Today's Tidbits

CP Issuance Continues to Decline As Credit Markets Remain Troubled
From JP Morgan: “Commercial paper outstanding fell again in the week ending August 29 (-$62.8 bn sa), although the magnitude of the drop was not as large as in the prior two weeks (avg decline $90.7 bn). Asset-backed commercial paper (ABCP) outstanding fell sharply, but financial CP stabilized after earlier declines. In the last three weeks, seasonally adjusted CP outstanding has fallen 11%, with ABCP down 16%, and financial CP down 6%. Nonfinancial CP—which makes up only 10% of outstanding CP—has remained within a narrow range for the last two months. Concerns about the quality of ABCP has also raised yields and shortened the maturity of new issuance. In contrast, yields on financial and nonfinancial CP have been quite stable.”
From Bloomberg: “Treasury three-month bill yields fell for a third day as investors fled asset-backed commercial paper and opted for the safety of government debt…. The average yield on the highest-rated asset-backed commercial paper with one-day maturity rose 11 basis points to 6.15 percent, the highest since January 2001.”
From Citi: “The liquidity crisis that began in early August in the commercial paper (CP)
market has since spread into the interbank market. Have the Fed's moves been successful? Our review of market liquidity conditions since the inception of the liquidity crisis on August 9 clearly shows that liquidity conditions have not improved in most of the affected short-term markets, despite the Fed's recent actions. In fact, market liquidity problems have since spread to other sectors, such as short-term municipals and auction rate preferreds. The current liquidity crisis could be much worse if it were not for the prevailing market expectation of an impending ease in the Fed Funds rate.”
From Deutsche Bank: “We thought that the Fed's use of the discount window, which included an expansion in acceptable collateral to cover bank sponsored commercial paper, would be enough to loosen the seizing-up of the money market in general and the asset backed commercial paper market in particular. If these non-traditional measures had worked, the Fed may have been able to keep the fed funds rate steady through, and possibly beyond, Q3. It has been nearly two weeks since the Fed first cut the discount rate, and financial conditions within the money market have further deteriorated. In response to this situation and the possibility that a much broader credit crunch could develop, we believe the Fed will reduce interest rates at the September 18 FOMC meeting by 25 bps and retain its easing bias.”
From Bloomberg: “The Bank of England, acting as the lender of last resort, extended 1.6 billion pounds ($3.2 billion) at its highest rate, suggesting commercial banks are reluctant to provide credit after the collapse of the U.S. subprime-mortgage market…The pound fell after the announcement on concern U.K. lenders are finding it harder to borrow money. The Bank of England hasn't auctioned any additional money or changed any of its lending rates, unlike the Federal Reserve or the European Central Bank. ``When people tap into this facility, it can mean only one thing: liquidity is gone,''…``It's clearly more of a sign of stress than stability,''…”

More on OFHEO Home Price Changes
From Lehman: “According to OFHEO, nominal home prices are still rising, albeit at the slowest pace since the early 1990s. After adjusting for inflation, real prices declined 1.4% q-o-q. As always, the focus of this report is on the regional data. To no surprise, Nevada, Michigan and California witnessed the biggest price declines of about 1.5% y-o-y. On the opposite end, Utah and Wyoming showed healthy appreciation of 15.3% and 12.8% y-o-y, respectively. On a MSA level, 61 out of 287 cities witnessed depreciation from the same quarter a year ago…the 20 weakest cities of which 12 are in California, 6 in Florida and the other two in Nevada and Michigan. Outside of Michigan, which has a depressed local economy, the cities showing the biggest declines are formerly bubble cities. For comparison, in Q1 2006, 12 of the top 20 strongest cities were in California and Florida.”



OFHEO Index Should be Supplemented with S&P Case/Shiller Data
From Lehman: “Historically, OFHEO has been the preferred measure of home prices since it has the broadest geographic coverage and controls for quality using a weighted repeat sales methodology. As such, it is used in the Federal Reserve Flow of Funds and is in most macro models. However, the fact that OFHEO only tracks homes with conforming mortgages has taken away from the attraction of OFHEO given the current state of the mortgage market. The exclusion of the depressed subprime and volatile jumbo sectors likely understated home price appreciation during the boom and is likely overstating during the bust. We therefore advise caution when interpreting OFHEO prices and suggest also monitoring Case-Shiller home prices.”
From JP Morgan: “Like the Case-Shiller index, the OFHEO indexes measure the price of constant-quality homes and controls for regional shifts in the mix of homes sold. However, unlike the CS indices, they does not include any nonconforming (jumbo) loans, and probably understate transactions financed with subprime loans. As a result, we believe the OFHEO indexes are overstating price appreciation at this time.”
From Merrill Lynch: “Over the past several years OFHEO's numbers have overstated home price growth (one gauge is to simply take the difference between the OFHEO and SPCS numbers) for a few important reasons: To be sure, a huge portion of OFHEO's loan sample are cashout refinance loans, which normally get higher than average appraisals, right? Freddie Mac's cashout refinance monitor shows loans that have been purchased by
that FM over the past few quarters have been predominantly "cashout" loans (loans that were 5% or more of the original UPB). This bias in OFHEO's data set will artificially inflate home price growth values.”

GDP Revisions Reduce First Quarter Incomes and Likely Increase Productivity and ULC
From Merrill Lynch: “Today's preliminary GDP report also contained new estimates for 1Q wages and salaries, which took personal income down by $17B in 1Q. Real personal disposable income growth was revised down to 5.4% QoQ (annualized) from 5.9%. These numbers reflect downward revisions to wage and salary disbursements, based on new and more complete estimates of income from the quarterly census of employment and wages (QCEW)… The BEA is now also in the process of smoothing out the $50B in bonuses accrued in 4Q 2006 and paid out in 1Q 2007. Wage and salary accruals, which feed into estimates of unit labor costs (ULC), were revised up by $33B in 1Q and by $25B in 2Q. So wage and salary accruals in the nonfarm business sector saw growth revised up to 4.2% QoQ (annualized) in 1Q (was 3.3%) - there was no change to 2Q growth of 7.2%. This implies an upward revision to ULC by a similar amount (was reported as 3.0% QoQ (annualized)). At this point the BEA has not altered the $50B assumption for bonuses accruals in 4Q, but in the July 2008 comprehensive NIPA revisions we expect them to smooth this number out, matching the bonuses against the profits earned in each quarter…Nonfarm business sector productivity growth is expected to be revised up to 2.7% QoQ (annualized) from 1.8% due to an expected upward revision in real nonfarm business sector output. Based on these numbers, ULC growth will be revised down to 0.9% from 2.1% (slowest growth since 2Q 2006). The YoY rate will edge down to 4.4% from 4.5%.”
From JP Morgan: “Today’s report showed a solid rebound in 2Q corporate profits, led by financial corporations. Labor compensation was also revised higher. These trends underscore balanced income growth over the past year, with both profits and labor compensation growing at a healthy clip. The income revisions will also further lift unit labor cost from already elevated levels: we now expect 2Q ULC to be revised higher to 4.9%oya from 4.5%. Recent tepid readings on core inflation notwithstanding, the Fed will certainly be alert to this important source of upside risk.”

