Monday, 8/27
July Existing Home Sales Consensus: 5.70M Prior: 5.75M
Decline expected to slow by -.9% MoM in July, vs -3.8% MoM in June, to another new cycle low
Over the past year, sales have fallen 11%, with the West seeing the biggest decline at -19% YoY
June pending home sales rose 5%, and usually lead existing home sales by 1-2 months, but there is reason to suspect higher fall-out than normal due to tightening credit conditions
Tuesday, 8/28
June S&P / Case-Shiller Home Price Index (20 City) Prior :-2.8%
2nd Qtr S&P/Case-Shiller Home Price Index (National) Prior: -1.4%
August Consumer Confidence Consensus: 105 Prior: 112.6
Financial market volatility expected to cause index to plunge
Other surveys indicate rapid deterioration in both current and future expectations
Cut-off date for responses was Aug 21
Expected to fall near a two year low
August Richmond Fed Manufacturing Index Prior: 4
Minutes of August 7 FOMC Meeting Released
Superseded by more recent announcement, but discussions will indicate initial reaction to earlier stage of financial market upsets of recent weeks
Wednesday, 8/29
No Data
Thursday, 8/30
2nd Qtr Preliminary GDP Annualized Consensus: 4% Prior: +3.4%
GDP Growth expected to be revised higher from original estimate
This would improve first half growth into Fed’s forecast range
Adjustment higher expected from higher exports and less imports
Consumer spending and non-residential construction investment should also be positive contributors to the upward revision
Housing will remain a drag
Personal income revisions will also be released for the 1st qtr, with implications for unit labor cost adjustments
Will also see first estimates for 2nd qtr corporate profits
2nd Qtr Preliminary Personal Consumption Prior: +1.3%
2nd Qtr GDP Price Index Annualized Consensus: +2.7% Prior: +2.7%
2nd Qtr Core PCE QoQ Consensus: +1.4% Prior: +1.4%
Initial Jobless Claims Consensus: 320k Prior: 322k
Four week moving average jumps to 318k from 306k prior week
Continuing Jobless Claims Consensus: 2575k Prior: 2572k
Currently at highest level since April
July Help Wanted Consensus: 25 Prior: 26
2nd Qtr OFHEO House Price Index Consensus: +0.3% Prior: +0.5%
NAR median existing home prices fell -1.1% annualized in 2nd qtr
Case/Shiller index also indicating falling home prices
Risk OFHEO index may show first quarterly decline since 1994
Friday, 8/31
July Personal Income Consensus: 0.3% Prior: +0.4%
Payroll hourly earnings rose +.3% MoM but aggregate hours worked fell -.1% MoM
July Personal Spending Consensus: +0.4% Prior: +0.1%
Growth expected from non-auto consumption, as auto sales have been weak
Service demand expected to remain at trend pace
July PCE Deflator YoY Prior: +2.3%
Expected to decline to +2.1% YoY
July Core PCE MoM Consensus: +.2% Prior: +.1%
YoY Consensus: +2% Prior: +1.9%
Expected to accelerate slightly, both monthly and annually, in line with July core CPI growth (+.2% MoM, +2.2% YoY)
August Chicago Purchasing Managers Index Consensus: 52.8 Prior: 53.4
Has been extremely variable this year
Machine tools and equipment parts have been relatively strong
Construction machinery demand has been soft
Foreign demand for heavy trucks has offset weakening US demand
July Factory Orders Consensus: +0.7% Prior: +0.6%
Consensus likely to be revised up following strong durable goods orders (+5.9% MoM in July)
Non-durable goods orders rose +.7% Mom
August Final Univ. of Michigan Consumer Confidence Consensus:82.7 Prior: 83.3
Preliminary figure saw a huge drop from 90.4 in July
More recent ABC/Washington Post survey indicated a record decline
Inflation expectations softened earlier this month to +3.2% over next year and +2.9% average over the next five years
Fed Chairman Bernanke gives opening speech at annual Jackson Hole symposium. This year’s topic is “Housing and Monetary Policy”. No Q&A.
Friday, August 24, 2007
Rising cancelations of new home purchases not in data
From JP Morgan:"...there is no official data on cancellations, but anecdotes from builders suggest roughly 50% of orders are being cancelled which compares to a historical ave of ~20%"
New Home Sales Unexpectedly Strengthened in July
July new home sales bounced back in July, growing +2.8% MoM (consensus -1.7%), and the supply of homes fell to 7.5 months from 7.7 months in June. In addition, new home sales in June were revised higher, to create only a 4% drop rather than the originally reported decline of -6.6% MoM. Sales rose substantially in the West, rising 22% MoM. The South, which is the region where the largest number of new homes are under construction, improved by a much more modest +.6% MoM. In contrast sales dropped dramatically in the Northeast by -24% MoM, and fell -.9% in the Midwest.
The median price of a new home rose +.6% YoY to a national average of $239,500. In contrast, the mean price dropped for the first time in at least six months, falling by -3.4% YoY to $300,800.
The July rebound in new home sales is not anticipated to be repeated again soon due the increasing turmoil in the subprime and other mortgage markets.
The median price of a new home rose +.6% YoY to a national average of $239,500. In contrast, the mean price dropped for the first time in at least six months, falling by -3.4% YoY to $300,800.
The July rebound in new home sales is not anticipated to be repeated again soon due the increasing turmoil in the subprime and other mortgage markets.
Durable Goods Orders Shoot Higher in July
Durable goods orders popped +5.9% MoM (consensus +1%) in July, and are up +9.3% YoY. This is the fifth increase in the past six months, and brings the series to a record high.
Though defense orders rose a massive 35.7% MoM (+12.3% YoY), the largest increase since January, non-defense new orders still rose a substantial +4.9% MoM (+9.2% YoY). Ex-transportation rose +3.7% MoM (+2.2% YoY).
Capital goods orders rose +8.3% MoM, and have risen +15.9% YoY. Transportation rose +10.8% MoM with non-defense aircraft orders (Boeing) rising +12.6% MoM. Over the past 12 months, non-defense aircraft orders have risen 131% YoY, while autos and trucks have risen 9.5% YoY. Computers also saw good demand, rising +7.4% MoM (+.5% YoY), as did primary metals at +7.9% MoM (+1.5% YoY) and machinery orders +5.5% MoM (+6.1% YoY).
The only category to see a decline in orders in July was electronic goods, which fell -1.2% MoM (+.9% YoY).
Shipments rose a more modest +3.9% MoM (+4.7% YoY) with capital goods shipments rising +2.2% MoM (+1.8% YoY), defense shipments rising +9.1% MoM (+11.2% YoY), and transportation also rising +9.1% MoM (+13.4% YoY). Shipments of durable manufactured goods have risen in four of the past five months, and are also at a record high.
Inventories rose .1% MoM and have risen +4.1% YoY. The inventory to shipments ratio has plunged on the increased demand, falling to 1.42 months, the lowest level of the year. In June the I/S ration was at 1.48 months.
Unfilled orders remain high, rising +2.4% MoM, and are up 21% YoY, and have been trending steadily higher for over two years to a record high. Transportation equipment had the largest monthly increase at +3.1% MoM, continuing an 18 month string of advances.
Net, this was a very strong report on manufacturing demand - much stronger than expected, with good breadth across industries. Last month's data was also revised higher, with June's durable goods orders rising +1.9% MoM instead of the originally reported +1.4%.
Though defense orders rose a massive 35.7% MoM (+12.3% YoY), the largest increase since January, non-defense new orders still rose a substantial +4.9% MoM (+9.2% YoY). Ex-transportation rose +3.7% MoM (+2.2% YoY).
Capital goods orders rose +8.3% MoM, and have risen +15.9% YoY. Transportation rose +10.8% MoM with non-defense aircraft orders (Boeing) rising +12.6% MoM. Over the past 12 months, non-defense aircraft orders have risen 131% YoY, while autos and trucks have risen 9.5% YoY. Computers also saw good demand, rising +7.4% MoM (+.5% YoY), as did primary metals at +7.9% MoM (+1.5% YoY) and machinery orders +5.5% MoM (+6.1% YoY).
The only category to see a decline in orders in July was electronic goods, which fell -1.2% MoM (+.9% YoY).
Shipments rose a more modest +3.9% MoM (+4.7% YoY) with capital goods shipments rising +2.2% MoM (+1.8% YoY), defense shipments rising +9.1% MoM (+11.2% YoY), and transportation also rising +9.1% MoM (+13.4% YoY). Shipments of durable manufactured goods have risen in four of the past five months, and are also at a record high.
Inventories rose .1% MoM and have risen +4.1% YoY. The inventory to shipments ratio has plunged on the increased demand, falling to 1.42 months, the lowest level of the year. In June the I/S ration was at 1.48 months.
Unfilled orders remain high, rising +2.4% MoM, and are up 21% YoY, and have been trending steadily higher for over two years to a record high. Transportation equipment had the largest monthly increase at +3.1% MoM, continuing an 18 month string of advances.
Net, this was a very strong report on manufacturing demand - much stronger than expected, with good breadth across industries. Last month's data was also revised higher, with June's durable goods orders rising +1.9% MoM instead of the originally reported +1.4%.
Thursday, August 23, 2007
Today's Tidbits
Bank of America Gets Sweetheart Deal Helping Countrywide
From Bloomberg: “Bank of America Corp., the second- biggest U.S. lender, is already up about $700 million on its $2 billion preferred stock investment in Countrywide Financial Corp. This is ``something of a sweetheart deal,'' David Hendler, an analyst at research firm CreditSights Inc. in New York, said in a report. Bank of America…can convert the preferred stock to common shares at $18 each, compared with a high reached today of $24.46. Countrywide, the biggest U.S. mortgage lender, will also pay interest of 7.25 percent on the preferred shares. Countrywide, which lost half its market value after peaking on Feb. 2, rose $1.07 or 4.9 percent…The deal, announced after the market closed yesterday, was made to help …Countrywide weather the global credit rout that had cut off its access to short-term financing. The investment reassured investors after Countrywide was forced last week to draw on $11.5 billion of bank credit lines and Merrill Lynch & Co. raised the prospect that the company may be headed for bankruptcy. ``The only time you see terms like this is if a company is really desperate for financing,'' …A 7.25 percent coupon on a convertible ``is pretty rare on a company that's investment-grade,''… Countrywide's ``funding problems will not be cured with a mere $2 billion infusion,'' said …JP Morgan Securities Inc. …``The main driver for the deal was a hope that the credit markets and CFC's depositors will see this as a reinforcement that CFC will survive the current liquidity crunch.'' The deal will increase Countrywide's diluted shares by 19 percent and cost about $145 million in dividends…`It was expensive for the company but it's ultimately better to keep the company in business,'' …``It helps to stabilize the company as a whole. On a personal basis, it's better for the world, for you and me going out to get mortgages, that they stay in business.''
From LEHC: “In an interview on CNBC today, Mozilo asked if he thought there would be a recession in the US, said "I think so ... I know I've been proven wrong so far, but I can't believe that when you're having a level of delinquencies, foreclosures -- equity has disappeared, equity is gone, the tide has gone out -- that this doesn't have a material effect… on the psyches of the American people, and eventually on their wallet." Mozilo also noted that the financial markets are in "one of the greatest panics I've ever seen in 55 years in financial services." Mr. Mozilo is 68 years old. Mr. Mozilo said that in his mind there was “no even thought” of BofA buying Countrywide. He said that BoA contacted him personally to see if BoA could “help”, and also noted that he would have loved to have “tapped” the discount window, but that he couldn’t, as the bulk of the company’s mortgage assets were not assets of Countrywide Bank. And finally, he said that he hasn’t seen any improvement in market liquidity, and overall he sounded pretty depressed.”
From Dow Jones: “The cost of protecting Countrywide Financial Corp.’s debt fell sharply after Bank of America Corp. acquired a $2 billion equity stake in the nation’s largest mortgage company. The credit default swaps, which measure the perceived risk of owning a company’s bonds, fell in price to $177,500 to insure $10 million of bonds annually for five years from $330,000 late Wednesday…That brings the CDS back to levels last seen at the start of the month, before Countrywide ran into trouble securing short-term funding. The CDS may be recovering, but it doesn’t mean Moody’s Investors Service thinks the mortgage company’s problems are over. The ratings agency, which downgraded the company three notches to its lowest investment-grade rating just last week, said it was keeping Countrywide’s ratings on review for possible downgrade.”
Bernanke Fed Less Inclined to Lower Rates and Risk Bubbles Than Greenspan Fed
From Fortune: “It may be the most important development to emerge from the recent market turbulence: The Federal Reserve, under Chairman Ben Bernanke, is going back to being a central bank. Judging by its cautious and finely-calibrated responses through a very ugly August, the Fed appears keen to put the Alan Greenspan years firmly in the past and take a much more orthodox approach to monetary policy. While the Fed will probably cut interest rates as early as next month, its behavior in August strongly suggests that Bernanke will avoid using interest rates to deliberately spark big increases in lending, the high risk strategy pursued by Greenspan from 2001 to 2004… A change at the Fed would have far-reaching consequences for the U.S. economy and the stock market. Initially, a much less accommodating Fed will be perceived as a reason for bearishness. But, over the longer term, market players may well see a less dysfunctional central bank as a good thing that could begin the process of cutting borrowing levels in the U.S., something that has to happen if the American economy is not going to seize up every time interest rates rise… this Fed has cut only the discount rate, a move designed to get healthy financial institutions trading with, and lending to, each other. Critically, Bernanke's Fed hasn't yet reduced the Fed funds rate, which does have a big impact on the economy. And it has not officially commented on what its next moves might be with that rate. And if it does lower the Federal funds rate next month, it's hard to see it rushing to further cuts, as happened in 1998. Why? Because there seems to be a recognition at the Fed that lending got out of hand in the past five years, and it's important now for markets to attach new, lower values to many loans and bonds. In a June speech, Bernanke commented on the shake-out in subprime mortgages in a conspicuously neutral way, suggesting the Fed was monitoring housing problems, but was not unduly concerned by adjustments taking place in it. "I think the Fed is happy to see that risk aversion is increasing," says Kasriel… Lacker argued that a reduction in a discount rate is a good thing to do because it can supply liquidity without leading the market to misprice credit once again. "Sound discount window policy, I believe, should aim at supplying adequate liquidity without undermining the market's assessment of risk," he stated. While Treasury secretary Henry Paulson is not a Fed member, it was more than interesting to see him making the same point, also on Tuesday, when he said: "As the Fed addresses liquidity this makes it possible, this makes it easier, for the market to focus on risk and pricing risk." What seems so different under Bernanke is a genuine recognition that interest rate cuts could spark another bubble, and thus must be enacted carefully. This appears to have been a big factor in the Fed's decision-making last week… The stand-back strategy of Bernanke's Fed was in many ways vindicated by news Wednesday night that Bank of America is making a $2 billion investment in Countrywide, the large mortgage company that is suffering a liquidity squeeze. It shows that stronger firms are capable of becoming part of the market adjustment by making investments in weaker companies during this crisis. This happened without a cut in the Fed funds rate… After nearly 20 years at the helm of the Fed, Greenspan left the U.S. economy more vulnerable to credit shocks than it has ever been.”
From Reuters: “Past experience suggests central banks overreacted, cutting rates more than was needed, says … an economist at Dutch investment bank ABN Amro. In the two weeks following the October 1987 market crash, the Fed cut its key interest rate by half a percentage point. The housing market took off and inflation kept creeping higher.
After LTCM's collapse triggered fears of a systemic crisis in late 1998, the Fed cut its key Fed Funds rate by 75 basis points, or three-quarters of a point, which was more than sufficient…In both cases, rates were higher within 18 months than prior to the crises, and it looked as if it had all been overdone. "In hindsight, it looks like the Fed over-reacted. Perhaps Mr (Fed chief Ben) Bernanke, a renowned U.S. economic historian, understands this better than some market commentators," … When Alan Greenspan ran the Fed, says [Morgan Stanley’s Steve] Roach, central bankers committed the "original sin of the bubble world", ignoring a surge in liquidity which fed directly into asset markets. "That set in motion a chain of events that has allowed one bubble to beget another, from equities to housing to credit,"… "The art and science of central banking is in desperate need of a major overhaul -- before it's too late," says Roach.”
Unemployment Claims Gradually Rising As Hiring Pace Slows
From FTN: “Initial claims filed for unemployment insurance were down 2k to 322k from a revised 324k last week (was 322k). The level of claims is at the high end of this year’s range, and the 4-week average has climbed very close to where it was in June, during seasonal auto layoffs. (Yes, these data are seasonally adjusted, but the layoffs were bigger than usual, and the timing shifts a bit year to year.) Essentially, this translates to a small, but by no means alarming, rise in layoffs. Continuing claims tell another story however. This is a measure of the total number of recipients receiving benefits, so it is a decent guide to the pace of net hiring. Continuing claims pushed to more than 2,550k in late June, remained high in July and is rising again in August. If the turmoil in the markets has only increased the pace of layoffs slightly, it has had a more substantial impact on hiring. (Remember, the turmoil in the money market is an August story, but the long end locked up in June after the bond market concluded the Fed would not ease within the next year.) The Fed will be paying more attention than usual to these data, just as we are, because they are starved for contemporaneous economic information. There is nothing in the data yet to justify an inter-meeting cut.”
Housing Industry Related Job Losses Accelerate
From AP: “…more than 25,000 workers nationwide who have lost jobs in the financial services industry since the beginning of the month -- with more than half coming since last Friday.…Since the start of the year, more than 40,000 workers have lost their jobs at mortgage lending institutions, according to recent company layoff announcements and data complied by global outplacement firm Challenger, Gray & Christmas Inc. Meanwhile, construction companies have announced nearly 20,000 job cuts this year, while the National Association of Realtors expects membership rolls to decline this year for the first time in a decade. It's an employment collapse that threatens to rival the massive layoffs in the airline industry that followed the Sept. 11, 2001, terrorist attacks, when some 100,000 employees lost their jobs… It's only been weeks," Challenger said. "These companies are acting remarkably quickly, stopping on a dime.””
As Expected, Fed’s Report on Commercial Paper Outstanding Shows Large Drop
From Bloomberg: “The amount of U.S. commercial paper outstanding had its biggest weekly percentage drop since 2000 as investors shunned debt that may be linked to mortgages and other risky assets and instead opted for the safety of Treasuries. The amount dropped $90.2 billion, or 4.23 percent, to a seasonally adjusted $2.04 trillion… Some companies that use commercial paper to buy asset-backed securities or collateralized debt obligations backed by subprime mortgages are having trouble finding investors. Commercial paper buyers, in the face of attempts by the Federal Reserve to ease the credit crunch, have headed for Treasury bills in which the yield on Aug. 20 fell the most since the stock market crash of 1987. ``There is a significant amount of cash in the system, it's just not getting to the parts of the market that need it,'' Conrad DeQuadros, a senior economist at Bear Stearns Cos., said in an interview today in New York. The Fed has lowered the interest it charges to lend to banks to encourage buyers of commercial paper after the market seized up last week for Countrywide Financial Corp. and other mortgage lenders. Countrywide, based in Calabasas, California, borrowed its
entire $11.5 billion in available bank credit lines in order to fund its operations…. The decline in outstanding commercial paper was driven by a 6.8 percent fall in asset-backed commercial paper, which represents about half the commercial paper market and has been used to finance purchases of subprime mortgages. The average yield on 30-day asset-backed paper rated A1, the second-highest short-term credit rating by Standard & Poor's, rose 5 basis points, or 0.05 percentage point, to 6.1 percent. It has risen 35 basis points in the past week.”
