Disadvantages of a Weak Dollar
From Merrill Lynch: “Who would have thought that the Fed would lower rates by more than investors expected with the dollar within a breath of an all-time low against all the major currencies? They did, and inflation expectations are accordingly rising. The 10-Year T-Note yield has now backed up 25+ basis points in the last 2 weeks, and TIPs spreads have jumped as well…A quick reiteration of our views on the global imbalances seems appropriate. Simply put, the US trade imbalances are so huge and the export base so small that the only way to solve the global imbalances is to constrain domestic US consumption. We have argued that there are basically three ways to do that: 1) raise taxes, 2) raise interest rates (or keep monetary policies tighter than they normally would be), and/or 3) depreciate the dollar so that goods produced outside the US become unaffordable to Americans. If #1 or #2 were not going to be implemented, then the markets would take care of #3. Depreciating the currency is generally a politically acceptable route, and one often chosen by developing nations with current account imbalances (after all, what politician wants to tell voters they can't buy things?). However, it is also the route that is the least controllable. It now seems quite clear that Washington as a whole (i.e., both fiscal and monetary authorities) has chosen #3. So, whereas American markets have been focusing on assets that seek to merely maintain wealth (dollar-denominated commodities and gold, for example), the remainder of the world is investing to build productive assets and wealth.”
From The Telegraph: “Saudi Arabia has refused to cut interest rates in lockstep with the US Federal Reserve for the first time, signalling that the oil-rich Gulf kingdom is preparing to break the dollar currency peg in a move that risks setting off a stampede out of the dollar across the Middle East… "Saudi Arabia has $800bn (GBP400bn) in their future generation fund, and the entire region has $3,500bn under management. They face an inflationary threat and do not want to import an interest rate policy set for the recessionary conditions in the United States,"… As a close ally of the US, Riyadh has so far tried to stick to the peg, but the link is now destabilising its own economy… There is now a growing danger that global investors will start to shun the US bond markets. The latest US government data on foreign holdings released this week show a collapse in purchases of US bonds from $97bn to just $19bn in July, with outright net sales of US Treasuries. The danger is that this could now accelerate as the yield gap between the United States and the rest of the world narrows rapidly, leaving America starved of foreign capital flows needed to cover its current account deficit – expected to reach $850bn this year, or 6.5pc of GDP. Mr Redeker said foreign investors have been gradually pulling out of the long-term US debt markets, leaving the dollar dependent on short-term funding. Foreigners have funded 25pc to 30pc of America's credit and short-term paper markets over the last two years… "This is nothing like the situation in 1998 when the crisis was in Asia, but the US was booming. This time the US itself is the problem," he said…the biggest danger for the dollar is that falling US rates will at some point trigger a reversal yen "carry trade", causing massive flows from the US back to Japan. Jim Rogers, the commodity king and former partner of George Soros, said the Federal Reserve was playing with fire by cutting rates so aggressively at a time when the dollar was already under pressure. The risk is that flight from US bonds could push up the long-term yields that form the base price of credit for most mortgages, the driving the property market into even deeper crisis. If Ben Bernanke starts running those printing presses even faster than he's already doing, we are going to have a serious recession. The dollar's going to collapse, the bond market's going to collapse. There's going to be a lot of problems," he said. The Federal Reserve, however, clearly calculates the risk of a sudden downturn is now so great that the it outweighs dangers of a dollar slide. Former Fed chief Alan Greenspan said this week that house prices may fall by "double digits" as the subprime crisis bites harder, prompting households to cut back sharply on spending. For Saudi Arabia, the dollar peg has clearly become a liability. Inflation has risen to 4pc and the M3 broad money supply is surging at 22pc. The pressures are even worse in other parts of the Gulf. The United Arab Emirates now faces inflation of 9.3pc, a 20-year high. In Qatar it has reached 13pc. Kuwait became the first of the oil sheikhdoms to break its dollar peg in May, a move that has begun to rein in rampant money supply growth.”
From Bloomberg: “The dollar sank to a record low against the euro …``One thing that should be clear is that this is not a dollar-friendly Fed,'' said Jim McCormick, the London-based global head of currency research at Lehman Brothers International. ``The biggest focus going forward is going to be the monetary policy expectations.''
From Lehman: “Then, wow! 50-bps? No warning. No steering the markets towards his decision. Just 50bps in the fact of $80 oil, a weak $, and inflation which, while perhaps waning, certainly not gone…the market has tossed away its dollars, its long bonds, and just about anything else that the market believed was good to own with a cool and credible Fed. I don't blame them.”
CP Market Improving
From JP Morgan: “Commercial paper outstanding fell $19.0 billion nsa in the week ending September 19… Over the last six weeks, CP outstanding has fallen a cumulative $294 bn, or 13.5%...ABCP outstanding has fallen 20.8% over the last six weeks, but the rate of decline has slowed in the past two weeks. In the past two weeks, ABCP outstanding has fallen an average of $15.1 bn per week, compared with an average of $53.6 bn in the four prior weeks. Yields for all types of CP fell after the Fed cut rates, and the spread between ABCP and other types of CP has narrowed over the last week. Nonetheless, the spread between ABCP and financial and nonfinancial CP remains much larger than usual.”
Consumers Have Shifted From Using MEW to Selling Assets to Fund Excess Spending – Risk is Corporate Buybacks End as Credit Conditions Tighten
From Morgan Stanley: “The household sector has an ostensibly solid balance sheet. In fact, the sector’s net worth hit a new all-time high in dollar terms in the June quarter, and is almost back at all-time highs relative to income. However, balance sheet metrics are typically poor indicators of financial risk, particularly when the assets are valued at market prices. At the top of a boom asset prices are almost always elevated, providing a false sense of financial solidity. For example, the non-financial corporate sector’s debt-equity ratio hit an all-time low in the US in 1999. Historically, debt, or leverage, has been a much better indicator of risk – and it hasn’t mattered what assets are on the other side of the ledger. On that measure, American households, with record leverage, are high risk. Cash-flow measures are even more worrying, in my view… the household sector’s net financial requirement, which is a net cash flow measure. As I’ve noted before, the household sector has never, prior to this cycle, run a cash-flow deficit. The deficit was 8¾% of disposable income at its low. Changes in cash-flow are very important for growth. If the cash-flow deficit is widening that is usually positive for growth, because it suggest that outlays are growing faster than cash income. Conversely, a rising cash-flow balance bodes ill for growth…Note that recessions are usually associated with the cash-flow balance rising, and it is a rising cash-flow balance that leads the GDP downturn.
The household sector’s cash-flow balance has risen gently over the past year, and that has led to GDP growth slowing to below-trend levels… there is potentially a lot more adjustment to come. What are the household sector’s options? It has two: continue to fund the deficit by either increasing debt or selling assets; or reduce the deficit by slowing the growth in outlays relative to the growth in cash-income. So far the household sector has found it relatively easy to finance the cash-flow deficit. For several years the principal financing tool was borrowing, largely funded against housing – so-called home equity withdrawal (HEW). Over the past 18 months, however, that has become more difficult. But households found an alternative financing source: selling assets, principally equities…The ‘surplus HEW’ series shows the household sector’s borrowing requirement net of HEW. In 2003-04 the sector over-funded its deficit, at the peak extracting US$394bn more in HEW than needed to cover the cash-flow deficit.
Now, however, HEW is $288bn less than the deficit – a financing hole that needs to be filled. The other series is net equity purchases. Over the four quarters to June the household sector sold just over $700 billion of equities. (This includes executives selling equity grants given as remuneration.) The household sector was able to sell equities because the corporate sector was a willing buyer… the corporate sector was a net buyer of $770bn of equities through the year. In other words, over the past three years there has been a transition from households borrowing to fund their cash-flow deficit to the corporate sector borrowing to buy back stock to fund the household sector’s cash-flow deficit. But here’s the rub: the apparent end of the boom in corporate activity will likely lead to a significant fall in net corporate buy-backs in the current half…A fall in household (equity) asset sales will come just as lending conditions have been significantly tightened, courtesy of the sub-prime problems. The risk is that the tightening in financial conditions – debt finance and the reduced scope for equity sales – may cause the household sector, either willingly or unwillingly, to accelerate the pace at which it narrows its cash-flow deficit. That would like be sufficient to tip the US into recession.”
Philly Fed Rises Sharply
From Deutsche Bank: “The September manufacturing index from the Philly Fed showed a pick up in activity in that region. The headline of this series rose to 10.9 from 0.0 previously. Two key details of the report corroborated the headline strength: new orders (15.1 vs. 7.1) and shipments (16.9 vs. 12.4) both gained. Prices paid also rose (23.1 vs. 15.4), but remained in the bottom end of the range for this series over the past two quarters; this was likely driven by oil prices. Of the components which declined, the drop in the employment component (7.5 vs. 21.2) was the most noteworthy to us, given our (and likely the Fed's) heightened concern regarding the labor market. The 6-month outlook for business conditions edged slightly lower (35.7 vs. 36.2), and in a special question 65% of respondents indicated that they saw no impact on their business from recent market turmoil.”
MISC
From Credit Suisse: “…many such borrowers are delinquent not because they're in economic distress (although clearly some are) but rather because many of these borrowers choose to be delinquent (e.g., housing market correction and lack of downpayment results in voluntarily handing in the keys) or unexpected expenses (especially for the large percentage of firsttime home buyers) or overstated income (e.g., for stated income loans). Obviously, borrowers may fall in one or all of these categories. The point is that the borrowers' source of financial duress is housing centric." They conclude that for many of these borrowers it is likely preferable to lose the house that they have zero or negative equity in than to lose their car and/or credit cards.”
From UBS: “UBS Economists have updated their estimates of contraction in the direct
housing sector to -17% in Q4 07, -11.5% Q1 08, -7.0% in Q2 08 before starting to grow modestly by Q3 next year. Their estimate has housing starts bottoming out at a 1.2mm annual pace next year – a pace not much lower than yesterday’s reading. Although the housing related component of GDP has shrunk to 5% from 6%, a sketchy estimate of direct and indirect housing-related component of GDP is likely above 10%. Though not our official call, what if 10% of the economy shrinks 25%? That would be a significant headwind.”
From Deutsche Bank: “…continue to see a reduction in the growth rate of mortgage borrowing and a flattening in consumer credit growth.”
From Lehman: “Natural gas storage …inventories for the United States have shifted back into a deficit to 2006…The United States as a whole has averaged warmer than normal every week for nearly two straight months. After a relatively cool month of July, August and September have been exceptionally warm on a population-weighted basis, and now make it very likely that the 2007 summer season will be one of the hottest on record…The very small storage builds in recent weeks have been caused in part by unusually hot weather in the Midwest and East, but also in part by declining LNG imports relative to levels recorded earlier in the summer. There have yet to be any significant storm-related supply disruptions in the Gulf of Mexico.”
From JP Morgan: “Continuing claims fell sharply in the week ending September 8, from 2.597 million to 2.544 million, and the insured unemployment rate dropped to 1.9% from 2.0%. There has been a sustained rise in continuing claims since late June, but this week’s decline reversed about half that. Nonetheless, continuing claims are still elevated and should be watched carefully.”
End-of-Day Market Update
From Morgan Stanley: “Today's rates market sell-off is looking like the disaster scenario for mortgages.”
From Bloomberg: “The difference between two- and 10- year Treasury note yields increased to the widest since May 2005 on speculation the tumbling dollar and the Federal Reserve's cut in borrowing costs will fuel inflation. Yields on 10-year notes, more sensitive to inflation expectations than shorter-term securities, rose faster than those on two-year notes, steepening the so-called yield curve… ``Investors are losing onfidence in the Fed's inflation-fighting credibility,'' said Michael Pond, an interest-rate strategist in New York at primary dealer Barclays Capital Inc. ``At the same time, we're seeing a run-up in commodities and a weakening dollar.'' The yield between 10- and two-year notes widened a third day, reaching 57 basis points… The three-month Treasury bill yield fell for the third straight day, decreasing 10 basis points to 3.80 percent, the lowest since Aug. 30.”
From Bloomberg: “Crude oil rose to a record $83.90 a barrel in New York after the U.S. said that production in the Gulf of Mexico was shut because of a storm threat. More than … 28 percent, of daily oil production was idled… Prices were already higher on signs that U.S. interest-rate cuts and a falling dollar will bolster demand.”
As of 3:40
Two year Treasury rates are 12bp higher at 4.11%, ten year Treasuries up 16bp to 4.70%
Swap spreads averaging 3bp wider on day.
The Dow is down 46.
The dollar index is down .72 to a new 15 year low of 78.58 (1992 low was 78.19).
Spot gold trading $14 higher at $735.7, after hitting new record high of $738.60 earlier.
Oil currently at 83.32, up $1.39.
Thursday, September 20, 2007
Wednesday, September 19, 2007
OFHEO PROVIDES FLEXIBILITY ON FANNIE MAE, FREDDIE MAC MORTGAGE PORTFOLIOS
For Immediate Release September 19, 2007
OFHEO PROVIDES FLEXIBILITY ON FANNIE MAE, FREDDIE MAC MORTGAGE PORTFOLIOS
Washington, DC – OFHEO Director James B. Lockhart announced today that OFHEO is providing Fannie Mae and Freddie Mac with additional flexibility in managing their mortgage portfolios to comply with the portfolio caps agreed to last year.
“These changes will make it easier for the Enterprises to manage market-based fluctuations in their portfolios and reduce the need to keep large cushions below the portfolio caps,” said Lockhart. “It will also make it easier for OFHEO to monitor compliance with the portfolio caps. Both companies have indicated that this portfolio flexibility, combined with their securitization capabilities, asset sales, and the monthly runoff of their portfolios, should allow them to provide greater assistance to subprime borrowers and others who may have difficulty refinancing their existing mortgages in the current environment,” Lockhart said.