Freddie Profit Falls 45% in 2nd Quarter
From Bloomberg: “Freddie Mac, the second-biggest U.S. mortgage finance company, reported second-quarter profit fell 45 percent after setting aside $320 million for losses from the worst housing slump in 16 years. Net income declined to $764 million, or $1.02 a share, from $1.4 billion, or $1.93, a year earlier… Revenue dropped 4.8 percent to $2.26 billion…``A lot of people's attention will next go to how they manage credit expenses because the time from delinquency to default is compressing,''… Net interest income fell to $973 million from $1.17 billion, reflecting the higher cost of Freddie Mac's maturing long-term debt. Credit-related expenses rose to $336 million from $63 million because of the provisions for losses on home loans…Administrative expenses will be about $1.7 billion in 2007, or about $100 million more than in 2006, Piszel said. Expenses had soared because of the probe into the company's accounting. ``We're going over a hill as far as our cost structure,'' he said. ``In 2008 and 2009 we should be coming down the other side.''”

Ginnie Mae Removes $417K Limit From Veterans Administration Mortgages
From RBSGC: “GNMA says they are eliminating the current $417,000 loan limit for VA loans they will accept for securitization effective September 1. Given the limited availability of credit for jumbo loans currently in the private market, we think this will draw a suprisingly large amount of interest from veterans. GNMA spreads are trading down today, with market participants anticipating increased issuance and changing loan characteristics. Currently, VA loans make up only 30% of GNMAs, and this could increase that percentage. One question we are looking into is whether GNMA securities with loans over $417,000 would be TBA eligible, or whether they would have to trade as specified pools.”


MISC
From Goldman Sachs: “…we are pulling down 2007 forecast for house prices to a fall of 7%, from -5% previously. We see further price declines of 7% in 2008, enough to get us close to, but not all the way to historical ratios of incomes and rents to house prices.”

From RBSGC: “Housing Affordability, July -- fell to 103.6 vs. 104.9 prior -- low in this cycle was 100 last July.”

From The National Mortgage News: “"Last week, the mortgage industry basically told their loan officers and call center representatives to simply stop taking calls. They basically stopped on a dime." --John Challenger, chief executive officer of Challenger Gray & Christmas, a Chicago outplacement consulting firm, reporting that over 13,000 mortgage jobs were lost the previous week and that nearly 88,000 mortgage industry workers had lost their jobs this year.”

From Bloomberg: “On the last business day of each month, new bonds sold during the month are added to bond market indexes, prompting some investors to buy on that day. The effect is typically biggest at the end of February, May, August and November, when
the Treasury holds its quarterly auctions of notes and bonds. The government sold $53 billion of notes and bonds in four auctions this month, including $31 billion in its monthly auctions of two- and five-year notes this week.”

From Barclays: “Real money buying in the long end. Index extension is fairly
large. Buying in both MBS and agencies from state funds in good size.”

From RBSGC: “…our London office estimates that $43 bn of assets will need to be sold from SIV-lites near-term. Most of these assets are AA or AAA and include US subprime collateral.”

From Lehman: “Initial claims rose to 334,000 from 325,000 last week as the series shows its fifth consecutive increase taking claims from 303,000 to the current level. The four week average is now 18,500 above the level seen in July. As a result of this jump, our model suggests a lower payroll print. As a result we are lowering our payroll forecast to 95,000 from 115,000 and also increasing our unemployment rate forecast to 4.7% from 4.6%. However, this will likely be an exercise in rounding with the actual figure close to 4.65%.”

From Dow Jones: “The help-wanted advertising index - a measure of job offerings
- slipped one point to a reading of 25 in July …the Conference Board said that in the last
three months, help-wanted advertising declined in all nine U.S. regions, with the largest decrease of 17.4% in the West North Central region.”

From Dow Jones: “General Electric Co.’s GE Capital Corp. priced a two-part, 60-year bond issue, in spite of the continued fallout from the U.S. subprime mortgage market and associated turbulence in credit conditions. The issue attracted a total of $5 billion of bids from investors, showing that despite the shocks that are currently reverberating trough the market, investor appetite for debt is still present.”

From Bloomberg: “Wheat rose to a record for a second day as demand increased for U.S. supplies and global inventories were forecast to fall to the lowest in 26 years… futures have gained 97 percent in the past year after global consumption exceeded production for the seventh time in eight years.”

From USA Today: “…one in four renters are paying more than half their income on rent — the highest level in at least two decades — according to a study being released Thursday by the Center for Housing Policy. That's up from one in five renters in 1997.”

End of Day Market Update

From RBSGC: “The market made some ground today, although largely replicating the range established Wednesday. The nuanced difference in the price action was that instead of closing at the lows of the day, prices are closing at the highs and, also, at the highest levels in this cycle (TY). We again point out that 10s closing under 4.62% tomorrow represents a break of a monthly trendline that reaches back to the low yield of 2003. The curve held onto its steepeness… Friday is an odd day -- month- and quarter-end for some banks, a big extension to contend with, and laden with data including July PCE and Chicago NAPM. More important than any of that is a speech from Bernanke on housing and the economy.”

From Lehman: “At the risk of sounding like a broken record, it was another very volatile day in treasuries and the market rallied sharply… Volumes were heavy today, and the market continued to trade in dislocated fashion, as quarter-end balance sheet constraints and holiday-week liquidity have clearly added to volatility… Thursday's yield changes were roughly as follows: 2 years: -4.0 bp 5 years: -5.9 bp 10 years: -5.1 bp
From Bloomberg: “U.S. stocks resumed their summer sell-off after Lehman Brothers Holdings Inc. said rising credit costs may reduce bank profits and Freddie Mac predicted the housing market will keep languishing. Goldman Sachs Group Inc., Morgan Stanley and Merrill Lynch & Co., Wall Street's biggest securities firms, led the Standard & Poor's 500 Index to its third decline this week. Freddie Mac fell the most in four years after the second-biggest U.S. mortgage finance company said the housing slump cut profit by 45 percent. The S&P 500 decreased 6.12, or 0.4 percent, to 1,457.64. The Dow Jones Industrial Average declined 50.56, or 0.4 percent, to 13,238.73. The Nasdaq Composite Index rose 2.14, or 0.1 percent, to 2,565.3, extending its gain after the biggest rally in a year. Lehman reduced its earnings estimates for investment banks two days after Merrill Lynch analysts slashed their projections. Financial shares in the S&P 500, which comprise about one-fifth of the index's value, are headed for their worst quarter in five years amid concern that higher borrowing costs spurred by mortgage defaults by the riskiest borrowers will erode earnings.”
From Bloomberg: “The yen rose, rebounding from the biggest decline versus the euro since January 2001, as concern U.S. subprime mortgage losses are weakening credit markets pushed investors to shun riskier assets funded by loans in Japan. Japan's yen was the best performer of the 16 most-active currencies as traders fled asset-backed commercial paper and turned to the safety of government debt.” [ Dollar index +.17 to 80.87]

From Dow Jones: “Crude-oil futures declined [15 cents] Thursday to just above $73 a barrel on a bout of profit- taking that was exacerbated by renewed concerns about the strength of the U.S. economy…”

***
The following graph of the S&P 500 clearly shows the increased volatility in the market recently, versus a few months ago. Each bar shows the range between high and low prices for each trading day. Compare daily ranges in March or April versus August .

