Today's TIDBITS

March 18, 2008   

Why is Bear Stearn’s Stock Trading at Over $2 a Share?

From Bloomberg:  “Bear Stearns Cos. rose 45 percent in New York trading to triple the current $275 million value of JPMorgan Chase & Co.'s buyout plan as traders increased bets that investor resistance would force a higher offer.  JPMorgan, with backing from the Federal Reserve, agreed on March 16 take over the 85-year-old New York-based securities firm for about $2 a share in stock to prevent a collapse.  Shareholders must approve the transaction.  Yesterday, billionaire Joseph Lewis, Bear Stearns's second-biggest shareholder, called the price ``derisory,'' according to a phone interview cited by CNBC. Other investors may share that opinion.  ``It's perfectly possible that the deal you see right now is not the deal you're going to get…There's every incentive for shareholders to vote `no' the first time.''

From Fortune:  “Why is Bear Stearns (BSC) up nearly 70% Tuesday, to a price about $6 a share above its $2-a-share buyout agreement with JPMorgan Chase (JPM)? Two groups are piling into the company’s stock so they can vote in favor of the deal…The first group is the hedge funds that were selling so-called credit default swaps that protect the purchaser against a possible bankruptcy at Bear Stearns. Spreads on Bear Stearns CDS soared to 1,000 basis points Friday - meaning it cost $1 million to insure against a default of $10 million face value of bonds. Those spreads have since narrowed to around 350 basis points, or $350,000 per $10 million in insurance, in light of the prospect that JPMorgan Chase will take over Bear’s obligations. So a seller of a Bear Stearns credit default swap on Friday, having taken in $1 million in premium, can now turn around and protect himself against a default in Bear Stearns for $350,000.  That translates into a $650,000 gain -and the potential profit stands to get bigger as the close of the transaction approaches and Bear spreads move more in line with JPMorgan’s, which are around 115. Those dynamics give hedge funds a big incentive to make sure the deal goes through.  Beyond the credit default swap trade, there’s another group interested in making sure JPMorgan winds up owning Bear Stearns. Holders of Bear Stearns debt want the deal to go through so they won’t end up fighting with other creditors in bankruptcy court over the remains of the firm - the likely outcome if Bear shareholders turn the deal down. And Bear Stearns bonds that recently traded as low as 80 cents on the dollar could soon be worth 100 cents if JPMorgan goes through with its purchase.  So while taking a loss on the stock makes little sense on the face of it, buying at $7 to get cashed out at $2 can pay off if you’ve bet enough money elsewhere.”

Fed Decided Systemic Risk Greater than Moral Hazard Risk - Puts Fed’s Resources and Reputation at Risk

From The International Herald Tribune:  “Far more than at any time before, the Federal Reserve is putting its vast resources and its reputation on the line to rescue Wall Street's biggest institutions from their far-reaching mistakes.  Over the next few months, the central bank will lend hundreds of billions of dollars to banks and investment firms that financed a mountain of mortgages now headed toward default.  No one knows how many financial institutions will be looking for money, or how much they will seek. No one knows how much in hard-to-value securities the central bank, in return, will have to hold as collateral.  And no one knows how much the Fed could lose if the borrowers fail to repay their loans or whether hundreds of billions of dollars will ultimately have to come from taxpayers to shield the nation's financial system from ruin.  In recent weeks, the central bank announced a series of emergency short-term loan programs that totaled about $400 billion. But on Sunday, Fed officials raised the stakes by offering investment banks a new loan program without any explicit size limit.  These moves, along with a $30 billion credit line to help JPMorgan Chase take over the failing Bear Stearns, is fraught with more than financial risk.  The biggest danger is damage to the Federal Reserve's credibility if it is seen as unwilling to let financial institutions face the consequences of their decisions. Central banks have long been acutely sensitive to "moral hazard," the danger that rescuing investors from their mistakes will simply encourage others to be more reckless in the future.  Fed officials for years have cringed at the mention of a "Greenspan put," an allusion to the belief of some investors that Alan Greenspan, the former Fed chairman, would use the Fed's powers to protect them against a plunge in financial markets and provide them with a metaphorical "put" — an option to unwind their positions at an acceptable price.  But the moves undertaken by the current chairman, Ben Bernanke, amount to a much bigger insurance policy than anything Greenspan provided.  Bernanke had made clear for months that he wanted to avoid a bailout of Wall Street. But as an economic scholar who spent years studying the Depression of the 1930s, he had also drawn the lesson that panics in financial markets can transform a modest downturn into a cataclysm.  Fed policy makers now contend that the consequences of not coming to the rescue would have been a cascade of bankruptcies and defaults on Wall Street that could have undermined the financial system and risked severe damage to the economy.  Few analysts were ready on Monday to question the Fed's uncomfortable effort in balancing risks. But it could be months or years before the full consequences become apparent.  Alan Blinder, a professor of economics at Princeton and a former Fed vice chairman, commented: "These kinds of crisis-prevention measures always have to balance potential moral hazard costs down the line against the clear and present danger that something is going to happen right now.  "You're taking on substantial risks when you do something virtually unprecedented or you put money at risk. The Fed has now done both."  Another big risk is that the central bank, in providing a cushion of emergency loans, could jeopardize its reputation as an inflation fighter… There were hints on Monday that the central bank's rescue operation might have bolstered confidence in the battered credit markets.  Several measures of risk aversion receded slightly. Spreads between the higher yields that investors demand for debt securities compared with those for safer Treasury bonds declined slightly. So did prices for credit default swaps, which amount to insurance premiums paid to protect bondholders in the case of a default… Analysts caution that for all its might, the Federal Reserve and its loan program face limits unless officials decide to start printing more money to pay for the rescue.