The temporary investment caps on their mortgage portfolios were established in May and July of last year because of both Enterprises’ operational, systems, financial reporting, risk management and internal control shortcomings. They have made progress in remediating some of these issues, including the publication by Fannie Mae of its 2006 financial statements and Freddie Mac of its second quarter 2007 financials, though neither was done in a timely fashion. Both companies have indicated they expect to produce audited, timely, annual financial statements for 2007 in February of 2008.
OFHEO has decided that it would not be prudent at this time to allow any major increases in the portfolio levels because the remediation process is not finished, many safety and soundness issues are not yet resolved, and the criteria in the Fannie Mae consent agreement and Freddie Mac’s voluntary agreement have not been met.
“Given our ongoing significant supervisory concerns, OFHEO will closely monitor the implementation of these portfolio cap flexibilities and will require the Enterprises to report regularly on the resulting changes and risks inherent in their portfolios,” Lockhart said.
With the ongoing concerns about the subprime mortgage market, both Fannie Mae and Freddie Mac have announced commitments to purchase tens of billions of dollars of subprime mortgages over the next several years. The portfolio cap flexibility plus their ongoing ability to securitize mortgages, sell assets, and replace maturing assets, will enhance each Enterprise’s ability to purchase or securitize, over the next six months up to $20 billion or more of subprime mortgages, refinanced mortgages for borrowers with lower credit scores, and affordable multi-family housing mortgages. These efforts should assist lenders in helping some subprime borrowers avoid foreclosure.
OFHEO expects Fannie Mae’s and Freddie Mac’s Chief Risk Officers and other senior executives to continue to closely monitor the Enterprises’ investment activities, as will OFHEO’s Office of Supervision, to ensure the activities meet sound credit underwriting and other safety and soundness standards. These standards include the recently implemented Interagency Guidance on Nontraditional Mortgage Product Risks and Statement on Subprime Mortgage Lending.
The specific flexibilities are as follows:
1. Change the portfolio measure from a GAAP number as reported on the balance sheet to Unpaid Principal Balance (UPB), which the Enterprises use in their publicly released monthly summaries. Under present market conditions, the GAAP value can fluctuate widely and we have concluded this adds unnecessary complexity for the Enterprises in managing to the portfolio cap. UPB, which reflects the original principal balance of mortgages and securities less repayments, is not subject to daily market fluctuations.
2. Set the new UPB portfolio cap at $735 billion on July 1, 2007 and apply it to the third quarter. On that date, the GAAP measured cap was $728.1 billion for Freddie Mac and $727.7 billion for Fannie Mae. (UPB often exceeds the GAAP value for the Enterprises. Due to market fluctuations over the first seven months of 2007, this difference has ranged from $0.1 billion to $9.4 billion.)
3. Allow Fannie Mae the same moderate increases that Freddie Mac has under its voluntary agreement of 2 percent annual growth and not more than 0.5 percent per quarter. This change for Fannie Mae would be effective Oct. 1, 2007, for the fourth quarter.
4. For the fourth quarter of 2007, the quarterly growth limit of 0.5 percent would be doubled to 1.0 percent, although the 2 percent per annum cap would remain in place.
5. The size of the portfolio used to determine compliance with the portfolio cap will no longer be the closing values at quarter end but rather an average of monthly closing values. The average will start at a specified amount in July 2007 and will build to a twelve-month moving average.
6. Frequent reporting on market conditions, portfolio sizes and new purchases will be required, including a monthly report on the Enterprises’ purchases of subprime and other mortgages to borrowers with lower credit scores and multi-family housing mortgages in relationship to the $20 billion level.
7. OFHEO examiners will ensure the Enterprises continue to have adequate capital to use this new flexibility and continue to adhere to their internal guidelines and limits on liquidity. OFHEO will also continue to monitor the increased credit and interest rate risk associated with current market conditions.
The combination of these changes should allow the Enterprises more flexibility in managing their portfolios and eliminate the need for a large cushion. This added flexibility will be especially helpful in making multi-billion dollar bulk purchases of subprime and multi-family housing mortgages and fulfilling the Enterprises’ commitments to purchase subprime mortgages to help borrowers avoid foreclosure and support affordable housing.
As OFHEO has repeatedly stated, the current portfolio limits are due to ongoing safety and soundness issues at each Enterprise. Some of these safety and soundness issues arose, in part, because of rapid portfolio growth in the past. Pending legislation would provide the Enterprises’ new regulator with clarified authorities and direction with respect to setting and enforcing portfolio size and growth as an ongoing matter, based upon their mission and safe and sound operations.
“OFHEO continues to believe that a more permanent solution to the portfolio limit question requires both congressional guidance and strengthened supervisory authorities,” said Lockhart.
###
OFHEO's mission is to promote housing and a strong national housing finance system by ensuring the safety and soundness of Fannie Mae and Freddie Mac.
OFHEO PROVIDES FLEXIBILITY ON FANNIE MAE, FREDDIE MAC MORTGAGE PORTFOLIOS
Washington, DC – OFHEO Director James B. Lockhart announced today that OFHEO is providing Fannie Mae and Freddie Mac with additional flexibility in managing their mortgage portfolios to comply with the portfolio caps agreed to last year.
“These changes will make it easier for the Enterprises to manage market-based fluctuations in their portfolios and reduce the need to keep large cushions below the portfolio caps,” said Lockhart. “It will also make it easier for OFHEO to monitor compliance with the portfolio caps. Both companies have indicated that this portfolio flexibility, combined with their securitization capabilities, asset sales, and the monthly runoff of their portfolios, should allow them to provide greater assistance to subprime borrowers and others who may have difficulty refinancing their existing mortgages in the current environment,” Lockhart said.
The temporary investment caps on their mortgage portfolios were established in May and July of last year because of both Enterprises’ operational, systems, financial reporting, risk management and internal control shortcomings. They have made progress in remediating some of these issues, including the publication by Fannie Mae of its 2006 financial statements and Freddie Mac of its second quarter 2007 financials, though neither was done in a timely fashion. Both companies have indicated they expect to produce audited, timely, annual financial statements for 2007 in February of 2008.
OFHEO has decided that it would not be prudent at this time to allow any major increases in the portfolio levels because the remediation process is not finished, many safety and soundness issues are not yet resolved, and the criteria in the Fannie Mae consent agreement and Freddie Mac’s voluntary agreement have not been met.
“Given our ongoing significant supervisory concerns, OFHEO will closely monitor the implementation of these portfolio cap flexibilities and will require the Enterprises to report regularly on the resulting changes and risks inherent in their portfolios,” Lockhart said.
With the ongoing concerns about the subprime mortgage market, both Fannie Mae and Freddie Mac have announced commitments to purchase tens of billions of dollars of subprime mortgages over the next several years. The portfolio cap flexibility plus their ongoing ability to securitize mortgages, sell assets, and replace maturing assets, will enhance each Enterprise’s ability to purchase or securitize, over the next six months up to $20 billion or more of subprime mortgages, refinanced mortgages for borrowers with lower credit scores, and affordable multi-family housing mortgages. These efforts should assist lenders in helping some subprime borrowers avoid foreclosure.
OFHEO expects Fannie Mae’s and Freddie Mac’s Chief Risk Officers and other senior executives to continue to closely monitor the Enterprises’ investment activities, as will OFHEO’s Office of Supervision, to ensure the activities meet sound credit underwriting and other safety and soundness standards. These standards include the recently implemented Interagency Guidance on Nontraditional Mortgage Product Risks and Statement on Subprime Mortgage Lending.
The specific flexibilities are as follows:
1. Change the portfolio measure from a GAAP number as reported on the balance sheet to Unpaid Principal Balance (UPB), which the Enterprises use in their publicly released monthly summaries. Under present market conditions, the GAAP value can fluctuate widely and we have concluded this adds unnecessary complexity for the Enterprises in managing to the portfolio cap. UPB, which reflects the original principal balance of mortgages and securities less repayments, is not subject to daily market fluctuations.
2. Set the new UPB portfolio cap at $735 billion on July 1, 2007 and apply it to the third quarter. On that date, the GAAP measured cap was $728.1 billion for Freddie Mac and $727.7 billion for Fannie Mae. (UPB often exceeds the GAAP value for the Enterprises. Due to market fluctuations over the first seven months of 2007, this difference has ranged from $0.1 billion to $9.4 billion.)
3. Allow Fannie Mae the same moderate increases that Freddie Mac has under its voluntary agreement of 2 percent annual growth and not more than 0.5 percent per quarter. This change for Fannie Mae would be effective Oct. 1, 2007, for the fourth quarter.
4. For the fourth quarter of 2007, the quarterly growth limit of 0.5 percent would be doubled to 1.0 percent, although the 2 percent per annum cap would remain in place.
5. The size of the portfolio used to determine compliance with the portfolio cap will no longer be the closing values at quarter end but rather an average of monthly closing values. The average will start at a specified amount in July 2007 and will build to a twelve-month moving average.
6. Frequent reporting on market conditions, portfolio sizes and new purchases will be required, including a monthly report on the Enterprises’ purchases of subprime and other mortgages to borrowers with lower credit scores and multi-family housing mortgages in relationship to the $20 billion level.
7. OFHEO examiners will ensure the Enterprises continue to have adequate capital to use this new flexibility and continue to adhere to their internal guidelines and limits on liquidity. OFHEO will also continue to monitor the increased credit and interest rate risk associated with current market conditions.
The combination of these changes should allow the Enterprises more flexibility in managing their portfolios and eliminate the need for a large cushion. This added flexibility will be especially helpful in making multi-billion dollar bulk purchases of subprime and multi-family housing mortgages and fulfilling the Enterprises’ commitments to purchase subprime mortgages to help borrowers avoid foreclosure and support affordable housing.
As OFHEO has repeatedly stated, the current portfolio limits are due to ongoing safety and soundness issues at each Enterprise. Some of these safety and soundness issues arose, in part, because of rapid portfolio growth in the past. Pending legislation would provide the Enterprises’ new regulator with clarified authorities and direction with respect to setting and enforcing portfolio size and growth as an ongoing matter, based upon their mission and safe and sound operations.
“OFHEO continues to believe that a more permanent solution to the portfolio limit question requires both congressional guidance and strengthened supervisory authorities,” said Lockhart.
###
OFHEO's mission is to promote housing and a strong national housing finance system by ensuring the safety and soundness of Fannie Mae and Freddie Mac.
OFHEO PROVIDES FLEXIBILITY ON FANNIE MAE, FREDDIE MAC MORTGAGE PORTFOLIOS
For Immediate Release September 19, 2007
OFHEO PROVIDES FLEXIBILITY ON FANNIE MAE, FREDDIE MAC MORTGAGE PORTFOLIOS
Washington, DC – OFHEO Director James B. Lockhart announced today that OFHEO is providing Fannie Mae and Freddie Mac with additional flexibility in managing their mortgage portfolios to comply with the portfolio caps agreed to last year.
“These changes will make it easier for the Enterprises to manage market-based fluctuations in their portfolios and reduce the need to keep large cushions below the portfolio caps,” said Lockhart. “It will also make it easier for OFHEO to monitor compliance with the portfolio caps. Both companies have indicated that this portfolio flexibility, combined with their securitization capabilities, asset sales, and the monthly runoff of their portfolios, should allow them to provide greater assistance to subprime borrowers and others who may have difficulty refinancing their existing mortgages in the current environment,” Lockhart said.
The temporary investment caps on their mortgage portfolios were established in May and July of last year because of both Enterprises’ operational, systems, financial reporting, risk management and internal control shortcomings. They have made progress in remediating some of these issues, including the publication by Fannie Mae of its 2006 financial statements and Freddie Mac of its second quarter 2007 financials, though neither was done in a timely fashion. Both companies have indicated they expect to produce audited, timely, annual financial statements for 2007 in February of 2008.
OFHEO has decided that it would not be prudent at this time to allow any major increases in the portfolio levels because the remediation process is not finished, many safety and soundness issues are not yet resolved, and the criteria in the Fannie Mae consent agreement and Freddie Mac’s voluntary agreement have not been met.
“Given our ongoing significant supervisory concerns, OFHEO will closely monitor the implementation of these portfolio cap flexibilities and will require the Enterprises to report regularly on the resulting changes and risks inherent in their portfolios,” Lockhart said.
With the ongoing concerns about the subprime mortgage market, both Fannie Mae and Freddie Mac have announced commitments to purchase tens of billions of dollars of subprime mortgages over the next several years. The portfolio cap flexibility plus their ongoing ability to securitize mortgages, sell assets, and replace maturing assets, will enhance each Enterprise’s ability to purchase or securitize, over the next six months up to $20 billion or more of subprime mortgages, refinanced mortgages for borrowers with lower credit scores, and affordable multi-family housing mortgages. These efforts should assist lenders in helping some subprime borrowers avoid foreclosure.
OFHEO expects Fannie Mae’s and Freddie Mac’s Chief Risk Officers and other senior executives to continue to closely monitor the Enterprises’ investment activities, as will OFHEO’s Office of Supervision, to ensure the activities meet sound credit underwriting and other safety and soundness standards. These standards include the recently implemented Interagency Guidance on Nontraditional Mortgage Product Risks and Statement on Subprime Mortgage Lending.