U of Michigan Consumer Confidence Remains at Low of Year in August

Tightening credit, rising layoffs, and equity and housing market turmoil, have all lead consumer confidence to plunge in August to the lowest level of the year. The final reading was essentially unchanged at 83.4 from the preliminary estimate of 83.3. This is a considerable drop from the 90.4 reading in July, or 96.9 level at the beginning of the year, in January. Versus the preliminary report, current conditions were revised higher and future conditions were revised lower. Inflation expectations held steady at 3.2% for the next year and 2.9% over the next five years.

Factory Orders Rise More Than Expected

Factory orders in July rose +3.7% MoM (consensus +3.3%), and June's figure was revised higher to +1% MoM from +.6%. Orders excluding transportation rebounded strongly from the decline of -.4% MoM in June to increase by +2.4% MoM in July, indicating the demand was broad-based. Aircraft growth slowed to +13% MoM from +37% MoM growth in June. Automobile orders jumped 11% MoM, the largest increase in 4.5 years, and a surprising increase based on anemic auto sales over the past few months, though GM says pick-up demand has risen in August.

Export demand was a key driver of sales, and it is not clear how the recent credit crunch will impact demand in the future. Orders for durable goods make up over half of total factory demand, and they surged higher in July. Durable goods orders more than tripled from the prior month, to +6% MoM growth. Computer and electronic demand rebounded, growing 7% after falling almost 5% last month. Demand for machinery rose 5.6% MoM. Non-durable goods demand rose 1.3% MoM, a definite improvement over the +.2% gain in June. Rising oil prices pushed up the value of orders for petroleum products.

It appears that future business investment started the third quarter on a stronger note. July orders for capital goods excluding aircraft and military equipment rose +1.7% MoM after declining the prior month. Shipments of capital goods excluding defense and aircraft ( used to calculate GDP growth) rose +.4% MoM after falling -.8% MoM the prior month. Unfilled orders rose 1.4% MoM.

Factory inventories rose for the second month in a row, but with sales rising, the inventory-to-sales ratio actually fell to 1.21 months of supply, the lowest level in a year.

*********************

Chicago PMI was also reported stronger than expected this morning with new orders and order backlogs rising. The index rose to 53.8 from 53.4 in July.

The Milwaukee NAPM also was higher, rising to 63 from 57 in July.

Personal Income and Spending Both Rose More Than Expected in July

Personal income rose +.5% MoM (consensus +.3%), and personal spending rose +.4% MoM (consensus +.3%) in July. The slower increase in spending versus incomes helped push the savings rate up to +.7%.

The +.5% MoM increase in income was the largest gain in four months. Disposable income (after taxes) rose +.6% MoM, an increase from the +.4% MoM gain in June.

Spending was also revised higher for June, to +.2% MoM from +.1% originally reported. By category, spending on durable goods rose +.5% MoM, non-durables rose +.4% MoM, and services (60% of total spending) rose +.2% MoM.

Total inflation held steady at 2.1% YoY based on the PCE deflator. But, core inflation rose less than expected, increasing +.1% MoM (consensus +.2%), and holding steady at +1.9% YoY (consensus +2% YoY). Core PCE, which excludes food and energy costs, is the Fed's preferred inflation gauge, so they will be happy to see the annual increase remaining below their presumed upper band of 2% annual growth. After adjusting for inflation, spending rose +.3% MoM in July after remaining unchanged the prior month. The peak in total inflation this year was at 2.5% YoY in March. Core PCE peaked a month earlier, in February, also at +2.5% YoY.

Over the past year, personal income has risen +6.6% YoY, with disposable income rising +6% YoY. Personal spending has risen a more moderate +4.7% YoY, but has only risen +2.5% YoY when adjusted for inflation.

Overall this is a good report for the Fed. Easing inflation and steady consumer spending and income growth.

OFHEO House Price Index Shows Anemic National Home Price Growth in the March Through June Period

OFHEO reports that home prices rose a tiny +.1% QoQ in the second quarter, versus the first quarter of 2007, based on their data. Consensus was for an increase of +.3% QoQ. The change from the second quarter of 2006 still shows an increase of +3.2% YoY. The annual change reached a peak in the second quarter of 2005 at 13.6% YoY.

When looking at purchase only data, the increase was only +2.6% YoY vs +3.2% YoY when refis are also included.

House price appreciate remains strongest in the West and weakest in New England. Florida and California had the majority of the cities with house price declines.

The OFHEO House Price Index focuses on data from repeat sales and refinances of conforming mortgages that can be sold to Fannie and Freddie, which means they only cover loans of less than $417k in value, and exclude jumbo and private label mortgages. For this reason, many economists now prefer the data available in the quarterly S&P Case/Schiller national home price index which is produced quarterly and was released earlier this week showing a national decline in housing prices of -3.2% YoY in the second quarter.

It is important to remember that this data only runs through June, and doesn't include the impacts from the most recent credit tightening in the mortgage markets.

GDP Revised Higher, Core Inflation Revised Lower

As expected, second quarter real GDP growth was revised higher to +4% annualized from the originally reported+3.4%. The improvement was based on stronger export growth, slowing import growth, and rising business spending. The pace was a clear acceleration from the +.6% annualized GDP growth in the first quarter, and in fact was the fastest rate of growth in the past year. Unfortunately, most economists are downgrading expectations for the remainder of the year. For the entire year, growth is expected to average around 2%.

The smaller trade deficit helped trade contribute 1.4% toward growth, its best positive contribution since 1996. Commercial construction grew 28% annualized in the second quarter, the largest increase since 1981. Residential construction continues to be a drag to GDP growth, and its negative impact was revised higher in the second quarter to reduce GDP by -.6%.

Investment in equipment almost doubled from the first quarter, as the inventory overhang was worked past, to grow 4.3%. Inventory growth remained low for the first half of the year, which means there is more scope for growth in the second half of the year, a positive for GDP.

Core PCE, the Fed's preferred inflation measure, rose less than expected at +1.3% annualized (consensus 1.4%). This was the smallest gain in four years. The price index held steady at 2.7%.

Consumer spending was revised slightly higher to 1.4% from 1.3%, but this is still the smallest increase in the past year. Tighter credit conditions, and increasing concerns about the economy and employment growth, may keep this figure subdued during the balance of this year.

GDP measures the total output of goods and services produced in the economy.