From JP Morgan: “…today we got the most recent data for CP outstanding (note this is a w/ a 1wk lag, so the data today is as of last Weds)...I think it's noteworthy that ABCP is down 70.9bb wk-over-wk...as we don't know of any defaults at this point, this decline in
notional outstanding appears to be a function of paying down CP (whether it's a result of bank lines getting tapped or de-levering is another question).”
Regulatory Bank Funding Requirements Reinforced Asset Price Spiral
From Barclays: “The root cause of this thirst for term finance is the near complete illiquidity in the term (one-month or longer) depo markets. The drought in the term money markets is attributable to banks' need to preserve liquidity to finance the involuntary growth in their balance sheets. This growth has been caused primarily by a rapid drawdown of standby credit lines extended to conduits and SIVs, [ Note – From The Financial Times: “SIV-lites are essentially collateralised debt obligations which pool together bonds backed by mortgages and other asset-backed debt. The main difference is that other CDOs sell long-term senior debt to fund their assets while SIV-lites raise senior debt in the short-term ABCP markets.] whose access to the CP market has been cut off by ABS-shy investors. In a similar vein, banks’ balance sheets have also been swollen by incoming collateral from margin calls. Most of this collateral is characterised by very weak or non-existent secondary market bids, so banks are opting – or being co-opted by circumstances – to keep these securities on their balance sheets. Banks have been forced to conserve liquidity to cover these contingent assets and as a result, have been unwilling to lend in the term depo market. Since all banks, to a greater or lesser extent, partly finance themselves in the money markets, the lack of offers much longer than a week left the system with a major headache. The regulatory framework sensibly prohibits banks from funding their entire balance sheet in the overnight market. Regulators require banks to maintain liquidity in certain maturity brackets in relation to the maturity of the assets they are financing. Since all the fresh assets – whether collateral or back-up credit lines – appearing on balance sheets are fairly long term and since the term depo market was not offering any liquidity, there is a potential liquidity ratio regulatory problem. And as each day passes, the existing financing shortens in maturity as the banking system’s term borrowing rolls-off, to be replaced by overnight finance. Unchecked, the net result would be a banking system that resembles a giant upturned pyramid resting on its apex. Needless to say, giant upturned pyramids resting on their apexes are not noted for their stability. Furthermore, as banks start hitting their regulatory liquidity ratio constraints, they are forced to shed assets in an effort to slim their balance sheets, adding to the pressure in secondary market valuations and contributing to the spiral of collateral liquidations and margin calls on levered investors… with improved access to term finance now available, banks may feel less inclined to shrink SIV and conduit balance sheets and therefore ease the fire-sale pressures on the underlying securities. Those pressures had been contributing to a spiral, whereby asset sales depressed secondary market valuations and therefore triggered more margin calls. So this move should help break this spiral and thus slow the involuntary expansion of bank balance sheets… Elsewhere in the money markets, we note one particular point that may be slowing the return to more normal conditions. Many of the contingent assets that are popping up on bank balance sheets are not eligible to be used as collateral at the central bank liquidity windows. This is particularly the case in the US, where banks cannot put up collateral in which they have a credit interest. This rules out assets that are appearing on balance sheets as a result of back-up credit lines being exercised. More generally, the flight to safety has resulted in a shortage of top quality collateral in the system, as the collapse in T-bill and repo rates for government securities suggests. In turn, there is a potential risk that this shortage of quality collateral is inhibiting access to liquidity… Outside the short-term money markets, one could be forgiven for imagining that the rest of the financial system inhabits a different planet. Both investment grade and high yield spreads have contracted very sharply. Since last week, the US investment grade CDX index has tightened some 28 bp or 34% of the widest levels attained. Since the end of last month, the US Crossover index has narrowed by 40% or around 150 bp. The primary market has also been active for investment grade bond and loan issuance. Indeed, as the Financial Times points out today, dollar-denominated investment grade bond issuance, at $28bn for the first three weeks of August, is actually up 47% from last year’s equivalent. Equally, the successful completion of the fourth largest syndicated loan ever issued – $40bn for Rio Tinto – tells us in no uncertain terms that the credit market are open for business, albeit much more selectively than before. The depth of this particular pool of liquidity – which is presumably real money rather then leveraged – is the matter of some conjecture. Equally, the $300bn overhang of bridge debt, which will be tapping the higher yield market, is a much harder test for the credit markets than good quality investment grade bond issuance. However, for the time being, the omens are relatively positive inasmuch as markets are becoming much more discriminating. Problems with asset-backed commercial paper are clearly not a pricing factor for corporate debt at the moment, while the illiquidity in the term money markets has not deterred value hunters in the equity market. Encouragingly, the recovery in longer-term credit and equity markets has taken place against a backdrop of fading rate cut expectations. This implies that investors are increasingly moving to the view that the various problems are contained and unlikely to be a decisive risk to economic growth – and by extension non-financial corporate earnings. Longer run, questions remain over the banking system’s ability to supply fresh credit for a while, given the sharp expansion in balance sheets. Given the efficiency with which most banks run their balance sheets, the recent involuntary asset growth from hung bridge loans, margined collateral and the exercise of back-up credit lines suggests that banks may soon approach capital adequacy limits. However, if real money investors are happy to finance an expansion of bank liabilities by buying bank bond issues – and this is the case at present – then this problem too will begin to fade in importance. We would caution that a lasting easing of this crisis requires these two preconditions to be met. Given the fragility of the financial sector, it is certainly too soon to sound the All Clear. However, compared to the position of the markets just one week ago, we appear to have successfully pulled back from the brink of what was looking like a very deep and dark abyss. ”
Rating Agencies Getting the Blame For Market Mayhem
From Economist: “Every crisis begets finger-pointing, and the blame now is falling on the rating agencies that helped structure these exotic instruments. The European Commission is understood to be reviewing why rating agencies failed to move more quickly in response to the growing crisis in subprime mortgages. Currently, they are guided by a voluntary code that aims to tackle potential conflicts of interest. The biggest is that the agencies are paid by the firms they rate. Rating CDOs was a profitable business. To understand why so much blame is being heaped on the rating agencies, consider how CDOs and collateralised-loan obligations (CLOs) came into vogue. In the mid-1990s individual loans looked appealing to investors, but their ratings (often below investment grade) made them too risky for conservative types. So whole forests of asset-backed securities were put together into a single CDO. These were structured so that the first losses would be taken by whoever had bought the riskiest, highest-yielding piece of the package. That piece had a low rating. But the piece at the top, which would take the last losses, was rated AAA—a reflection of how unlikely it was that all the loans in the CDO would default at once. Rather than standing back and observing this from the sidelines, the rating agencies got involved in structuring these products. Like schoolgirls asking for help with their homework, the banks would go to the agencies and ask how the different slices of the CDOs they were putting together would score. The agencies would suggest improvements based on their models. And lo, the senior tranches were given the ratings required to market them to banks, which liked the security the triple-A ratings conferred, especially because their yields were higher than those of American Treasuries… Goldman Sachs admitted as much when it said that its funds had been hit by moves that its models suggested were 25 standard deviations away from normal. In terms of probability (where 1 is a certainty and 0 an impossibility), that translates into a likelihood of 0.000...0006, where there are 138 zeros before the six. That is silly. "Securitisation," … "has meant that credit risks have moved from knowledgeable, long-term hands, to fast hands, where the principal risk-management strategy is to sell before prices fall more". Working out who has won and who has lost in this round will take a long time.”
Friedman Billings Ramsey Report Thinks Mortgage Markets Won’t Stablize for at Least 6 Months
From Dow Jones: “It may take a long time for investors to start bidding for mortgages again. In recent months, companies from mortgage lenders, hedge funds and firms investing in structured products - such as assetbacked bonds - have been racing to dump mortgage assets to repay creditors, as the fallout from the credit squeeze continues to reverberate. The upshot: Businesses are earning even less from selling loans, more lenders are failing, and investors - except for those savvy specialists in distressed investing – are reluctant to dip their toes back. In a report entitled “De-Leveraging Destroying Value - New Capital Needed,” analyst Paul Miller Jr. at Friedman Billings Ramsey estimated that it takes roughly $150 billion to $250 billion of new capital to “normalize pricing” in the mortgage market. But it’s also a kind of Catch-22 situation: Without new capital, it could be difficult for asset prices to come back up; without pricing adjustment and better returns, new capital may be hard to come by. Miller projected that it will take six to 12 months for the prices of mortgage assets to normalize and for capital to flow back into the space. “There is no quick fix here,” he noted. And until then, lenders will continue to come under pressure with respect to earnings and book values.”
Japan
From JP Morgan: “The Bank of Japan left policy rates unchanged at 0.5% on an 8-1 vote. Governor Fukui emphasized that investors are engaged in the repricing of risk and that this is a process that will take time to play out. As such, the BoJ needs time to assess how market developments might affect the economy. In its monthly report, the BoJ reaffirmed its assessment of current conditions (moderate expansion) and the longer-term outlook.”
From Bloomberg: “Japanese investors were net sellers of foreign bonds during the week ended Aug. 18 according to figures based on reports from designated major investors released by the Ministry of Finance in Tokyo.”
From Bloomberg: “The yen fell against the euro and dollar on speculation investors resumed riskier bets financed by borrowing in Japan.”
From Dow Jones: “The Bank of Japan’s governor said that investors have made “significant progress” in cutting from their portfolios risky yen-selling investments, but remained cautious about the resurgence of such bets. “I think there has been significant progress in the unwinding of short positions linked to yen-carry trades” during the past few weeks of turbulent global markets, Toshihiko Fukui said at post-policy board meeting news conference. Yen-carry trades refer to the strategy of borrowing money at Japan’s low interest rates and investing in more attractive assets outside Japan. But Fukui also indicated that he hasn’t let his guard down against another boom in such trades, and he signaled that the BOJ wants to raise interest rates partly to discourage such trades.”
MISC
From Lehman: “The pullback in mortgage origination continued, largely in subprime and Alt-A lending, as more mortgage lenders shut down operations. In addition, credit conditions in overall capital markets worsened. We now look for an even deeper housing recession: Sales and starts should continue to fall through the middle of next year. Inventory of new homes should fall at a faster pace than inventory of existing homes. National home prices should fall modestly; bubble regions will likely witness bigger declines.”
From Bloomberg: “BP Plc, the world's third-biggest oil refiner, may scrap a $3.8 billion expansion of its Whiting, Indiana, refinery, as public opposition increases…``Ongoing regional opposition to any increase in discharge permit limits for Lake Michigan creates an unacceptable level of business risk'' for the expansion, Bob Malone, president of BP's U.S. unit, said in the statement. ``If necessary changes to the project result in a material impact to project viability, we could be forced to cancel it.''”
From Time: “…Las Vegas--where 40% of the houses up for sale now sit vacant.”
From Merrill Lynch: “The majority of companies within the S&P 500 Index exceeded earnings expectations in 2Q, with the index in aggregate delivering 7.5% year-over-year quarterly growth…[but] earnings failed to break the 10% growth mark for the second quarter in a row.”
From Dow Jones: “The U.S. federal budget deficit will fall for the third year running, totaling $158 billion in fiscal-year 2007, the Congressional Budget Office estimated.
The budget deficit for fiscal year 2006 was $248 billion. A nominal-dollar record high annual deficit of $412 billion was set in 2004.”
End-of-Day Market Update
From SunTrust: “Things looked rosy early this morning. Equities were higher overnight, CFC got liquidity from BOA and the odds of a FED ease decreased considerably. It looked like we might see some increased activity in term cp issuance. But, it shaped up to be a lot like yesterday. Rates were mostly unchanged for A2/P2 (BBB+ long-term) names today and about 5bp higher for A1/P1 ABCP. The market continues to be very sloppy. Very similar credit quality names in both markets can trade 20bp away from each other. The major factor in deciding rates is the panic level of the issuers to get paper placed and the amount they need to issue. We saw additional activity in A2/P2 issuers hitting bank lines for more favorable financing. A1/P1 non-asset backed cp traded today at 5% for overnight maturities. ABCP and A2/P2s both traded today between 5.50 and 6.10 overnight and 5.90-6.20 term. The total amount of cp outstanding has decreased by $90B (4%) since last week and $181B (9%) from two weeks ago. ABCP is down by almost 7% for this week alone. ABCP outstandings could go down another 15% if most of the lower quality ABCP names disappear.”
From Bloomberg: “Bank of America Corp., the second- biggest U.S. lender, is already up about $700 million on its $2 billion preferred stock investment in Countrywide Financial Corp. This is ``something of a sweetheart deal,'' David Hendler, an analyst at research firm CreditSights Inc. in New York, said in a report. Bank of America…can convert the preferred stock to common shares at $18 each, compared with a high reached today of $24.46. Countrywide, the biggest U.S. mortgage lender, will also pay interest of 7.25 percent on the preferred shares. Countrywide, which lost half its market value after peaking on Feb. 2, rose $1.07 or 4.9 percent…The deal, announced after the market closed yesterday, was made to help …Countrywide weather the global credit rout that had cut off its access to short-term financing. The investment reassured investors after Countrywide was forced last week to draw on $11.5 billion of bank credit lines and Merrill Lynch & Co. raised the prospect that the company may be headed for bankruptcy. ``The only time you see terms like this is if a company is really desperate for financing,'' …A 7.25 percent coupon on a convertible ``is pretty rare on a company that's investment-grade,''… Countrywide's ``funding problems will not be cured with a mere $2 billion infusion,'' said …JP Morgan Securities Inc. …``The main driver for the deal was a hope that the credit markets and CFC's depositors will see this as a reinforcement that CFC will survive the current liquidity crunch.'' The deal will increase Countrywide's diluted shares by 19 percent and cost about $145 million in dividends…`It was expensive for the company but it's ultimately better to keep the company in business,'' …``It helps to stabilize the company as a whole. On a personal basis, it's better for the world, for you and me going out to get mortgages, that they stay in business.''
From LEHC: “In an interview on CNBC today, Mozilo asked if he thought there would be a recession in the US, said "I think so ... I know I've been proven wrong so far, but I can't believe that when you're having a level of delinquencies, foreclosures -- equity has disappeared, equity is gone, the tide has gone out -- that this doesn't have a material effect… on the psyches of the American people, and eventually on their wallet." Mozilo also noted that the financial markets are in "one of the greatest panics I've ever seen in 55 years in financial services." Mr. Mozilo is 68 years old. Mr. Mozilo said that in his mind there was “no even thought” of BofA buying Countrywide. He said that BoA contacted him personally to see if BoA could “help”, and also noted that he would have loved to have “tapped” the discount window, but that he couldn’t, as the bulk of the company’s mortgage assets were not assets of Countrywide Bank. And finally, he said that he hasn’t seen any improvement in market liquidity, and overall he sounded pretty depressed.”
From Dow Jones: “The cost of protecting Countrywide Financial Corp.’s debt fell sharply after Bank of America Corp. acquired a $2 billion equity stake in the nation’s largest mortgage company. The credit default swaps, which measure the perceived risk of owning a company’s bonds, fell in price to $177,500 to insure $10 million of bonds annually for five years from $330,000 late Wednesday…That brings the CDS back to levels last seen at the start of the month, before Countrywide ran into trouble securing short-term funding. The CDS may be recovering, but it doesn’t mean Moody’s Investors Service thinks the mortgage company’s problems are over. The ratings agency, which downgraded the company three notches to its lowest investment-grade rating just last week, said it was keeping Countrywide’s ratings on review for possible downgrade.”
Bernanke Fed Less Inclined to Lower Rates and Risk Bubbles Than Greenspan Fed
From Fortune: “It may be the most important development to emerge from the recent market turbulence: The Federal Reserve, under Chairman Ben Bernanke, is going back to being a central bank. Judging by its cautious and finely-calibrated responses through a very ugly August, the Fed appears keen to put the Alan Greenspan years firmly in the past and take a much more orthodox approach to monetary policy. While the Fed will probably cut interest rates as early as next month, its behavior in August strongly suggests that Bernanke will avoid using interest rates to deliberately spark big increases in lending, the high risk strategy pursued by Greenspan from 2001 to 2004… A change at the Fed would have far-reaching consequences for the U.S. economy and the stock market. Initially, a much less accommodating Fed will be perceived as a reason for bearishness. But, over the longer term, market players may well see a less dysfunctional central bank as a good thing that could begin the process of cutting borrowing levels in the U.S., something that has to happen if the American economy is not going to seize up every time interest rates rise… this Fed has cut only the discount rate, a move designed to get healthy financial institutions trading with, and lending to, each other. Critically, Bernanke's Fed hasn't yet reduced the Fed funds rate, which does have a big impact on the economy. And it has not officially commented on what its next moves might be with that rate. And if it does lower the Federal funds rate next month, it's hard to see it rushing to further cuts, as happened in 1998. Why? Because there seems to be a recognition at the Fed that lending got out of hand in the past five years, and it's important now for markets to attach new, lower values to many loans and bonds. In a June speech, Bernanke commented on the shake-out in subprime mortgages in a conspicuously neutral way, suggesting the Fed was monitoring housing problems, but was not unduly concerned by adjustments taking place in it. "I think the Fed is happy to see that risk aversion is increasing," says Kasriel… Lacker argued that a reduction in a discount rate is a good thing to do because it can supply liquidity without leading the market to misprice credit once again. "Sound discount window policy, I believe, should aim at supplying adequate liquidity without undermining the market's assessment of risk," he stated. While Treasury secretary Henry Paulson is not a Fed member, it was more than interesting to see him making the same point, also on Tuesday, when he said: "As the Fed addresses liquidity this makes it possible, this makes it easier, for the market to focus on risk and pricing risk." What seems so different under Bernanke is a genuine recognition that interest rate cuts could spark another bubble, and thus must be enacted carefully. This appears to have been a big factor in the Fed's decision-making last week… The stand-back strategy of Bernanke's Fed was in many ways vindicated by news Wednesday night that Bank of America is making a $2 billion investment in Countrywide, the large mortgage company that is suffering a liquidity squeeze. It shows that stronger firms are capable of becoming part of the market adjustment by making investments in weaker companies during this crisis. This happened without a cut in the Fed funds rate… After nearly 20 years at the helm of the Fed, Greenspan left the U.S. economy more vulnerable to credit shocks than it has ever been.”
From Reuters: “Past experience suggests central banks overreacted, cutting rates more than was needed, says … an economist at Dutch investment bank ABN Amro. In the two weeks following the October 1987 market crash, the Fed cut its key interest rate by half a percentage point. The housing market took off and inflation kept creeping higher.
After LTCM's collapse triggered fears of a systemic crisis in late 1998, the Fed cut its key Fed Funds rate by 75 basis points, or three-quarters of a point, which was more than sufficient…In both cases, rates were higher within 18 months than prior to the crises, and it looked as if it had all been overdone. "In hindsight, it looks like the Fed over-reacted. Perhaps Mr (Fed chief Ben) Bernanke, a renowned U.S. economic historian, understands this better than some market commentators," … When Alan Greenspan ran the Fed, says [Morgan Stanley’s Steve] Roach, central bankers committed the "original sin of the bubble world", ignoring a surge in liquidity which fed directly into asset markets. "That set in motion a chain of events that has allowed one bubble to beget another, from equities to housing to credit,"… "The art and science of central banking is in desperate need of a major overhaul -- before it's too late," says Roach.”