The specific flexibilities are as follows:
1. Change the portfolio measure from a GAAP number as reported on the balance sheet to Unpaid Principal Balance (UPB), which the Enterprises use in their publicly released monthly summaries. Under present market conditions, the GAAP value can fluctuate widely and we have concluded this adds unnecessary complexity for the Enterprises in managing to the portfolio cap. UPB, which reflects the original principal balance of mortgages and securities less repayments, is not subject to daily market fluctuations.
2. Set the new UPB portfolio cap at $735 billion on July 1, 2007 and apply it to the third quarter. On that date, the GAAP measured cap was $728.1 billion for Freddie Mac and $727.7 billion for Fannie Mae. (UPB often exceeds the GAAP value for the Enterprises. Due to market fluctuations over the first seven months of 2007, this difference has ranged from $0.1 billion to $9.4 billion.)
3. Allow Fannie Mae the same moderate increases that Freddie Mac has under its voluntary agreement of 2 percent annual growth and not more than 0.5 percent per quarter. This change for Fannie Mae would be effective Oct. 1, 2007, for the fourth quarter.
4. For the fourth quarter of 2007, the quarterly growth limit of 0.5 percent would be doubled to 1.0 percent, although the 2 percent per annum cap would remain in place.
5. The size of the portfolio used to determine compliance with the portfolio cap will no longer be the closing values at quarter end but rather an average of monthly closing values. The average will start at a specified amount in July 2007 and will build to a twelve-month moving average.
6. Frequent reporting on market conditions, portfolio sizes and new purchases will be required, including a monthly report on the Enterprises’ purchases of subprime and other mortgages to borrowers with lower credit scores and multi-family housing mortgages in relationship to the $20 billion level.
7. OFHEO examiners will ensure the Enterprises continue to have adequate capital to use this new flexibility and continue to adhere to their internal guidelines and limits on liquidity. OFHEO will also continue to monitor the increased credit and interest rate risk associated with current market conditions.
The combination of these changes should allow the Enterprises more flexibility in managing their portfolios and eliminate the need for a large cushion. This added flexibility will be especially helpful in making multi-billion dollar bulk purchases of subprime and multi-family housing mortgages and fulfilling the Enterprises’ commitments to purchase subprime mortgages to help borrowers avoid foreclosure and support affordable housing.
As OFHEO has repeatedly stated, the current portfolio limits are due to ongoing safety and soundness issues at each Enterprise. Some of these safety and soundness issues arose, in part, because of rapid portfolio growth in the past. Pending legislation would provide the Enterprises’ new regulator with clarified authorities and direction with respect to setting and enforcing portfolio size and growth as an ongoing matter, based upon their mission and safe and sound operations.
“OFHEO continues to believe that a more permanent solution to the portfolio limit question requires both congressional guidance and strengthened supervisory authorities,” said Lockhart.
###
OFHEO's mission is to promote housing and a strong national housing finance system by ensuring the safety and soundness of Fannie Mae and Freddie Mac.-->
Washington, DC – OFHEO Director James B. Lockhart announced today that OFHEO is providing Fannie Mae and Freddie Mac with additional flexibility in managing their mortgage portfolios to comply with the portfolio caps agreed to last year.
“These changes will make it easier for the Enterprises to manage market-based fluctuations in their portfolios and reduce the need to keep large cushions below the portfolio caps,” said Lockhart. “It will also make it easier for OFHEO to monitor compliance with the portfolio caps. Both companies have indicated that this portfolio flexibility, combined with their securitization capabilities, asset sales, and the monthly runoff of their portfolios, should allow them to provide greater assistance to subprime borrowers and others who may have difficulty refinancing their existing mortgages in the current environment,” Lockhart said.
The temporary investment caps on their mortgage portfolios were established in May and July of last year because of both Enterprises’ operational, systems, financial reporting, risk management and internal control shortcomings. They have made progress in remediating some of these issues, including the publication by Fannie Mae of its 2006 financial statements and Freddie Mac of its second quarter 2007 financials, though neither was done in a timely fashion. Both companies have indicated they expect to produce audited, timely, annual financial statements for 2007 in February of 2008.
OFHEO has decided that it would not be prudent at this time to allow any major increases in the portfolio levels because the remediation process is not finished, many safety and soundness issues are not yet resolved, and the criteria in the Fannie Mae consent agreement and Freddie Mac’s voluntary agreement have not been met.
“Given our ongoing significant supervisory concerns, OFHEO will closely monitor the implementation of these portfolio cap flexibilities and will require the Enterprises to report regularly on the resulting changes and risks inherent in their portfolios,” Lockhart said.
With the ongoing concerns about the subprime mortgage market, both Fannie Mae and Freddie Mac have announced commitments to purchase tens of billions of dollars of subprime mortgages over the next several years. The portfolio cap flexibility plus their ongoing ability to securitize mortgages, sell assets, and replace maturing assets, will enhance each Enterprise’s ability to purchase or securitize, over the next six months up to $20 billion or more of subprime mortgages, refinanced mortgages for borrowers with lower credit scores, and affordable multi-family housing mortgages. These efforts should assist lenders in helping some subprime borrowers avoid foreclosure.
OFHEO expects Fannie Mae’s and Freddie Mac’s Chief Risk Officers and other senior executives to continue to closely monitor the Enterprises’ investment activities, as will OFHEO’s Office of Supervision, to ensure the activities meet sound credit underwriting and other safety and soundness standards. These standards include the recently implemented Interagency Guidance on Nontraditional Mortgage Product Risks and Statement on Subprime Mortgage Lending.
The specific flexibilities are as follows:
1. Change the portfolio measure from a GAAP number as reported on the balance sheet to Unpaid Principal Balance (UPB), which the Enterprises use in their publicly released monthly summaries. Under present market conditions, the GAAP value can fluctuate widely and we have concluded this adds unnecessary complexity for the Enterprises in managing to the portfolio cap. UPB, which reflects the original principal balance of mortgages and securities less repayments, is not subject to daily market fluctuations.
2. Set the new UPB portfolio cap at $735 billion on July 1, 2007 and apply it to the third quarter. On that date, the GAAP measured cap was $728.1 billion for Freddie Mac and $727.7 billion for Fannie Mae. (UPB often exceeds the GAAP value for the Enterprises. Due to market fluctuations over the first seven months of 2007, this difference has ranged from $0.1 billion to $9.4 billion.)
3. Allow Fannie Mae the same moderate increases that Freddie Mac has under its voluntary agreement of 2 percent annual growth and not more than 0.5 percent per quarter. This change for Fannie Mae would be effective Oct. 1, 2007, for the fourth quarter.
4. For the fourth quarter of 2007, the quarterly growth limit of 0.5 percent would be doubled to 1.0 percent, although the 2 percent per annum cap would remain in place.
5. The size of the portfolio used to determine compliance with the portfolio cap will no longer be the closing values at quarter end but rather an average of monthly closing values. The average will start at a specified amount in July 2007 and will build to a twelve-month moving average.
6. Frequent reporting on market conditions, portfolio sizes and new purchases will be required, including a monthly report on the Enterprises’ purchases of subprime and other mortgages to borrowers with lower credit scores and multi-family housing mortgages in relationship to the $20 billion level.
7. OFHEO examiners will ensure the Enterprises continue to have adequate capital to use this new flexibility and continue to adhere to their internal guidelines and limits on liquidity. OFHEO will also continue to monitor the increased credit and interest rate risk associated with current market conditions.
The combination of these changes should allow the Enterprises more flexibility in managing their portfolios and eliminate the need for a large cushion. This added flexibility will be especially helpful in making multi-billion dollar bulk purchases of subprime and multi-family housing mortgages and fulfilling the Enterprises’ commitments to purchase subprime mortgages to help borrowers avoid foreclosure and support affordable housing.
As OFHEO has repeatedly stated, the current portfolio limits are due to ongoing safety and soundness issues at each Enterprise. Some of these safety and soundness issues arose, in part, because of rapid portfolio growth in the past. Pending legislation would provide the Enterprises’ new regulator with clarified authorities and direction with respect to setting and enforcing portfolio size and growth as an ongoing matter, based upon their mission and safe and sound operations.
“OFHEO continues to believe that a more permanent solution to the portfolio limit question requires both congressional guidance and strengthened supervisory authorities,” said Lockhart.
###
OFHEO's mission is to promote housing and a strong national housing finance system by ensuring the safety and soundness of Fannie Mae and Freddie Mac.-->
Housing Starts Fall to 12 Year Low in First Data to Show Impact of Subprime Fallout
Housing starts fell 2.6% MoM (-19.8% YoY) in August to a 12 year low of 1.33 million annualized. Building permits, an indication of future construction, fell an even larger -5.9% MoM, indicating that a recovery in the housing market is not imminent. In addition, the figures for housing starts and permits were revised lower in July, making the cumulative two month decline even steeper.
Single family home starts plunged -7.1% MoM (-27.6% YoY) to the lowest level since 1993. Conversely, multi-family starts, which include apartments, rose 13% MoM (+16.7% YoY). Homes remaining under construction fell -1.2% MoM (-15.8% YoY), and the number of houses completed during August fell -.2% MoM (-19.3% YoY).
Regionally, the Northeast saw the largest drop in starts, falling by 38% MoM, representing the largest monthly drop since 1990 when the area was last in a housing recession. The West also saw a large decline of -18% MoM. But, housing starts actually rose +11% MoM in the South and +4.2% in the Midwest.
Demand for new homes is likely to remain subdued as credit tightens and mortgage defaults for existing homes continues to rise. Builders remain pessimistic as the NAHB survey settles at record lows. GDP growth will be restricted by the continuing decline in home construction.
Last weekend's home sale by Hovnanian, with discounts of up to $100k on new homes, saw 1,700 new contracts signed and an additional 400 houses having deposits placed on them. The president of the company commented yesterday that he is seeing a "more rapid descent" in the housing market recently.
Single family home starts plunged -7.1% MoM (-27.6% YoY) to the lowest level since 1993. Conversely, multi-family starts, which include apartments, rose 13% MoM (+16.7% YoY). Homes remaining under construction fell -1.2% MoM (-15.8% YoY), and the number of houses completed during August fell -.2% MoM (-19.3% YoY).
Regionally, the Northeast saw the largest drop in starts, falling by 38% MoM, representing the largest monthly drop since 1990 when the area was last in a housing recession. The West also saw a large decline of -18% MoM. But, housing starts actually rose +11% MoM in the South and +4.2% in the Midwest.
Demand for new homes is likely to remain subdued as credit tightens and mortgage defaults for existing homes continues to rise. Builders remain pessimistic as the NAHB survey settles at record lows. GDP growth will be restricted by the continuing decline in home construction.
Last weekend's home sale by Hovnanian, with discounts of up to $100k on new homes, saw 1,700 new contracts signed and an additional 400 houses having deposits placed on them. The president of the company commented yesterday that he is seeing a "more rapid descent" in the housing market recently.
CPI Inflation Fell in August
As expected, lower gas prices in August helped keep inflation growth subdued. Total CPI actually declined -.1% MoM in August and fell to +2% YoY from +2.4% in July. This was the first monthly decline in CPI this year. Core CPI, which excludes food and energy costs, rose +.2% MoM, as expected, but fell a tenth to +2.1% YoY(consensus +2.2%).
Energy prices fell -3.2% MoM in August (-2.5% YoY), the largest decline since last October, and gasoline prices fell an even larger -4.9% MoM (-6.4% YoY). Food prices continue to trend higher, rising +.4% MoM (+4.2% YoY). Medical care costs continue to rise faster than the general inflation rate, rising +.5% MoM (+4.5% YoY). Clothing prices gave up last months gain, falling -.5% MoM after rising +.4% MoM in July. Auto prices rose +.1% MoM, while all vehicle costs rose +.3% MoM (-1.4% YoY). Personal computers remain the deflationary winner, falling -10.2% YoY. Approximately 60% of the CPI covers services.
General housing inflation was unchanged in August, but owners' equivalent rent continued to grow at +.2% MoM (+3% YoY), its pace for the past few months.
The Fed remains concerned about inflation, even as headline CPI has eased in the past few months, because of the weakening dollar and rising commodity prices,
as evidenced by the record high prices for wheat, oil, and gold this month.
Energy prices fell -3.2% MoM in August (-2.5% YoY), the largest decline since last October, and gasoline prices fell an even larger -4.9% MoM (-6.4% YoY). Food prices continue to trend higher, rising +.4% MoM (+4.2% YoY). Medical care costs continue to rise faster than the general inflation rate, rising +.5% MoM (+4.5% YoY). Clothing prices gave up last months gain, falling -.5% MoM after rising +.4% MoM in July. Auto prices rose +.1% MoM, while all vehicle costs rose +.3% MoM (-1.4% YoY). Personal computers remain the deflationary winner, falling -10.2% YoY. Approximately 60% of the CPI covers services.
General housing inflation was unchanged in August, but owners' equivalent rent continued to grow at +.2% MoM (+3% YoY), its pace for the past few months.
The Fed remains concerned about inflation, even as headline CPI has eased in the past few months, because of the weakening dollar and rising commodity prices,
as evidenced by the record high prices for wheat, oil, and gold this month.
Tuesday, September 18, 2007
Today's Tidbits
Comments on FOMC 50 Basis Point Rate Cut
From Goldman Sachs: “FOMC chooses aggressive option on funds rate, emphasizing risks to growth, cutting it by 50 basis points (bp); discount rate also cut 50 bp (i.e., no further narrowing of penalty); statement emphasizes uncertainty on the outlook and keeping options open.”