Initial Jobless Claims Unexpectedly Rise 9k

Jobless claims rose to 334k (consensus 320k) last week, to the highest level since April. The four week average is now up to 325k. Year-to-date, initial claims have averaged 318k versus 313k in 2006.

Claims are watched as a high-frequency indicator of economic health for the economy. Rising claims indicate rising unemployment. Layoffs in housing industries are accelerating. Financial companies announced almost 21k layoffs in August. So far this year, Challenger, Gray & Christmas say layoffs in the construction, real estate and financial institutions have totaled 57.5K.

Bernanke letter to Schumer

BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

WASHINGTON, DC. 20551

BEN S. BERNANKE
CHAIRMAN

August 27, 2007

The Honorable Charles E. Schumer
United States Senate
Washington, D.C. 20510

Dear Senator:

Thank you for your recent letters of August 8 and 22, in which you express concern about the potential effects of volatility in financial markets and the tightening of credit conditions on homebuyers, consumers, and the economy as a whole.

I want to assure you that the Federal Reserve, in cooperation with other federal agencies, is closely monitoring developments in financial markets. As you recognized, the Federal Reserve has also taken steps to increase liquidity in the markets. In particular, our changes to our discount window program are designed to assure depositories of the availability of a backstop source of liquidity so that concerns about funding do not constrain them from extending credit and making markets. Also, the Federal Open Market Committee has stated that it is monitoring the situation and is prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets.

I share your concern about the potential impact of scheduled payment resets on homeowners with variable-rate subprime mortgages. Over the next several years, many such homeowners will face significantly higher monthly payments and, consequently, an increased risk of losing their homes to forced sale or foreclosure. The federal banking regulators have encouraged banks and thrifts to work actively with troubled borrowers to modify loans or to refinance as needed to avoid default or foreclosure and have jointly issued guidances to address underwriting and disclosure practices related to subprime mortgage lending.

The twelve Federal Reserve Banks around the country are working closely with community and industry groups dedicated to reducing the risks of foreclosure and financial distress among homebuyers. The Board is also engaged in these issues; for example, Governor Randall Kroszner serves as the Federal Reserve's representative on the board of directors of Neighbor Works America, which has a program to encourage


The Honorable Charles E. Schumer
Page 2

borrowers facing mortgage payment difficulties to seek help by making early contact with their lenders, servicers, or trusted counselors. And as I noted in my testimony in July, in order to strengthen consumer protections, the Federal Reserve Board is currently undertaking a comprehensive review of the rules regarding loans subject to the Home Owner Equity Protection Act as well as some rules pertaining to mortgage-related disclosures under the Truth in Lending Act.

It might be worth considering at this juncture whether the private and public sectors, separately or in collaboration, could help the situation by developing a broader range of mortgage products which are appropriate for low-and moderate-income borrowers, including those seeking to refinance. Such products could be designed to avoid or mitigate the risk of payment shock and to be more transparent with respect to their terms. They might also contain features to improve affordability, such as variable maturities or shared-appreciation provisions for example. One public agency with considerable experience in providing home financing for low-and moderate-income borrowers is the Federal Housing Administration (FHA). The Congress might wish to consider FHA reforms that allow the agency more flexibility to design new products and to
collaborate with the private sector in facilitating the refinancing of creditworthy subprime borrowers facing large resets.

As you note, the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac are currently assisting in subprime refinancings. However, the GSEs' charters limit their ability to take on higher-risk mortgages and their programs are relevant only to a relatively small share of subprime borrowers. The GSEs should be encouraged to provide products for subprime borrowers to the extent permitted by their charters. The current caps on GSE portfolios -- which were imposed for safety and soundness reasons-need not be lifted to allow them to accommodate new borrowers. Currently, the GSE portfolios include substantial holdings of GSE-guaranteed mortgage products, which are easily placed in the private secondary market even under current conditions. Thus, the GSEs could readily sell these securities to make space for new mortgages if they wished to do so. Policymakers may also want to encourage the GSEs to increase their mortgage securitization efforts, which are not constrained by their portfolio caps.

We will continue to keep the Congress informed of developments in the subprime markets and in the credit markets more generally. As you know, Federal Reserve governors and staff have made numerous appearances before the Congress and in other forums on subprime-related issues. Board staff members have continued to brief members of Congressional staffs on these matters. Board staff members are also assisting the Government Accountability Office in the report that they are preparing that will provide a comprehensive review of developments in the subprime mortgage market.


The Honorable Charles E. Schumer
Page 3

Again, thank you for your interest and please be assured that we are
following these issues closely.

Sincerely,

BEN S. BERNANKE

Today's Tidbits

Letter From Fed Chairman Bernanke to Senator Schumer (8/27/07) on current mortgage market problems will be posted after the tidbits.

One Year ARM Rates Jumps 67bp Last Week, Pushing Above 30 Year Fixed Rate
From Bloomberg: “Mortgage applications in the U.S. declined to a four-week low as the rate on one-year adjustable loans jumped by the most since the Mortgage Bankers Association began keeping records in 1996…Banks may be jacking up short-term rates to dissuade buyers from choosing riskier mortgages as defaults on subprime loans climb. The housing slump will worsen as banks restrict the availability of credit and falling real-estate prices prevent owners from tapping home equity for extra spending money, economists said. ``If rates go up and credit gets tighter, that is going to lead to a drop in demand on top of what we have already seen,'' said Abiel Reinhart, an economist at JPMorgan Chase & Co. in New York. ``That is going to have an adverse impact'' on the economy through the first half of 2008, he said…The average rate on a one-year adjustable mortgage surged to 6.51 percent, the highest since January 2001, from 5.84 percent the prior week. The rate also surpassed the cost of a 30-year fixed loan for the first time. The number of applications for adjustable-rate loans slumped 23 percent, while those for fixed-rate mortgages rose 0.2 percent. Adjustable-rate mortgages dropped to 15 percent of all applications, the fewest since July 2003. The average rate on a 30-year fixed loan fell to 6.41 percent last week,…”

Cost of Insuring Against Mortgage Lender Defaults Rising Again
From Reuters: “Debt protection costs on U.S. mortgage lenders, including Countrywide Financial Corp., rose on Wednesday as concerns about weakness in residential mortgages and the housing market continued. The cost to insure the debt of the home loan unit of Countrywide, the largest U.S. mortgage lender, rose around 50 basis points to 280 basis points, or $280,000 per year for five years to insure $10 million in debt. CIT Group Inc.'s credit default swap spreads were around 30 basis points wider at 245 basis points. Swap spreads of Capital One Bank, a unit of Capital One Financial Corp. widened around 20 basis points to 90 basis points. Washington Mutual Inc.'s debt protection costs also rose around 15 basis points to 122.5 basis points.”

Rating Agencies Downgrade Security Companies Earnings Potential
From Bloomberg: “Standard & Poor's said business conditions for securities firms are worse than in the second half of 1998 and revenue from investment banking and trading
could fall 47 percent in the final six months of this year…``This is more severe than in 1998,'' when investment- banking and trading revenue fell 31 percent in the second half
following Russia's debt default… In a separate report, Moody's Investors Service estimated revenue losses of 10 percent or less due to loan markdowns for the five largest U.S. investment banks in the second half of 2007.”

