January 10, 2008    TIDBITS

Comments on Bernanke’s Testimony

From Bloomberg:  “Federal Reserve Board Chairman Ben S. Bernanke said ``additional policy easing may well be necessary'' to offset ``downside risks'' to growth… ``We stand ready to take substantive additional action as needed to support growth and to provide adequate insurance against downside risks.''  Bernanke's comments suggest the Federal Open Market Committee will cut interest rates further this month to reduce the risk of a recession…``Incoming information has suggested that the baseline outlook for real activity in 2008 has worsened and the downside risks to growth have become more pronounced,'' Bernanke said … ``A number of factors, including higher oil prices, lower equity prices, and softening home values, seem likely to weigh on consumer spending as we move into 2008.''…In December, Fed officials didn't explicitly recognize downside risks to growth, saying increased ``uncertainty'' surrounded the outlook for growth and inflation.”

From FTN:  [Bernanke said] “Financial and economic conditions can change quickly. Consequently, the Committee must remain exceptionally alert and flexible, prepared to act in a decisive and timely manner and, in particular, to counter any adverse dynamics that might threaten economic or financial stability.”

From Goldman:  “Bernanke's speech today is very supportive of additional Fed cuts over the first half of 2008.  Significantly, he notes the possibility of more action to support growth, but makes only passing reference to inflation.  His commitment to "act in a decisive and timely" manner is consistent with our expectations of a 50bp cut at the January 30/31 FOMC meeting…Much of the speech contains a cogent discussion of the housing downturn, and how it has spilled over -- and will likely continue to spill over -- into a broader economic downturn.  Specifically, he discusses the spread of weakness from falling housing prices into rising delinquencies which then feed into falling values for assets built on them.  This cycle continues with reduced capital bases for financial intermediaries which hold the assets, causing them to cut back on their lending which pushes down asset prices further.  Bernanke also notes the potential for adverse dynamics to take hold in the labor market following the very weak December employment report.  Left unsaid, but clearly lurking below the surface, is the potential a multiplier interaction between weaker consumer spending and further labor market weakening.”

From Reuters:  “Analysts welcomed Bernanke's forthright acknowledgment of the dangers faced by the economy, which many fear could fall into recession.  "I think he's come to terms with the fact that while inflation may be a concern down the road, he has to take care of the train that's coming at him right now, which is the fear of a recession,"… U.S. stock markets surged after Bernanke's comments, while the dollar remained weaker against a basket of currencies as investors concluded that the Fed would aggressively lower interest rates at its end-of-month policy-setting meeting.  The Fed's policy-setting Federal Open Market Committee holds a two-day meeting January 29-30. Bernanke's comments reinforced market expectations that it will cut interest rates a half percentage point.”

From HSBC:  “Given Bernanke's speech today, we stick with our 3% Fed funds year-end call, but are now looking for a 50bp cut on Jan 30 instead of our earlier call of 25bp… After a 50bp cut in Jan, we look for 25bp eases in March, June and September.”

From CITI:  “50 bps cut no later than the January meeting.  There is a slight chance (10%) that they can go inter-meeting if things get significantly worse.  Fed Funds Futures have an 84% cut built into that date, increased from 65% yesterday.

From Deutsche Bank:  “Mr. Bernanke's comments on the economic outlook were dovish; he highlighted the downside risks to growth from fragile financial markets and did not sound overly concerned about inflation, although he did repeat the Fed's familiar refrain that inflation expectations must remain stable.  Should inflation expectations become "unmoored" the Fed would lose credibility as well as the flexibility to respond to adverse economic shocks.  We thought the most important part of the speech was at the end; it sounds to us that a 50 bp rate cut is on the table and that the Fed is going to adopt an explicit easing bias…we are staying with 25 bps and an easing bias.”