Unemployment Claims Gradually Rising As Hiring Pace Slows
From FTN: “Initial claims filed for unemployment insurance were down 2k to 322k from a revised 324k last week (was 322k). The level of claims is at the high end of this year’s range, and the 4-week average has climbed very close to where it was in June, during seasonal auto layoffs. (Yes, these data are seasonally adjusted, but the layoffs were bigger than usual, and the timing shifts a bit year to year.) Essentially, this translates to a small, but by no means alarming, rise in layoffs. Continuing claims tell another story however. This is a measure of the total number of recipients receiving benefits, so it is a decent guide to the pace of net hiring. Continuing claims pushed to more than 2,550k in late June, remained high in July and is rising again in August. If the turmoil in the markets has only increased the pace of layoffs slightly, it has had a more substantial impact on hiring. (Remember, the turmoil in the money market is an August story, but the long end locked up in June after the bond market concluded the Fed would not ease within the next year.) The Fed will be paying more attention than usual to these data, just as we are, because they are starved for contemporaneous economic information. There is nothing in the data yet to justify an inter-meeting cut.”
Housing Industry Related Job Losses Accelerate
From AP: “…more than 25,000 workers nationwide who have lost jobs in the financial services industry since the beginning of the month -- with more than half coming since last Friday.…Since the start of the year, more than 40,000 workers have lost their jobs at mortgage lending institutions, according to recent company layoff announcements and data complied by global outplacement firm Challenger, Gray & Christmas Inc. Meanwhile, construction companies have announced nearly 20,000 job cuts this year, while the National Association of Realtors expects membership rolls to decline this year for the first time in a decade. It's an employment collapse that threatens to rival the massive layoffs in the airline industry that followed the Sept. 11, 2001, terrorist attacks, when some 100,000 employees lost their jobs… It's only been weeks," Challenger said. "These companies are acting remarkably quickly, stopping on a dime.””
As Expected, Fed’s Report on Commercial Paper Outstanding Shows Large Drop
From Bloomberg: “The amount of U.S. commercial paper outstanding had its biggest weekly percentage drop since 2000 as investors shunned debt that may be linked to mortgages and other risky assets and instead opted for the safety of Treasuries. The amount dropped $90.2 billion, or 4.23 percent, to a seasonally adjusted $2.04 trillion… Some companies that use commercial paper to buy asset-backed securities or collateralized debt obligations backed by subprime mortgages are having trouble finding investors. Commercial paper buyers, in the face of attempts by the Federal Reserve to ease the credit crunch, have headed for Treasury bills in which the yield on Aug. 20 fell the most since the stock market crash of 1987. ``There is a significant amount of cash in the system, it's just not getting to the parts of the market that need it,'' Conrad DeQuadros, a senior economist at Bear Stearns Cos., said in an interview today in New York. The Fed has lowered the interest it charges to lend to banks to encourage buyers of commercial paper after the market seized up last week for Countrywide Financial Corp. and other mortgage lenders. Countrywide, based in Calabasas, California, borrowed its
entire $11.5 billion in available bank credit lines in order to fund its operations…. The decline in outstanding commercial paper was driven by a 6.8 percent fall in asset-backed commercial paper, which represents about half the commercial paper market and has been used to finance purchases of subprime mortgages. The average yield on 30-day asset-backed paper rated A1, the second-highest short-term credit rating by Standard & Poor's, rose 5 basis points, or 0.05 percentage point, to 6.1 percent. It has risen 35 basis points in the past week.”
From JP Morgan: “…today we got the most recent data for CP outstanding (note this is a w/ a 1wk lag, so the data today is as of last Weds)...I think it's noteworthy that ABCP is down 70.9bb wk-over-wk...as we don't know of any defaults at this point, this decline in
notional outstanding appears to be a function of paying down CP (whether it's a result of bank lines getting tapped or de-levering is another question).”
Regulatory Bank Funding Requirements Reinforced Asset Price Spiral
From Barclays: “The root cause of this thirst for term finance is the near complete illiquidity in the term (one-month or longer) depo markets. The drought in the term money markets is attributable to banks' need to preserve liquidity to finance the involuntary growth in their balance sheets. This growth has been caused primarily by a rapid drawdown of standby credit lines extended to conduits and SIVs, [ Note – From The Financial Times: “SIV-lites are essentially collateralised debt obligations which pool together bonds backed by mortgages and other asset-backed debt. The main difference is that other CDOs sell long-term senior debt to fund their assets while SIV-lites raise senior debt in the short-term ABCP markets.] whose access to the CP market has been cut off by ABS-shy investors. In a similar vein, banks’ balance sheets have also been swollen by incoming collateral from margin calls. Most of this collateral is characterised by very weak or non-existent secondary market bids, so banks are opting – or being co-opted by circumstances – to keep these securities on their balance sheets. Banks have been forced to conserve liquidity to cover these contingent assets and as a result, have been unwilling to lend in the term depo market. Since all banks, to a greater or lesser extent, partly finance themselves in the money markets, the lack of offers much longer than a week left the system with a major headache. The regulatory framework sensibly prohibits banks from funding their entire balance sheet in the overnight market. Regulators require banks to maintain liquidity in certain maturity brackets in relation to the maturity of the assets they are financing. Since all the fresh assets – whether collateral or back-up credit lines – appearing on balance sheets are fairly long term and since the term depo market was not offering any liquidity, there is a potential liquidity ratio regulatory problem. And as each day passes, the existing financing shortens in maturity as the banking system’s term borrowing rolls-off, to be replaced by overnight finance. Unchecked, the net result would be a banking system that resembles a giant upturned pyramid resting on its apex. Needless to say, giant upturned pyramids resting on their apexes are not noted for their stability. Furthermore, as banks start hitting their regulatory liquidity ratio constraints, they are forced to shed assets in an effort to slim their balance sheets, adding to the pressure in secondary market valuations and contributing to the spiral of collateral liquidations and margin calls on levered investors… with improved access to term finance now available, banks may feel less inclined to shrink SIV and conduit balance sheets and therefore ease the fire-sale pressures on the underlying securities. Those pressures had been contributing to a spiral, whereby asset sales depressed secondary market valuations and therefore triggered more margin calls. So this move should help break this spiral and thus slow the involuntary expansion of bank balance sheets… Elsewhere in the money markets, we note one particular point that may be slowing the return to more normal conditions. Many of the contingent assets that are popping up on bank balance sheets are not eligible to be used as collateral at the central bank liquidity windows. This is particularly the case in the US, where banks cannot put up collateral in which they have a credit interest. This rules out assets that are appearing on balance sheets as a result of back-up credit lines being exercised. More generally, the flight to safety has resulted in a shortage of top quality collateral in the system, as the collapse in T-bill and repo rates for government securities suggests. In turn, there is a potential risk that this shortage of quality collateral is inhibiting access to liquidity… Outside the short-term money markets, one could be forgiven for imagining that the rest of the financial system inhabits a different planet. Both investment grade and high yield spreads have contracted very sharply. Since last week, the US investment grade CDX index has tightened some 28 bp or 34% of the widest levels attained. Since the end of last month, the US Crossover index has narrowed by 40% or around 150 bp. The primary market has also been active for investment grade bond and loan issuance. Indeed, as the Financial Times points out today, dollar-denominated investment grade bond issuance, at $28bn for the first three weeks of August, is actually up 47% from last year’s equivalent. Equally, the successful completion of the fourth largest syndicated loan ever issued – $40bn for Rio Tinto – tells us in no uncertain terms that the credit market are open for business, albeit much more selectively than before. The depth of this particular pool of liquidity – which is presumably real money rather then leveraged – is the matter of some conjecture. Equally, the $300bn overhang of bridge debt, which will be tapping the higher yield market, is a much harder test for the credit markets than good quality investment grade bond issuance. However, for the time being, the omens are relatively positive inasmuch as markets are becoming much more discriminating. Problems with asset-backed commercial paper are clearly not a pricing factor for corporate debt at the moment, while the illiquidity in the term money markets has not deterred value hunters in the equity market. Encouragingly, the recovery in longer-term credit and equity markets has taken place against a backdrop of fading rate cut expectations. This implies that investors are increasingly moving to the view that the various problems are contained and unlikely to be a decisive risk to economic growth – and by extension non-financial corporate earnings. Longer run, questions remain over the banking system’s ability to supply fresh credit for a while, given the sharp expansion in balance sheets. Given the efficiency with which most banks run their balance sheets, the recent involuntary asset growth from hung bridge loans, margined collateral and the exercise of back-up credit lines suggests that banks may soon approach capital adequacy limits. However, if real money investors are happy to finance an expansion of bank liabilities by buying bank bond issues – and this is the case at present – then this problem too will begin to fade in importance. We would caution that a lasting easing of this crisis requires these two preconditions to be met. Given the fragility of the financial sector, it is certainly too soon to sound the All Clear. However, compared to the position of the markets just one week ago, we appear to have successfully pulled back from the brink of what was looking like a very deep and dark abyss. ”
Rating Agencies Getting the Blame For Market Mayhem
From Economist: “Every crisis begets finger-pointing, and the blame now is falling on the rating agencies that helped structure these exotic instruments. The European Commission is understood to be reviewing why rating agencies failed to move more quickly in response to the growing crisis in subprime mortgages. Currently, they are guided by a voluntary code that aims to tackle potential conflicts of interest. The biggest is that the agencies are paid by the firms they rate. Rating CDOs was a profitable business. To understand why so much blame is being heaped on the rating agencies, consider how CDOs and collateralised-loan obligations (CLOs) came into vogue. In the mid-1990s individual loans looked appealing to investors, but their ratings (often below investment grade) made them too risky for conservative types. So whole forests of asset-backed securities were put together into a single CDO. These were structured so that the first losses would be taken by whoever had bought the riskiest, highest-yielding piece of the package. That piece had a low rating. But the piece at the top, which would take the last losses, was rated AAA—a reflection of how unlikely it was that all the loans in the CDO would default at once. Rather than standing back and observing this from the sidelines, the rating agencies got involved in structuring these products. Like schoolgirls asking for help with their homework, the banks would go to the agencies and ask how the different slices of the CDOs they were putting together would score. The agencies would suggest improvements based on their models. And lo, the senior tranches were given the ratings required to market them to banks, which liked the security the triple-A ratings conferred, especially because their yields were higher than those of American Treasuries… Goldman Sachs admitted as much when it said that its funds had been hit by moves that its models suggested were 25 standard deviations away from normal. In terms of probability (where 1 is a certainty and 0 an impossibility), that translates into a likelihood of 0.000...0006, where there are 138 zeros before the six. That is silly. "Securitisation," … "has meant that credit risks have moved from knowledgeable, long-term hands, to fast hands, where the principal risk-management strategy is to sell before prices fall more". Working out who has won and who has lost in this round will take a long time.”
Friedman Billings Ramsey Report Thinks Mortgage Markets Won’t Stablize for at Least 6 Months
From Dow Jones: “It may take a long time for investors to start bidding for mortgages again. In recent months, companies from mortgage lenders, hedge funds and firms investing in structured products - such as assetbacked bonds - have been racing to dump mortgage assets to repay creditors, as the fallout from the credit squeeze continues to reverberate. The upshot: Businesses are earning even less from selling loans, more lenders are failing, and investors - except for those savvy specialists in distressed investing – are reluctant to dip their toes back. In a report entitled “De-Leveraging Destroying Value - New Capital Needed,” analyst Paul Miller Jr. at Friedman Billings Ramsey estimated that it takes roughly $150 billion to $250 billion of new capital to “normalize pricing” in the mortgage market. But it’s also a kind of Catch-22 situation: Without new capital, it could be difficult for asset prices to come back up; without pricing adjustment and better returns, new capital may be hard to come by. Miller projected that it will take six to 12 months for the prices of mortgage assets to normalize and for capital to flow back into the space. “There is no quick fix here,” he noted. And until then, lenders will continue to come under pressure with respect to earnings and book values.”
Japan
From JP Morgan: “The Bank of Japan left policy rates unchanged at 0.5% on an 8-1 vote. Governor Fukui emphasized that investors are engaged in the repricing of risk and that this is a process that will take time to play out. As such, the BoJ needs time to assess how market developments might affect the economy. In its monthly report, the BoJ reaffirmed its assessment of current conditions (moderate expansion) and the longer-term outlook.”
From Bloomberg: “Japanese investors were net sellers of foreign bonds during the week ended Aug. 18 according to figures based on reports from designated major investors released by the Ministry of Finance in Tokyo.”
From Bloomberg: “The yen fell against the euro and dollar on speculation investors resumed riskier bets financed by borrowing in Japan.”
From Dow Jones: “The Bank of Japan’s governor said that investors have made “significant progress” in cutting from their portfolios risky yen-selling investments, but remained cautious about the resurgence of such bets. “I think there has been significant progress in the unwinding of short positions linked to yen-carry trades” during the past few weeks of turbulent global markets, Toshihiko Fukui said at post-policy board meeting news conference. Yen-carry trades refer to the strategy of borrowing money at Japan’s low interest rates and investing in more attractive assets outside Japan. But Fukui also indicated that he hasn’t let his guard down against another boom in such trades, and he signaled that the BOJ wants to raise interest rates partly to discourage such trades.”
MISC
From Lehman: “The pullback in mortgage origination continued, largely in subprime and Alt-A lending, as more mortgage lenders shut down operations. In addition, credit conditions in overall capital markets worsened. We now look for an even deeper housing recession: Sales and starts should continue to fall through the middle of next year. Inventory of new homes should fall at a faster pace than inventory of existing homes. National home prices should fall modestly; bubble regions will likely witness bigger declines.”
From Bloomberg: “BP Plc, the world's third-biggest oil refiner, may scrap a $3.8 billion expansion of its Whiting, Indiana, refinery, as public opposition increases…``Ongoing regional opposition to any increase in discharge permit limits for Lake Michigan creates an unacceptable level of business risk'' for the expansion, Bob Malone, president of BP's U.S. unit, said in the statement. ``If necessary changes to the project result in a material impact to project viability, we could be forced to cancel it.''”
From Time: “…Las Vegas--where 40% of the houses up for sale now sit vacant.”
From Merrill Lynch: “The majority of companies within the S&P 500 Index exceeded earnings expectations in 2Q, with the index in aggregate delivering 7.5% year-over-year quarterly growth…[but] earnings failed to break the 10% growth mark for the second quarter in a row.”
From Dow Jones: “The U.S. federal budget deficit will fall for the third year running, totaling $158 billion in fiscal-year 2007, the Congressional Budget Office estimated.
The budget deficit for fiscal year 2006 was $248 billion. A nominal-dollar record high annual deficit of $412 billion was set in 2004.”
End-of-Day Market Update
From SunTrust: “Things looked rosy early this morning. Equities were higher overnight, CFC got liquidity from BOA and the odds of a FED ease decreased considerably. It looked like we might see some increased activity in term cp issuance. But, it shaped up to be a lot like yesterday. Rates were mostly unchanged for A2/P2 (BBB+ long-term) names today and about 5bp higher for A1/P1 ABCP. The market continues to be very sloppy. Very similar credit quality names in both markets can trade 20bp away from each other. The major factor in deciding rates is the panic level of the issuers to get paper placed and the amount they need to issue. We saw additional activity in A2/P2 issuers hitting bank lines for more favorable financing. A1/P1 non-asset backed cp traded today at 5% for overnight maturities. ABCP and A2/P2s both traded today between 5.50 and 6.10 overnight and 5.90-6.20 term. The total amount of cp outstanding has decreased by $90B (4%) since last week and $181B (9%) from two weeks ago. ABCP is down by almost 7% for this week alone. ABCP outstandings could go down another 15% if most of the lower quality ABCP names disappear.”
Wednesday, August 22, 2007
Today's Tidbits
Fed Should Protect System, Not Individual Participants, Says Dallas Fed President
From Reuters: “It is not the job of the U.S. central bank to protect individual risk-takers, but the system itself, Federal Reserve Bank of Dallas President Richard Fisher said in a magazine article published on Wednesday. The Dallas Fed said the interview with International Economy was conducted in June. "I don't mind tears among individual market operators, as long as we don't get tears in the fabric of the financialsystem," Fisher said.”
From Bloomberg: “Dallas Fed President Richard Fisher said the central bank's job is safeguarding the financial system, not protecting ``risk- takers.''… ``A cut in the federal funds rate would be for the whole economy,'' he said. Another reduction of the discount rate ``can address very specific problems such as lack of liquidity in the market.''
Fed “Cautiously Optimistic” Efforts Working to Stabilize Markets
From The Wall Street Journal: “Federal Reserve officials are cautiously optimistic that the series of steps they have taken to stabilize markets have started to work. Officials acknowledge conditions are far from calm, and markets could easily take a turn for the worse. But they cite stable stock prices, a pickup in issuance of jumbo mortgages and other factors as evidence that in recent days conditions have improved, though gradually, instead of worsened. Many on Wall Street are more pessimistic, and believe the Fed will still have to cut interest rates sharply, perhaps starting in the next week or two. But as long as Fed officials think things are getting better, they are less likely to feel pressured to cut interest rates immediately and more likely to wait until their scheduled meeting Sept. 18 to decide.”
Four Large Banks Borrow From Fed’s Discount Window
From Barclays: “JP Morgan Chase, Bank of America, and Wachovia issued a joint press release today indicating that they had each drawn $500mn through the discount window in order to "take a leadership role in demonstrating the potential value of the Fed's primary credit facility and to encourage its use by other financial institutions." In a separate statement, Citigroup indicated it had also tapped the discount window for $500mn. It is unclear whether these public announcements in support of the Fed's recent policy change will affect the behavior of other depositories, although it does suggest that the Fed is likely to give the policy some time before is assesses its effect, as there may be some hesitancy on the part of banks who have traditionally viewed the Fed as a lender of last resort. The average amount of loans through the discount window over the past three months is $216mn. Tomorrow the Fed releases its H.4.1 report, Factors Affecting Reserve Balances, which includes data on discount window loans through August 22 and will provide the first snapshot of the response to the Fed's policy change.”
From Dow Jones: “The trio said while it has “substantial liquidity and the
capacity to borrow money elsewhere on more favorable terms,” they believed it was important to show leadership in showing the value of Fed’s credit facility.”
From RBSGC: “Interesting to see the effort to preempt potential speculation on WHO borrowed ahead of Thursday's Fed data.”
FDIC Says Late Loan Payments at 17 Year High
From Bloomberg: “U.S. banks and thrifts suffered the biggest increase in late loan payments in 17 years as more homeowners fell behind on mortgages, the Federal Deposit
Insurance Corp. said. Loans more than 90 days past due rose 10.6 percent to $66.9
billion in the period ending June 30, the largest quarterly rise since 1990, the FDIC said in its Quarterly Banking Profile released today. ``The bottom line for banks is that the credit environment continues to be more challenging now than it has been in recent years,'' FDIC Chairman Sheila Bair said during a news briefing at the agency's Washington headquarters. The report reflects the growing strain lenders are facing as the collapse of the subprime mortgage market roils the banking industry. At least 90 U.S. mortgage companies have halted operations or sought buyers since the start of 2006, according to Bloomberg data. Loans more than 90 days past due grew 36.2 percent from $49.1 billion in the second quarter a year ago, the largest 12- month increase since 1991. Residential mortgage loans 90 days delinquent increased 12.6 percent to $27.5 billion in the second quarter from $24.4 billion in the first quarter.”
From Investment News: “The "tremendous golden age of banking" for U.S. financial institutions had ended, at least temporarily, said FDIC chairman Sheila Bair in a statement. "Everybody is being challenged in this current environment," she said.”