Commercial Banks Also Under Pressure
From Handelsbanken: “The details of the second quarter FDIC data highlight the problems facing the financial markets and the economy. A combination of a flat yield curve, rising troubled loans, and a weak housing market all combined to depress bank earnings and force a tightening in lending standards. Specifically, insured commercial banks and savings institutions reported $36.7 billion in net income – a decline of 3.4% from the comparable period a year ago. This decline in earnings was caused by higher provisioning for loan losses, particularly at large institutions. FDIC insured institutions added $11.4 billion in provisions for loan losses to their reserves during the second quarter, the largest quarterly loss provision since the fourth quarter of 2002. Net charge-offs spiked to $9.2 billion in the second quarter. The loan categories with the largest increase in charge-offs included consumer loans other than credit cards (up $757 million, or 60.9%), commercial and industrial loans (up $577 million, or 71.4%), residential mortgage loans (up $422 million, or 144.3%), and credit card loans (up $393 million, or 12.1%). Real estate loans 90 days past due grew $6.4billion or 10.6% which is the largest increase in this category since the fourth quarter of 1990. The second quarter was also the fifth consecutive period of rising non-performing real estate loans. Although insured institutions accelerated their reserve growth during the April-to-June period, the rising non-current loan rate still pushed the banking industries coverage rate to its lowest level five years. The industry’s coverage ratio of reserves to non-current loans fell from $1.30 in reserves for every dollar of non-current loans to $1.21 during the quarter. With bank earnings under pressure and the need to build reserves accelerating, it is likely that banks will further ration credit to the economy.”

British SIV (Special Investment Vehicle) Forced to Liquidate Assets
From Reuters: “Cheyne Finance Plc, a structured investment vehicle (SIV) …said on Wednesday it was seeking to restructure after the value of its investments fell enough to force it to start selling assets. Standard & Poor's late on Tuesday downgraded Cheyne Finance's ratings sharply, with the issuer rating falling to A- from the top AAA, after the SIV told investors and ratings agencies it had breached its major capital loss test and had to liquidate assets to repay outstanding debt. SIVs raise a mixture of short-term and medium-term debt to invest in longer-term securities, often in the asset-backed market. Fears have risen over this strategy as fallout from the U.S. subprime mortgage crisis has battered both the values of the securities SIVs invest in and reduced investor appetite for short-term debt…S&P said that most of Cheyne's portfolio was in real estate securitisations.”

Non-Chinese Asia Showing Strong Growth Too
From Goldman Sachs: “[South Korean] Industrial production (IP) rose 14.3% year on year (yoy) in …Encouraging bounce in consumption. The Consumer Goods Sales Index increased to 9.8% yoy in July versus 4.8% yoy previously… Some easing in capex. Facilities (plant and machinery) investment slowed to 1.3% yoy in July versus 9.2% yoy in June. We continue to expect robust exports growth for the remainder of the year which should underpin a firmer capex trend going forward. …GDP growth forecasts… consensus of 4.7% and 5.1% respectively. The strength in the tradable sector should underpin the capex recovery and in turn bolster the labor market. We believe this should set the stage for further consumption strength down the road.”

First Funding of New Chinese State Foreign Exchange Investment Company
From Goldman Sachs: “According to media reports, the first installment of Rmb600 billion (US$79 billion) worth of Special Treasury Bonds (STB) has been issued (effectively) to the People’s Bank of China (PBOC) today. The duration of the bonds is 10 years, and the yield is set at around 4.3% p.a., which is close to the current market rate of 4.23% of the corresponding treasury bonds. 2) It is reported that the total of Rmb1.55 trillion (US$200 billion) Special Treasury Bonds will likely to be issued in three installments, with sizes of Rmb600 billion, Rmb600 billion and Rmb350 billion, respectively. In execution, the special bonds will be first purchased by the Bank of Agriculture (BOA), then sold to the PBOC by the BOA in exchange for foreign exchange (FX) funds, which will be later injected into the State Foreign Exchange Investment Company. 3) Under this arrangement, the issuance of the STB to the PBOC will not have any direct impact on market liquidity, and therefore no impact on market interest rates. The issuance of the STB adds another bond instrument to the central bank’s sterilization assets, with a much longer duration (maximum of 10 years) than current central bank bills (maximum duration of 3 years). 4) However, in our view, neither the establishment of the State Foreign Exchange Investment Company, nor the issuance of the STB will change the amount of FX inflows, i.e., the amount of sterilization that needs to be undertaken. Therefore, the fundamental policy challenge remains unchanged for the central bank: how to conduct independent monetary policy in a very open economy with a significantly undervalued currency. Pressures in domestic inflation, in particular asset inflation, are reflections of such challenges.”

Tech Company M&A Especially Hard Hit by Tightening Credit Conditions
From TheStreet.com: “The widening credit crisis is exposing the vulnerability of tech companies that have borrowed avidly in recent years as hedge funds, pension funds and other large investors have loaded their portfolios with corporate debt, holding down interest rates. The tighter link to the credit markets could choke the growth of tech companies that have made acquisitions a major plank of their expansion plans. In recent years, IT services firms as well as makers of software, semiconductors and telecom gear have used cash instead of stock to make acquisitions. The reliance on debt is showing up on their balance sheets at a time when skittish investors are draining the credit markets of liquidity, making it costlier to refinance existing debt or take on new debt. Software maker Oracle (ORCL) , for instance, spent nearly $20 billion in cash on acquisitions over the last three years. In that time, the company's debt as a proportion of total capital, a common measure of a company's debt burden, rose from 2% to 31% according to a study by the Center for Financial Research and Analysis…"If companies have debt that is maturing, the issue is whether they have enough cash on their balance sheet to retire the debt, and if not, are they going to be able to refinance it in the current market environment,"… Credit market turmoil has widened the spread between the yields on Treasury bonds and some corporate debt by roughly two percentage points, according to data from UBS.”

MISC

From RBSGC: “MBA reports this morning that the 1yr ARMs rate rose by the most on record (WoW gain) to 6.51% vs. 5.84% last week. This is the most since Feb 2001 and coincides with resetting of ARMs as an ongoing issue…”

From Lehman: “Latest data from the Fed showed that asset-backed commercial paper (ABCP) yields remained elevated at 6.05%, roughly 80bp above similarly rated unsecured CP rates.”

From The Wall Street Journal: “Countrywide is counting on its savings bank, along with Fannie Mae and Freddie Mac, to fund nearly all of its future lending by drawing on deposits and borrowings from the Federal Home Loan Bank system. Countrywide officials say the bank's above-average interest rates on certificates of deposit and savings accounts are reversing a recent loss of deposits. New deposits have exceeded outflows so far this week, a Countrywide spokesman says.”