From Morgan Stanley:  “we now look for the FOMC to cut the funds rate target by 50 bp at the January 30 meeting… In the Q&A, Bernanke indicated that the Fed is not currently forecasting a recession but sees slow growth with downside risks. When asked about the possibility of fiscal stimulus, the Fed Chairman indicated that he can’t comment until he sees some specifics and that his current focus is on monetary policy because that is an immediate tool that can be used to influence the economy.  We suspect that the Fed is not headed toward an intermeeting move largely because we don’t really see a potential trigger on the economic calendar. Some sort of significant market event would probably be required to bring the Fed in before their meeting at the end of the month.  Finally, Bernanke noted that the TAF operations “have had some positive effects” but that tight financial conditions continue to “pose downside risks to growth.” This is because the impact of the TAF operations on term funding markets cannot address broad credit concerns and balance sheet constraints. Still, officials indicate that the TAF will continue as long as there are bids and may well become a permanent addition to the Fed’s toolkit.”

From Credit Suisse:  “We now expect a 50 basis point cut in the funds rate at the January FOMC meeting, to 3.75%, and a further 75 basis points in 2008.”

From Deutsche Bank:  “Fed's Hoenig (non-voter) says inflation pressures rising, economy has been under considerable stress but not as pessimistic as some about outlook.”

WSJ Says Bank of America Seriously Considering Buying Countrywide

From Bloomberg:  “Countrywide Financial Corp., the biggest U.S. mortgage lender, rose the most ever after the Wall Street Journal reported the company is in ``advanced'' talks to be acquired by Bank of America Corp.  Countrywide issued a statement declining to comment after the shares rose as much as 74 percent, and Bank of America spokesman Bob Stickler declined to respond to the Journal's report, which cited people familiar with the situation.”

Moody’s Concerned Freddie Mac May Not Have Sufficient Capital

From Bloomberg:  “Freddie Mac, the U.S. mortgage-finance company that lost a record $2 billion in the third quarter, may be downgraded by Moody's Investors Service because damage from loan defaults could be worse than the ratings company expected.  Moody's threatened to lower Freddie Mac's financial strength rating from A-, the second-highest grade, which may prompt the government-chartered company to raise additional capital. McLean, Virginia-based Freddie Mac's Aaa senior long-term debt rating and Prime-1 rating for its commercial paper or short-term IOUs won't be cut, Moody's said.  Freddie Mac declined 59 percent in the past 12 months on the New York Stock Exchange and dropped another 2.9 percent today. Rising mortgage defaults forced Chief Executive Officer Richard Syron to shore up Freddie Mac's finances by selling $6 billion of preferred stock in November, slicing the dividend by 50 percent and reducing mortgage assets by 4 percent to $701.4 billion in the three months ended Nov. 30. Freddie Mac ``may experience higher credit losses than Moody's previous expectations,'' Moody's analysts led by Brian L. Harris in New York said in the report late yesterday. ``In its review, Moody's will focus on Freddie Mac's asset quality and the potential that the company may experience an elevated level of credit charges over the near to medium term.''  The New York-based rating company's financial strength rating measures the likelihood a company will need assistance from a third party, such as the government or shareholders.”

From Deutsche:  “This raises the possibility that Freddie might proactively address its

expected credit losses/provisions for Q4 before the release of its Q4 financials report. To continue to manage capital, we would expect to see further declines in the retained portfolio. The retained portfolio has declined by about $30bn since August and now stands at 701.4bn. Our expectation is that Freddie will choose to reduce the portfolio size before resorting to another dividend cut or preferred stock issuance or a BFSR downgrade. This could be positive for the senior debt in the medium-term after the headline shock subsides as long as no actual debt downgrades occur.”