Inflation-Adjusted Incomes Drop, Adding to Economic Stress of Workers
From New York Times: “Americans earned a smaller average income in 2005 than in 2000, the fifth consecutive year that they had to make ends meet with less money than at the peak of the last economic expansion, new government data shows. While incomes have been on the rise since 2002, the average income in 2005 was $55,238, still nearly 1 percent less than the $55,714 in 2000, after adjusting for inflation, analysis of new tax statistics show… Total income listed on tax returns grew every year after World War II, with a single one-year exception, until 2001, making the five-year period of lower average incomes and four years of lower total incomes a new experience for the majority of Americans born since 1945… The growth in total incomes was concentrated among those making more than $1 million. The number of such taxpayers grew by more than 26 percent, to 303,817 in 2005, from 239,685 in 2000. These individuals, who constitute less than a quarter of 1 percent of all taxpayers, reaped almost 47 percent of the total income gains in 2005, compared with 2000. .. nearly 90 percent of Americans who make less than $100,000 a year… Nearly half of Americans reported incomes of less than $30,000, and two-thirds make less than $50,000… The fact that average incomes remained lower in 2005 than five years earlier helps explain why so many Americans report feeling economic stress despite overall growth in the economy. Many Americans are also paying a larger share of their health care costs and have had their retirement benefits reduced, adding to their out-of-pocket costs.”
More Firms Close Subprime Businesses
From Bloomberg: “Lehman Brothers Holdings Inc., the biggest underwriter of U.S. bonds backed by mortgages, became the first firm on Wall Street to close its subprime-lending unit and said 1,200 employees will lose their jobs…Accredited Home Lenders Holding Co., a subprime specialist, announced 1,600 job cuts earlier today in an effort to outlast the credit crunch that has forced dozens of rivals out of business. HSBC Holdings Plc is eliminating 600 positions in its U.S. operations and closing a mortgage office in Indiana, and Capital One Financial Corp. is closing GreenPoint Mortgage because it can't make money anymore lending to homeowners and then selling those mortgages to investors.”
Gasoline Demand at All-Time High
From Lehman: “Gasoline demand rose by 190k b/d w-o-w to its highest level ever, 9.76m b/d, 40k b/d higher than the next highest level achieved in July 2005. Combined with total motor gasoline imports falling by 285k b/d and a draw in blending components of 3.8m bbls, gasoline inventories fell by 5.7m bbls on the week, putting them 6.2m bbls below the five-year average. The divergence between this year and last year's gasoline stocks picture has grown more stark with stocks off 9.6m bbls y-o-y… The crude oil build leaves crude stocks still above 2006 levels and above the five-year range, likely further undermining, in our view, any chance that OPEC would increase output at its September 11 meeting.”
Baltic Freight Index Indicates Demand For Industrial Commodities Remains Strong
From Barclays: “One index that has proven the past to be a very reliable indicator of underlying trends in the bulk commodity markets is the Baltic Freight Index (BFI). It is composed of a survey carried out each day into the costs of booking raw material cargos, such as iron ore, base metal concentrates, coal or grains on a variety of representative trade routes. With no speculative participation, there is little linkage to the broader financial markets. Twice already this year the BFI has proved a reliable indicator of underlying fundamental trends for commodities when financial market pressures have caused confidence to wobble. At the start of the year when oil and metals prices were under pressure from short-selling hedge funds expecting a big slowdown in US demand, the steep increase in the BFI showed that Chinese commodity demand was accelerating and was an indicator of the subsequent price corrections. Again, in February, after a steep decline in the Shanghai Stock Exchange, the strength of the BFI showed that there had been little impact on underlying Chinese commodity demand. It is therefore noteworthy that on the day that base metals fell sharply last week (Thursday 16th) the BFI made a fresh all-time high and is still trading close to that level. The continued strength of China’s commodity demand that the upward trend in freight rates is pointing to is reinforced by the latest Chinese commodity import data (reviewed on page 2 of this report) which continues to look very strong indeed. The message to take from the strength of the BFI is that once the dust from the current financial market settles, the likelihood is for some very strong rebounds in commodity prices.
MISC
From Reuters: “The ABC News/Washington Post Consumer Comfort Index tanked to -20 in the latest week from -11 in the previous period. It was the first time the index fell 9 points in a week since it was launched in 1985…"The decline is broadly based among population groups, and there seems not to be a single negative event to blame, but a confluence,"…”From MNI: “ABC News/Washington Post Consumer Comfort … 'falling to its lowest level since the aftermath of Hurricane Katrina in late October 2005.”
From Dow Jones: “Toll Brothers Inc.’s fiscal third-quarter net fell 85% as the luxury home builder recorded more land writedowns amid continued slowing in new-home construction. Chairman and Chief Executive Robert Toll said in a statement that the builder had experienced “a much higher rate of cancellations than at any time in our 21-year history as a public company” due to the downturn in the housing market.”
From RBSGC: “Historically, the Fed has eased when we've seen unemployment 0.3% UP from the cycle low -- not a guaranty, but over 4.7% and you have one duck lined up.”
From Barclays: “[Hurricane] Dean is likely to result in significant lost Mexican oil production in the order of 10m barrels ... However, the risk of serious damage to Mexican operations is dissipating, with Dean being downgraded to a Category 1 hurricane as it heads toward oil installations in the Campeche Bay…the impact of incremental Mexican production losses and temporary closure of oil ports will result in lower US imports in the weeks ahead, therefore contributing at the margin to further declines in US crude oil inventories which are already falling fast…”
From Bloomberg: “General Motors Corp. is trimming production at six plants that make large pickup trucks and sport- utility vehicles as the biggest U.S. automaker moves to clear dealer lots in a sales decline…GM already offers no-interest loans for as long as five years and rebates as high as $4,000 on light-truck models…”
From Bloomberg: “Wheat surged to a record in Chicago, extending a rally that began in April, on signs of rising demand for U.S. supplies and slumping output from the world's largest growers… Large grain users probably will pass on higher costs to grocers, who will then increase consumer prices…”
End-of-Day Market Update
From Bloomberg: “U.S. two-year Treasury notes led the bond market lower on speculation the Federal Reserve will cut its benchmark interest rate no more than a quarter-percentage point in the next month. Three-month bill yields rose a second day, suggesting investors are returning to risky assets. Interest-rate futures show traders reduced bets the central bank will lower its overnight lending rate by a half-percentage point to 4.75 percent at its Sept. 18 meeting… ``The attitude has changed, and we're returning to some level of a regular market environment,…The early read is what the Fed has done so far is working. That's removing the safe-haven flight.'' The yield on the two-year note rose 10 basis points, or 0.1 percentage point, to 4.12 percent as of 3:02 p.m. in New York, according to bond broker Cantor Fitzgerald LP. The increase ended a seven-day rally that was the longest since April 2005…The yield on the benchmark 10-year note increased 3 basis points to 4.62 percent. Ten-year Treasuries yielded about 50 basis points more than two-year notes, down from a two-year high of 56 basis points yesterday, when investors sought the safety of shorter maturities. The so-called flattening of the yield curve today suggests investors trimmed expectations for an imminent rate cut… Three-month bill yields rose 7 basis points to 3.67 percent…The spread between three-month bill yields and the London interbank offered rate, seen as an indicator of credit risk, shrank for a second day, by 0.06 percentage point to 1.84 percentage points. The ``TED'' spread, as it's known, was the widest on Aug. 20 since the 1987 crash.”
From Lehman: “The flattening was clearly the big story today, and the move was a relentless one… Wednesday's yield changes were roughly as follows: 2 years: +9.5 bp
5 years: +7.0 bp 10 years: +2.8 bp 18 years: +2.4 bp 30 years: +1.2 bp”
From UBS: “4-week T-bills, which tailed 200bps in yesterday's auction, cheapened 75bps, perhaps signaling the return of some semblance of sanity in the markets. TIPS … Breakevens widened across the board.”
From Bloomberg: “U.S. stocks climbed for a fifth day on growing speculation the summer breakdown in credit markets won't derail the economy or pending company mergers… Stocks extended a rebound from their worst decline in four years after the Federal Reserve on Aug. 17 cut the rate it charges banks to borrow in a bid to stem rising credit costs. The Standard & Poor's 500 Index increased 16.95, or 1.2 percent, to 1,464.07. The Dow Jones Industrial Average added 145.27, or 1.1 percent, to 13,236.13. The Nasdaq Composite Index advanced 31.5, or 1.3 percent, to 2,552.8… An unprecedented amount of acquisitions propelled the stock market to a record July 19. The pace declined 65 percent this month from July after mortgage defaults sent the Standard & Poor's down 5.7 percent from its peak.”
From Dow Jones: “The dollar weakened to a one-week low against the euro Wednesday as volatility in U.S. stocks continued to decline, leading investors to focus back on interest rates comparisons between the Fed and the ECB. The ECB hinted that it still is planning to hike rates next month despite market turmoil, which helped push the euro to an intraday high of $1.3552. Meanwhile, investors are still betting the Fed will start cutting rates, although these forecasts were pared back slightly Wednesday. The greenback gained modestly against the yen but remained in rather tight ranges near Y115.00, as carry trade investors remain unsure if it’s safe to venture back into short yen positions.” [ Dollar index down -.27 to 81.23]
From Dow Jones: “Crude oil futures dropped Wednesday morning after U.S. oil and oil product inventory data revealed that gasoline inventories fell and crude oil stocks increased, countering analysts’ expectations… the Department of Energy said that U.S. gasoline inventories fell by a shocking 5.7 million barrels in the week ended August 17, more than 5 million barrels above projections of a 600,000 barrel draw in a Dow Jones survey of analysts.” [Oil futures fell -.34 cents to $69.23 barrel]
From Reuters: “It is not the job of the U.S. central bank to protect individual risk-takers, but the system itself, Federal Reserve Bank of Dallas President Richard Fisher said in a magazine article published on Wednesday. The Dallas Fed said the interview with International Economy was conducted in June. "I don't mind tears among individual market operators, as long as we don't get tears in the fabric of the financialsystem," Fisher said.”
From Bloomberg: “Dallas Fed President Richard Fisher said the central bank's job is safeguarding the financial system, not protecting ``risk- takers.''… ``A cut in the federal funds rate would be for the whole economy,'' he said. Another reduction of the discount rate ``can address very specific problems such as lack of liquidity in the market.''
Fed “Cautiously Optimistic” Efforts Working to Stabilize Markets
From The Wall Street Journal: “Federal Reserve officials are cautiously optimistic that the series of steps they have taken to stabilize markets have started to work. Officials acknowledge conditions are far from calm, and markets could easily take a turn for the worse. But they cite stable stock prices, a pickup in issuance of jumbo mortgages and other factors as evidence that in recent days conditions have improved, though gradually, instead of worsened. Many on Wall Street are more pessimistic, and believe the Fed will still have to cut interest rates sharply, perhaps starting in the next week or two. But as long as Fed officials think things are getting better, they are less likely to feel pressured to cut interest rates immediately and more likely to wait until their scheduled meeting Sept. 18 to decide.”
Four Large Banks Borrow From Fed’s Discount Window
From Barclays: “JP Morgan Chase, Bank of America, and Wachovia issued a joint press release today indicating that they had each drawn $500mn through the discount window in order to "take a leadership role in demonstrating the potential value of the Fed's primary credit facility and to encourage its use by other financial institutions." In a separate statement, Citigroup indicated it had also tapped the discount window for $500mn. It is unclear whether these public announcements in support of the Fed's recent policy change will affect the behavior of other depositories, although it does suggest that the Fed is likely to give the policy some time before is assesses its effect, as there may be some hesitancy on the part of banks who have traditionally viewed the Fed as a lender of last resort. The average amount of loans through the discount window over the past three months is $216mn. Tomorrow the Fed releases its H.4.1 report, Factors Affecting Reserve Balances, which includes data on discount window loans through August 22 and will provide the first snapshot of the response to the Fed's policy change.”
From Dow Jones: “The trio said while it has “substantial liquidity and the
capacity to borrow money elsewhere on more favorable terms,” they believed it was important to show leadership in showing the value of Fed’s credit facility.”
From RBSGC: “Interesting to see the effort to preempt potential speculation on WHO borrowed ahead of Thursday's Fed data.”
FDIC Says Late Loan Payments at 17 Year High
From Bloomberg: “U.S. banks and thrifts suffered the biggest increase in late loan payments in 17 years as more homeowners fell behind on mortgages, the Federal Deposit
Insurance Corp. said. Loans more than 90 days past due rose 10.6 percent to $66.9
billion in the period ending June 30, the largest quarterly rise since 1990, the FDIC said in its Quarterly Banking Profile released today. ``The bottom line for banks is that the credit environment continues to be more challenging now than it has been in recent years,'' FDIC Chairman Sheila Bair said during a news briefing at the agency's Washington headquarters. The report reflects the growing strain lenders are facing as the collapse of the subprime mortgage market roils the banking industry. At least 90 U.S. mortgage companies have halted operations or sought buyers since the start of 2006, according to Bloomberg data. Loans more than 90 days past due grew 36.2 percent from $49.1 billion in the second quarter a year ago, the largest 12- month increase since 1991. Residential mortgage loans 90 days delinquent increased 12.6 percent to $27.5 billion in the second quarter from $24.4 billion in the first quarter.”
From Investment News: “The "tremendous golden age of banking" for U.S. financial institutions had ended, at least temporarily, said FDIC chairman Sheila Bair in a statement. "Everybody is being challenged in this current environment," she said.”
Inflation-Adjusted Incomes Drop, Adding to Economic Stress of Workers
From New York Times: “Americans earned a smaller average income in 2005 than in 2000, the fifth consecutive year that they had to make ends meet with less money than at the peak of the last economic expansion, new government data shows. While incomes have been on the rise since 2002, the average income in 2005 was $55,238, still nearly 1 percent less than the $55,714 in 2000, after adjusting for inflation, analysis of new tax statistics show… Total income listed on tax returns grew every year after World War II, with a single one-year exception, until 2001, making the five-year period of lower average incomes and four years of lower total incomes a new experience for the majority of Americans born since 1945… The growth in total incomes was concentrated among those making more than $1 million. The number of such taxpayers grew by more than 26 percent, to 303,817 in 2005, from 239,685 in 2000. These individuals, who constitute less than a quarter of 1 percent of all taxpayers, reaped almost 47 percent of the total income gains in 2005, compared with 2000. .. nearly 90 percent of Americans who make less than $100,000 a year… Nearly half of Americans reported incomes of less than $30,000, and two-thirds make less than $50,000… The fact that average incomes remained lower in 2005 than five years earlier helps explain why so many Americans report feeling economic stress despite overall growth in the economy. Many Americans are also paying a larger share of their health care costs and have had their retirement benefits reduced, adding to their out-of-pocket costs.”
More Firms Close Subprime Businesses
From Bloomberg: “Lehman Brothers Holdings Inc., the biggest underwriter of U.S. bonds backed by mortgages, became the first firm on Wall Street to close its subprime-lending unit and said 1,200 employees will lose their jobs…Accredited Home Lenders Holding Co., a subprime specialist, announced 1,600 job cuts earlier today in an effort to outlast the credit crunch that has forced dozens of rivals out of business. HSBC Holdings Plc is eliminating 600 positions in its U.S. operations and closing a mortgage office in Indiana, and Capital One Financial Corp. is closing GreenPoint Mortgage because it can't make money anymore lending to homeowners and then selling those mortgages to investors.”
Gasoline Demand at All-Time High
From Lehman: “Gasoline demand rose by 190k b/d w-o-w to its highest level ever, 9.76m b/d, 40k b/d higher than the next highest level achieved in July 2005. Combined with total motor gasoline imports falling by 285k b/d and a draw in blending components of 3.8m bbls, gasoline inventories fell by 5.7m bbls on the week, putting them 6.2m bbls below the five-year average. The divergence between this year and last year's gasoline stocks picture has grown more stark with stocks off 9.6m bbls y-o-y… The crude oil build leaves crude stocks still above 2006 levels and above the five-year range, likely further undermining, in our view, any chance that OPEC would increase output at its September 11 meeting.”
Baltic Freight Index Indicates Demand For Industrial Commodities Remains Strong
From Barclays: “One index that has proven the past to be a very reliable indicator of underlying trends in the bulk commodity markets is the Baltic Freight Index (BFI). It is composed of a survey carried out each day into the costs of booking raw material cargos, such as iron ore, base metal concentrates, coal or grains on a variety of representative trade routes. With no speculative participation, there is little linkage to the broader financial markets. Twice already this year the BFI has proved a reliable indicator of underlying fundamental trends for commodities when financial market pressures have caused confidence to wobble. At the start of the year when oil and metals prices were under pressure from short-selling hedge funds expecting a big slowdown in US demand, the steep increase in the BFI showed that Chinese commodity demand was accelerating and was an indicator of the subsequent price corrections. Again, in February, after a steep decline in the Shanghai Stock Exchange, the strength of the BFI showed that there had been little impact on underlying Chinese commodity demand. It is therefore noteworthy that on the day that base metals fell sharply last week (Thursday 16th) the BFI made a fresh all-time high and is still trading close to that level. The continued strength of China’s commodity demand that the upward trend in freight rates is pointing to is reinforced by the latest Chinese commodity import data (reviewed on page 2 of this report) which continues to look very strong indeed. The message to take from the strength of the BFI is that once the dust from the current financial market settles, the likelihood is for some very strong rebounds in commodity prices.
MISC
From Reuters: “The ABC News/Washington Post Consumer Comfort Index tanked to -20 in the latest week from -11 in the previous period. It was the first time the index fell 9 points in a week since it was launched in 1985…"The decline is broadly based among population groups, and there seems not to be a single negative event to blame, but a confluence,"…”From MNI: “ABC News/Washington Post Consumer Comfort … 'falling to its lowest level since the aftermath of Hurricane Katrina in late October 2005.”
From Dow Jones: “Toll Brothers Inc.’s fiscal third-quarter net fell 85% as the luxury home builder recorded more land writedowns amid continued slowing in new-home construction. Chairman and Chief Executive Robert Toll said in a statement that the builder had experienced “a much higher rate of cancellations than at any time in our 21-year history as a public company” due to the downturn in the housing market.”
From RBSGC: “Historically, the Fed has eased when we've seen unemployment 0.3% UP from the cycle low -- not a guaranty, but over 4.7% and you have one duck lined up.”
From Barclays: “[Hurricane] Dean is likely to result in significant lost Mexican oil production in the order of 10m barrels ... However, the risk of serious damage to Mexican operations is dissipating, with Dean being downgraded to a Category 1 hurricane as it heads toward oil installations in the Campeche Bay…the impact of incremental Mexican production losses and temporary closure of oil ports will result in lower US imports in the weeks ahead, therefore contributing at the margin to further declines in US crude oil inventories which are already falling fast…”
From Bloomberg: “General Motors Corp. is trimming production at six plants that make large pickup trucks and sport- utility vehicles as the biggest U.S. automaker moves to clear dealer lots in a sales decline…GM already offers no-interest loans for as long as five years and rebates as high as $4,000 on light-truck models…”
From Bloomberg: “Wheat surged to a record in Chicago, extending a rally that began in April, on signs of rising demand for U.S. supplies and slumping output from the world's largest growers… Large grain users probably will pass on higher costs to grocers, who will then increase consumer prices…”
End-of-Day Market Update
From Bloomberg: “U.S. two-year Treasury notes led the bond market lower on speculation the Federal Reserve will cut its benchmark interest rate no more than a quarter-percentage point in the next month. Three-month bill yields rose a second day, suggesting investors are returning to risky assets. Interest-rate futures show traders reduced bets the central bank will lower its overnight lending rate by a half-percentage point to 4.75 percent at its Sept. 18 meeting… ``The attitude has changed, and we're returning to some level of a regular market environment,…The early read is what the Fed has done so far is working. That's removing the safe-haven flight.'' The yield on the two-year note rose 10 basis points, or 0.1 percentage point, to 4.12 percent as of 3:02 p.m. in New York, according to bond broker Cantor Fitzgerald LP. The increase ended a seven-day rally that was the longest since April 2005…The yield on the benchmark 10-year note increased 3 basis points to 4.62 percent. Ten-year Treasuries yielded about 50 basis points more than two-year notes, down from a two-year high of 56 basis points yesterday, when investors sought the safety of shorter maturities. The so-called flattening of the yield curve today suggests investors trimmed expectations for an imminent rate cut… Three-month bill yields rose 7 basis points to 3.67 percent…The spread between three-month bill yields and the London interbank offered rate, seen as an indicator of credit risk, shrank for a second day, by 0.06 percentage point to 1.84 percentage points. The ``TED'' spread, as it's known, was the widest on Aug. 20 since the 1987 crash.”