From Reuters: “Euro zone banks bid for a record amount of money at the ECB's regular long-term funding operation on Wednesday, reflecting ongoing tightness in the interbank lending market. Central banks have poured funds into money markets to tackle a liquidity crisis, stemming from the subprime saga, which has made many banks clam up on normal interbank lending. The European Central Bank lent out 50 billion euros for 91 days but with banks bidding for a total of 119.75 billion euros, strong demand pushed up the cost. "There is still a huge premium for cash particularly in the three months area," one trader said.”

From USA Today: “August car sales could be down 10% compared with a year ago as the mortgage credit crunch makes homeowners feel less secure and unwilling to sign on for another large monthly payment. Consumer website Edmunds.com estimates that sales will be down about 10% compared with last August, even as the automakers continue to pile on incentives to lure customers. Auto sales are particularly weak in regions such as Florida, Nevada and California, where the housing market also is being hard-hit.”
From Bloomberg: “China to `Actively' Take Measures to Curb Inflation…China's inflation rate surged to a 10-year high of 5.6 percent in July…Increases in food prices account for 80 percent of inflation…``Based on analysis of current data, the full-year consumer price index may still rise to more than 3 percent even if we step up micro-economic control measures for the rest of this year,'' he [Su Ning, deputy Chinese central bank governor] said. China's government is concerned burgeoning investment will overheat the economy, risking a slump…Inflation may ease once the government restrains food prices, he said.”
From JP Morgan: “Korea’s manufacturing output surged an additional 2.1%m/m in July [+14.3% YoY], reinforcing the impressive acceleration in industrial production in the major Asian economies. Korea’s advance was led by the high-tech sector, as is the case throughout Asia. EM Asia’s traditionally tight linkage to US industry and US tech demand, both of which have picked up pace, has been reaffirmed by recent developments.”

From Dow Jones: “Bernanke is expected to stop short of sending an implied policy signal when he addresses the Jackson Hole conference in Wyoming Friday.”

From RBSGC: “…despite Wednesday's gain to stocks, our read on things in mortgage space remains quite dire. Using a Titanic analogy conveyed by our long bond trader and echoed by others in the structured space, we in the bond market are in the boiler room, waist deep in cold sea waters, and the stock market is up there in first glasses enjoying martinis with ice chunks clipped off a convenient berg.”

End-of-Day Market Update

From Lehman: “Treasuries finished lower after a wild and exceedingly choppy session that saw an early rally, a big concession into 2 year supply, a 2 year auction that came
almost 3 basis points through the market, and then a late day selloff driven by heavy selling of the 5 year sector as equities powered to new highs…There were big market dislocations today suggesting that the combination of yield curve volatility and quarter end balance sheet constraints are starting to take a toll…The yield curve flattened on the day, moving by about a basis point from 2s to bonds.”

From Reuters: “Stocks rebounded on Wednesday, pushing the S&P 500 and the Nasdaq up more than 2 percent, after investors snapped up beaten down technology shares, while the energy sector benefited from a surge in oil prices.” [Dow closing up 247 points, almost exactly reversing yesterday’s broad-based decline on relatively low volume]

From Market Watch: “The dollar reversed its previous-session losses against the yen on Wednesday as investors renewed their appetite for risk amid a bargain-hunt for U.S. equities. The dollar was up 2% against the Japanese currency at 116.14 yen…Although the unwinding of carry trades continued during the Asian session, they reversed during early European trading…In carry trades, investors borrow lower-yielding currencies like yen to reinvest in higher-yielding assets elsewhere.” [Dollar index closing down .05 at 80.70]

From Fortune: “Oil prices extended early gains Wednesday after a government report showing drops in crude and gasoline supplies overshadowed fears of a slowing economy. U.S. light crude settled $1.78 higher to $73.51 a barrel…EIA also noted that gasoline supplies are at their lowest level ever, when taking into account the level of demand…supplies will be able to meet only 20 days of fuel use…Oil prices hit a record trading high of $78.77 on Aug. 1…”



If a picture is worth a thousand words…

3-Month Treasury T-Bill Yield

10-Year Treasury Note Yield

Today's Tidbits

FOMC Minutes
From Bloomberg: “Federal Reserve policy makers put aside concerns about the rising cost of credit at their Aug. 7 meeting because they weren't convinced a slowdown in inflation would last, according to minutes of the session. Ten days before the central bank was forced to cut a key interest rate, the Federal Open Market Committee was given lower growth forecasts by staff economists and noted that ``strains in financial markets'' jeopardized the expansion. Further turmoil might require a response, Fed officials said. ``Policy makers would need to watch the situation carefully,'' the minutes said. ``For the present, however, given expectations that the most likely outcome for the economy was
continued moderate growth, the upside risks to inflation remained the most significant policy concern… On inflation, ``meeting participants believed that the readings for the past few months likely had been damped by transitory factors and did not provide reliable evidence that the recent level would be sustained,'' the minutes said.''
From Goldman Sachs: “Minutes from August 7 FOMC meeting suggest that most or all officials were comfortable with a continued focus on inflation risks at the time; although the potential risks from the housing sector are mentioned, they are downplayed. Clearly, both markets and Fed officials have moved significantly since then, but this is a more hawkish tone than we would have expected even at that time.”

ABS Delinquencies Rising
From RBSGC: “Delinquencies rose across all four ABX structures last month, with serious delinquencies increasing more than expectations on everything except possibly the ABX 06-2 structure, in our opinion. Prepayment speeds were relatively stable with the exception of the ABX 06-1 structure, where we are seeing a lot of coupon resets currently on the 2/28s backing the deals. In ABX 06-1, we saw a significant increase in prepayment speeds to 47% from 34% CPR. Despite the 2/28 resets, the magnitude of the speed increase is somewhat surprising given the current market environment for refinancing subprime loans, and we suspect we will see somewhat slower prepayments on this structure by early next year as the current depth of the credit crunch becomes reflected in secondary market data.”

Median Individual Earnings Fell for 3rd Year in a Row
From CNN: “Median household income rose 0.7 percent to $48,200, adjusted for inflation, the Census Bureau reported. But more people had to be at work in each household to get there. That's because median earnings for individuals working full-time year-round actually fell for the third consecutive year. For men, earnings slipped 1.1 percent to a median of $42,300, while for women, earnings sank 1.2 percent to a median of $32,500.”

Health Insurance Availability
From CNN: “When it comes to health insurance, the ranks of the haves and have-nots widened for the second straight year. The number of Americans not covered by health insurance rose to 47 million in 2006 - or 15.8 percent of the population …Among those who do have health insurance, the total number of people with policies rose by 800,000 to 249.8 million. But the percentage of people covered through their employers fell to 59.7 percent from 60.2 percent, as did the percentage of those covered by government health programs - down to 27 percent from 27.3 percent.”