Implications of a $2,500 Car on Oil Prices

From The Houston Chronicle:  “On Thursday, the Indian automaker Tata Motors is expected to unveil a car that sells for $2,500.  That's less than some Americans will spend on a big-screen high-definition television before the Super Bowl. But it's within reach for many in India's emerging middle class, where the nominal per capita income is $1,089, according to the International Monetary Fund…The car, of course, is not something most Americans would want to drive. Tata's design codifies cheap, and the sacrifices are legion, according to a description in the New York Times. Standard safety equipment for most U.S. vehicles, for example, costs more than $2,500.  The new Tata will not, by our standards, be safe or environmentally friendly, and it probably won't be fun to drive. It has a maximum horsepower of about 35, the Times reported, so it's more lawn mower than muscle car.  But that's not the point. Tata knows that most people who already own cars won't be interested in its new model, whose name hasn't been revealed.  It's targeting the hundreds of millions of people in the developing world who now ride scooters or bicycles or walk.  If it succeeds, crude prices may continue their climb of the past year. The Tata probably will consume far less gasoline than the sport utility monstrosities common on American highways, but even the addition of several hundred million lawn mowers would rattle the markets.  "This is going to really shoot demand to levels we have not seen before," said Michael Economides, an oil expert at the University of Houston and a former adviser to several state-owned oil companies. "That's going to open up segments of the population that weren't accessible."  In China, for example, demand for oil surged in recent years as more people moved to urban areas, their incomes rose, and they bought cars. Now, 1,000 new cars take to the streets of Beijing daily, Economides said.  Tata is, in essence, offering mobility to the emerging middle-class economies of India, Vietnam, Pakistan, China and much of Africa. We know, better than anyone, what a middle class does when it adopts a device that fundamentally changes lifestyles: It never lets go.  In fact, it upgrades. The people buying $2,500 Tatas today will someday be buying more expensive models with more car-ness — bigger and heavier bodies, more powerful engines and more options like air conditioning and electronics. All of which translates into even greater demand for fuel.  "The price of oil is becoming less and less dependent on what happens in the U.S.,"…”

MISC

From Bloomberg:  “European Central Bank President Jean- Claude Trichet signaled the bank won't cut interest rates and may raise them to contain inflation even as economic growth slows.  The ECB's Governing Council is ``prepared to act preemptively so that second-round effects and risks to price stability do not materialize,'' Trichet said at a press

conference in Frankfurt today after the bank kept its benchmark interest rate at 4 percent. He said policy makers will ``not tolerate'' an inflation spiral of rising prices and wages.”

From The Wall Street Journal:  “Two of the biggest names on Wall Street are going hat in hand, again, to foreign investors.  Citigroup Inc. and Merrill Lynch & Co… Now, they are in discussions to get additional infusions of capital from investors, primarily foreign governments.  Merrill is expected to get $3 billion to $4 billion, much of it from a Middle Eastern government investment fund. Citi could get as much as $10 billion, likely all from foreign governments.”

From Morgan Stanley:  “It is likely that SWFs [Sovereign Wealth Funds], in the aggregate, may outsource 20% or so of their assets to external investors. The new SWFs being established may place US$150 billion or so of funds with external managers. Going forward, as the AUM of all SWFs grow over time, another US$200 billion may be placed with external managers annually over the coming five years.”

From CITI:  “GS reports there is a 50% chance Japan will slip into recession and cut its

2008 growth estimate for Japan.”

From Bloomberg:  “Wal-Mart Stores Inc. and Costco Wholesale Corp. posted December sales that exceeded analysts' estimates as shoppers increased spending at discount chains after feeling the pinch of higher gasoline costs and lower home prices.  The results provided a glimmer of hope after the worst holiday-sales season since 2002.”

From The LA Times:  “Americans shopped hard enough during the holidays to give stores a boost in sales over last year -- with many purchases charged to credit cards.  That's not unusual. But in November, according to government data, revolving consumer debt climbed at an annual rate of 11.3%, the most in six months.  That means people will be struggling to wipe away debt even as the economy is relying on them to help it steer clear of a recession.  "It's just a matter of time before we see more pronounced weakness in consumer spending," …And as the new year gets underway, shoppers …are reining themselves in. "I found that my spending was a lot more on credit cards," … "So now I have to cut back so I can pay it off." …"The credit card debt is the hardest debt to escape from," …Many Americans will be redirecting or curtailing their spending as they worry about an expanding array of problems, including the weak housing market, tighter credit, slower job growth and an unnervingly erratic stock market.  Some who spend beyond their means can dip into savings and pull out the plastic only so long before they're left with two unpleasant options: sharply cut spending or file for bankruptcy. Or both. That's bad news either way for retailers coming off a less than cheery holiday season.”

From The Atlanta-Journal Constitution:  “…for a shot at a job at a new Wal-Mart…In just two days, and with virtually no advertising or even any signs, a staggering 7,500 people filled out applications for one of the 350 to 400 available positions.”