From Lehman: “The flattening was clearly the big story today, and the move was a relentless one… Wednesday's yield changes were roughly as follows: 2 years: +9.5 bp
5 years: +7.0 bp 10 years: +2.8 bp 18 years: +2.4 bp 30 years: +1.2 bp”
From UBS: “4-week T-bills, which tailed 200bps in yesterday's auction, cheapened 75bps, perhaps signaling the return of some semblance of sanity in the markets. TIPS … Breakevens widened across the board.”
From Bloomberg: “U.S. stocks climbed for a fifth day on growing speculation the summer breakdown in credit markets won't derail the economy or pending company mergers… Stocks extended a rebound from their worst decline in four years after the Federal Reserve on Aug. 17 cut the rate it charges banks to borrow in a bid to stem rising credit costs. The Standard & Poor's 500 Index increased 16.95, or 1.2 percent, to 1,464.07. The Dow Jones Industrial Average added 145.27, or 1.1 percent, to 13,236.13. The Nasdaq Composite Index advanced 31.5, or 1.3 percent, to 2,552.8… An unprecedented amount of acquisitions propelled the stock market to a record July 19. The pace declined 65 percent this month from July after mortgage defaults sent the Standard & Poor's down 5.7 percent from its peak.”
From Dow Jones: “The dollar weakened to a one-week low against the euro Wednesday as volatility in U.S. stocks continued to decline, leading investors to focus back on interest rates comparisons between the Fed and the ECB. The ECB hinted that it still is planning to hike rates next month despite market turmoil, which helped push the euro to an intraday high of $1.3552. Meanwhile, investors are still betting the Fed will start cutting rates, although these forecasts were pared back slightly Wednesday. The greenback gained modestly against the yen but remained in rather tight ranges near Y115.00, as carry trade investors remain unsure if it’s safe to venture back into short yen positions.” [ Dollar index down -.27 to 81.23]
From Dow Jones: “Crude oil futures dropped Wednesday morning after U.S. oil and oil product inventory data revealed that gasoline inventories fell and crude oil stocks increased, countering analysts’ expectations… the Department of Energy said that U.S. gasoline inventories fell by a shocking 5.7 million barrels in the week ended August 17, more than 5 million barrels above projections of a 600,000 barrel draw in a Dow Jones survey of analysts.” [Oil futures fell -.34 cents to $69.23 barrel]
Quick Market Update
Since there was no PUP this morning, and a lot is going on in the markets, wanted to send out a brief update.
Three month T-Bills have fallen from just under 5% yields a little over two weeks ago, to a low of 2.7% yesterday, and are currently at 2.95%. Yesterday's 67bp decline was the largest one day drop in 20 years for the 3m Bills. As investors worry about lending their money long-term, which means even three month commercial paper interest rates have risen dramatically to attract funds, safe government bills and bonds have seen a huge flight to quality bid that has pushed down their interest rates.
This morning there is a rumor circulating that the Fed may ease short-term market rates, not just the discount rate used by banks to borrow funds from the Fed that was lowered last Friday, but the Fed Funds target rate, before the meeting at 10am this morning between Fed Chairman Bernanke, Treasury Sec. Paulson, and Senate Finance Chairman Dodd, in a supposed effort to prove the Fed isn't being swayed by politics to ease. Many economists are becoming increasingly concerned the U.S. may be entering into a recession, the first one in five years.
Equity markets are rallying on the rumor. Stocks still haven't had a 10% correction on closing levels from the record highs reached last month. Only the very broad-based Wilshire 5000 is actually lower on the year.
The dollar is likely to be under pressure if the U.S. lowers interest rates. The dollar index has been fluttering above 12 year lows at 80 recently. Short-term, the dollar has been helped by flight-to-quality buying out of emerging markets, and repatriation by U.S. investors, but long-term lower interest rates will be less attractive to foreign investors, as will a slowing economy for stock demand.
This morning foreclosure data was released. Foreclosures rose 93% MoM in July, and the increases are spreading from the rust belt to California and Florida.
Three month T-Bills have fallen from just under 5% yields a little over two weeks ago, to a low of 2.7% yesterday, and are currently at 2.95%. Yesterday's 67bp decline was the largest one day drop in 20 years for the 3m Bills. As investors worry about lending their money long-term, which means even three month commercial paper interest rates have risen dramatically to attract funds, safe government bills and bonds have seen a huge flight to quality bid that has pushed down their interest rates.
This morning there is a rumor circulating that the Fed may ease short-term market rates, not just the discount rate used by banks to borrow funds from the Fed that was lowered last Friday, but the Fed Funds target rate, before the meeting at 10am this morning between Fed Chairman Bernanke, Treasury Sec. Paulson, and Senate Finance Chairman Dodd, in a supposed effort to prove the Fed isn't being swayed by politics to ease. Many economists are becoming increasingly concerned the U.S. may be entering into a recession, the first one in five years.
Equity markets are rallying on the rumor. Stocks still haven't had a 10% correction on closing levels from the record highs reached last month. Only the very broad-based Wilshire 5000 is actually lower on the year.
The dollar is likely to be under pressure if the U.S. lowers interest rates. The dollar index has been fluttering above 12 year lows at 80 recently. Short-term, the dollar has been helped by flight-to-quality buying out of emerging markets, and repatriation by U.S. investors, but long-term lower interest rates will be less attractive to foreign investors, as will a slowing economy for stock demand.
This morning foreclosure data was released. Foreclosures rose 93% MoM in July, and the increases are spreading from the rust belt to California and Florida.
Tuesday, August 21, 2007
August 20, 2007 TIDBITS
Evolution of a Credit Crunch
From HSBC: “The financial system is suffering a seizure. The good news is that central banks appear willing to act, adding liquidity and, in the Fed’s case, cutting the discount rate. The bad news is that the seizure may not respond swiftly or easily to changes in monetary policy. The seizure reflects a loss of faith in subprime mortgages and collateralised debt obligations and a loss of faith, also, in the institutions that have invested in these products. Most of us thought weak US housing would be a problem for debt-laden households. Increasingly, though, it’s the creditors who are having difficulties. The seizure is a capital market problem. Central bank actions so far are designed to guarantee additional liquidity to the commercial banks, whether through injections of cash or through reductions in discount rates. However, the crunch is occurring in the non-bank financial sector, and the commercial banks are increasingly wary of extending liquidity to these institutions. The central banks may be able to control the price of money, but at the moment it’s quantity that counts…The financial market turmoil is best understood with reference to the Manias, Panics and Crashes2 so well described by the late Charles Kindleberger. The past few weeks have revealed a crisis that is linked to the US housing market. The crisis, though, is not for the debtors (i.e. the households). Instead, the problem lies with the creditors. This, therefore, is not so much the wealth effect of old, constraining household spending, but rather a credit crunch problem. It is a problem that lies at the heart of the financial system. The good news is that other parts of the economy – in particular, the corporate sector with its excellent balance sheet position – will not be affected for now. Companies are likely to find themselves in trouble only in the light of a major collapse in demand…The roots of the problem are three-fold. First, the Federal Reserve left monetary conditions too loose for too long in the early years of this decade, helping to trigger a housing boom. Second, emerging market reserve managers invested their mammoth reserves in safe assets, placing downward pressure on yields and forcing other investors to take more risk to achieve desired returns. Third, housing-related innovations in financial products acted as a magnet for the resulting “excess liquidity”. These products – the alphabet soup of modern finance – include CDOs, ABS, MBS and asset-backed commercial paper…The fire-sale of equities in recent weeks, for example, can only be understood in this context. The latest crisis has historical precedents. If, as seems likely, there is a credit squeeze, the comparable periods include the aftermaths of the late 1980s Savings and Loans crisis, the 1998 LTCM crisis and the 2000 NASDAQ crash. However, the outcomes from these episodes varied hugely.”
Poor Regulatory Oversight Leaves Market Unsure Where Problems Lie
From Bill Gross: “Those looking for clues to the extent of the spreading fungus should understand that there really is no comprehensive data to allow anyone to know how many subprimes actually rest in individual institutional portfolios. Regulators have been absent from the game, and information release has been left in the hands of individual institutions…Also many institutions, including pension funds and insurance companies, argue that accounting rules allow them to mark subprime derivatives at cost. Default exposure, therefore, can hibernate for many months before its true value is revealed to investors and, importantly, to other lenders. The significance of proper disclosure is, in effect, the key to the current crisis. Financial institutions lend trillions of dollars…The food chain in this case is not one of predator feasting on prey, but a symbiotic credit extension, always for profit, but never without trust and belief that their money will be repaid upon contractual demand. When no one really knows where and how many Waldos there are, the trust breaks down, and money is figuratively stuffed in Wall Street and London mattresses as opposed to extended into the increasingly desperate hands of hedge funds and similarly levered financial conduits. These structures in turn are experiencing runs from depositors and lenders exposed to asset price declines of unexpected proportions. In such an environment, markets become incredibly volatile as more and more financial institutions reach their risk limits at the same time. Waldo morphs and becomes a man with a thousand faces. All assets, with the exception of U.S. Treasuries, look suspiciously like one another. They're all Waldos now. The past few weeks have exposed a giant crack in modern financial architecture, created by youthful wizards and endorsed for its diversity by central bankers present and past. While the newborn derivatives may hedge individual institutional and sector risk, they cannot eliminate the Waldos. In fact, the inherent leverage that accompanies derivative creation may foster systemic risk when information is unavailable or delayed in its release. Nothing within the current marketplace allows for the hedging of liquidity risk, and that is the problem at the moment. Only the central banks can solve this puzzle, with their own liquidity infusions and perhaps a series of rate cuts. The markets stand by with apprehension.”
High Priced Home Markets Under Attack Too
From Fortune: “Not only has the [subprime mortgage] collapse driven up rates on many kinds of mortgages, but fear of a stock crash -- one perhaps sparked by the bursting of the credit bubble -- has for now prompted many high-end homebuyers to either trim their offers or stop shopping altogether...For years jumbo rates were only 0.25 of a percentage point above those of "conforming" loans -- those below the cutoff (now $417,000). In recent weeks that spread has exploded to 0.75 of a percentage point or more. BankRate.com reports that the average tariff on jumbo loans soared to 7.35% nationally in August, and many mortgage brokers are reporting figures that exceed 8%. Increased rates on big home loans translate to a substantial decline in buying power. Two years ago a $6,000 monthly payment would support a $1 million, 30-year mortgage at 6%. Today that same $6,000 payment covers only an $870,000 mortgage at 7.35%. In other words, higher rates have trimmed the buying power of luxury-home buyers by 10% to 15%. Throw in the fact that some buyers can't get a mortgage at any rate right now, and you've got all the makings for a national price correction for luxury homes… One top mortgage fund manager says he's sworn off investing in jumbos because he doesn't trust the rating agencies to distinguish the good credit from the bad.”
From RGSGC: “A separate issue whispered about is how the last few weeks will impact Wall Street's bonuses and employment. The point here is that the higher end of the earnings spectrum may feel the pinch that the lower end has already been feeling -- it's the Tiffany vs. Wal-Mart reconciliation.”
Why Banks Might Want to Fund Through Discount Window
From Morgan Stanley: “…if a bank can borrow at 5.25% on an unsecured basis in the fed funds market, why would they go to the discount window for 5.75%? My response stressed the certainty of a 30-day term, renewable by the borrower, in an environment in which the fed funds market was very volatile, as well as the counter party risk inherent in the fed funds market. But, here is an excerpt from a Q&A with Lou Crandall of Wrightson Assoc, appearing on Greg Ip's blog, that comes at it from a slightly different angle that I find pretty compelling. Q: Why might a bank take out a discount loan, under these new terms, instead of borrow fed funds? A: Credit line limits. Fed funds are a bilateral market, and each bank puts a limit on its trading line with every other participant. (Those limits are sometimes effectively zero – that is, the credit department of a bank may choose to monitor only a certain number of participants). Moreover, the credit lines in fed funds are not commitments, they are discretionary caps. Bank A is not required to lend up to its own self-determined limit to Bank B. Rather, the limit is the max that its traders can do, and they (or the credit department) can choose to lower their exposure at any time. Banks tend to assume that their access to funding will dry up in a crisis, and so are reluctant to make commitments that can only be met that way. The Fed’s statement noted that the new primary credit terms would give banks “assurance” of funding, or wording to that effect. I think the biggest point here is that banks can now make a commitment to, say, a commercial paper issuer whose assets they consider sound, to provide funding knowing that the window is available even if a bank’s own market access dries up. I think the Fed wants to make sure that banks’ decisions about lending are based only on traditional asset-side risk (credit risk and interest-rate risk) and not on banks’ own liquidity risk.”
Schedule of ARM Resets and Likely Default Rates
From Lehman: “With more than $120-$140 billion of mortgages expected to reset every quarter for the next five quarters, reset volumes will peak to historically high levels. The vast majority—more than 80%—of these resets are from subprime 2/28s originated in 2005 and 2006, notorious for their weak underwriting. The comparatively few agency and prime borrowers resetting in the coming months are from the 2003 and 2004 vintages. In addition to sound underwriting, these prime resets have seen stronger HPA. The bulk of the prime ARM universe is scheduled to reset in 2010 and beyond. There are about $30 billion per month in ARMs coming up for reset from the subprime market alone. We expect loan originations in the subprime space to run at $10 billion a month. Even if all the subprime ARM borrowers wanted to refinance, 60% of them are likely to be denied credit under current market conditions. About 40% of the resetting borrowers would not have been able to refinance their mortgages at their original terms even before the liquidity seizure in the markets. If market conditions were to revert to the May-June period, we think aggregate defaults in the next 24 months will be about $240 billion. This represents approximately 950,000 homes going through the foreclosure process. We project lifetime defaults of $584 billion and 2.3 million homes going through foreclosure in this scenario. In the extreme case that market conditions do not revert back,
we think defaults could total as much as $733 billion in aggregate and an additional 500,000 of homes would go through the foreclosure process by December 2008. The additional increase in defaults represents approximately one month of existing home sales.”
I.R.S. Always Wants It’s Cut, Even in Default
From The New York Times: “Two years ago, William Stout lost his home in Allentown, Pa., to foreclosure when he could no longer make the payments on his $106,000 mortgage. Wells Fargo offered the two-bedroom house for sale on the courthouse steps. No bidders came forward. So Wells Fargo bought it for $1, county records show. Despite the setback, Mr. Stout was relieved that his debt was wiped clean and he could make a new start…But on July 9, they received a bill from the Internal Revenue Service for $34,603 in back taxes. The letter explained that the debt canceled by Wells Fargo upon foreclosure was subject to income taxes, as well as penalties and late fees. The couple had a month to challenge the charges… losing one’s home can feel like hitting bottom. But one more financial indignity may await as the fallout from the great housing boom ripples across the United States… Notices of unpaid taxes, unanticipated and little understood, will probably multiply as more people fall behind on their mortgages… Foreclosure is one way that beleaguered homeowners can fall into this tax trap. The other is when homeowners are forced to sell their homes for less than the value of the mortgage. If the lender forgives that difference, they are liable for income taxes on that amount. The 1099 shortfall, as it is called, stems from an Internal Revenue Service policy that treats forgiven debt of all types as income even if the taxpayer has nothing tangible to show for it, unless the debt is canceled through bankruptcy.”
Money Market Funds Invested in Risky CDO’s – Too Much Reliance on Ratings
From Bloomberg: “Money market funds were invented 37 years ago to offer investors better returns than bank savings accounts while providing a high degree of safety. Most of the $2.5 trillion sitting in these funds is invested in such assets as U.S. Treasury bills, certificates of deposit and short-term commercial debt. Unlike bank accounts, money market funds aren't insured by the federal government. They almost never fail. Unbeknownst to most investors, some of the largest money market funds today are putting part of their cash into one of the riskiest debt investments in the world: collateralized debt obligations backed by subprime mortgage loans. CDOs are packages of bonds and loans, and almost half of all CDOs sold in the U.S. in 2006 contained subprime debt, according to a March report by Moody's Investors Service…Under SEC rules, money market managers must invest in securities with ``minimal credit risks.'… Money market funds have become a staple for investors. There are 38.4 million money market fund accounts in the U.S….Investors have sought safety during the subprime meltdown by moving their holdings to U.S. Treasuries and money market funds. On Aug. 8, just after the Bear Stearns hedge funds filed for bankruptcy protection, U.S. money market fund total assets reached a record high of $2.66 trillion, with investors pouring
$49 billion into such funds in one week, according to the ICI. As a sign of stability, money market funds never allow their share price to rise above or fall under $1 for each dollar invested. A money market fund that invests in subprime debt increases the risk that its share price could drop below $1. If 5 percent of a fund's holding is subprime debt, and in a worst-case situation that asset collapses, then the value of the fund could drop to 95 cents… ``Fund companies will support the funds,'' he says. ``They won't let them break $1 a share. The odds of money market funds breaking the buck are virtually nil.'' Just once has a money market fund failed. In 1994, a fund run by Community Bankers Mutual Fund of Denver invested in securities that defaulted. Investors were paid 96 cents a share, and the fund was liquidated…Commercial paper pays relatively low interest rates, which averaged about 5.3 percent in June and July, because it rarely defaults…CDO commercial paper, often loaded with subprime debt, pays higher returns than corporate paper, and it paid as much as 6.5 percent in August… Money market managers buy CDO commercial paper even when prospectuses warn of the risks. Zurich-based Credit Suisse, Morgan Stanley in New York and San Francisco-based Wells Fargo are among money market managers that poured more than $1 billion into commercial paper …``Reliable sources of statistical information do not exist with respect to the default rates for many of the types of collateral debt securities eligible to be purchased by the Issuer,'' say both the 2005 and 2006 CDO prospectuses backing commercial paper held in the funds…Tim Wilson, head of Credit Suisse's cash management portfolio desk, says he's comfortable with CDO commercial paper because it has the highest credit ratings and because his funds hold the debt for only one to three months. ``We don't have any concerns these are going to have any defaults in 90 days,'' he says. ``We're obviously watching.'' The paper matures within three months, and after that the fund doesn't hold any subprime debt, unless Wilson decides to buy more. Vanguard Group Inc., the second-largest mutual fund company in the U.S., has a policy of never buying CDO commercial paper for its $90 billion in money market funds or $325 billion in fixed-income mutual funds. ``It really gets down to transparency questions,'' says John Hollyer, risk management director at Valley Forge, Pennsylvania-based Vanguard. ``Can you understand what you have?