At the moment, the central bank has committed cash and Treasury bonds that are in its own reserves, totaling about $800 billion. But having agreed to provide at least $400 billion in short-term loans, and probably more, it is pledging a big share of its resources to the rescue.  "The Fed is now running on less than a half tank of gas," Laurence Meyer, a forecaster at Macroeconomic Advisers and a former Fed governor, wrote in a note to clients. "The Fed seems to be running out of room for these types of measures."  Officials at the central bank brushed aside such concerns, noting that many of the loans would be limited to 28 days and that the longest-term loans have to be repaid within 90 days. Fed officials also say that the combined rescue effort is not as big as the sum of the individual loan programs implies, because some institutions will simply shift from an earlier program that is less convenient to the newest one announced on Sunday.  If the rescue effort fails, taxpayers could indirectly wind up having to assume part of the cost. Tax revenue does not pay for the Federal Reserve's operations, including the rescue effort, because the Fed earns income from its trading operations.  But the Fed does pay the Treasury a regular stream of money every year out of its trading profits, lowering the amount it needs to borrow from outsiders. If the new borrowers on Wall Street are unable to repay, and if the market value of the securities they pledge as collateral continues to drop, the losses will come out of the Fed's payments to the Treasury.”

How Bond Ratings Became So Important to the Financial System

From Time:  “The practice of giving letter grades to bonds to reflect their riskiness was pioneered by John Moody in 1909. But the industry took its current form only in the early 1970s. That's when Moody's and its competitors switched from selling research to investors to charging bond issuers to rate their goods. This approach wasn't unheard of: you have to advertise in Good Housekeeping to get the Good Housekeeping Seal of Approval. What made it problematic was that at about the same time, the Securities and Exchange Commission (SEC) exalted the status of the ratings by writing them into the rules governing securities firms' capital holdings. Since then, the use of bond ratings in regulation has only grown. Many institutional investors are banned from owning non-investment-grade bonds. Bank-capital requirements--the cash and equivalents banks need to keep on hand--give more weight to highly graded securities. And this is increasingly the case not just in the U.S. but around the world.  What all this amounts to, argues Frank Partnoy, a derivatives salesman turned University of San Diego law professor, who is one of the sharpest critics of the ratings status quo, is a "regulatory license" for the ratings agencies. It's certainly a license to print money. Moody's, the lone ratings firm for which data are available, made $702 million in after-tax profit last year, up from $289 million just five years before. Its operating profit margin was a stunning 50% of revenue. By comparison, Google's was 30%.  To keep that profit machine going, Moody's and S&P have to keep finding new things to rate. And they're under intense pressure from issuers and investors alike to get as many securities as possible into the top ratings categories. The result is grade inflation, especially in new products like CDOs. That's how banks and investors around the world ended up owning billions of dollars in triple-A mortgage junk. It also helps explain the growth of bond insurers, companies that used their own triple-A ratings to bump ever more bond issues into the top categories--even as their businesses ceased to be triple-A safe.  One way to combat these tendencies would be to subject the raters to tight regulation by the sec. But that understaffed agency is unlikely to be up to the task, especially since it's not clear what exactly the task would be.  Which leaves the alternative suggested by Partnoy and several economists: cleansing the federal code of its reliance on bond ratings. Among the simplest fixes would be removing the ban on pension funds' holding debt securities rated lower than BBB. The funds can make far riskier investments in stocks and hedge funds, after all. Bank-capital requirements do have to take into account the quality of securities, but there are market-based measures that could at least partly replace ratings.”