World Won’t Starve Without Bees, But Diversity Definitely Suffers
From Fortune: “We wouldn't starve if the mysterious disappearance of bees, dubbed colony collapse disorder, or CCD, decimated hives worldwide. For one thing, wheat, corn, and other grains don't depend on insect pollination. But in a honeybee-less world, almonds, blueberries, melons, cranberries, peaches, pumpkins, onions, squash, cucumbers, and scores of other fruits and vegetables would become as pricey as sumptuous old wine. Honeybees also pollinate alfalfa used to feed livestock, so meat and milk would get dearer as well. Ditto for farmed catfish, which are fed alfalfa too. And jars of honey, of course, would become golden heirlooms to pass along to the grandkids. (Used for millennia as a wound dressing, honey contains potent antimicrobial compounds that enable it to last for decades in sealed containers.) In late June, U.S. Agriculture Secretary Mike Johanns starkly warned that "if left unchecked, CCD has the potential to cause a $15 billion direct loss of crop production and $75 billion in indirect losses."

Yen Rallies As Carry Trade Unwind Resumes
From Bloomberg: “…speculation banks will report more credit-market losses pushed traders to reduce riskier investments funded by loans in Japan. The Japanese yen gained against all 16 major currencies tracked by Bloomberg as investors pared the so-called carry trade… The yen rose 1.3 percent to 114.41 per dollar at 4:01 p.m. in New York, and is up 3.6 percent in August… Japan's benchmark interest rate of 0.5 percent is the lowest among industrialized nations, encouraging the carry trade and weakening the yen 3.8 percent versus the euro over the past 12 months. The rate compares with 5.25 percent in the U.S., 4 percent in the euro region, 5.75 percent in the U.K., 6.5 percent in Australia and 8.25 percent in New Zealand.”

Concern Rising That Firms Will Cut Back Business Investment
From USA Today: “Business investment, such as opening new offices as Burnett was considering, or buying new equipment and buildings, has been a key player in the economy in recent years, accounting for more than 10% of U.S. economic activity in 2006. In the second quarter, business spending provided its biggest boost to the economy in more than a year, almost equal to the contribution from consumer spending. And a key measure of business spending, orders for capital durable goods excluding defense and aircraft, rose in July at the fastest pace since March. Business spending is also a barometer of corporate sentiment, which can influence hiring, salaries and other factors that can affect consumers, the biggest driver of the $13 trillion U.S. economy. But some economists are questioning if businesses will continue to be a pillar of strength, given the erratic stock market, a barrage of credit crunch news, and concerns that the housing market will not pick up for quite some time. Federal Reserve policymakers are closely watching how businesses react to determine if they need to cut interest rates to help prop up the economy. "All this noise will affect people's outlook," says William Dunkelberg, chief economist at the National Federation of Independent Business. He's not concerned that businesses will stop spending because they can't find financing — many have a lot of cash on hand and don't need to borrow. The issue is if the wave of bad news will have a negative impact on business owners' view of where the economy is headed and lead them to exercise greater caution, like Burnett…Moody's Economy.com chief economist Mark Zandi says businesses will make or break the economy going forward. "What businesses decide to do determines if we end up in a recession or not, both in terms of their investment and in terms of their hiring," Zandi says. "If they pull back in either, confidence will completely unravel, and we will be in recession," … Companies outside of farming and banking had $1.5 trillion in liquid assets at the end of the first quarter, up 3.5% from a year ago according to the latest available data from the Federal Reserve. Earnings were up more than 10% in the second quarter, the biggest gain since the third quarter of last year, according to Standard & Poor's… But business owners who have dipped their toes in the borrowing waters are giving mixed reviews, with some reporting problems even before the recent credit crunch worries emerged. Charles Weinacker, owner of Pet Friendly of Fairhope, Ala., recently notched an unusually large $1.2 million in orders from Wal-Mart, Whole Foods and other stores. They were largely buying his organic dog food after traces of melamine were found in many other brands of pet food, sparking a massive recall. But Weinacker wasn't able to secure a line of credit from a local bank to buy boxes, labels and raw materials to fill the orders. He needed the loan, he says, because the big chains don't pay him until about two months after he delivers the merchandise. After a search of several months, Weinacker ultimately snared a $3 million line of credit but at nearly double his typical 7% interest rate. Loan officers "are scared to death, 'cause they get fired if a loan goes bad," he says… "It seems like everybody is in a wait-and-see mode," he says of his clients, noting companies often hire based on their gut feelings of the economy, which can be influenced by the stock market and other financial news. "Businesses are very fickle sometimes." It's such caution that would be unwelcome news for the economy. Even if companies have access to money, they have to feel confident enough to spend it and to hire to make a difference. In a survey of more than 30 economists conducted by USA TODAY last week, nearly all marked down their forecasts for business spending in the third and fourth quarters. But the reductions were not dramatic. "Most of the fundamentals for business investment are still quite positive," Jeffrey Lacker, president of the Federal Reserve Bank of Richmond, said last week. "Profitability is high, and the cost of capital is still fairly low, despite recent financial market developments. Thus, investment could well maintain momentum this year." Paul Villella, CEO of HireStrategy, a Reston, Va.-based job placement firm operating in the Washington, D.C., area, is watching his clients closely. While businesses are going ahead with hiring plans, the time between starting the job search and closing the deal seems to be expanding, he says. Temporary help and placement firms are often among the first to pick up on changes in business sentiment.”

Credit Card Defaults Rise From
The Financial Times: “US consumers are defaulting on credit-card payments at a significantly higher rate than last year, raising the prospect of problems in the stricken US subprime mortgage market spreading to other types of consumer debt. Credit-card companies were forced to write off 4.58 per cent of payments as uncollectable in the first half of 2007, almost 30 per cent higher year-on-year. Late payments also rose, and the quarterly payment rate – a measure of cardholders’ willingness and ability to repay their debt – fell for the first time in more than four years.”


MISC

From Dow Jones: “U.S. sales of home-repair and remodeling products should drop 1.3% to $308.9 billion this year as the housing market isn’t expected to improve until mid-2008, a trade group for the home-improvement industry said. The Home Improvement Research Institute said the decline would be the first since 1991 and only the third since it began tracking industry figures in 1977.”

From Dow Jones: “A federal judge in New York has overturned a bankruptcy court’s decision in the Enron Corp. case that had sent shudders throughout Wall Street, saying the ruling “threatened to wreak havoc on the markets for distressed debt.” In a 53-page decision Monday, U.S. District Judge Shira Scheindlin said U.S. Bankruptcy Judge Arthur Gonzalez was wrong to have ruled last year that holders of claims against a
bankrupt company could see those claims wiped out if they bought them from a seller who engaged in “inequitable conduct.” Gonzalez’s ruling alarmed Wall Street. The Bond Market Association, the International Swaps and Derivatives Association, the Loan Syndications and Trading Association, and the Securities Industry Association filed court papers criticizing the ruling.”

End-of-Day Market Update

From JP Morgan: “After a few calm days where spec positions were unwound (mostly curve and spreads), we’ve spent most of the day today putting risk premium back into the market.”