And can you measure it appropriately? We haven't been comfortable that we could.'' Bank of New York Mellon Corp.'s Dreyfus unit has banned CDO commercial paper from its $110 billion in money market funds because it has found that analyzing subprime holdings in CDOs is too difficult. The firm's money market investment committee decided in 2005 that such paper was too risky… Most of the dollar value of all CDOs, as much as 90 percent, gets a credit rating of AAA or Aaa. The higher the credit rating, the lower the return that's demanded by investors. The CDO commercial paper bought by money market funds always has a top credit rating, even when it's backed by subprime debt. In the past three years, Fitch, Moody's and S&P have made more money from evaluating structured finance -- which includes CDOs and asset-backed securities -- than from rating anything else, including corporate or municipal bonds, according to their
financial reports. The companies charge as much as three times more to rate CDOs than to analyze bonds, their cost listings show. The three rating companies say these fees are higher because CDOs are so complex. The close working relationships between CDO managers and rating companies -- and the fees that change hands -- mean money market funds shouldn't rely on ratings to evaluate CDOs, says Harvey Pitt, who was SEC chairman from 2001 to 2003. Pitt says fund managers should do their own research on
CDOs by reading the hundreds of pages of prospectuses and the monthly trustee reports. Some managers may not have been doing their homework. ``Relying on rating agencies for investment advice is dicey,'' he says. ``Their reliance on rating agencies left them
a day late and several dollars short.''…Fidelity Investments, the world's biggest mutual fund company, owned $2.3 billion in CDO-issued commercial paper in two money market funds as of May 31…The biggest money market fund in the U.S., Fidelity Cash Reserves Fund, had 1.5 percent of its $98.2 billion assets invested in CDO commercial paper backed by subprime debt. The Fidelity Institutional Money Market Portfolio had 2.3 percent of its $32.3 billion in assets in such commercial paper. Boston-based Fidelity fund manager Kim Miller says he's holding off on buying more CDO debt…. Money market managers are required to determine that their investments are safe and have high credit ratings, according to Rule 2a-7, a 1997 addition to the Investment Company Act of
1940. ``The money market fund shall limit its portfolio investments to those United States dollar-denominated securities that the fund's board of directors determines present minimal credit risks,'' the rule says…The subprime-backed commercial paper in money market funds offers some of the highest yields managers can include in their investments because such funds are prohibited by SEC rules from buying junk-rated debt. The Bear Stearns hedge fund implosion demonstrated how misleading credit ratings of CDOs can be… While CDOs aren't regulated by the SEC, mutual funds -- including money markets -- are. The SEC disclosed in June it's begun looking at some CDO investments, without releasing further details…Investors are accustomed to treating money market funds as
if they were bank savings accounts. The last thing they expect is that the subprime debt turmoil would enter their safe cash havens. And now it has.”
MISC
From JP Morgan: “…the Fed now is expected to trim the funds rate 25bp at both the September and October FOMC meetings. This action is expected to bolster financial markets and limit the slowdown in US GDP growth to a trend-like 2.5% pace over the three quarters through 1Q08.”
From Morgan Stanley: “Higher volatility is here to stay, and the threat to earnings and volatility means there is still more risk in equities and credit. Yield curves likely will steepen by more, and depending on risk appetite, the dollar may continue to weaken.”
From RGSGC: “[Tomorrow] 10am closed-door meeting with Bernanke, Paulson, and Sen. Dodd -- Chairman of the Senate Banking Committee. To discuss responses to "ongoing turmoil". Senator Dodd then speaks at 11 am post-meeting to discuss recent developments.”
From RBSGC: “With quarter end approaching for several firms this month and with, we presume, hedge funds having redemption issues a bounce in collateralized debt areas will be deemed a chance to pare back exposure, not extend.”
From MNI: “The [Chinese] government has permitted individuals to invest directly in an overseas stock market for the first time, with a trial program allowing individuals to start trading securities on the Hong Kong Stock Exchange, according to the State Administration of Foreign Exchange. Under the trial program, domestic investors can invest foreign exchanges already in their possession or purchase them, outside the current quota of 50,000 usd of foreign exchange that individuals are allowed every year.”
From Bloomberg: “SunTrust Banks Inc., seeking to cut $530 million in annual costs by 2009, expects to eliminate about 7 percent (2,400 employees) of its workforce by the end of next year as profit from retail and commercial banking declines.”
From Barclays: “Equity vol continues to come off: VIX traded at 37+ on Thursday.. currently 28 which is down 2 on the day. Appears the broader equity mkt is not super worried about the economy collapsing and stocks crashing. This is about credit, and the ability of some firms (non-banks) to finance. The huge drop in Bill rates must
mean that money is just flowing out of money mkt funds into bills/cash instruments.”
From Morgan Stanley: “Tighter financial conditions imply downside risks to global growth for now…The US is most at risk, but global spillover effects matter; this shock is economic decoupling's first real test. There are downside risks in commodities, and this shock is disinflationary, giving central banks latitude to respond to growth threats…. Global softening is in the price, but global recession is not. Therefore, near-term weakness in US consumer spending could ignite fears of global economic contagion… Investors should not lose sight of the global economy's underlying resilience, which could play an important role in reversing the downside risks for markets.”
End-of-Day Market Update
From RBSGC: “The market was well bid on Monday in a continuation of the credit/liquidity concerns that have driven Treasuries to these levels and have held us here. Today's data was a non-event, a consensus uptick in Leading Indicators did nothing but clear the way for more buying as Treasuries moved higher on the weakness in equities. Despite the afternoon recovery in stocks, yields stayed low, with 2s staying closer to 4% than we have seen in recent weeks while 10s hover near 4.61% -- an important level. The beginning of this week has brought with it more credit-related jitters as the Commercial Paper continues to show signs of stress. The theme in short-dated corporate debt remains limited liquidity for second-tier credit borrowers and obligations beyond 2-weeks. While the concerns surrounding near-term liquidity have been addressed (at least temporarily) by the Fed, there remains an overarching concern that these measures will prove insufficient. The bill market has been one of the biggest benefactors of the risk aversion trade -- with the benchmark 1-month T-Bill (9/13/07) yielding just 2.21% -- vs. a 3.14% close last Thursday -- impressive demand for the sector by any measure. This bid for quality has not gone unnoticed at the NY Fed, which announced that it will redeem $5 bn of its maturing holdings on Thursday -- bring the cash onto its balance sheet to help in overnight operations and fund the demand for money at the Discount Window -- currently the two most meaningful ways of addressing the credit crunch… Volumes were modest… Current levels are hardly screaming buys. We are concerned with the front end in particularly given just how aggressive it's been in pricing in easing and are reminded that 125 bp through funds is normal into that first ease which means inside 4% 2s are fair, not cheap. And while the market won't argue with a 50 bp rate cut over the next few weeks -- at the least -- the steps the Fed has taken so far are incremental and you cannot divorce market expectations from Fed reality. If Monday's action is any guide, while liquidity is certainly a continuing issue the frozen panic of the prior week has calmed somewhat. Everyone is in something of a waiting mode.”
From SunTrust: “The lack of liquidity in spread products has moved into Treasuries. The short bill market is off the charts. The 3 month bill opened at a 3.80, dropped to 2.50, then back to 2.90. The move reportedly started with a large purchase by a central bank in the w.i. three month. Then continued angst in the commercial paper market forced more investors, including money market funds, into the bill market. The bill auction was a complete disaster. The three month tailed back 20 bp vs the bid at the auction deadline
while the six month tailed by 25 bp. Both had very low bid covers. Volume has not been huge, but traders are fearful of being left short, so it doesn't take much to move the market. Spread products aren't sure yet what they think of Bernanke's move. Agency and mortgage spreads are unchanged. Corporate spreads are selectively wider with the new issue market pressuring financials. It has become a game of wait-and-see if the FED's two-step approach of extra liquidity and access to the discount window is enough to calm fear. The FED would really prefer NOT to have to cut the funds rate before the September 18 FOMC meeting.”
From JP Morgan: “Money markets remain under stress. In the United States, 3-month Treasury yields auctioned today at 91bp below their Friday yields, while the interbank lending rate is more or less unchanged, leading to a new high in the TED spread. In Europe, issuers of asset-backed commercial paper had trouble rolling over their debt. One encouraging development in financial markets is the continued decline in energy prices.”
Previous Today’s
Close Low Hi Close Change
3m T-Bill 3.754 2.505 3.837 3.072 -68bp
3y Treasury Yld 4.185 4.05 4.201 4.083 -10bp
5y Treasury Yld 4.358 4.274 4.376 4.292 -7bp
10y Treas Yld 4.685 4.61 4.702 4.626 -6bp
30y Treas Yld 4.986 4.947 5.02 4.969 -2bp
Dow 13079 12983 13181 13121 +42
Trans 4768 4769 4870 4855 +87
Util 487 481 490 488 +1
S&P 1446 1430.5 1451.75 1445.5 -.5
Dollar Index 81.43 81.26 81.49 81.38 -.035
Japan Yen 114.4 113.7 115.5 115 +.5
Oil 71.98 70.05 71.77 71.12 -.86
Evolution of a Credit Crunch
From HSBC: “The financial system is suffering a seizure. The good news is that central banks appear willing to act, adding liquidity and, in the Fed’s case, cutting the discount rate. The bad news is that the seizure may not respond swiftly or easily to changes in monetary policy. The seizure reflects a loss of faith in subprime mortgages and collateralised debt obligations and a loss of faith, also, in the institutions that have invested in these products. Most of us thought weak US housing would be a problem for debt-laden households. Increasingly, though, it’s the creditors who are having difficulties. The seizure is a capital market problem. Central bank actions so far are designed to guarantee additional liquidity to the commercial banks, whether through injections of cash or through reductions in discount rates. However, the crunch is occurring in the non-bank financial sector, and the commercial banks are increasingly wary of extending liquidity to these institutions. The central banks may be able to control the price of money, but at the moment it’s quantity that counts…The financial market turmoil is best understood with reference to the Manias, Panics and Crashes2 so well described by the late Charles Kindleberger. The past few weeks have revealed a crisis that is linked to the US housing market. The crisis, though, is not for the debtors (i.e. the households). Instead, the problem lies with the creditors. This, therefore, is not so much the wealth effect of old, constraining household spending, but rather a credit crunch problem. It is a problem that lies at the heart of the financial system. The good news is that other parts of the economy – in particular, the corporate sector with its excellent balance sheet position – will not be affected for now. Companies are likely to find themselves in trouble only in the light of a major collapse in demand…The roots of the problem are three-fold. First, the Federal Reserve left monetary conditions too loose for too long in the early years of this decade, helping to trigger a housing boom. Second, emerging market reserve managers invested their mammoth reserves in safe assets, placing downward pressure on yields and forcing other investors to take more risk to achieve desired returns. Third, housing-related innovations in financial products acted as a magnet for the resulting “excess liquidity”. These products – the alphabet soup of modern finance – include CDOs, ABS, MBS and asset-backed commercial paper…The fire-sale of equities in recent weeks, for example, can only be understood in this context. The latest crisis has historical precedents. If, as seems likely, there is a credit squeeze, the comparable periods include the aftermaths of the late 1980s Savings and Loans crisis, the 1998 LTCM crisis and the 2000 NASDAQ crash. However, the outcomes from these episodes varied hugely.”
Poor Regulatory Oversight Leaves Market Unsure Where Problems Lie
From Bill Gross: “Those looking for clues to the extent of the spreading fungus should understand that there really is no comprehensive data to allow anyone to know how many subprimes actually rest in individual institutional portfolios. Regulators have been absent from the game, and information release has been left in the hands of individual institutions…Also many institutions, including pension funds and insurance companies, argue that accounting rules allow them to mark subprime derivatives at cost. Default exposure, therefore, can hibernate for many months before its true value is revealed to investors and, importantly, to other lenders. The significance of proper disclosure is, in effect, the key to the current crisis. Financial institutions lend trillions of dollars…The food chain in this case is not one of predator feasting on prey, but a symbiotic credit extension, always for profit, but never without trust and belief that their money will be repaid upon contractual demand. When no one really knows where and how many Waldos there are, the trust breaks down, and money is figuratively stuffed in Wall Street and London mattresses as opposed to extended into the increasingly desperate hands of hedge funds and similarly levered financial conduits. These structures in turn are experiencing runs from depositors and lenders exposed to asset price declines of unexpected proportions. In such an environment, markets become incredibly volatile as more and more financial institutions reach their risk limits at the same time. Waldo morphs and becomes a man with a thousand faces. All assets, with the exception of U.S. Treasuries, look suspiciously like one another. They're all Waldos now. The past few weeks have exposed a giant crack in modern financial architecture, created by youthful wizards and endorsed for its diversity by central bankers present and past. While the newborn derivatives may hedge individual institutional and sector risk, they cannot eliminate the Waldos. In fact, the inherent leverage that accompanies derivative creation may foster systemic risk when information is unavailable or delayed in its release. Nothing within the current marketplace allows for the hedging of liquidity risk, and that is the problem at the moment. Only the central banks can solve this puzzle, with their own liquidity infusions and perhaps a series of rate cuts. The markets stand by with apprehension.”
High Priced Home Markets Under Attack Too
From Fortune: “Not only has the [subprime mortgage] collapse driven up rates on many kinds of mortgages, but fear of a stock crash -- one perhaps sparked by the bursting of the credit bubble -- has for now prompted many high-end homebuyers to either trim their offers or stop shopping altogether...For years jumbo rates were only 0.25 of a percentage point above those of "conforming" loans -- those below the cutoff (now $417,000). In recent weeks that spread has exploded to 0.75 of a percentage point or more. BankRate.com reports that the average tariff on jumbo loans soared to 7.35% nationally in August, and many mortgage brokers are reporting figures that exceed 8%. Increased rates on big home loans translate to a substantial decline in buying power. Two years ago a $6,000 monthly payment would support a $1 million, 30-year mortgage at 6%. Today that same $6,000 payment covers only an $870,000 mortgage at 7.35%. In other words, higher rates have trimmed the buying power of luxury-home buyers by 10% to 15%. Throw in the fact that some buyers can't get a mortgage at any rate right now, and you've got all the makings for a national price correction for luxury homes… One top mortgage fund manager says he's sworn off investing in jumbos because he doesn't trust the rating agencies to distinguish the good credit from the bad.”
From RGSGC: “A separate issue whispered about is how the last few weeks will impact Wall Street's bonuses and employment. The point here is that the higher end of the earnings spectrum may feel the pinch that the lower end has already been feeling -- it's the Tiffany vs. Wal-Mart reconciliation.”
Why Banks Might Want to Fund Through Discount Window
From Morgan Stanley: “…if a bank can borrow at 5.25% on an unsecured basis in the fed funds market, why would they go to the discount window for 5.75%? My response stressed the certainty of a 30-day term, renewable by the borrower, in an environment in which the fed funds market was very volatile, as well as the counter party risk inherent in the fed funds market. But, here is an excerpt from a Q&A with Lou Crandall of Wrightson Assoc, appearing on Greg Ip's blog, that comes at it from a slightly different angle that I find pretty compelling. Q: Why might a bank take out a discount loan, under these new terms, instead of borrow fed funds? A: Credit line limits. Fed funds are a bilateral market, and each bank puts a limit on its trading line with every other participant. (Those limits are sometimes effectively zero – that is, the credit department of a bank may choose to monitor only a certain number of participants). Moreover, the credit lines in fed funds are not commitments, they are discretionary caps. Bank A is not required to lend up to its own self-determined limit to Bank B. Rather, the limit is the max that its traders can do, and they (or the credit department) can choose to lower their exposure at any time. Banks tend to assume that their access to funding will dry up in a crisis, and so are reluctant to make commitments that can only be met that way. The Fed’s statement noted that the new primary credit terms would give banks “assurance” of funding, or wording to that effect. I think the biggest point here is that banks can now make a commitment to, say, a commercial paper issuer whose assets they consider sound, to provide funding knowing that the window is available even if a bank’s own market access dries up. I think the Fed wants to make sure that banks’ decisions about lending are based only on traditional asset-side risk (credit risk and interest-rate risk) and not on banks’ own liquidity risk.”
Schedule of ARM Resets and Likely Default Rates
From Lehman: “With more than $120-$140 billion of mortgages expected to reset every quarter for the next five quarters, reset volumes will peak to historically high levels. The vast majority—more than 80%—of these resets are from subprime 2/28s originated in 2005 and 2006, notorious for their weak underwriting. The comparatively few agency and prime borrowers resetting in the coming months are from the 2003 and 2004 vintages. In addition to sound underwriting, these prime resets have seen stronger HPA. The bulk of the prime ARM universe is scheduled to reset in 2010 and beyond. There are about $30 billion per month in ARMs coming up for reset from the subprime market alone. We expect loan originations in the subprime space to run at $10 billion a month. Even if all the subprime ARM borrowers wanted to refinance, 60% of them are likely to be denied credit under current market conditions. About 40% of the resetting borrowers would not have been able to refinance their mortgages at their original terms even before the liquidity seizure in the markets. If market conditions were to revert to the May-June period, we think aggregate defaults in the next 24 months will be about $240 billion. This represents approximately 950,000 homes going through the foreclosure process. We project lifetime defaults of $584 billion and 2.3 million homes going through foreclosure in this scenario. In the extreme case that market conditions do not revert back,
we think defaults could total as much as $733 billion in aggregate and an additional 500,000 of homes would go through the foreclosure process by December 2008. The additional increase in defaults represents approximately one month of existing home sales.”
I.R.S. Always Wants It’s Cut, Even in Default
From The New York Times: “Two years ago, William Stout lost his home in Allentown, Pa., to foreclosure when he could no longer make the payments on his $106,000 mortgage. Wells Fargo offered the two-bedroom house for sale on the courthouse steps. No bidders came forward. So Wells Fargo bought it for $1, county records show. Despite the setback, Mr. Stout was relieved that his debt was wiped clean and he could make a new start…But on July 9, they received a bill from the Internal Revenue Service for $34,603 in back taxes. The letter explained that the debt canceled by Wells Fargo upon foreclosure was subject to income taxes, as well as penalties and late fees. The couple had a month to challenge the charges… losing one’s home can feel like hitting bottom. But one more financial indignity may await as the fallout from the great housing boom ripples across the United States… Notices of unpaid taxes, unanticipated and little understood, will probably multiply as more people fall behind on their mortgages… Foreclosure is one way that beleaguered homeowners can fall into this tax trap. The other is when homeowners are forced to sell their homes for less than the value of the mortgage. If the lender forgives that difference, they are liable for income taxes on that amount. The 1099 shortfall, as it is called, stems from an Internal Revenue Service policy that treats forgiven debt of all types as income even if the taxpayer has nothing tangible to show for it, unless the debt is canceled through bankruptcy.”