Bank Credit Remains Tight As More Back-Up Lines Are Used

From Bloomberg:  “Citigroup Inc., JPMorgan Chase & Co. and the rest of the banking industry face a new drain on their capital.  Borrowers from Sprint Nextel Corp. to Porsche Automobile Holding SE to MGIC Investment Corp. are drawing on credit lines.

JPMorgan analysts say it's the start of a trend that may force banks to raise as much as $40 billion to keep an adequate cushion against potential losses.  Companies are scrambling for cash at one of the worst times for the financial services industry. The world's biggest firms have taken $195 billion in writedowns and losses on securities tied to subprime mortgages, and the 10 biggest U.S. banks have the lowest capital levels in at least 17 years, according to Credit Suisse Group… ``The capital of the financial system has imploded,'' Goldman, a former head of debt research at Bank of America Corp., said in an interview on Bloomberg Radio in New York last week. ``They have commitments to make loans, which they are being called out on, and their capital is bleeding to death.''   Bear Stearns Cos. was forced to sell itself to JPMorgan for $240 million, 90 percent less than its value last week, after the firm was crippled by clients pulling money and lenders reining in credit.  Banks had more than $1.4 trillion in untapped loan commitments as of September, the most since data became available in 1989, according to the Shared National Credit survey by four U.S. regulators including the Federal Reserve and Office of the Comptroller of the Currency.  New York-based Citigroup had $471 billion at yearend, more than any other U.S. bank, according to regulatory filings.  Charlotte, North Carolina-based Bank of America disclosed $406 billion of undrawn loan agreements and New York-based JPMorgan had $251 billion. Merrill Lynch & Co. had $59.3 billion.  The banks' Tier 1 capital, which includes common stock, retained earnings and perpetual stock, shows why any further drain may ``severely'' limit new lending, said Credit Suisse …The median Tier 1 level at the 10 biggest U.S. banks fell to 7.3 percent of risk-weighted assets at the end of 2007, from 8.7 percent a year earlier, according to the analysts. The ratio hasn't been as low since the Zurich-based bank began tracking in 1990. The minimum for a ``well-capitalized'' rating from regulators is 6 percent. The assets are calculated by weighing each type relative to its chance of default.  To compensate for the declines, banks have raised at least $50 billion in new capital from investors such as the Government of Singapore Investment Corp. and Abu Dhabi Investment Authority to bolster their balance sheets… The added demand from borrowers comes as banks rein in lending to everyone from hedge funds to homeowners in an attempt to preserve capital… Borrowers will be more inclined to tap credit lines as banks tighten their lending standards… ``It's a vicious cycle,'' he said. ``The more that they tighten the lending standards, the more there will be certain stresses in the financial market. Any sort of unfunded commitments they've put out are likely to be called on.''… ``If they are short of capital at some point, banks may stop offering credit to borrowers that would normally qualify for a loan,'' said Anil Kashyap, a professor at the University of Chicago Graduate School of Business, and a former economist for the Federal Reserve. ``That's the definition of a credit crunch.''”

European Central Bank (ECB) Monetary Policy On Hold for Now

From MNI:  “Acute and ongoing concerns about inflation will keep the European Central Bank's monetary policy on hold for the foreseeable future despite slowing economic growth and a sharply rising euro, well-placed eurozone central bankers have told Market News International.   With inflation above 3%, oil over $100 a barrel, and wage talks threatening to yield potentially inflationary pay rises, the ECB would probably be considering an interest rate hike under more normal circumstances.  But severe market turbulence, economic headwinds from across the Atlantic, and the euro's unrelenting ascent have left the bank with its hands tied for now…”