From CITI: “The half point cuts in the funds rate and discount rate confirm that the
Committee's sense of risks to the outlook are in line with the dramatic change in investor perceptions of the past two months. The action is is also consistent with our assessments and as a result does not change our view that modest additional easing is likely, entailing another quarter point move before yearend. The Committee departed from its usual balance of risk judgment and therefore doesn't provide too much guidance about the likely outcome of the October meeting. Nonetheless, it's important to note the tone of the discussion of the risks to growth suggests that is the greater concern. We suspect consensus may have been achieved by shifting the focus of "monitoring" to inflation developments, recognizing that recent favorable trends may still not foretell a sustained easing of price pressures. The Committee's focus on financial developments in the final paragraph is a signal that further easing like this initial move may not necessarily be data dependent but could be triggered by additional signs that financial conditions are tightening. The initial response in markets hints that they have bought themselves some time and may be closing off some of the more aggressive rate cutting expectations by being preemptive here at the outset.”
From Wachovia: “Two and done?”
From FTN: “Looking ahead, the FOMC clearly wants to keep all options open. If calm returns in the credit markets, the Fed will likely raise rates. But if turmoil persists or the economy continues to deteriorate, they may cut further. We can’t remember the last time the Fed had both an easing and a tightening bias in place, but the Committee clearly feels it has insufficient information to commit to any course of action today.”
From Lehman: “The FOMC makes it sound like "one and done" as it cuts both the Fed funds and discount rate by 50 basis points but continues to note inflation risks. The statement noted that the "Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully." The "bias paragraph" (paragraph 4) suggests a balanced statement with the Fed noting that it will "assess the effects of these and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth." As of this writing, we no longer look for the Fed to cut rates in October but that position, like the Fed's, remains data dependent.”
From Morgan Stanley: “We suspect that the references to inflation concerns in today’s statement may have been necessary to achieve a unanimous vote. We did not anticipate that there would be any dissents to a 25 bp move, but are a bit surprised that no dissenting votes were cast on the 50 bp outcome.”
From Credit Suisse: “Transparency is difficult to sustain when you are in significant doubt about what the future will bring or what you will do about it. The honest and forthcoming statement is "I don’t know." And that’s what the FOMC said today. Their statement highlights the "uncertainty surrounding the economic outlook."”
From Dow Jones: “U.S. interest rate futures prices soared Tuesday afternoon, reflecting increased expectations for the Federal Reserve to implement further cuts to its benchmark rate later this year…”
From RBSGC: “The Fed opted for the dramatic gesture today, cutting both the fed funds and discount rates by 50 BPs. We are very surprised, but we view this as a valuable data point on the Bernanke Fed's reaction function. For all of the talk of Bernanke being less inclined to respond to financial market difficulties than Greenspan, the reality is that this Fed has been very aggressive -- cutting the discount rate by 50 BP in August along with a number of administrative moves aimed at promoting liquidity, and giving the markets more than they expected on the funds rate today. If Greenspan's modus operandi was gradualism, then Bernanke's may be "a stitch in time saves nine." The key question is whether the Fed eased by 50 BP rather than 25 BP because 1) they wanted to get ahead of the curve and frontload whatever they were going to do (in which case, there may be less rate cutting going forward) or 2) they are more worried about the economy than they had let on (in which case, there may be more rate cutting going forward). This is the critical question for the outlook, and policymakers very skillfully kept their opinions to themselves. If the FOMC had wanted to send a signal either way, it would have been easy enough in the statement. Instead, the Fed failed to lean in either direction. I think this is a very shrewd and very intentional strategy. The Fed has just as much uncertainty as the rest of us, and officials did not want to lock in a forecast (I can certainly identify with that!) or to artificially govern market expectations (they probably view market expectations as a valuable read on the outlook and did not want to taint that signal).
If the Fed had hoped to ease by 50 BP today and be done, then the statement could have suggested something along the lines that "today's action should help to counteract the tightening of credit conditions" or to suggest that "the FOMC expects the economy to grow at a moderate pace in light of today's action." Instead, the FOMC said that the action was "intended to help forestall some of the adverse effects on the broader economy...and to promote moderate growth over time." What I find most interesting here is that there is no presumption of success. They tell us their intention, but there is no assertion that they think they will be successful. The other thing from the statement that, in my mind, points to the Fed being open to further easing is the wording of the forward-looking paragraph. Again, no sense of confidence from policymakers that they have their hands around the dimensions of the situation. Instead, the statement merely notes that "the Committee will continue to assess the effects of these and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth." That's a pretty open-ended promise that sounds like something that would come in the midst of financial market difficulties, not at the tail end of a crisis. So, despite the improving tone in recent days, the Fed does not presume that financial markets are out or nearly out of the woods yet.”
Fed’s Discount Rate is a Penalty Rate for Bank’s “Last Resort” Borrowing
From the Wall Street Journal: “Normally, banks pay a "penalty" to borrow from the Fed's discount window of one percentage point over the target for the federal-funds rate, at which banks lend to one another in a market heavily influenced by the Fed. Banks seldom borrow at the discount window because they can borrow federal funds more cheaply. The direct loans also have carried a stigma because they were often a last resort for troubled banks. On Aug. 17, in a bid to improve the flow of cash to clogged credit markets, the Fed cut the discount rate to 5.75%, a penalty of half a percentage point above the 5.25% federal-funds target. It also extended the term of such loans to as long as 30 days from one day, and declared that using them would be regarded as a sign of strength, not weakness. Its hope was that banks would use discount loans, or the knowledge that they were available, to finance customer holdings of hard-to-sell securities such as asset-backed commercial paper and jumbo mortgages. Many on Wall Street feel the Fed has yet to make the discount window attractive. The actual penalty, they note, is larger than the normal half point because the Fed has allowed the federal-funds rate to fall to 5%, a quarter point below its target. Many market participants recommend that the Fed cut the discount rate so it sits just a quarter point above the fed-funds rate or even matches it…Wall Street officials say they are still reluctant to borrow at the discount window because, if their identity became known, it could make counterparties skittish or hurt share prices. If the penalty were cut or eliminated, they say, banks could argue they were using the window because it was profitable…Officials also worry that cutting the discount rate too much would prompt many banks to fund all of their needs from the window instead of the money market. That could make it harder for the Fed to manage the fed-funds rate with open-market operations.”
Mortgage Defaults Double Over Past Year
From CNN: “The number of homes in some stage of default jumped 36 percent month-over-month in August, according to a regular monthly survey. Delinquencies and defaults more than doubled year over year to 243,947, according to August figures released Tuesday by RealtyTrac, a marketer of foreclosed properties…The jump in foreclosure filings this month might be the beginning of the next wave of increased foreclosure activity, as a large number of subprime adjustable rate loans are beginning to reset now," James Saccacio, chief executive of RealtyTrac, said in a statement. October is expected to be a peak month for hybrid adjustable rate mortgages (ARMs) to reset, with the interest rates on some $50 billion worth of loans poised to go up dramatically. In the past few months, the foreclosure story has become a tale of two regions. Some of the hardest hit states have traditionally been in the Midwest, where plant closings and job losses have hit the economy there hard. The other region is the Sun Belt, which is showing even more significant foreclosure growth as out-sized price increases in the first half of the decade led to virtually unchecked real estate speculation. Nevada led all the other states in the rate of August foreclosure filings: one for every 165 households for a total of 6,197. Other hard-hit, sun-belt states were California (one in 224), Florida (one in 243), Georgia (one in 271), Arizona (one in 289), Colorado (one in 312) and Texas (one in 532). Rust-belt states in the top 10 included Ohio (one in 281), Michigan (one in 288) and Indiana (one in 544). California placed six cities among the top 10 metro areas for the number of filings. Modesto led the way with one of every 79 households. Stockton, Merced, Vallejo-Fairfield, Riverside-San Bernardino and Sacramento also hit the top 10. Detroit, Cleveland, Ft. Lauderdale and Las Vegas rounded out the list of worst hit metro areas. California, by far the most populous state, also led the nation in the actual number of foreclosures. Some 57,975 households were in some stage of default during the month. Florida was next with 33,932 and Ohio, with 17,793, was third…When borrowers can't catch up on their mortgages, their homes are often sold before the actual foreclosure takes place. Even if they go on to the next step in the process - auction - they may not draw higher enough bids for lenders to accept the sales. In that event, they return to the banks as REO properties.”
Too Much Leverage Hurts Housing More Than ARM Resets as Prices Fall
From Barclays: “The worst-performing mortgages are those that were made in 2006 – their delinquency rates are very high and quite worrying. Yet, the vast majority of these loans have not yet reset. In other words, their credit performance is poor for other reasons… Leverage, not ARM resets, is the real problem with US housing. Many borrowers were allowed to take on too much leverage in the lax lending standards of 2005/06… The keen-eyed reader will also notice that loans made in 2005 and 2006 had roughly the same leverage. 40-45% of Alt-A first lien mortgages made in both years had second liens. Then why are 2006 loans doing so much less poorly than 2005 loans? The reason is that home prices were rising far more in 2005 than in 2006… It is possible that ARM resets could add to the pain being felt by mortgage borrowers. By our estimates, the payment shock due to mortgage resets is only about $25bn annually, and that is for all ARMs resetting, not just subprime. Subprime borrowers will foot $15bn of this $25bn. If that is the main problem, it is an easy one to solve. As a client of ours recently suggested, the government could simply subsidize the $15bn and help subprime borrowers; it seems a small price to pay for the health of the $10trn mortgage market.”
MISC
From Bloomberg: “Crude oil climbed to a record $81.90 a barrel in New York after the Federal Reserve reduced U.S. interest rates by more than expected… ``Lower interest rates are bullish for oil because they boost economic growth and energy demand, always have and always will,'' … ``It should also put pressure on the U.S. dollar. The dollar price of oil will to have to rise to keep the same value in other currencies.''…the highest since [futures] trading began in 1983. Prices are up 28 percent from a year ago.”
From FTN: “NAHB Housing Market Index continues to plummet, falling to 20 in September, matching the lowest level in the history of the index. Since 1985 it has touched 20 only once, in January 1991. The NAHB has fallen more than 50 points from its June 2005 peak. The survey has three components: Sales conditions, both present and future, fell in September, with prospective buyers’ traffic unchanged from August at 16. The survey is reported as a diffusion index measuring homebuilders’ assessments of market conditions for home sales. Looking at the trend, the question now is whether the index will continue lower or begin to consolidate near the record low. Right now, homebuilders’ confidence in a market recovery continues to deteriorate.”
From JP Morgan: “Compared to August, builders downgraded their assessments of present and future sales, but said buyer traffic held steady. The findings are consistent with the view that the tightening of credit terms and availability is producing further weakness in sales.”
From Lehman: “The Fed’s flow of funds report for the second quarter provides evidence of a substantial shift underway in borrowing patterns even before the latest blow-up in credit markets. Corporate sector borrowing continues to pick up, with borrowing requirements now at 1.7% of GDP. The profligate household sector maintained a steady pace of debt accumulation, while the federal government actually paid down debt in the second quarter. Third-quarter data are likely to show a sharp deceleration in borrowing as tighter credit standards took hold. Mortgage borrowing looks poised for an especially heavy hit, and as a result we have revised down our forecasts for mortgage equity withdrawal (MEW). We now expect total MEW to fall to just over $200 billion in 2008, from our previous forecast of roughly $300 billion and a 2006 level of $830 billion.”
From Dow Jones: “[Washington Mutual (Wamu)] … is unlikely to face the same kind of dire, life threatening problems as those its competitor Countrywide Financial Corp. CFC) battled recently. That is mainly because Washington Mutual, with more than 2,000 retail branches, has a much larger deposit base than Countrywide, meaning it is less dependent on short-term debt markets to raise financing for its operations. Also, because Washington Mutual originates its loans as thrift, it has much broader access to funds from the Federal Home Loan Bank.”
From CSFB: “…prices of manufacturing goods imported from EM countries ran at -6% yoy during 1998 easing, -2.1% during 2001/2002, but have risen +2.4% over the past year.”
From MNI: “China may impose more restrictions on mortgage lending as the industry grows rapidly, Lehman Brothers said. China's mortgage loans as a share of total loans outstanding have risen sharply to 9.4 pct in 2006 from 0.2 pct in 1997, and as a share of urban household income to 31 pct in 2006 from 0.6 pct in 1997.”
From MNI: “ China will require 3,400 new airplanes worth about 340 bln usd over the next 20 years, according to an updated annual forecast by Boeing. Boeing had previously forecast that China would need 2,900 new aircraft over the next two decades. “
End-of-Day Market Update
From UBS: “After the larger than expected cut, short-end yields immediately plunged, while 30-year yields spiked about 8bps. 10-year yields showed confusion at first as they plummeted, then shot upwards, then proceeded to solidify not too far from pre-Fed levels. On the day, the 2s10s curve steepened 9.5bps, and 2s30s is nearly 14bps steeper. In T-bills, 3-month paper rallied 13.5bps, while the 6-month bill richened 20bps. TIPS saw breakevens explode after the Fed announcement, going from narrower on the day to 4-5bps wider across the board… swap spreads ended the day significantly tighter across the board. Mortgages were trading about 2 ticks tighter to swaps early in the day on light flows, but screamed tighter post-Fed. On the day, the FNMA 5's and 5.5's tightened 6-7 ticks versus swaps and 10-13 to Treasuries, while the 6's and 6.5's tightened 3-4 ticks to swaps and 6-8 versus Treasuries. Agencies saw better buying across the curve pre-Fed, trading mixed to swaps and 4-5bps tighter to Treasuries.”