Money Market Funds Invested in Risky CDO’s – Too Much Reliance on Ratings
From Bloomberg: “Money market funds were invented 37 years ago to offer investors better returns than bank savings accounts while providing a high degree of safety. Most of the $2.5 trillion sitting in these funds is invested in such assets as U.S. Treasury bills, certificates of deposit and short-term commercial debt. Unlike bank accounts, money market funds aren't insured by the federal government. They almost never fail. Unbeknownst to most investors, some of the largest money market funds today are putting part of their cash into one of the riskiest debt investments in the world: collateralized debt obligations backed by subprime mortgage loans. CDOs are packages of bonds and loans, and almost half of all CDOs sold in the U.S. in 2006 contained subprime debt, according to a March report by Moody's Investors Service…Under SEC rules, money market managers must invest in securities with ``minimal credit risks.'… Money market funds have become a staple for investors. There are 38.4 million money market fund accounts in the U.S….Investors have sought safety during the subprime meltdown by moving their holdings to U.S. Treasuries and money market funds. On Aug. 8, just after the Bear Stearns hedge funds filed for bankruptcy protection, U.S. money market fund total assets reached a record high of $2.66 trillion, with investors pouring
$49 billion into such funds in one week, according to the ICI. As a sign of stability, money market funds never allow their share price to rise above or fall under $1 for each dollar invested. A money market fund that invests in subprime debt increases the risk that its share price could drop below $1. If 5 percent of a fund's holding is subprime debt, and in a worst-case situation that asset collapses, then the value of the fund could drop to 95 cents… ``Fund companies will support the funds,'' he says. ``They won't let them break $1 a share. The odds of money market funds breaking the buck are virtually nil.'' Just once has a money market fund failed. In 1994, a fund run by Community Bankers Mutual Fund of Denver invested in securities that defaulted. Investors were paid 96 cents a share, and the fund was liquidated…Commercial paper pays relatively low interest rates, which averaged about 5.3 percent in June and July, because it rarely defaults…CDO commercial paper, often loaded with subprime debt, pays higher returns than corporate paper, and it paid as much as 6.5 percent in August… Money market managers buy CDO commercial paper even when prospectuses warn of the risks. Zurich-based Credit Suisse, Morgan Stanley in New York and San Francisco-based Wells Fargo are among money market managers that poured more than $1 billion into commercial paper …``Reliable sources of statistical information do not exist with respect to the default rates for many of the types of collateral debt securities eligible to be purchased by the Issuer,'' say both the 2005 and 2006 CDO prospectuses backing commercial paper held in the funds…Tim Wilson, head of Credit Suisse's cash management portfolio desk, says he's comfortable with CDO commercial paper because it has the highest credit ratings and because his funds hold the debt for only one to three months. ``We don't have any concerns these are going to have any defaults in 90 days,'' he says. ``We're obviously watching.'' The paper matures within three months, and after that the fund doesn't hold any subprime debt, unless Wilson decides to buy more. Vanguard Group Inc., the second-largest mutual fund company in the U.S., has a policy of never buying CDO commercial paper for its $90 billion in money market funds or $325 billion in fixed-income mutual funds. ``It really gets down to transparency questions,'' says John Hollyer, risk management director at Valley Forge, Pennsylvania-based Vanguard. ``Can you understand what you have?
And can you measure it appropriately? We haven't been comfortable that we could.'' Bank of New York Mellon Corp.'s Dreyfus unit has banned CDO commercial paper from its $110 billion in money market funds because it has found that analyzing subprime holdings in CDOs is too difficult. The firm's money market investment committee decided in 2005 that such paper was too risky… Most of the dollar value of all CDOs, as much as 90 percent, gets a credit rating of AAA or Aaa. The higher the credit rating, the lower the return that's demanded by investors. The CDO commercial paper bought by money market funds always has a top credit rating, even when it's backed by subprime debt. In the past three years, Fitch, Moody's and S&P have made more money from evaluating structured finance -- which includes CDOs and asset-backed securities -- than from rating anything else, including corporate or municipal bonds, according to their
financial reports. The companies charge as much as three times more to rate CDOs than to analyze bonds, their cost listings show. The three rating companies say these fees are higher because CDOs are so complex. The close working relationships between CDO managers and rating companies -- and the fees that change hands -- mean money market funds shouldn't rely on ratings to evaluate CDOs, says Harvey Pitt, who was SEC chairman from 2001 to 2003. Pitt says fund managers should do their own research on
CDOs by reading the hundreds of pages of prospectuses and the monthly trustee reports. Some managers may not have been doing their homework. ``Relying on rating agencies for investment advice is dicey,'' he says. ``Their reliance on rating agencies left them
a day late and several dollars short.''…Fidelity Investments, the world's biggest mutual fund company, owned $2.3 billion in CDO-issued commercial paper in two money market funds as of May 31…The biggest money market fund in the U.S., Fidelity Cash Reserves Fund, had 1.5 percent of its $98.2 billion assets invested in CDO commercial paper backed by subprime debt. The Fidelity Institutional Money Market Portfolio had 2.3 percent of its $32.3 billion in assets in such commercial paper. Boston-based Fidelity fund manager Kim Miller says he's holding off on buying more CDO debt…. Money market managers are required to determine that their investments are safe and have high credit ratings, according to Rule 2a-7, a 1997 addition to the Investment Company Act of
1940. ``The money market fund shall limit its portfolio investments to those United States dollar-denominated securities that the fund's board of directors determines present minimal credit risks,'' the rule says…The subprime-backed commercial paper in money market funds offers some of the highest yields managers can include in their investments because such funds are prohibited by SEC rules from buying junk-rated debt. The Bear Stearns hedge fund implosion demonstrated how misleading credit ratings of CDOs can be… While CDOs aren't regulated by the SEC, mutual funds -- including money markets -- are. The SEC disclosed in June it's begun looking at some CDO investments, without releasing further details…Investors are accustomed to treating money market funds as
if they were bank savings accounts. The last thing they expect is that the subprime debt turmoil would enter their safe cash havens. And now it has.”
MISC
From JP Morgan: “…the Fed now is expected to trim the funds rate 25bp at both the September and October FOMC meetings. This action is expected to bolster financial markets and limit the slowdown in US GDP growth to a trend-like 2.5% pace over the three quarters through 1Q08.”
From Morgan Stanley: “Higher volatility is here to stay, and the threat to earnings and volatility means there is still more risk in equities and credit. Yield curves likely will steepen by more, and depending on risk appetite, the dollar may continue to weaken.”
From RGSGC: “[Tomorrow] 10am closed-door meeting with Bernanke, Paulson, and Sen. Dodd -- Chairman of the Senate Banking Committee. To discuss responses to "ongoing turmoil". Senator Dodd then speaks at 11 am post-meeting to discuss recent developments.”
From RBSGC: “With quarter end approaching for several firms this month and with, we presume, hedge funds having redemption issues a bounce in collateralized debt areas will be deemed a chance to pare back exposure, not extend.”
From MNI: “The [Chinese] government has permitted individuals to invest directly in an overseas stock market for the first time, with a trial program allowing individuals to start trading securities on the Hong Kong Stock Exchange, according to the State Administration of Foreign Exchange. Under the trial program, domestic investors can invest foreign exchanges already in their possession or purchase them, outside the current quota of 50,000 usd of foreign exchange that individuals are allowed every year.”
From Bloomberg: “SunTrust Banks Inc., seeking to cut $530 million in annual costs by 2009, expects to eliminate about 7 percent (2,400 employees) of its workforce by the end of next year as profit from retail and commercial banking declines.”
From Barclays: “Equity vol continues to come off: VIX traded at 37+ on Thursday.. currently 28 which is down 2 on the day. Appears the broader equity mkt is not super worried about the economy collapsing and stocks crashing. This is about credit, and the ability of some firms (non-banks) to finance. The huge drop in Bill rates must
mean that money is just flowing out of money mkt funds into bills/cash instruments.”
From Morgan Stanley: “Tighter financial conditions imply downside risks to global growth for now…The US is most at risk, but global spillover effects matter; this shock is economic decoupling's first real test. There are downside risks in commodities, and this shock is disinflationary, giving central banks latitude to respond to growth threats…. Global softening is in the price, but global recession is not. Therefore, near-term weakness in US consumer spending could ignite fears of global economic contagion… Investors should not lose sight of the global economy's underlying resilience, which could play an important role in reversing the downside risks for markets.”
End-of-Day Market Update
From RBSGC: “The market was well bid on Monday in a continuation of the credit/liquidity concerns that have driven Treasuries to these levels and have held us here. Today's data was a non-event, a consensus uptick in Leading Indicators did nothing but clear the way for more buying as Treasuries moved higher on the weakness in equities. Despite the afternoon recovery in stocks, yields stayed low, with 2s staying closer to 4% than we have seen in recent weeks while 10s hover near 4.61% -- an important level. The beginning of this week has brought with it more credit-related jitters as the Commercial Paper continues to show signs of stress. The theme in short-dated corporate debt remains limited liquidity for second-tier credit borrowers and obligations beyond 2-weeks. While the concerns surrounding near-term liquidity have been addressed (at least temporarily) by the Fed, there remains an overarching concern that these measures will prove insufficient. The bill market has been one of the biggest benefactors of the risk aversion trade -- with the benchmark 1-month T-Bill (9/13/07) yielding just 2.21% -- vs. a 3.14% close last Thursday -- impressive demand for the sector by any measure. This bid for quality has not gone unnoticed at the NY Fed, which announced that it will redeem $5 bn of its maturing holdings on Thursday -- bring the cash onto its balance sheet to help in overnight operations and fund the demand for money at the Discount Window -- currently the two most meaningful ways of addressing the credit crunch… Volumes were modest… Current levels are hardly screaming buys. We are concerned with the front end in particularly given just how aggressive it's been in pricing in easing and are reminded that 125 bp through funds is normal into that first ease which means inside 4% 2s are fair, not cheap. And while the market won't argue with a 50 bp rate cut over the next few weeks -- at the least -- the steps the Fed has taken so far are incremental and you cannot divorce market expectations from Fed reality. If Monday's action is any guide, while liquidity is certainly a continuing issue the frozen panic of the prior week has calmed somewhat. Everyone is in something of a waiting mode.”
From SunTrust: “The lack of liquidity in spread products has moved into Treasuries. The short bill market is off the charts. The 3 month bill opened at a 3.80, dropped to 2.50, then back to 2.90. The move reportedly started with a large purchase by a central bank in the w.i. three month. Then continued angst in the commercial paper market forced more investors, including money market funds, into the bill market. The bill auction was a complete disaster. The three month tailed back 20 bp vs the bid at the auction deadline
while the six month tailed by 25 bp. Both had very low bid covers. Volume has not been huge, but traders are fearful of being left short, so it doesn't take much to move the market. Spread products aren't sure yet what they think of Bernanke's move. Agency and mortgage spreads are unchanged. Corporate spreads are selectively wider with the new issue market pressuring financials. It has become a game of wait-and-see if the FED's two-step approach of extra liquidity and access to the discount window is enough to calm fear. The FED would really prefer NOT to have to cut the funds rate before the September 18 FOMC meeting.”
From JP Morgan: “Money markets remain under stress. In the United States, 3-month Treasury yields auctioned today at 91bp below their Friday yields, while the interbank lending rate is more or less unchanged, leading to a new high in the TED spread. In Europe, issuers of asset-backed commercial paper had trouble rolling over their debt. One encouraging development in financial markets is the continued decline in energy prices.”
Previous Today’s
Close Low Hi Close Change
3m T-Bill 3.754 2.505 3.837 3.072 -68bp
3y Treasury Yld 4.185 4.05 4.201 4.083 -10bp
5y Treasury Yld 4.358 4.274 4.376 4.292 -7bp
10y Treas Yld 4.685 4.61 4.702 4.626 -6bp
30y Treas Yld 4.986 4.947 5.02 4.969 -2bp
Dow 13079 12983 13181 13121 +42
Trans 4768 4769 4870 4855 +87
Util 487 481 490 488 +1
S&P 1446 1430.5 1451.75 1445.5 -.5
Dollar Index 81.43 81.26 81.49 81.38 -.035
Japan Yen 114.4 113.7 115.5 115 +.5
Oil 71.98 70.05 71.77 71.12 -.86
Today's Tidbits
Bernanke Tells Dodd He Will Use All of the Tools at His Disposal
From Bloomberg: “Senate Banking Committee Chairman Christopher Dodd said U.S. Federal Reserve Chairman Ben S. Bernanke agreed to use ``all of the tools at his disposal'' to restore stability in financial markets roiled by the subprime mortgage crisis … Dodd said he didn't specifically ask Bernanke to cut the benchmark federal-funds rate, and Bernanke didn't pledge to do so. Interest-rate futures show that traders are betting the credit crunch will force Bernanke to ease monetary policy for the first time since 2003.”
Fed Governor Lacker Says Give Markets Time to See If Fed’s Efforts Working
From Bloomberg: “Federal Reserve Bank of Richmond President Jeffrey Lacker said the impact of ``financial turbulence'' on the broader economy will determine decisions on
interest rates. ``Financial market volatility, in and of itself, doesn't require a change in the target federal funds rate,'' Lacker said at a luncheon of the Risk Management Association of Charlotte. ``Policy needs to be guided by the outlook for real spending and inflation.'' Lacker is the first Fed official to provide a detailed analysis of the economic and policy implications of the global market tumult that has spread beyond defaults and delinquencies in mortgage markets. His comments suggest he supports the Federal Open Market Committee's approach, which has addressed liquidity needs with policy tools other than the benchmark federal funds rate target… Lacker said the ``jury is still out'' on whether the Fed moves have eased trading problems in the market for asset-backed commercial paper. ``It is too soon to really make a judgment,''…”
Comparing Size of CP to T-Bill Markets
From UBS: “The money market instrument sector of the fixed income market has roughly $4.2 trillion in debt outstanding, or slightly less than the $4.5 trillion Treasury sector…According to Fed data about half of total money market instruments are commercial paper, or $2.13 trillion, and half of that commercial paper is asset-backed. The assets backing the commercial paper can range from car loans, bonds, trade receivables, credit cards to mortgage loans. Of the $1.2 trillion of ABCP currently outstanding, estimates are that 39% of it, or around $468 billion, is backed by mortgages or CDOs. To put that in perspective, according to Wrightson's (Treasury Finance, August 21st, 2007): "the supply of Treasury bills held outside the Fed is a little less than $700 billion." Subprime mortgage losses have driven money market investors away from mortgage-related commercial paper, into the safe harbour of T-bills. Despite seasonal highs in issuance, the Treasury bill market, overwhelmed by demand, saw 1m rates dive below 2.00%.”
From Deutsche: “While the moves in the Treasury bill market are dramatic, we don't think they have much import in themselves, since the bill market is highly technical and can be easily squeezed nowadays. But they are a symptom of the turmoil in the ABCP market, and the disposition of the conduits and their assets if they are no longer being funded. Eventually, the banking system will have to take on many of these assets and fund them, and that is where the Fed's discount window can provide a short term solution and legislative action a longer term one. By and large, the "eventual" underlying value of the conduit assets are likely still strong, since most subprime exposure is of the AAA variety. But the market illiquidity for the assets means that the existing system for realizing their value is dysfunctional and has to be replaced.”
Foreclosure Rate Rises Rapidly
From Bloomberg: “U.S. homes facing foreclosure almost doubled in July as property owners with adjustable-rate mortgages saw their payments rise, RealtyTrac Inc. said. Lenders sent 179,599 notices of default, scheduled auctions or bank repossessions last month, a 93 percent increase from a year earlier, Irvine, California-based RealtyTrac said today in a statement. California, Florida, Michigan, Ohio and Georgia accounted for more than half of the country's total filings…Forty-three states had year-over-year increases in foreclosure activity…California foreclosure filings totaled 39,013 in July, about triple the previous year. The state led the nation in foreclosure for the seventh consecutive month, RealtyTrac, a seller of foreclosure data, said. Florida ranked second with a 78 percent increase to 19,179 foreclosure filings. Michigan replaced Ohio as the state with the third highest number foreclosures: 13,979. Nevada ranked the worst with one foreclosure filing for every 199 homes, about three times the national average. Georgia's rate jumped from eighth to second highest in the country with one foreclosure filing for every 299 households.”[Please note 93% change was YoY not MoM as I incorrectly indicated this morning.]
Challenger Sees Rapidly Rising Job Losses Tied to Housing Market Troubles
From CNBC: “The deepening housing slump has caused an alarming surge in job losses at financial services companies, and the end is nowhere in sight, consulting firm Challenger, Gray & Christmas said on Tuesday. The industry has announced 87,962 job cuts so far this year, 75 percent more than the 50,327 recorded for all of 2006, Challenger said. Nearly one-fourth of this year's cuts have been announced in August alone. Of this year's cuts, 35,830, or 41 percent, were tied to housing market troubles, including riskier subprime mortgages. Job cuts set by real estate and construction firms total 21,620, more than twice the number for all of 2006, Challenger said. "Many companies expected the mortgage situation to implode; they've just been wondering when the bubble would burst," Chief Executive John Challenger said in an interview. "But many are stopping on a dime, shutting down operations," he said. "Companies are not surprised by what's happening, but the reality of the situation and the speed with which it occurred is shocking." The CEO said it could be months before housing-related job cuts peak.”
Fannie Mae Decided Not to Issue New Long-Term Benchmark Debt in August
From UBS: “Fannie Mae passed on issuing any benchmark notes in August [first pass since 5/06], stating that skipping the sale "allows us some additional flexibility to gauge investor interest and portfolio needs." This was a reasonable decision by Fannie for two reasons: first, they only have approximately $6 billion left of room before bumping up against their mortgage portfolio cap. They may be planning to allow some additional run-off before re-entering the market, which would keep their funding needs low for the time being. Second, agency debt has underperformed Libor across the curve over the past 6 weeks, and current GSE funding levels aren't especially attractive. For example, 10y agency debt was trading 17 to 20 bps through Libor as recently as May, but the credit crunch has driven it out to L-9 bps.”
Fed Lowers Cost of Borrowing Treasuries From Fed
From JP Morgan: “Today the NY Fed lowered the minimum fee on securities lending from the System Open Market Account (SOMA) from 1.0% to 0.5%. The move was designed to provide greater liquidity in the T-bill market, which has seen sharply lower rates as money funds have fled to the safety of the Treasury market. The securities lending program is designed to promote liquidity in the Treasury market by allowing the 21 primary dealers to borrow securities overnight from the SOMA's $785 billion portfolio of Treasuries. Borrowers are required to deliver collateral of other Treasuries and are subject to the minimum fee which was reduced today. The minimum fee rate is essentially the effective lending fee as most bids are awarded at the minimum fee. Because borrowers in the securities lending program deliver other securities as collateral, this facility does not alter the amount of reserves in the banking system.”
China Tries to Encourage Bank Savings Over Speculation in Property and Equities From MNI: “China's high housing prices are having a "major negative impact" on the country's economy, the State Information Center said. The government think-tank argued that excessive growth in housing prices has placed a burden on the people and widened the gap between rich and the poor.”
From Bloomberg: “The [Chinese] government is trying to make bank savings more attractive to stem the flow of money into property and stock speculation and curb asset bubbles…Inflation has outstripped returns on bank savings. The government reduced a tax on interest income last week to 5 percent from 20 percent to make deposits more attractive…The key CSI 300 Index has climbed 144 percent this year after more than doubling in 2006. Property prices have also surged. In July, housing prices jumped 19.4 percent in Shenzhen and 10.4 percent in Beijing.”
From Citi: “China hiked [the benchmark one year lending rate] for the fourth time [since March], which may add further [downward] pressure on commodities.”
Rumors Buffett Buying Countrywide Shares
From CNBC: “Billionaire investor Warren Buffett told CNBC… that speculation he may buy parts of beleaguered mortgage lender Countrywide Financial is just that, speculation. As always, Buffett never directly comments on what stocks he has bought or may be buying. Today's Wall Street Journal said Countrywide's debt-servicing business and its portfolio of mortgages and mortgage-backed securities may be attractive to Buffett. Like many mortgage lenders, Countrywide has struggled with rising delinquencies and foreclosures, and an unwillingness among bankers to extend credit, and among investors to buy the loans it makes. Countrywide, which is being closely monitored by U.S. regulators, sought to reassure investors earlier on Monday that it is safe to do business with the company. Buffett has been increasing his stake in financial services companies, including those with significant exposure to the mortgage market.”
From Bloomberg: “Countrywide added $1.98, or 10 percent, to $21.79.”