From Bloomberg:  “Some economists, including Blinder, also fault Greenspan for fostering the housing bubble by keeping interest rates too low for too long. The Fed cut its benchmark rate to a 45-year low of 1 percent in June 2003, held it there for a year, then raised it only gradually, in quarter-percentage-point increments…A simulation by Stanford University professor John Taylor suggested that much of the housing boom could have been avoided if the Fed hadn't cut rates so deeply and had raised them back

up more quickly…Greenspan maintained that the housing bubble was inflated not by the Fed's monetary policy but by a global savings glut that held down long-term interest rates worldwide… Greenspan also pointed out that the U.S. wasn't alone in experiencing a housing boom in the early 2000s. The IMF said in its World Economic Outlook last October that other nations, including Britain, Spain and Australia, experienced bigger house price run-ups than the U.S.”

From Bloomberg:  “Greenspan said in the interview that, while the Fed's bank examiners were hard at work during the mortgage-lending boom, ``we have to be realistic about what regulators can and cannot do.''  ``It is extremely rare to uncover fraud other than through whistle-blowers,'' he said. ``You don't get at it through internal audits, you don't get it through outside audits and you certainly don't get it through bank examinations.''

From CNN:  “With the national foreclosure rate zooming and the real estate market in a two-year funk, the insurance industry fears more homeowners will see arson as a way out of their financial woes. A recent report by the industry-funded Coalition Against Insurance Fraud notes that with "untold thousands of homeowners struggling with ballooning subprime mortgage payments, fraud fighters are watching closely for a spike in arsons by desperate homeowners who can no longer afford their home payments."

History indicates such a spike is coming. "When the economy is down, we see an increase in fraud," says Dennis Schulkins, a claim consultant in State Farm's Special Investigative Unit.  It may already be happening. Allstate spokesman Mike Siemienas says his company has seen an increase nationally in arsons among homes in foreclosure. In California, the state¹s insurance division reports that the number of questionable residential fires in 2007 increased 76 percent over 2006.  National arson statistics for 2007 aren't yet available, but Federal Bureau of Investigation crime data shows there was a significant uptick - 4 percent - in suburban arson in 2006, when the real estate downturn began to take hold. The arson increase in 2006 marked a change from the prior three years when suburban arson fell 3 percent, 5 percent and 6 percent, respectively.”

From Bloomberg:  “Lennar Corp.'s November sale of 11,000 properties in eight states set a price that may mark the bottom for the U.S. housing market: 40 cents on the dollar.  That's how much Morgan Stanley Real Estate paid for an 80 percent stake in the 32 communities, 60 percent less than the price at which the properties were valued just two months earlier. That's also what some investors say they would pay for distressed land, condominiums, homes and whole developments, whether it's now or later this year… About 150 so-called real estate opportunity funds have been formed to buy distressed properties and other assets, a 21 percent increase over the number this time last year and an all- time high, according to Real Estate Alert”

From The Christian Science Monitor:  “…the plight of the real estate agent – average age, 51 – reveals the human dimension of how loose lending, raw opportunity, and self-determination produced a housing bust that has stunned the US economy… "They've tasted success and big money, and now their standard of living has been rocked and reality has set in," says John Baen, a real estate professor at the University of North Texas in Denton. "The whole [economy] has been built on real estate. When the music stops, what is left?"… Evidence is growing that agents, especially in hard-hit markets like Florida, California, and Georgia, are closing up shop in large numbers, experts say.

Here in Atlanta, the number of agents letting their licenses lapse is growing at a faster pace than the number of overall licenses held. Nationally, an average agent's income dropped from $49,300 to $47,900 between 2004 and 2006… In Cape Coral, Fla., where only 30 percent of agents sold even a single home last year, real estate agents are "dropping out" daily… The Oregon Association of Realtors reports an 11.5 percent decline statewide of licensed agents in the past year… Real estate is a line of work filled with mothers returning to the workforce, older workers squeezed out of lifetime careers, and young opportunists looking to trade sweat equity for potentially big cash-outs. Indeed, the industry norm is that only 4 percent of agents choose real estate sales as a first career.”