From Bloomberg: “U.S. stocks rallied the most in four years after the Federal Reserve cut its benchmark lending rate by half a percentage point to keep credit-market losses and the real estate slump from dragging down the economy… ``The markets were concerned that the risk of recession had increased, and these aggressive moves have reduced those risks.''… in the Standard & Poor's 500 Index. Consumer shares climbed the most since 2003… Four-hundred ninety stocks in the index gained the broadest advance since at least 1996. The S&P 500 climbed 43.13, or 2.9 percent, to 1,519.78. The Dow Jones Industrial Average advanced 335.97, or 2.5 percent, to 13,739.39. The Nasdaq Composite Index increased 70, or 2.7 percent, to 2,651.66.”
From Bloomberg: “The dollar fell to a record low against the euro… The Dollar Index against six other major currencies sank to the lowest since September 1992… The U.S. currency also fell to a 30-year low of 98.74 U.S. cents per Canadian dollar. The dollar has lost 5.5 percent this year versus the euro… The yen fell 1 percent to 116.21 per dollar and 1.7 percent to 162.36 per euro on speculation the rate cut will encourage investors to borrow in yen to finance a risky strategy known as the carry trade. In a sign investors added to risky wagers, U.S. stocks soared… ``Growth and interest-rate differentials are both turning against the dollar,''…”[Gold up $5.50]
Oil is finishing at the high of the day, and at another record all-time high of $82.38, up $1.81.
From Goldman Sachs: “FOMC chooses aggressive option on funds rate, emphasizing risks to growth, cutting it by 50 basis points (bp); discount rate also cut 50 bp (i.e., no further narrowing of penalty); statement emphasizes uncertainty on the outlook and keeping options open.”
From CITI: “The half point cuts in the funds rate and discount rate confirm that the
Committee's sense of risks to the outlook are in line with the dramatic change in investor perceptions of the past two months. The action is is also consistent with our assessments and as a result does not change our view that modest additional easing is likely, entailing another quarter point move before yearend. The Committee departed from its usual balance of risk judgment and therefore doesn't provide too much guidance about the likely outcome of the October meeting. Nonetheless, it's important to note the tone of the discussion of the risks to growth suggests that is the greater concern. We suspect consensus may have been achieved by shifting the focus of "monitoring" to inflation developments, recognizing that recent favorable trends may still not foretell a sustained easing of price pressures. The Committee's focus on financial developments in the final paragraph is a signal that further easing like this initial move may not necessarily be data dependent but could be triggered by additional signs that financial conditions are tightening. The initial response in markets hints that they have bought themselves some time and may be closing off some of the more aggressive rate cutting expectations by being preemptive here at the outset.”
From Wachovia: “Two and done?”
From FTN: “Looking ahead, the FOMC clearly wants to keep all options open. If calm returns in the credit markets, the Fed will likely raise rates. But if turmoil persists or the economy continues to deteriorate, they may cut further. We can’t remember the last time the Fed had both an easing and a tightening bias in place, but the Committee clearly feels it has insufficient information to commit to any course of action today.”
From Lehman: “The FOMC makes it sound like "one and done" as it cuts both the Fed funds and discount rate by 50 basis points but continues to note inflation risks. The statement noted that the "Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully." The "bias paragraph" (paragraph 4) suggests a balanced statement with the Fed noting that it will "assess the effects of these and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth." As of this writing, we no longer look for the Fed to cut rates in October but that position, like the Fed's, remains data dependent.”
From Morgan Stanley: “We suspect that the references to inflation concerns in today’s statement may have been necessary to achieve a unanimous vote. We did not anticipate that there would be any dissents to a 25 bp move, but are a bit surprised that no dissenting votes were cast on the 50 bp outcome.”
From Credit Suisse: “Transparency is difficult to sustain when you are in significant doubt about what the future will bring or what you will do about it. The honest and forthcoming statement is "I don’t know." And that’s what the FOMC said today. Their statement highlights the "uncertainty surrounding the economic outlook."”
From Dow Jones: “U.S. interest rate futures prices soared Tuesday afternoon, reflecting increased expectations for the Federal Reserve to implement further cuts to its benchmark rate later this year…”
From RBSGC: “The Fed opted for the dramatic gesture today, cutting both the fed funds and discount rates by 50 BPs. We are very surprised, but we view this as a valuable data point on the Bernanke Fed's reaction function. For all of the talk of Bernanke being less inclined to respond to financial market difficulties than Greenspan, the reality is that this Fed has been very aggressive -- cutting the discount rate by 50 BP in August along with a number of administrative moves aimed at promoting liquidity, and giving the markets more than they expected on the funds rate today. If Greenspan's modus operandi was gradualism, then Bernanke's may be "a stitch in time saves nine." The key question is whether the Fed eased by 50 BP rather than 25 BP because 1) they wanted to get ahead of the curve and frontload whatever they were going to do (in which case, there may be less rate cutting going forward) or 2) they are more worried about the economy than they had let on (in which case, there may be more rate cutting going forward). This is the critical question for the outlook, and policymakers very skillfully kept their opinions to themselves. If the FOMC had wanted to send a signal either way, it would have been easy enough in the statement. Instead, the Fed failed to lean in either direction. I think this is a very shrewd and very intentional strategy. The Fed has just as much uncertainty as the rest of us, and officials did not want to lock in a forecast (I can certainly identify with that!) or to artificially govern market expectations (they probably view market expectations as a valuable read on the outlook and did not want to taint that signal).
If the Fed had hoped to ease by 50 BP today and be done, then the statement could have suggested something along the lines that "today's action should help to counteract the tightening of credit conditions" or to suggest that "the FOMC expects the economy to grow at a moderate pace in light of today's action." Instead, the FOMC said that the action was "intended to help forestall some of the adverse effects on the broader economy...and to promote moderate growth over time." What I find most interesting here is that there is no presumption of success. They tell us their intention, but there is no assertion that they think they will be successful. The other thing from the statement that, in my mind, points to the Fed being open to further easing is the wording of the forward-looking paragraph. Again, no sense of confidence from policymakers that they have their hands around the dimensions of the situation. Instead, the statement merely notes that "the Committee will continue to assess the effects of these and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth." That's a pretty open-ended promise that sounds like something that would come in the midst of financial market difficulties, not at the tail end of a crisis. So, despite the improving tone in recent days, the Fed does not presume that financial markets are out or nearly out of the woods yet.”
Fed’s Discount Rate is a Penalty Rate for Bank’s “Last Resort” Borrowing
From the Wall Street Journal: “Normally, banks pay a "penalty" to borrow from the Fed's discount window of one percentage point over the target for the federal-funds rate, at which banks lend to one another in a market heavily influenced by the Fed. Banks seldom borrow at the discount window because they can borrow federal funds more cheaply. The direct loans also have carried a stigma because they were often a last resort for troubled banks. On Aug. 17, in a bid to improve the flow of cash to clogged credit markets, the Fed cut the discount rate to 5.75%, a penalty of half a percentage point above the 5.25% federal-funds target. It also extended the term of such loans to as long as 30 days from one day, and declared that using them would be regarded as a sign of strength, not weakness. Its hope was that banks would use discount loans, or the knowledge that they were available, to finance customer holdings of hard-to-sell securities such as asset-backed commercial paper and jumbo mortgages. Many on Wall Street feel the Fed has yet to make the discount window attractive. The actual penalty, they note, is larger than the normal half point because the Fed has allowed the federal-funds rate to fall to 5%, a quarter point below its target. Many market participants recommend that the Fed cut the discount rate so it sits just a quarter point above the fed-funds rate or even matches it…Wall Street officials say they are still reluctant to borrow at the discount window because, if their identity became known, it could make counterparties skittish or hurt share prices. If the penalty were cut or eliminated, they say, banks could argue they were using the window because it was profitable…Officials also worry that cutting the discount rate too much would prompt many banks to fund all of their needs from the window instead of the money market. That could make it harder for the Fed to manage the fed-funds rate with open-market operations.”
Mortgage Defaults Double Over Past Year
From CNN: “The number of homes in some stage of default jumped 36 percent month-over-month in August, according to a regular monthly survey. Delinquencies and defaults more than doubled year over year to 243,947, according to August figures released Tuesday by RealtyTrac, a marketer of foreclosed properties…The jump in foreclosure filings this month might be the beginning of the next wave of increased foreclosure activity, as a large number of subprime adjustable rate loans are beginning to reset now," James Saccacio, chief executive of RealtyTrac, said in a statement. October is expected to be a peak month for hybrid adjustable rate mortgages (ARMs) to reset, with the interest rates on some $50 billion worth of loans poised to go up dramatically. In the past few months, the foreclosure story has become a tale of two regions. Some of the hardest hit states have traditionally been in the Midwest, where plant closings and job losses have hit the economy there hard. The other region is the Sun Belt, which is showing even more significant foreclosure growth as out-sized price increases in the first half of the decade led to virtually unchecked real estate speculation. Nevada led all the other states in the rate of August foreclosure filings: one for every 165 households for a total of 6,197. Other hard-hit, sun-belt states were California (one in 224), Florida (one in 243), Georgia (one in 271), Arizona (one in 289), Colorado (one in 312) and Texas (one in 532). Rust-belt states in the top 10 included Ohio (one in 281), Michigan (one in 288) and Indiana (one in 544). California placed six cities among the top 10 metro areas for the number of filings. Modesto led the way with one of every 79 households. Stockton, Merced, Vallejo-Fairfield, Riverside-San Bernardino and Sacramento also hit the top 10. Detroit, Cleveland, Ft. Lauderdale and Las Vegas rounded out the list of worst hit metro areas. California, by far the most populous state, also led the nation in the actual number of foreclosures. Some 57,975 households were in some stage of default during the month. Florida was next with 33,932 and Ohio, with 17,793, was third…When borrowers can't catch up on their mortgages, their homes are often sold before the actual foreclosure takes place. Even if they go on to the next step in the process - auction - they may not draw higher enough bids for lenders to accept the sales. In that event, they return to the banks as REO properties.”
Too Much Leverage Hurts Housing More Than ARM Resets as Prices Fall
From Barclays: “The worst-performing mortgages are those that were made in 2006 – their delinquency rates are very high and quite worrying. Yet, the vast majority of these loans have not yet reset. In other words, their credit performance is poor for other reasons… Leverage, not ARM resets, is the real problem with US housing. Many borrowers were allowed to take on too much leverage in the lax lending standards of 2005/06… The keen-eyed reader will also notice that loans made in 2005 and 2006 had roughly the same leverage. 40-45% of Alt-A first lien mortgages made in both years had second liens. Then why are 2006 loans doing so much less poorly than 2005 loans? The reason is that home prices were rising far more in 2005 than in 2006… It is possible that ARM resets could add to the pain being felt by mortgage borrowers. By our estimates, the payment shock due to mortgage resets is only about $25bn annually, and that is for all ARMs resetting, not just subprime. Subprime borrowers will foot $15bn of this $25bn. If that is the main problem, it is an easy one to solve. As a client of ours recently suggested, the government could simply subsidize the $15bn and help subprime borrowers; it seems a small price to pay for the health of the $10trn mortgage market.”
MISC
From Bloomberg: “Crude oil climbed to a record $81.90 a barrel in New York after the Federal Reserve reduced U.S. interest rates by more than expected… ``Lower interest rates are bullish for oil because they boost economic growth and energy demand, always have and always will,'' … ``It should also put pressure on the U.S. dollar. The dollar price of oil will to have to rise to keep the same value in other currencies.''…the highest since [futures] trading began in 1983. Prices are up 28 percent from a year ago.”
From FTN: “NAHB Housing Market Index continues to plummet, falling to 20 in September, matching the lowest level in the history of the index. Since 1985 it has touched 20 only once, in January 1991. The NAHB has fallen more than 50 points from its June 2005 peak. The survey has three components: Sales conditions, both present and future, fell in September, with prospective buyers’ traffic unchanged from August at 16. The survey is reported as a diffusion index measuring homebuilders’ assessments of market conditions for home sales. Looking at the trend, the question now is whether the index will continue lower or begin to consolidate near the record low. Right now, homebuilders’ confidence in a market recovery continues to deteriorate.”
From JP Morgan: “Compared to August, builders downgraded their assessments of present and future sales, but said buyer traffic held steady. The findings are consistent with the view that the tightening of credit terms and availability is producing further weakness in sales.”
From Lehman: “The Fed’s flow of funds report for the second quarter provides evidence of a substantial shift underway in borrowing patterns even before the latest blow-up in credit markets. Corporate sector borrowing continues to pick up, with borrowing requirements now at 1.7% of GDP. The profligate household sector maintained a steady pace of debt accumulation, while the federal government actually paid down debt in the second quarter. Third-quarter data are likely to show a sharp deceleration in borrowing as tighter credit standards took hold. Mortgage borrowing looks poised for an especially heavy hit, and as a result we have revised down our forecasts for mortgage equity withdrawal (MEW). We now expect total MEW to fall to just over $200 billion in 2008, from our previous forecast of roughly $300 billion and a 2006 level of $830 billion.”
From Dow Jones: “[Washington Mutual (Wamu)] … is unlikely to face the same kind of dire, life threatening problems as those its competitor Countrywide Financial Corp. CFC) battled recently. That is mainly because Washington Mutual, with more than 2,000 retail branches, has a much larger deposit base than Countrywide, meaning it is less dependent on short-term debt markets to raise financing for its operations. Also, because Washington Mutual originates its loans as thrift, it has much broader access to funds from the Federal Home Loan Bank.”
From CSFB: “…prices of manufacturing goods imported from EM countries ran at -6% yoy during 1998 easing, -2.1% during 2001/2002, but have risen +2.4% over the past year.”
From MNI: “China may impose more restrictions on mortgage lending as the industry grows rapidly, Lehman Brothers said. China's mortgage loans as a share of total loans outstanding have risen sharply to 9.4 pct in 2006 from 0.2 pct in 1997, and as a share of urban household income to 31 pct in 2006 from 0.6 pct in 1997.”
