMC on December 11.”


End-of-Day Market Update

From JP Morgan: “The US stock market is rebounding today, reversing some of yesterday’s loss. Markets were down in Europe and mixed in Asia. US Treasury yields have increased sharply, reversing all of yesterday’s decline. In Fx markets, the dollar has regained a bit of ground against the euro and the yen. Most carry currencies are up marginally too. Oil prices are down almost $3 to near $95/bbl.”

From Lehman: “…if we've learned one thing over the past week, it is that there are few counterparties willing to step in to take the other side of anything.”

From Lehman: “The treasury market made a sharp turnaround after yesterday's stunning rally, but finished well off of the day's lows as equity markets were unable to sustain an early rally. The selloff started on the news that Citigroup would receive a $7.5 bln cash infusion from an outside investor, and we saw heavy selling from both fast and real money in the overnight session, and early NY trading. Ten year yields rose as much as 17 basis points intra-day, and two year note yields over 20 before an afternoon stock swoon, combined with some deal pricing, ripped the market from its lows, pulling ten year yields from 4.01% back down to 3.93%. Volumes were incredibly high… Despite the heavy volumes going through today, the market still feels very illiquid to us, and so big flows are pushing both the overall market and RV relationships all over the map with little resistance…”

From UBS: “The 2s30s curve flattened about 5bps… Swaps saw light flows, and front end spreads came in while spreads further out remained flat on the day. Agencies saw good buying of 2- and 3-year notes, richening slightly to Libor in the front end and trading in line the rest of the way. Mortgages had about $2B in origination and some selling out of Asia. Despite all the selling and the rise in volatility, mortgages hung in quite well, widening only a tick to Treasuries and swaps.”

From RBSGC: “People will call it a 'reversal' from Monday's capitulation -- we're referring to the bond market's bearish flattening -- but, in fact, it was an inside day meaning prices/yields held within Monday's extremes. That's true across the curve. While we extract more of a flattening bias, albeit with a switch to somewhat bearish view, in reality the action looks kind of consolidative.”

Three month T-Bill yield rose 4bp to 3.15%.
Two year T-Note yield rose 18bp to 3.07%
Ten year T-Note yield rose 11bp to 3.95%
Dow rose 215 to 12,958
S&P 500 rose 21 to 1428
Dollar index rose.34 at 75.20
Yen weakened 1.49 to 118.9 per dollar
Euro fell .005 to 1.483
Gold fell $11.4 to $813
Oil fell 3.14 to $94.56
*All prices as of 5:20pm