MISC
From Bloomberg: “More than half of the 21 primary government security dealers that trade with the Fed now expect the central bank to cut its target rate for by next month from the current level of 5.25 percent.”
From Citi: “…the Street is in balance sheet reduction mode, and as usual dealers tend to have all the same trades on and aggregates so things are getting pushed out of line or facing little resistance. We're seeing this across the curve, and across cash products…It seems though at this point, the bid to GC is mostly the flight by money-funds, retail investors into risk-free assets.”
From Merrill Lynch: “This is NOT a rate problem, it is a perceived credit problem. (I say perceived since most assets are "money good", the SubPrime "bad money" bonds are relatively small in the context of the global markets.) As such, cutting rates will not directly cure the market. The REAL issue is that Levered Investors have DISINTERMEDIATED the banking system from the FED. Portfolio lenders would never have created this menu of SubPrime loans if they had to own them. Brokers would not have been allowed to act so aggressively if the lenders could not sell the risk into market. Consequently, the FED needs to disipline the markets to restore the RISK PREMIUMS to rational levels. They need to let the "Invisible Hand" guide the markets to equilibrium. Cutting rates ala the "Greenspan Put" should be the last option, not the first.”
From MNI: “The 4-week T-Bill closed at around 2.1% yesterday, down 0.8% after
hitting an intra-day low of 1.25%, as investors shunned money market funds.”
From UBS: “3-month Treasury bills continued their remarkable run-up, rallying 74bps for the day, their largest one-day change since October 1987. At one point, 3M yields had fallen as much as 120bps on the day. Over the past four business days, the 3M yield was slashed 161bps, the largest four-day change in yield going as far back as we have data for.”
From JP Morgan: “Natural gas futures experienced the greatest sell-off in more than
four years on forecasts that Hurricane Dean will probably miss the oil and gas production regions of the Gulf of Mexico. The September contract settled down 97 cents on the day at $6.04. The sell-off far exceeded that of the petroluem complex in percentage terms due to the fact that natural gas rig activity was at a greater risk if the storm had taken a more northerly direction through the Gulf.”
From UBS: “House Financial Service Committee Chairman Frank (D-MA) also announced a hearing for September 5, titled “Recent Events in the Credit and Mortgage Markets and Possible Implications for U.S. Consumers and the Global Economy.” The witness list has yet to be announced.”
From American Banker: “Profits at the Chicago [Home Loan Bank] dropped 50% from a year earlier…in part because of problems with its mortgage program…”
From CNN: “Already-battered U.S. auto sales could be the next victim of the problems with mortgages, declining home and stock prices, as potential car buyers delay purchases due to uncertainty. Industrywide U.S. auto sales in August could be off 10 percent from a year ago, according to an early read from sales tracker Edmunds.com. That follows July sales that were 19 percent below year-earlier levels.”
From Dow Jones: “The asset-backed commercial paper market, where highly rated
lenders have gone for their short-term funding needs, is still broken despite the Federal Reserve’s attempt late last week to fix the logjam in this key part of credit markets. The Fed on Friday cut its discount rate by half-percentage point in an attempt to alleviate the pressure on banks that found their access to the commercial paper market shut off amid a crisis of investor confidence. “Apparently, the market’s worse today than it’s ever been,” said Dominic Konstam, head of interest rate strategy at Credit Suisse. “The big failure to roll HBOS paper in Europe has upset people.””
End-of-Day Market Update
From Lehman: “It was another wild day in treasury land, and the front end led the way despite a quiet and positive day for stocks and credit. Our market's focus has turned almost wholly to the money market, where dislocations in commercial paper, term repo, and Treasury bills continue to unnerve investors. Implied repo on ten year note futures continued to plunge, moving from 3.3% yesterday to a low of 2.3% today. T-bills remained the investment of choice for money market funds, and traded low this morning until the 4 week bill tailed 200 basis points (yes, 200 basis points) which sent bill rates sharply higher. The treasury curve was literally all over the place, steepening early, flattening on what appeared to be a massive flow at the front end midday, and then steepening back out again later on… Tuesday's yield changes were roughly as follows: 2 years: -7.2 bp 5 years: -4.5 bp 10 years: -4.6 bp 18 years: -3.9 bp 30 years: -2.7 bp
From Citi: Commentary on today’s 1m T-bill auction in the early afternoon- “They were trading at 2.50% at 12:59pm. Auction came at 4.75% at 1:00 pm. They are now 3.50% bid at 3.25%. Financial markets are not working too well when you have this kind of volatility around a 4 week bill auction...” See graph at end for daily movement
From UBS: “Agency spreads outperformed swaps by 1-2bps in the front end, and were unchanged in the long end. Mortgages were 7 ticks tighter to Treasuries early on, but faltered later in the day to finish only 1 tighter.”
From Bloomberg: “The S&P 500 increased 1.56, or 0.1 percent, to 1,447.11. The
Dow Jones Industrial Average slipped 30.49, or 0.2 percent, to 13,090.86. The Nasdaq Composite Index climbed 12.71, or 0.5 percent, to 2,521.3. About six stocks rose for every five that fell on the New York Stock Exchange.”
From Dow Jones: “The dollar held firm above Y114.0 throughout the session and was little changed against the euro from day-earlier numbers.” [ The dollar index rose .08 to 81.48]
From Bloomberg: “Crude oil fell below $70 a barrel in New York for the first time since July 2 after Hurricane Dean missed U.S. oil fields and was downgraded to a Category 2 storm by the U.S. National Hurricane Center… ``There's a growing confluence of events that point to the economy being due for a correction,'' Beutel said. ``The credit crunch is a symptom of consumer fatigue, which is in large part due to high commodity prices, especially energy.''” [Oil closed down $1.65]
Graph of 1 month generic T-Bill yield for today
From Bloomberg: “Senate Banking Committee Chairman Christopher Dodd said U.S. Federal Reserve Chairman Ben S. Bernanke agreed to use ``all of the tools at his disposal'' to restore stability in financial markets roiled by the subprime mortgage crisis … Dodd said he didn't specifically ask Bernanke to cut the benchmark federal-funds rate, and Bernanke didn't pledge to do so. Interest-rate futures show that traders are betting the credit crunch will force Bernanke to ease monetary policy for the first time since 2003.”
Fed Governor Lacker Says Give Markets Time to See If Fed’s Efforts Working
From Bloomberg: “Federal Reserve Bank of Richmond President Jeffrey Lacker said the impact of ``financial turbulence'' on the broader economy will determine decisions on
interest rates. ``Financial market volatility, in and of itself, doesn't require a change in the target federal funds rate,'' Lacker said at a luncheon of the Risk Management Association of Charlotte. ``Policy needs to be guided by the outlook for real spending and inflation.'' Lacker is the first Fed official to provide a detailed analysis of the economic and policy implications of the global market tumult that has spread beyond defaults and delinquencies in mortgage markets. His comments suggest he supports the Federal Open Market Committee's approach, which has addressed liquidity needs with policy tools other than the benchmark federal funds rate target… Lacker said the ``jury is still out'' on whether the Fed moves have eased trading problems in the market for asset-backed commercial paper. ``It is too soon to really make a judgment,''…”
Comparing Size of CP to T-Bill Markets
From UBS: “The money market instrument sector of the fixed income market has roughly $4.2 trillion in debt outstanding, or slightly less than the $4.5 trillion Treasury sector…According to Fed data about half of total money market instruments are commercial paper, or $2.13 trillion, and half of that commercial paper is asset-backed. The assets backing the commercial paper can range from car loans, bonds, trade receivables, credit cards to mortgage loans. Of the $1.2 trillion of ABCP currently outstanding, estimates are that 39% of it, or around $468 billion, is backed by mortgages or CDOs. To put that in perspective, according to Wrightson's (Treasury Finance, August 21st, 2007): "the supply of Treasury bills held outside the Fed is a little less than $700 billion." Subprime mortgage losses have driven money market investors away from mortgage-related commercial paper, into the safe harbour of T-bills. Despite seasonal highs in issuance, the Treasury bill market, overwhelmed by demand, saw 1m rates dive below 2.00%.”
From Deutsche: “While the moves in the Treasury bill market are dramatic, we don't think they have much import in themselves, since the bill market is highly technical and can be easily squeezed nowadays. But they are a symptom of the turmoil in the ABCP market, and the disposition of the conduits and their assets if they are no longer being funded. Eventually, the banking system will have to take on many of these assets and fund them, and that is where the Fed's discount window can provide a short term solution and legislative action a longer term one. By and large, the "eventual" underlying value of the conduit assets are likely still strong, since most subprime exposure is of the AAA variety. But the market illiquidity for the assets means that the existing system for realizing their value is dysfunctional and has to be replaced.”
Foreclosure Rate Rises Rapidly
From Bloomberg: “U.S. homes facing foreclosure almost doubled in July as property owners with adjustable-rate mortgages saw their payments rise, RealtyTrac Inc. said. Lenders sent 179,599 notices of default, scheduled auctions or bank repossessions last month, a 93 percent increase from a year earlier, Irvine, California-based RealtyTrac said today in a statement. California, Florida, Michigan, Ohio and Georgia accounted for more than half of the country's total filings…Forty-three states had year-over-year increases in foreclosure activity…California foreclosure filings totaled 39,013 in July, about triple the previous year. The state led the nation in foreclosure for the seventh consecutive month, RealtyTrac, a seller of foreclosure data, said. Florida ranked second with a 78 percent increase to 19,179 foreclosure filings. Michigan replaced Ohio as the state with the third highest number foreclosures: 13,979. Nevada ranked the worst with one foreclosure filing for every 199 homes, about three times the national average. Georgia's rate jumped from eighth to second highest in the country with one foreclosure filing for every 299 households.”[Please note 93% change was YoY not MoM as I incorrectly indicated this morning.]
Challenger Sees Rapidly Rising Job Losses Tied to Housing Market Troubles
From CNBC: “The deepening housing slump has caused an alarming surge in job losses at financial services companies, and the end is nowhere in sight, consulting firm Challenger, Gray & Christmas said on Tuesday. The industry has announced 87,962 job cuts so far this year, 75 percent more than the 50,327 recorded for all of 2006, Challenger said. Nearly one-fourth of this year's cuts have been announced in August alone. Of this year's cuts, 35,830, or 41 percent, were tied to housing market troubles, including riskier subprime mortgages. Job cuts set by real estate and construction firms total 21,620, more than twice the number for all of 2006, Challenger said. "Many companies expected the mortgage situation to implode; they've just been wondering when the bubble would burst," Chief Executive John Challenger said in an interview. "But many are stopping on a dime, shutting down operations," he said. "Companies are not surprised by what's happening, but the reality of the situation and the speed with which it occurred is shocking." The CEO said it could be months before housing-related job cuts peak.”
Fannie Mae Decided Not to Issue New Long-Term Benchmark Debt in August
From UBS: “Fannie Mae passed on issuing any benchmark notes in August [first pass since 5/06], stating that skipping the sale "allows us some additional flexibility to gauge investor interest and portfolio needs." This was a reasonable decision by Fannie for two reasons: first, they only have approximately $6 billion left of room before bumping up against their mortgage portfolio cap. They may be planning to allow some additional run-off before re-entering the market, which would keep their funding needs low for the time being. Second, agency debt has underperformed Libor across the curve over the past 6 weeks, and current GSE funding levels aren't especially attractive. For example, 10y agency debt was trading 17 to 20 bps through Libor as recently as May, but the credit crunch has driven it out to L-9 bps.”
Fed Lowers Cost of Borrowing Treasuries From Fed
From JP Morgan: “Today the NY Fed lowered the minimum fee on securities lending from the System Open Market Account (SOMA) from 1.0% to 0.5%. The move was designed to provide greater liquidity in the T-bill market, which has seen sharply lower rates as money funds have fled to the safety of the Treasury market. The securities lending program is designed to promote liquidity in the Treasury market by allowing the 21 primary dealers to borrow securities overnight from the SOMA's $785 billion portfolio of Treasuries. Borrowers are required to deliver collateral of other Treasuries and are subject to the minimum fee which was reduced today. The minimum fee rate is essentially the effective lending fee as most bids are awarded at the minimum fee. Because borrowers in the securities lending program deliver other securities as collateral, this facility does not alter the amount of reserves in the banking system.”
China Tries to Encourage Bank Savings Over Speculation in Property and Equities From MNI: “China's high housing prices are having a "major negative impact" on the country's economy, the State Information Center said. The government think-tank argued that excessive growth in housing prices has placed a burden on the people and widened the gap between rich and the poor.”
From Bloomberg: “The [Chinese] government is trying to make bank savings more attractive to stem the flow of money into property and stock speculation and curb asset bubbles…Inflation has outstripped returns on bank savings. The government reduced a tax on interest income last week to 5 percent from 20 percent to make deposits more attractive…The key CSI 300 Index has climbed 144 percent this year after more than doubling in 2006. Property prices have also surged. In July, housing prices jumped 19.4 percent in Shenzhen and 10.4 percent in Beijing.”
From Citi: “China hiked [the benchmark one year lending rate] for the fourth time [since March], which may add further [downward] pressure on commodities.”
Rumors Buffett Buying Countrywide Shares
From CNBC: “Billionaire investor Warren Buffett told CNBC… that speculation he may buy parts of beleaguered mortgage lender Countrywide Financial is just that, speculation. As always, Buffett never directly comments on what stocks he has bought or may be buying. Today's Wall Street Journal said Countrywide's debt-servicing business and its portfolio of mortgages and mortgage-backed securities may be attractive to Buffett. Like many mortgage lenders, Countrywide has struggled with rising delinquencies and foreclosures, and an unwillingness among bankers to extend credit, and among investors to buy the loans it makes. Countrywide, which is being closely monitored by U.S. regulators, sought to reassure investors earlier on Monday that it is safe to do business with the company. Buffett has been increasing his stake in financial services companies, including those with significant exposure to the mortgage market.”
From Bloomberg: “Countrywide added $1.98, or 10 percent, to $21.79.”
MISC
From Bloomberg: “More than half of the 21 primary government security dealers that trade with the Fed now expect the central bank to cut its target rate for by next month from the current level of 5.25 percent.”
From Citi: “…the Street is in balance sheet reduction mode, and as usual dealers tend to have all the same trades on and aggregates so things are getting pushed out of line or facing little resistance. We're seeing this across the curve, and across cash products…It seems though at this point, the bid to GC is mostly the flight by money-funds, retail investors into risk-free assets.”
From Merrill Lynch: “This is NOT a rate problem, it is a perceived credit problem. (I say perceived since most assets are "money good", the SubPrime "bad money" bonds are relatively small in the context of the global markets.) As such, cutting rates will not directly cure the market. The REAL issue is that Levered Investors have DISINTERMEDIATED the banking system from the FED. Portfolio lenders would never have created this menu of SubPrime loans if they had to own them. Brokers would not have been allowed to act so aggressively if the lenders could not sell the risk into market. Consequently, the FED needs to disipline the markets to restore the RISK PREMIUMS to rational levels. They need to let the "Invisible Hand" guide the markets to equilibrium. Cutting rates ala the "Greenspan Put" should be the last option, not the first.”
From MNI: “The 4-week T-Bill closed at around 2.1% yesterday, down 0.8% after
hitting an intra-day low of 1.25%, as investors shunned money market funds.”
From UBS: “3-month Treasury bills continued their remarkable run-up, rallying 74bps for the day, their largest one-day change since October 1987. At one point, 3M yields had fallen as much as 120bps on the day. Over the past four business days, the 3M yield was slashed 161bps, the largest four-day change in yield going as far back as we have data for.”
From JP Morgan: “Natural gas futures experienced the greatest sell-off in more than
four years on forecasts that Hurricane Dean will probably miss the oil and gas production regions of the Gulf of Mexico. The September contract settled down 97 cents on the day at $6.04. The sell-off far exceeded that of the petroluem complex in percentage terms due to the fact that natural gas rig activity was at a greater risk if the storm had taken a more northerly direction through the Gulf.”
From UBS: “House Financial Service Committee Chairman Frank (D-MA) also announced a hearing for September 5, titled “Recent Events in the Credit and Mortgage Markets and Possible Implications for U.S. Consumers and the Global Economy.” The witness list has yet to be announced.”
From American Banker: “Profits at the Chicago [Home Loan Bank] dropped 50% from a year earlier…in part because of problems with its mortgage program…”
From CNN: “Already-battered U.S. auto sales could be the next victim of the problems with mortgages, declining home and stock prices, as potential car buyers delay purchases due to uncertainty. Industrywide U.S. auto sales in August could be off 10 percent from a year ago, according to an early read from sales tracker Edmunds.com. That follows July sales that were 19 percent below year-earlier levels.”
From Dow Jones: “The asset-backed commercial paper market, where highly rated
lenders have gone for their short-term funding needs, is still broken despite the Federal Reserve’s attempt late last week to fix the logjam in this key part of credit markets. The Fed on Friday cut its discount rate by half-percentage point in an attempt to alleviate the pressure on banks that found their access to the commercial paper market shut off amid a crisis of investor confidence. “Apparently, the market’s worse today than it’s ever been,” said Dominic Konstam, head of interest rate strategy at Credit Suisse. “The big failure to roll HBOS paper in Europe has upset people.””
End-of-Day Market Update
From Lehman: “It was another wild day in treasury land, and the front end led the way despite a quiet and positive day for stocks and credit. Our market's focus has turned almost wholly to the money market, where dislocations in commercial paper, term repo, and Treasury bills continue to unnerve investors. Implied repo on ten year note futures continued to plunge, moving from 3.3% yesterday to a low of 2.3% today. T-bills remained the investment of choice for money market funds, and traded low this morning until the 4 week bill tailed 200 basis points (yes, 200 basis points) which sent bill rates sharply higher. The treasury curve was literally all over the place, steepening early, flattening on what appeared to be a massive flow at the front end midday, and then steepening back out again later on… Tuesday's yield changes were roughly as follows: 2 years: -7.2 bp 5 years: -4.5 bp 10 years: -4.6 bp 18 years: -3.9 bp 30 years: -2.7 bp
From Citi: Commentary on today’s 1m T-bill auction in the early afternoon- “They were trading at 2.50% at 12:59pm. Auction came at 4.75% at 1:00 pm. They are now 3.50% bid at 3.25%. Financial markets are not working too well when you have this kind of volatility around a 4 week bill auction...” See graph at end for daily movement
From UBS: “Agency spreads outperformed swaps by 1-2bps in the front end, and were unchanged in the long end. Mortgages were 7 ticks tighter to Treasuries early on, but faltered later in the day to finish only 1 tighter.”
From Bloomberg: “The S&P 500 increased 1.56, or 0.1 percent, to 1,447.11. The
Dow Jones Industrial Average slipped 30.49, or 0.2 percent, to 13,090.86. The Nasdaq Composite Index climbed 12.71, or 0.5 percent, to 2,521.3. About six stocks rose for every five that fell on the New York Stock Exchange.”
From Dow Jones: “The dollar held firm above Y114.0 throughout the session and was little changed against the euro from day-earlier numbers.” [ The dollar index rose .08 to 81.48]
From Bloomberg: “Crude oil fell below $70 a barrel in New York for the first time since July 2 after Hurricane Dean missed U.S. oil fields and was downgraded to a Category 2 storm by the U.S. National Hurricane Center… ``There's a growing confluence of events that point to the economy being due for a correction,'' Beutel said. ``The credit crunch is a symptom of consumer fatigue, which is in large part due to high commodity prices, especially energy.''” [Oil closed down $1.65]
Graph of 1 month generic T-Bill yield for today
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