From MNI: “ China will require 3,400 new airplanes worth about 340 bln usd over the next 20 years, according to an updated annual forecast by Boeing. Boeing had previously forecast that China would need 2,900 new aircraft over the next two decades. “
End-of-Day Market Update
From UBS: “After the larger than expected cut, short-end yields immediately plunged, while 30-year yields spiked about 8bps. 10-year yields showed confusion at first as they plummeted, then shot upwards, then proceeded to solidify not too far from pre-Fed levels. On the day, the 2s10s curve steepened 9.5bps, and 2s30s is nearly 14bps steeper. In T-bills, 3-month paper rallied 13.5bps, while the 6-month bill richened 20bps. TIPS saw breakevens explode after the Fed announcement, going from narrower on the day to 4-5bps wider across the board… swap spreads ended the day significantly tighter across the board. Mortgages were trading about 2 ticks tighter to swaps early in the day on light flows, but screamed tighter post-Fed. On the day, the FNMA 5's and 5.5's tightened 6-7 ticks versus swaps and 10-13 to Treasuries, while the 6's and 6.5's tightened 3-4 ticks to swaps and 6-8 versus Treasuries. Agencies saw better buying across the curve pre-Fed, trading mixed to swaps and 4-5bps tighter to Treasuries.”
From Bloomberg: “U.S. stocks rallied the most in four years after the Federal Reserve cut its benchmark lending rate by half a percentage point to keep credit-market losses and the real estate slump from dragging down the economy… ``The markets were concerned that the risk of recession had increased, and these aggressive moves have reduced those risks.''… in the Standard & Poor's 500 Index. Consumer shares climbed the most since 2003… Four-hundred ninety stocks in the index gained the broadest advance since at least 1996. The S&P 500 climbed 43.13, or 2.9 percent, to 1,519.78. The Dow Jones Industrial Average advanced 335.97, or 2.5 percent, to 13,739.39. The Nasdaq Composite Index increased 70, or 2.7 percent, to 2,651.66.”
From Bloomberg: “The dollar fell to a record low against the euro… The Dollar Index against six other major currencies sank to the lowest since September 1992… The U.S. currency also fell to a 30-year low of 98.74 U.S. cents per Canadian dollar. The dollar has lost 5.5 percent this year versus the euro… The yen fell 1 percent to 116.21 per dollar and 1.7 percent to 162.36 per euro on speculation the rate cut will encourage investors to borrow in yen to finance a risky strategy known as the carry trade. In a sign investors added to risky wagers, U.S. stocks soared… ``Growth and interest-rate differentials are both turning against the dollar,''…”[Gold up $5.50]
Oil is finishing at the high of the day, and at another record all-time high of $82.38, up $1.81.
Fed Cuts Rates 50bp
They Did It!!!
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U.S. Federal Open Market Committee Statement: Text2007-09-18 14:15 (New York)
Sept. 18 (Bloomberg) -- The following is the full text ofthe statement released today by the Federal Reserve:
The Federal Open Market Committee decided today to lowerits target for the federal funds rate 50 basis points to 4 3/4percent.
Economic growth was moderate during the first half of theyear, but the tightening of credit conditions has the potentialto intensify the housing correction and to restrain economicgrowth more generally. Today's action is intended to helpforestall some of the adverse effects on the broader economythat might otherwise arise from the disruptions in financialmarkets and to promote moderate growth over time.
Readings on core inflation have improved modestly thisyear. However, the Committee judges that some inflation risksremain, and it will continue to monitor inflation developmentscarefully.
Developments in financial markets since the Committee'slast regular meeting have increased the uncertainty surroundingthe economic outlook. The Committee will continue to assess theeffects of these and other developments on economic prospectsand will act as needed to foster price stability andsustainable economic growth.
Voting for the FOMC monetary policy action were: Ben S.Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; ThomasM. Hoenig; Donald L. Kohn; Randall S. Kroszner; Frederic S.Mishkin; Charles L. Evans; William Poole; Eric S. Rosengren;and Kevin M. Warsh.
In a related action, the Board of Governors unanimouslyapproved a 50 basis point decrease in the discount rate to 51/4 percent. In taking this action, the Board approved therequests submitted by the Boards of Directors of the FederalReserve banks of Boston, New York, Cleveland, St. Louis,Minneapolis, Kansas City and San Francisco.
--Washington newsroom +1-202-624-1820
[TAGINFO]NI FED
----------------
U.S. Federal Open Market Committee Statement: Text2007-09-18 14:15 (New York)
Sept. 18 (Bloomberg) -- The following is the full text ofthe statement released today by the Federal Reserve:
The Federal Open Market Committee decided today to lowerits target for the federal funds rate 50 basis points to 4 3/4percent.
Economic growth was moderate during the first half of theyear, but the tightening of credit conditions has the potentialto intensify the housing correction and to restrain economicgrowth more generally. Today's action is intended to helpforestall some of the adverse effects on the broader economythat might otherwise arise from the disruptions in financialmarkets and to promote moderate growth over time.
Readings on core inflation have improved modestly thisyear. However, the Committee judges that some inflation risksremain, and it will continue to monitor inflation developmentscarefully.
Developments in financial markets since the Committee'slast regular meeting have increased the uncertainty surroundingthe economic outlook. The Committee will continue to assess theeffects of these and other developments on economic prospectsand will act as needed to foster price stability andsustainable economic growth.
Voting for the FOMC monetary policy action were: Ben S.Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; ThomasM. Hoenig; Donald L. Kohn; Randall S. Kroszner; Frederic S.Mishkin; Charles L. Evans; William Poole; Eric S. Rosengren;and Kevin M. Warsh.
In a related action, the Board of Governors unanimouslyapproved a 50 basis point decrease in the discount rate to 51/4 percent. In taking this action, the Board approved therequests submitted by the Boards of Directors of the FederalReserve banks of Boston, New York, Cleveland, St. Louis,Minneapolis, Kansas City and San Francisco.
--Washington newsroom +1-202-624-1820
[TAGINFO]NI FED
Producer Price Inflation Falls Dramatically in August, But Core Holds Steady
Total producer prices fell much more than expected in August, declining -1.4% MoM (consensus -.3%) and falling to +2.2% YoY (consensus +3.2%), and down substantially from the +4% YoY change in July. This was the largest monthly decline in headline inflation in almost a year. On the other hand, core inflation, which excludes food and energy costs, grew +.2% MoM (consensus +.1%) and only declined modestly, and as expected, to +2.2% YoY from +2.3% YoY in July. Today's data moves headline inflation down to equal the gain in core PPI inflation over the past year.
The large decline in headline inflation was due to a -14% drop in wholesale gasoline prices. The larger energy category saw prices decline -6.6% MoM (unchanged YoY), which was the largest monthly decline in over 4 years, as all major categories fell. Energy accounts for 19% of the weighting in the PPI. Unfortunately, the record oil prices reached this week indicate the August decline in energy costs is going to be unwound in the September figures. So, the low inflation rates of this month may prove to be an aberration unless the economy falters.
Consumer goods costs fell -1.8% MoM as food prices fell -.2% MoM (+4.7% YoY). Capital goods prices rose +.1% MoM, and accounts for 24% of the weighting in PPI. Gains in aircraft (+.9% MoM) exactly offset declines in light motor truck (-.9% MoM) showing the benefits of a strong export market for aircraft, and softening demand for energy hogging trucks and SUVs in the US. Passenger car prices rose +.5% MoM and prescriptions rose +1.3% MoM helping to push up core PPI.
Intermediate and crude producer prices also fell in August. Intermediate goods costs fell -1.2% MoM and are now up only +2.4% YoY. Crude intermediate costs have also risen +2.4% YoY, but fell -.5% MoM. Crude goods prices for raw materials dropped 3%.
The large decline in headline inflation was due to a -14% drop in wholesale gasoline prices. The larger energy category saw prices decline -6.6% MoM (unchanged YoY), which was the largest monthly decline in over 4 years, as all major categories fell. Energy accounts for 19% of the weighting in the PPI. Unfortunately, the record oil prices reached this week indicate the August decline in energy costs is going to be unwound in the September figures. So, the low inflation rates of this month may prove to be an aberration unless the economy falters.
Consumer goods costs fell -1.8% MoM as food prices fell -.2% MoM (+4.7% YoY). Capital goods prices rose +.1% MoM, and accounts for 24% of the weighting in PPI. Gains in aircraft (+.9% MoM) exactly offset declines in light motor truck (-.9% MoM) showing the benefits of a strong export market for aircraft, and softening demand for energy hogging trucks and SUVs in the US. Passenger car prices rose +.5% MoM and prescriptions rose +1.3% MoM helping to push up core PPI.
Intermediate and crude producer prices also fell in August. Intermediate goods costs fell -1.2% MoM and are now up only +2.4% YoY. Crude intermediate costs have also risen +2.4% YoY, but fell -.5% MoM. Crude goods prices for raw materials dropped 3%.
TIC Data Shows Drastically Reduced Foreign Demand for Long-Term U.S. Assets in July
Today's TIC data showed a dramatic reversal away from foreign demand for U.S. long-term securities to short-term securities as the flight-to-quality trend began in July as investors fled the subprime arena. The weakness may also be payback from the record strength of the past couple of months.
Net long-term TIC flows for June were revised down to $97.3 billion from the originally reported very high level of $120.9 billion, and declined further in July to only $19.2 billion in net demand, the lowest level in 9 months. In contrast, the total net TIC flows, which includes T-Bills and other short term debt securities soared to $103.8 billion in July after being revised lower to $34.4 billion in June. International sales of US Treasuries were the highest in four years, and foreign demand also declined for U.S agency and corporate debt as well as stocks. All areas were hit on concern that the subprime woes would hurt asset values and cause the U.S. economy to slow. Another negative for foreign investors was the -1.8% drop in the dollar's value in July against a basket of major currencies which directly reduces the value of U.S. assets for foreign investors. The dollar's drop in July was the largest monthly decline in over a month.
By category, total purchases saw large drops from both foreign central banks as well as private investors for U.S. assets. Treasury instruments saw outright selling in both categories for a total amount sold of over $9 billion during July. All other categories saw net buying, but at much lower levels. Equities held in the best, falling to $21 billion in July from $29 billion in June, this in spite of equities falling over 3% during the month for the largest monthly decline in three years. The debt sectors both saw substantial decline. Corporate bond demand fell from $26 billion to $4 billion, while agency demand ( which includes both agency debt and MBS) fell from $40 billion to $9 billion from the prior month. In both categories, official demand fell by half, while private sector demand fell much more.
For the first time in four months, Chinese demand for U.S. Treasuries rose (+$3 billion to $408 billion). Brazil and the UK were also net buyers in July. It is thought that a lot of the UK demand is actually for the Middle East. UK holdings rose $17.5 billion to $210 billion in total. Japan, the largest foreign investor in U.S. government debt sold over $2 billion in Treasuries, to bring their total holding down to $611 billion.
Foreign demand for U.S assets in July fell below the average monthly second quarter current account deficit of $64 billion. If this continues, it could spell increasing trouble for the U.S. economy's ability to fund consumption levels over GDP output. The dollar is at risk over this news, and did in fact fall -.07, as measured by the dollar index, to 79.66, which is just above the 15 year low reached last week. A benefit is that the U.S. trade deficit seems to have stopped widening as foreign demand for U.S. goods improves.
Net long-term TIC flows for June were revised down to $97.3 billion from the originally reported very high level of $120.9 billion, and declined further in July to only $19.2 billion in net demand, the lowest level in 9 months. In contrast, the total net TIC flows, which includes T-Bills and other short term debt securities soared to $103.8 billion in July after being revised lower to $34.4 billion in June. International sales of US Treasuries were the highest in four years, and foreign demand also declined for U.S agency and corporate debt as well as stocks. All areas were hit on concern that the subprime woes would hurt asset values and cause the U.S. economy to slow. Another negative for foreign investors was the -1.8% drop in the dollar's value in July against a basket of major currencies which directly reduces the value of U.S. assets for foreign investors. The dollar's drop in July was the largest monthly decline in over a month.
By category, total purchases saw large drops from both foreign central banks as well as private investors for U.S. assets. Treasury instruments saw outright selling in both categories for a total amount sold of over $9 billion during July. All other categories saw net buying, but at much lower levels. Equities held in the best, falling to $21 billion in July from $29 billion in June, this in spite of equities falling over 3% during the month for the largest monthly decline in three years. The debt sectors both saw substantial decline. Corporate bond demand fell from $26 billion to $4 billion, while agency demand ( which includes both agency debt and MBS) fell from $40 billion to $9 billion from the prior month. In both categories, official demand fell by half, while private sector demand fell much more.
For the first time in four months, Chinese demand for U.S. Treasuries rose (+$3 billion to $408 billion). Brazil and the UK were also net buyers in July. It is thought that a lot of the UK demand is actually for the Middle East. UK holdings rose $17.5 billion to $210 billion in total. Japan, the largest foreign investor in U.S. government debt sold over $2 billion in Treasuries, to bring their total holding down to $611 billion.
Foreign demand for U.S assets in July fell below the average monthly second quarter current account deficit of $64 billion. If this continues, it could spell increasing trouble for the U.S. economy's ability to fund consumption levels over GDP output. The dollar is at risk over this news, and did in fact fall -.07, as measured by the dollar index, to 79.66, which is just above the 15 year low reached last week. A benefit is that the U.S. trade deficit seems to have stopped widening as foreign demand for U.S. goods improves.