From Handelsbanken: “The latest set of news reports highlighting troubled financial institutions, both domestically as well as overseas, shook investor confidence again …and resulted in a renewed downturn in the broad stock market indices and sparked a flight to quality rally in the Treasury bond market. All three major domestic stock indices opened lower and traded in negative territory all day. The sell off in stocks pushed up the Treasury prices and widened out the 2-year/10-year spread at the margin after narrowing for almost a week.”
From RBSGC: “The bond market had a very impressive day with the curve resteepening quite sharply and prices making technically significant gains… the aura of calm doesn't translate to liquidity or an end to the problems… To the extent that weaker stocks are supporting our generic bias for bull steepening, stocks do not look healthy. Corporate issuance is coming, but at a cost. We emphasize that buyback/LBOs/M&A activity that has accounted for nearly 2.5 years worth of NEGATIVE equity issuance WAS a main source of that strength. With borrowing costs to everyone BUT Treasury the highest they've been in years, we see a major source of support largely gone.”
From UBS: “Overnight general collateral Treasury repo rates are now back to the Fed funds rate at ~ 5.15-5.25%. Term repo markets continue to rebuild slowly, restoring (some) confidence for now. The curve re-steepened sharply as stocks followed the Financials and Homebuilders lower… Swap spreads widened on very little volume despite corporate issuance picking up, a curve steepening and the market rallying. Agency debt saw heavy buying all day from both domestic and foreign accounts. As Agencies outperformed Libor 3 to 5 bps across the curve, some accounts took profit in the front end. 5y agency debt has become the hottest sector, surpassing 10s, which struggled to stay even on spread.”

From JP Morgan: “Late day rally in term general collateral markets and bills are spooking specials markets…Term GC offers and term specials offers are few and far between and likely will be good for about 25mm and that’s it! Bills continue to rally w/ 3s @ 4.09 last and 6s @ 4.11 last. Stocks falling sharply into the close and $$ seems to want govies…”

From SunTrust: “We continue to see buyers creep back into the ABCP and A2/P2 term
market… Problems continue for SIV and CDO conduits.”

Three month T-Bill yields fell 24bp
Two year Treasury Note yields fell 13.5bp
Ten year Treasury Note yields fell 5bp

Dow closed down 280pts to lowest level in a week, trading below 50 day moving average and above 200 day moving average. The S&P 500 closed down 34.5 points.

Dollar index rallied .15 to 80.88. The Japanese yen exchange rate fell by 1.6 yen to the dollar, to 114.3.

Oil fell 44 cents, to $71.53, after rallying close to its 50 day moving average yesterday.

Consumer Confidence Sinks Most in 2 Years in Reaction to Recent Market Disruptions

August consumer confidence saw the largest monthly drop since the reaction to Hurricane Katrina in 2005. The index fell to 105 (consensus 104) in August from a revised lower 111.9 in July (a six year high). The actual index has fallen to a one year low. In August 2006 it was at 100.2.

Both current conditions and future expectations fell in August, with current conditions dropping more. Fewer people reported jobs as plentiful (27.5%) while jobs hard to get rose to 19.7%. Inflation expectations held steady as did people's income growth expectations.

As expected, plans for purchasing durable goods declined, but surprisingly plans to buy a house rose again, to 3.5%, after bottoming in May at 2.8%.

Consumer confidence is watched for signs of consumer health and willingness to spend money. Other confidence surveys have recently shown even larger declines.

S&P Case-Shiller Home Price Index Shows Record National Home Price Decline in 2nd Quarter

The national S&P Case-Shiller home price index showed a -3.2% YoY decline in the second quarter of 2007 versus the 2nd quarter of 2006. The index turned negative in the first quarter of 2007 when it fell -1.6% YoY. As recently as the second quarter of 2006 the index was still showing annual growth of 7.5% YoY. The Case-Shiller index includes homes at all price levels, as opposed to the OFHEO index which only studies conforming mortgages which misses the higher end of the market, and is the preferred home price appreciation index for many economists.

Looking at just the monthly index of 20 large metropolitan areas, the Case-Shiller index shows as of June 2007 that prices in these areas are down -3.5% YoY (consensus -3.3% YoY). This is the largest decline in the 20 city index since it was begun in 2001, and an accelerating decline rate from the -2.9% YoY figure observed in May. Because the figures are not seasonally adjusted, most economists prefer watching 12 month changes.

Fifteen of the 20 cities surveyed showed a drop in home prices year-over-year in June. Detroit led the decline with a drop of 11% YoY. The Washington, DC metro area is calculated to have seen prices drop 7% YoY. The five cities that still showed appreciation are Seattle, Charlotte, Atlanta, Dallas, and Portland. The smaller 10 city index, which is focused on cities which have had a larger bubble in prices, fell -4.1% YoY. Of concern are signs that the home price depreciation seems to be accelerating in Florida and California.

Many economists are now looking for national home prices to decline by 5% or more by the end of 2007, and expect the decline to continue into at least 2008. The record inventory level of existing homes for sale, reported yesterday, indicates that homeowners are less inclined to pull their houses off the market in hopes of a quick recovery in home values.

Market reaction was muted to these figures as bad news was expected.

Existing Home Sales Fell Less Than Expected in July

Existing home sales fell -.2% MoM (consensus -.9%) in July, and June's declined was revised slightly smaller to only -3.7% from -3.8% MoM. This marks the fifth consecutive month that existing home sales have declined. The pace has dropped by 9% versus a year ago, and has now fallen to a sales pace last seen in 2002.

Single family home sales fell -.4% MoM (-9.3% YoY), while condos rose +1.4% MoM (-7.5% YoY).

Total supply rose to 9.6 months, at the current sales pace, the highest level since 1991. Single family is at 9.2 months, while condos rose to 11.9 months, almost a 20% increase from the 10 month supply available in June. The actual number of resale homes for sale rose 5.1% to 4.59 million.

Median home prices fell -.6% YoY, with single family median prices falling -1% YoY and condos rising +2.4% YoY. The median resale price for a home in the U.S. is now $228,900.

The Midwest was the only region to see a decline in home sales (-2.2% MoM). Sales in the South were static. Sales rose +1% MoM in the Northeast and +1.8% MoM in the West during July. Median home sales prices have risen +5.9% YoY in the Northeast, are up +.9% YoY in the West, and have fallen -1.8% YoY in the Midwest and -3.2% YoY in the South as of July.

Existing home sales represent contract closings of agreements typically made one to two months earlier, so these figures are less likely to have been impacted by recent credit tightening events, as long as the mortgage lender remained in business to fund the loan. Existing home sales account for about 85% of homes sold each year, with new home sales meeting the balance of the demand for housing.

July tends to be a peak home selling month as people move between school years. Most economists are expecting sales to continue contracting as the credit markets tighten.

U.S Attorney General Stepping down

Today, the Justice Department scheduled a news conference for 10:30 a.m, for the official announcement of U.S. Attorney General stepping down. Like a poorly built puzzle, the Bush Administration is crumbling since November 2006 when the Head of the DoD stepped down. We do not know yet, if this isn't just the beginning of the show.