From BBC:  “People across South Asia are struggling to cope with a severe shortage of affordable wheat and rice…Last week Afghanistan appealed for foreign help to combat a wheat shortage while Bangladesh recently warned it faced a crisis over rice supplies. 
Global wheat prices are at record highs. Problems have been compounded by crop failures in the northern hemisphere and an increase in demand from developing countries…Initially, flour shortages pushed up the price on the open market in Pakistan to as much as 60 rupees (about $1) per kilogram in some areas. The average day labourer earns only 100 rupees a day.  The state-run Utility Stores Corporation has been selling flour at 18 rupees per kilogram, but it does not have enough outlets to serve the population of 160 million.”

From Barclays:  “US crude inventories are now 71 mb lower than at the end of June. We estimate that inventories above minimum operating requirements have fallen over that time by some 70%...The cumulative effect of the gradual marginal tightening of the oil market over the past year has been to take a significant bite out of the inventory overhang …. As a very rough proxy measure of the current situation, adding together the latest available inventory data from the US, Japan and the EU-15 results in the following picture. Crude oil inventories have fallen by 45 mb Y/Y, while oil product inventories have fallen by about 86 mb Y/Y. Regionally, there are some stark differences. In Europe the Y/Y fall is virtually all in products, in Japan it is mainly crude, and in the US it is about 50-50 crude and products. In the US, the latest weekly data takes the overall inventory situation further below the five-year average…”

From Handelsbanken:  “While everyone is focused on the housing market, rising stress in the automobile industry may prove to be the unexpected event that eventually pushes the economy over the edge. Just when it looks as if a number of auto parts manufacturers are about to exit bankruptcy protection, domestic manufacturers have scheduled a significant reduction in planned assemblies. According to recently released data, domestic assemblies are set to decrease 7.5% in the current quarter to 9.8 million units seasonally-adjusted annual rate. A drop in the automotive build rate is long overdue and reflects the excessive level of inventories on dealer lots. Dislocations in the financial markets have also made it more expensive for manufacturers to offer consumer incentives to move vehicles. Although a cut back in assemblies will add to the downward pressure on the labor market, rising delinquencies on auto loans will probably not exacerbate the problems already facing the asset-backed market. The auto ABS market is fundamentally different from the sub-prime mortgage market. Specifically, consumers did not buy autos anticipating price appreciation and auto loans are not subject to reset risk as they are fixed rate loans.”

From Goldman:  “…evidence of rising inflationary pressure has raised the spectre of ‘stagflation’. Inflationary pressures have picked up. A variety of measures of global inflation show both headline and core inflation rising in a broad range of markets. Still-tight capacity, easy policy in places and the surge in food and energy prices are largely to blame. The next couple of months may also see the most troubling combination of growth and inflation headlines. Given that the market has seen and traded weak growth news already, signs of inflation problems may present the greatest new data risk in the near term. Despite these headlines, we think the risk of a persistent inflationary threat is exaggerated. As the US and others slow more, upward pressure on core inflation should reverse later in 2008. And food and energy prices may remain high, the rate of inflation here could drop quite sharply, bringing headline inflation lower. But while we expect this more benign reality to become clearer through 2008, the current point – with growth slowing, but inflation yet to respond – means the market may well worry more about inflation constraints.”

End-of-Day Market Update

From Deutsche Bank:  “In response to Bernanke's comments markets have sharply steepened the Treasury curve - whilst the front end has rallied, 10yr Treasury yields are actually up 5bps on the day. Equities have rallied, although this seems to owe as much to news that Bank of America is in advanced talks to buy Countrywide Financial Corporation.”

From AP:  “Gold soared to a record high Thursday after Federal Reserve Chairman Ben Bernanke pledged to cut interest rates, undermining the dollar and boosting demand for metals as a safe investment.”

Three month T-Bill yield unchanged at 3.23%.

Two year T-Note yield fell 3bp to 2.68%

Ten year T-Note yield rose 5.5 bp to 3.88%

2/10 Treasury curve steepened to  120bp

Dow rose 118 to 12,853 

S&P 500 rose 11 to 1420

Dollar index fell .54 to 75.88

Gold rose $14 to $893 (New all-time record high)

Oil fell $1.50 to $94.13

*All prices as of  4:30pm