Monday, September 17, 2007
Today's Tidbits
Market Expectations of FOMC
From The Wall Street Journal: “Investors are putting a lot of hope in the Federal Reserve’s ability to ride to the rescue tomorrow. Maybe too much hope…a rate cut would offer little immediate help for the fundamental problems weighing on the nation’s economy and financial markets. These include a worsening housing slump and high gasoline prices, which are damping consumer spending, and fears of further defaults on the billions of dollars of low-quality loans that have been used to finance mortgages and corporate takeovers. Even if the Fed carries out a series of rate cuts, the economy and stock market are likely to be dealing with the fallout from these problems well into next year.”
From Merrill Lynch: “We're likely going to see the first cut in the Funds rate since June/03. Whether the Fed goes 25 bps or 50 bps could be a close call - two-thirds of economists expect a 25 bps point cut while the Fed funds futures market is almost priced for a 50 bps move - the press release will be key for future rate relief.”
From Lehman: “Don’t look for the mortgage ARM reset Fed bailout just yet. That may be the story for late 2008.”
From Market News International: “While official comments have not been uniform, their main thrust has been in line with market expectations that the FOMC will cut the federal funds rate 25 basis points to 5.00%. Bernanke and his fellow policymakers have had plenty of chances to change those expectations, but have not taken them. So it would be astonishing if the FOMC were to stay on hold and disappoint the market. Not that the Fed always strives to give the market just what it wants. It has proven that in spades over the past year. But generally speaking the Fed does not go out of its way to surprise the markets -- particularly at a time of unsettled financial conditions. If there is to be a surprise it would be in the direction of a larger than expected rate cut.”
Bear Stearns Turns Bearish
From Bear Stearns: “We expect a material U.S. slowdown beginning in the fourth quarter and broadening to a global slowdown in 2008. We think the August-September credit market turbulence caused a downward inflection point in the global outlook. It took the liquidity-filled punch bowl away…In coming months, we think this will cause an extra drag on jobs, earnings, consumption and investment (including residential, commercial and business spending)… We don’t expect a U.S. or global recession…A key variable in our soft-landing view is whether the dollar price of assets is way too high – for land, houses, skyscrapers, commodities, equities. We think prices will be tested strenuously in coming months due the abruptness of the downward inflection point in credit, but will find buyers. The dollar has lost substantial value since 2002, so much of the asset price run-up is more of an adjustment to the weaker value of the dollar, rather than a “bubble” in real values. We expect some further weakness in U.S. house prices, but we think the housing excesses showed up more in housing starts than in nationwide median prices. If it turns out this way -- that the excesses were more in activity than in prices – then we should see an economic slowdown but not a recession or a bear market in asset prices.” [This is notable because Bear Stearns has consistently been among the most bullish on the economy.]
Greenspan’s Comments on Housing Market
From The Wall Street Journal: “There is now a ‘very large’ inventory of unsold, newly built homes whose condition is deteriorating more rapicly, than, say, a steel mill’s, and that puts pressure on builders to sell them quickly, he said. As a result, ‘we have the capability of far bigger price declines,’ which will pinch home equity, lead to more defaults on subprime mortgages and pressure consumer spending. The probability of a recession, which earlier this year he put at one-third, is now ‘slightly more than a third,” he replied.”
From The Financial Times: “US house prices are likely to fall significantly from their present levels, Alan Greenspan has told the Financial Times, admitting that there was a bubble in the US housing market…the former chairman of the Federal Reserve said the decline in house prices "is going to be larger than most people expect"…Mr Greenspan said he would expect "as a minimum, large single-digit" percentage declines in US house prices from peak to trough and added that he would not be surprised if the fall was "in double digits". Mr Greenspan said house prices were probably already down about 2-3 per cent from their peak on a national level. However, he cautioned that it was very difficult to predict how big the decline would be…Mr Greenspan told the FT that froth "was a euphemism for a bubble"”
From Fortune: “…there is no question that there is an overhang of inventories, especially newly constructed, unoccupied single-family homes. I judge there are about 200,000 units that are excess. And at the rate we're going now, we're running off a very small number of these inventories a month. These units are going to overhang the structure and move prices inexorably lower. So I think we're going through a period that is not over yet, and it's important that we bring this to an end sooner rather than later, because it has a corrosive effect on the economy.”
Greenspan on Current Market Risks and Recent Financial Product Innovations
From The Financial Times: But Mr Greenspan said that his successors at the Fed - who meet tomorrow to set interest rates - would have to be careful not to ease rates too aggressively, because the risk of an"inflationary resurgence" was greater now than when he was Fed chief… The former chairman said the current turmoil in financial markets was "an accident waiting to happen". He said the price of risk had fallen to unsustainably low levels beforehand, with investors addicted to asset-backed securities that offered some additional yield over Treasury bonds as if they were "cocaine". Mr Greenspan said this demand induced the big increase in the origination of subprime mortgages by mortgage brokers. The rise in defaults on subprime mortgages was only the trigger that set off a broad re-evaluation of risk, he argued. Mr Greenspan said the off-balance sheet investment vehicles that issued much of the asset-backed commercial paper represented a "savings and loans disaster waiting to happen" because of the mismatch between their assets and liabilities. Mr Greenspan thought the issuance of asset-backed commercial paper "is probably not going to get back to where it was". They had "five-year maturity assets financed with 30-day commercial paper", he said. The former Fed chairman said collateralised debt obligations - securities that slice up and repackage loans to meet the risk-appetite of different investors - "will never get back to the levels and structures that they were, because now everybody knows you cannot price them". He added that in an innovative financial market "there will always be products that fail". But he said he believed that credit default swaps were "here to stay" and had demonstrated their capacity to diversify risk.”
From Deutsche Bank: “Probably the most interesting aspect of the accounts of Greenspan's book has been his expectation that the low-inflation period (due to globalization and productivity) is over, and that nominal bond yields would have to rise to 8% and short-term interest rates to "double digits" in order to keep inflation at around 1-2%. This is probably a good time for TIPS traders.”
From Fortune: “How would you judge chairman Ben Bernanke's response so far?
I think it's been a very sensible one, because the board is confronted with something I was not confronted with, namely, evidence of finally coming out of this disinflationary trend. Cost pressures are beginning to build around the world. This suggests that, longer term, the Fed's going to have to be tighter. It means that stock prices are going to have some difficulty moving forward. Shorter term, clearly, it's got problems with very significant credit disruptions and turmoil. [In my tenure] we had a relatively easy task in lowering rates without concern about triggering inflation. I regret that that is no longer the case… We have a dysfunctional political system in the sense that there are very serious fiscal problems out there, most importantly Medicare. As best I can judge, when the baby boom retires, we are going to have to either raise taxes very sharply or cut benefits by half. No politician wants to confront this. And this is a very sad event because what's at stake here is the fiscal stability of the American government.”
Stock Market Has Been Poor Predictor of Recessions During Last 50 Years
From Citi: “There have been seven recessions in the U.S. over the past 50 years. So, I went back to see if stocks are truly a good leader in forecasting recessions. On average, the Dow has fallen 15.3% into recessions as measured from the nearest market high to the first GDP print after NBER says a recession start (remember that NBER only picks the start of a recession well after it has already begun). The range was -7.8% to -24.5%. Obviously, not all 15% declines led to recession most notably '87, '89 and '98. Financial crises have not been a good leading indicator with only 1 of 5 leading to recession with three others occurring during the downturn. Oil supply shocks have a better record (3 for 3 - one of which coincided with the lone financial crisis that preceded a recession - the 1990 S&L crisis). Even non-correlated events have a better record than financial woes. 3 of 4 of the Mets World Series appearances have seen economic dips within weeks of the final out! Ahmadinejad and Pedro Martinez could have more to say about recession than where 3-month Libor is, statistically speaking.”
Second Quarter Flow-of-Funds Data from Fed on Debt Growth and Net Worth
From JP Morgan: “According to the 2Q Flow of Funds report, total debt of the nonfinancial sector increased at a 7.1% annual rate last quarter, down 0.8% points from the previous quarter. Federal debt contracted at a 1.4% rate, the first decline in that series since the first half of 2001; home mortgage debt growth continued to ease, slipping to 7.3% from 7.7%, but business borrowing perked up to a 10.6% rate from 8.9% the prior quarter. The financing gap -- capital expenditures less internal funds -- is now a fairly large $237 billion, last quarter's gap was revised up massively, from $18 billion to $203 billion, a revision reflecting a variety of factors. This highlights a vulnerability of the corporate sector that the previous data did not reveal: because firms have to access credit markets to fund their capital spending, rather than finance them out of internal funds as the unrevised data suggested was feasible, the capital spending outlook now looks more sensitive to stresses in the credit markets. A more favorable picture emerged from the household balance sheet: household net worth increased to $57.8 trillion, which represents 571% of disposable income, the highest the net worth-to-income ratio has stood since 2000. The $1.2 trillion increase in household net worth in the second quarter was mostly the result of holding gains on financial assets. The Flow of Funds measure of the US funding needs vis-a-vis the rest of the world suggests a smaller gap than the current account data. Although the size of the discrepancy is not unprecedented, it confirms a message from the NIPA's measure of external funding needs (i.e. national saving less national investment). Whereas the current account deficit number is $738 billion, the NIPA and Flow of Funds external funding numbers are, respectively, $654 and $601 billion. In a stark turn-about, in 2Q ABS issuers funding needs were met with a surge in CP issuance, $295 billion (annual rate), up from $46 billion the previous quarter, at the same time their funding out of bonds fell to $229 billion from $527 billion the previous quarter. The net change in mortgages increased for the first time in over a year, though all the increase was due to commercial mortgages which increased at a record $343 billion pace last quarter. Funding for all mortgages by ABS issuers declined to $401 billion rate even as agency mortgage pools increased at a record $544 billion annual pace.”
From Dow Jones: “Household net worth is a measure of total assets, such as houses and pensions, minus total liabilities, such as mortgages and credit card debt. U.S. household debt rose at a 7.1% annual rate in the second quarter, matching the first quarter.”
MISC
From Morgan Stanley: “Our repo desk expects quarter end to be an issue . Already Trsy collateral at quarter end is trading at 4%. Customers want to be long quality for reporting purposes at quarter end.”
From RBSGC: “MBS holdings by US banks increased by $7 bn with pass-through holdings up $2 bn and CMO holdings up $5 bn. MBS holding were down $11 bn since the start of this year. Deposits increased by $6 bn over the past week. Since the start of this year, deposits increased $213 bn. Commercial and industrial loans increased by $14 bn for all banks over the week. Since the start of the year, C&I loans increased by $137 bn. Whole loan holdings increased by $9 bn over the week. Since the beginning of the year, whole loan holdings increased by $81 bn. Due to data lags from the Fed, they recently reported increases in both deposits (+$6 bn) and asset holdings (+$44 bn) for the week ended on September 5. All numbers are seasonally adjusted.”
From Merrill Lynch: “The [U of Michigan consumer confidence] index assessing whether now is a good time to buy a home because interest rates are low actually sank to 14 in September from 19 in August - and that is the lowest number since late '90. At the same time, the index gauging whether it is a bad time to buy a home because interest rates are too high and credit too tight jumped to 23 from 20 - the highest since the summer of '89 when that credit crunch was in its infancy stage.”
From Reuters: “Pacific Investment Management Co is planning to launch a $2 billion distressed-debt fund…The Pimco Distressed Mortgage Fund will invest in a variety of assets, including mortgage-backed securities, asset-backed securities and collateralized debt obligations…”
From Morgan Stanley: “US Money markets ended last week in much better shape than they have been in all month. CP spreads over the Fed Funds target have fallen by more than 25bp from their August highs. The spread between 1m LIBOR and Funds has also fallen by 20bp from its August highs. Note also that quality spreads within the CP markets have also narrowed. Certainly, these spreads levels remain very elevated, demonstrating money-market stresses remain high – but it is easy to argue that things are getting better (and it would be very difficulty to argue that they are getting worse).”
From Dow Jones: “U.S. Treasury Secretary Henry Paulson said regulators shouldn’t rush to impose new rules on financial markets in reaction to the recent crisis in credit markets…Financial market turbulence “will take some time” to work through, and regulators must ensure that any new requirements for financial services firms don’t stunt innovation, Paulson said. “There is great vigilance now on the part of regulators, in terms of staying close to markets, as we work our way through this situation, Paulson said. “We want to get the balance right...we don’t want to rush to judgment and overreact.”
From Dow Jones: “U.S. corporate executives think the effect of recent credit market problems on their businesses will be limited, according to a survey by the Business Roundtable. Sixty percent of chief executives surveyed said they did not expect “substantial” effects from credit market turmoil on business prospects. Forty percent said they did foresee substantial effects, according to the Business Roundtable, an association of chief executives at major companies with combined annual revenues of $4.5 trillion and more than 10 million employees. The organization’s third quarter outlook index - which combines expectations for sales, investment and payrolls - fell 4.5 points from the previous quarter to 77.4. Still, that’s well above the breakeven level of 50 between expansion and contraction.”
End-of-Day Market Update
From RBSGC: “The bond market drifted a bit lower, the curve a bit steeper, and was joined by stocks, which also edged a bit lower on an otherwise lackluster day.”
From Dow Jones: “Crude oil futures rose to an intraday record on speculation the Federal will cut interest rates. The expiration of crude oil options, as well as talk of more Atlantic hurricanes, also spurred prices higher. The front-month October light, sweet crude contract on the New York Mercantile Exchange rose as much as $1.40, or
1.8%, to an intraday record of $80.50 a barrel beating the previous record of $80.36 set Friday.”
Dow down 39 to 13,403. Dollar index up .1 to 79.72. Gold up $10 to $718, highest close in over a year.
From The Wall Street Journal: “Investors are putting a lot of hope in the Federal Reserve’s ability to ride to the rescue tomorrow. Maybe too much hope…a rate cut would offer little immediate help for the fundamental problems weighing on the nation’s economy and financial markets. These include a worsening housing slump and high gasoline prices, which are damping consumer spending, and fears of further defaults on the billions of dollars of low-quality loans that have been used to finance mortgages and corporate takeovers. Even if the Fed carries out a series of rate cuts, the economy and stock market are likely to be dealing with the fallout from these problems well into next year.”
From Merrill Lynch: “We're likely going to see the first cut in the Funds rate since June/03. Whether the Fed goes 25 bps or 50 bps could be a close call - two-thirds of economists expect a 25 bps point cut while the Fed funds futures market is almost priced for a 50 bps move - the press release will be key for future rate relief.”
From Lehman: “Don’t look for the mortgage ARM reset Fed bailout just yet. That may be the story for late 2008.”
From Market News International: “While official comments have not been uniform, their main thrust has been in line with market expectations that the FOMC will cut the federal funds rate 25 basis points to 5.00%. Bernanke and his fellow policymakers have had plenty of chances to change those expectations, but have not taken them. So it would be astonishing if the FOMC were to stay on hold and disappoint the market. Not that the Fed always strives to give the market just what it wants. It has proven that in spades over the past year. But generally speaking the Fed does not go out of its way to surprise the markets -- particularly at a time of unsettled financial conditions. If there is to be a surprise it would be in the direction of a larger than expected rate cut.”
Bear Stearns Turns Bearish
From Bear Stearns: “We expect a material U.S. slowdown beginning in the fourth quarter and broadening to a global slowdown in 2008. We think the August-September credit market turbulence caused a downward inflection point in the global outlook. It took the liquidity-filled punch bowl away…In coming months, we think this will cause an extra drag on jobs, earnings, consumption and investment (including residential, commercial and business spending)… We don’t expect a U.S. or global recession…A key variable in our soft-landing view is whether the dollar price of assets is way too high – for land, houses, skyscrapers, commodities, equities. We think prices will be tested strenuously in coming months due the abruptness of the downward inflection point in credit, but will find buyers. The dollar has lost substantial value since 2002, so much of the asset price run-up is more of an adjustment to the weaker value of the dollar, rather than a “bubble” in real values. We expect some further weakness in U.S. house prices, but we think the housing excesses showed up more in housing starts than in nationwide median prices. If it turns out this way -- that the excesses were more in activity than in prices – then we should see an economic slowdown but not a recession or a bear market in asset prices.” [This is notable because Bear Stearns has consistently been among the most bullish on the economy.]
Greenspan’s Comments on Housing Market
From The Wall Street Journal: “There is now a ‘very large’ inventory of unsold, newly built homes whose condition is deteriorating more rapicly, than, say, a steel mill’s, and that puts pressure on builders to sell them quickly, he said. As a result, ‘we have the capability of far bigger price declines,’ which will pinch home equity, lead to more defaults on subprime mortgages and pressure consumer spending. The probability of a recession, which earlier this year he put at one-third, is now ‘slightly more than a third,” he replied.”
From The Financial Times: “US house prices are likely to fall significantly from their present levels, Alan Greenspan has told the Financial Times, admitting that there was a bubble in the US housing market…the former chairman of the Federal Reserve said the decline in house prices "is going to be larger than most people expect"…Mr Greenspan said he would expect "as a minimum, large single-digit" percentage declines in US house prices from peak to trough and added that he would not be surprised if the fall was "in double digits". Mr Greenspan said house prices were probably already down about 2-3 per cent from their peak on a national level. However, he cautioned that it was very difficult to predict how big the decline would be…Mr Greenspan told the FT that froth "was a euphemism for a bubble"”
From Fortune: “…there is no question that there is an overhang of inventories, especially newly constructed, unoccupied single-family homes. I judge there are about 200,000 units that are excess. And at the rate we're going now, we're running off a very small number of these inventories a month. These units are going to overhang the structure and move prices inexorably lower. So I think we're going through a period that is not over yet, and it's important that we bring this to an end sooner rather than later, because it has a corrosive effect on the economy.”
Greenspan on Current Market Risks and Recent Financial Product Innovations
From The Financial Times: But Mr Greenspan said that his successors at the Fed - who meet tomorrow to set interest rates - would have to be careful not to ease rates too aggressively, because the risk of an"inflationary resurgence" was greater now than when he was Fed chief… The former chairman said the current turmoil in financial markets was "an accident waiting to happen". He said the price of risk had fallen to unsustainably low levels beforehand, with investors addicted to asset-backed securities that offered some additional yield over Treasury bonds as if they were "cocaine". Mr Greenspan said this demand induced the big increase in the origination of subprime mortgages by mortgage brokers. The rise in defaults on subprime mortgages was only the trigger that set off a broad re-evaluation of risk, he argued. Mr Greenspan said the off-balance sheet investment vehicles that issued much of the asset-backed commercial paper represented a "savings and loans disaster waiting to happen" because of the mismatch between their assets and liabilities. Mr Greenspan thought the issuance of asset-backed commercial paper "is probably not going to get back to where it was". They had "five-year maturity assets financed with 30-day commercial paper", he said. The former Fed chairman said collateralised debt obligations - securities that slice up and repackage loans to meet the risk-appetite of different investors - "will never get back to the levels and structures that they were, because now everybody knows you cannot price them". He added that in an innovative financial market "there will always be products that fail". But he said he believed that credit default swaps were "here to stay" and had demonstrated their capacity to diversify risk.”
From Deutsche Bank: “Probably the most interesting aspect of the accounts of Greenspan's book has been his expectation that the low-inflation period (due to globalization and productivity) is over, and that nominal bond yields would have to rise to 8% and short-term interest rates to "double digits" in order to keep inflation at around 1-2%. This is probably a good time for TIPS traders.”
From Fortune: “How would you judge chairman Ben Bernanke's response so far?
I think it's been a very sensible one, because the board is confronted with something I was not confronted with, namely, evidence of finally coming out of this disinflationary trend. Cost pressures are beginning to build around the world. This suggests that, longer term, the Fed's going to have to be tighter. It means that stock prices are going to have some difficulty moving forward. Shorter term, clearly, it's got problems with very significant credit disruptions and turmoil. [In my tenure] we had a relatively easy task in lowering rates without concern about triggering inflation. I regret that that is no longer the case… We have a dysfunctional political system in the sense that there are very serious fiscal problems out there, most importantly Medicare. As best I can judge, when the baby boom retires, we are going to have to either raise taxes very sharply or cut benefits by half. No politician wants to confront this. And this is a very sad event because what's at stake here is the fiscal stability of the American government.”
Stock Market Has Been Poor Predictor of Recessions During Last 50 Years
From Citi: “There have been seven recessions in the U.S. over the past 50 years. So, I went back to see if stocks are truly a good leader in forecasting recessions. On average, the Dow has fallen 15.3% into recessions as measured from the nearest market high to the first GDP print after NBER says a recession start (remember that NBER only picks the start of a recession well after it has already begun). The range was -7.8% to -24.5%. Obviously, not all 15% declines led to recession most notably '87, '89 and '98. Financial crises have not been a good leading indicator with only 1 of 5 leading to recession with three others occurring during the downturn. Oil supply shocks have a better record (3 for 3 - one of which coincided with the lone financial crisis that preceded a recession - the 1990 S&L crisis). Even non-correlated events have a better record than financial woes. 3 of 4 of the Mets World Series appearances have seen economic dips within weeks of the final out! Ahmadinejad and Pedro Martinez could have more to say about recession than where 3-month Libor is, statistically speaking.”
Second Quarter Flow-of-Funds Data from Fed on Debt Growth and Net Worth
From JP Morgan: “According to the 2Q Flow of Funds report, total debt of the nonfinancial sector increased at a 7.1% annual rate last quarter, down 0.8% points from the previous quarter. Federal debt contracted at a 1.4% rate, the first decline in that series since the first half of 2001; home mortgage debt growth continued to ease, slipping to 7.3% from 7.7%, but business borrowing perked up to a 10.6% rate from 8.9% the prior quarter. The financing gap -- capital expenditures less internal funds -- is now a fairly large $237 billion, last quarter's gap was revised up massively, from $18 billion to $203 billion, a revision reflecting a variety of factors. This highlights a vulnerability of the corporate sector that the previous data did not reveal: because firms have to access credit markets to fund their capital spending, rather than finance them out of internal funds as the unrevised data suggested was feasible, the capital spending outlook now looks more sensitive to stresses in the credit markets. A more favorable picture emerged from the household balance sheet: household net worth increased to $57.8 trillion, which represents 571% of disposable income, the highest the net worth-to-income ratio has stood since 2000. The $1.2 trillion increase in household net worth in the second quarter was mostly the result of holding gains on financial assets. The Flow of Funds measure of the US funding needs vis-a-vis the rest of the world suggests a smaller gap than the current account data. Although the size of the discrepancy is not unprecedented, it confirms a message from the NIPA's measure of external funding needs (i.e. national saving less national investment). Whereas the current account deficit number is $738 billion, the NIPA and Flow of Funds external funding numbers are, respectively, $654 and $601 billion. In a stark turn-about, in 2Q ABS issuers funding needs were met with a surge in CP issuance, $295 billion (annual rate), up from $46 billion the previous quarter, at the same time their funding out of bonds fell to $229 billion from $527 billion the previous quarter. The net change in mortgages increased for the first time in over a year, though all the increase was due to commercial mortgages which increased at a record $343 billion pace last quarter. Funding for all mortgages by ABS issuers declined to $401 billion rate even as agency mortgage pools increased at a record $544 billion annual pace.”
From Dow Jones: “Household net worth is a measure of total assets, such as houses and pensions, minus total liabilities, such as mortgages and credit card debt. U.S. household debt rose at a 7.1% annual rate in the second quarter, matching the first quarter.”
MISC
From Morgan Stanley: “Our repo desk expects quarter end to be an issue . Already Trsy collateral at quarter end is trading at 4%. Customers want to be long quality for reporting purposes at quarter end.”
From RBSGC: “MBS holdings by US banks increased by $7 bn with pass-through holdings up $2 bn and CMO holdings up $5 bn. MBS holding were down $11 bn since the start of this year. Deposits increased by $6 bn over the past week. Since the start of this year, deposits increased $213 bn. Commercial and industrial loans increased by $14 bn for all banks over the week. Since the start of the year, C&I loans increased by $137 bn. Whole loan holdings increased by $9 bn over the week. Since the beginning of the year, whole loan holdings increased by $81 bn. Due to data lags from the Fed, they recently reported increases in both deposits (+$6 bn) and asset holdings (+$44 bn) for the week ended on September 5. All numbers are seasonally adjusted.”
From Merrill Lynch: “The [U of Michigan consumer confidence] index assessing whether now is a good time to buy a home because interest rates are low actually sank to 14 in September from 19 in August - and that is the lowest number since late '90. At the same time, the index gauging whether it is a bad time to buy a home because interest rates are too high and credit too tight jumped to 23 from 20 - the highest since the summer of '89 when that credit crunch was in its infancy stage.”
From Reuters: “Pacific Investment Management Co is planning to launch a $2 billion distressed-debt fund…The Pimco Distressed Mortgage Fund will invest in a variety of assets, including mortgage-backed securities, asset-backed securities and collateralized debt obligations…”
From Morgan Stanley: “US Money markets ended last week in much better shape than they have been in all month. CP spreads over the Fed Funds target have fallen by more than 25bp from their August highs. The spread between 1m LIBOR and Funds has also fallen by 20bp from its August highs. Note also that quality spreads within the CP markets have also narrowed. Certainly, these spreads levels remain very elevated, demonstrating money-market stresses remain high – but it is easy to argue that things are getting better (and it would be very difficulty to argue that they are getting worse).”
From Dow Jones: “U.S. Treasury Secretary Henry Paulson said regulators shouldn’t rush to impose new rules on financial markets in reaction to the recent crisis in credit markets…Financial market turbulence “will take some time” to work through, and regulators must ensure that any new requirements for financial services firms don’t stunt innovation, Paulson said. “There is great vigilance now on the part of regulators, in terms of staying close to markets, as we work our way through this situation, Paulson said. “We want to get the balance right...we don’t want to rush to judgment and overreact.”
From Dow Jones: “U.S. corporate executives think the effect of recent credit market problems on their businesses will be limited, according to a survey by the Business Roundtable. Sixty percent of chief executives surveyed said they did not expect “substantial” effects from credit market turmoil on business prospects. Forty percent said they did foresee substantial effects, according to the Business Roundtable, an association of chief executives at major companies with combined annual revenues of $4.5 trillion and more than 10 million employees. The organization’s third quarter outlook index - which combines expectations for sales, investment and payrolls - fell 4.5 points from the previous quarter to 77.4. Still, that’s well above the breakeven level of 50 between expansion and contraction.”
End-of-Day Market Update
From RBSGC: “The bond market drifted a bit lower, the curve a bit steeper, and was joined by stocks, which also edged a bit lower on an otherwise lackluster day.”
From Dow Jones: “Crude oil futures rose to an intraday record on speculation the Federal will cut interest rates. The expiration of crude oil options, as well as talk of more Atlantic hurricanes, also spurred prices higher. The front-month October light, sweet crude contract on the New York Mercantile Exchange rose as much as $1.40, or
1.8%, to an intraday record of $80.50 a barrel beating the previous record of $80.36 set Friday.”
Dow down 39 to 13,403. Dollar index up .1 to 79.72. Gold up $10 to $718, highest close in over a year.
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