Dealer Comments on FOMC Decision

From Goldman:  “The decision of the Federal Open Market Committee to cut its federal funds rate target by 75 basis points is a clear disappointment to the markets, which had priced in 100bp up until right before the announcement, when they backed off only slightly from this view.  From the nature of the statement, it seems clear that any thought of easing by 100bp would have met with considerable resistance. As it was, two members -- Fisher of Dallas and Plosser of Philadelphia -- dissented from the 75bp move; both "preferred less aggressive action at this meeting."  Moreover, only three district banks -- Boston, New York, and San Francisco -- applied for the parallel cut in the discount rate to 2-1/2%.  Of those, only the New York President -- Timothy Geithner -- is a voting member at this time (he is permanently Vice Chair of the FOMC).  Although one cannot be absolutely sure what the other banks had applied for, it appears that even the 75bp rate cut had soft support outside the Northeast corridor.  If so, then 100bp could have invited a couple more dissents.  The statement is factually faithful to recent developments, noting a further weakening in growth, both overall and in consumer spending in particular, and a softening in the labor markets.  It also comments on the stress in financial markets, noting the likely dampening effect on growth in coming quarters.  On the inflation side, the statement notes an increase in "some" measures of expectations but reiterates the Committee's expectation that inflation will moderate as pressures ease in commodity markets and on resource utilization.  Although the final pargraph focuses mainly on "downside risks to growth," the final statement has shifted a bit to resurrect this concern about inflation. Whereas in January it promised that the Committee "will act in a timely manner as needed to address those risks" -- implying risks to growth -- today the parallel statement amends the final clause to say "to promote sustainable economic growth and price stability."”

From FTN:  “…they are concerned about inflation, too, enough that they say more about inflation than growth… It is entirely possible that Bernanke pressed for a full point cut and was forced to settle for 75bp, but more likely he got exactly what he asked for. Fisher and Plosser apparently were unable to push Mishkin, who has expressed a similar concern over inflation in recent weeks, or anyone else to stand with them. Still, Bernanke will have his hands full if inflation continues to push higher. There is internal division within the Fed now.”

From Morgan Stanley:  “…for the first time in memory, the statement indicated that “inflation expectations have risen.”  We are surprised at the outcome of the meeting from a number of different standpoints. In the wake of the unprecedented action announced on Sunday night, we had been looking for a 100 bp cut in the funds rate target. We also believed that the wording of the statement would be at least as dovish as the January version. Finally, even though Plosser and Fisher are well known hawks, we are very surprised that more than one policymaker would issue a formal dissent in such a fragile environment.  Indeed, the dissents might be a signal that the 75 bp outcome represented a compromise between some who pushed for a larger move and those that would go along with only a 50bp cut.”

From Deutsche Bank:  “Some of the internal debate was probably reflected in the votes for the discount rate cut.  Only three banks supported a 75bps cut, whereas the January move had the support of nine banks.  After today's action, we believe any further rate cuts are likely to be in smaller increments.  At present, we are looking for a 50 bp cut at the April meeting and a 25 bp cut at the June meeting.” 

From Citi:  “In the context of recent days' near seizing up of the financial markets, this is a surprising  posture. If this action fails to support renewed financial stability, inflation

will not be among the key worries and policy would be more likely pressed eventually to use unconventional policy and let go of controlling the funds rate. Credit and equities will be key over the next few days in assessing how much closer to zero policy may need to go.”

From Merrill Lynch:  “It is a sign of these turbulent times that the Fed can be accused of doing the minimum expected while lowering the funds rate …in what was the largest proportional easing on record.  This would have been like Volcker cutting rates 450 bps in one fell swoop.”

From Merrill Lynch:  “…in nominal terms, the FFR [Fed funds rate] is now 150.0 to 175.0 bps below its 'neutral" level, which is highly accommodative, and in 'real" terms, the FFR is negative, and highly stimuluative.”

From Bank of America:  “The Federal funds rate is now below both headline and core inflation, and is also below select measures of inflationary expectations. :

[ Note- Post FOMC, most dealers are looking for another 50bp of easing in April]

MISC

From Deutsche:  “The repo mkt has broken its mooring and seems to be headed for zero.  There is so much cash out there looking for a short-term place to rest that it has overwhelmed the mkt.  The Treasury just auctioned 31bln 1mo Bills at 0.52[%].”

From Morgan Stanley:  “The GSEs could grow roughly 30-40 bln for each 1 bln in capital that is released from the ofheo surcharge …That is if they earmark each 1bln of capital release to straight purchases of mortgages.”

From USA Today:  “More than three in four Americans think the country is in a recession, a USA TODAY/Gallup Poll over the weekend shows, reflecting a crisis of confidence that economists say could make the economy worse… Not since September 1992, two months before President George H.W. Bush lost re-election, have so many Americans said the economy was in such bad shape… Asked if the nation could slip into a depression lasting several years, 59% said it was likely, and 79% said they were worried about it. A recession is an economic downturn that usually lasts at least six months; a depression is longer, deeper and more broadly dispersed.”

From Bloomberg:  “The cost of crude oil exceeded the value of gasoline for the first time in more than two years as oil surged to a record, undermining the profitability of refining. U.S. gasoline futures on the New York Mercantile Exchange, representing wholesale prices, normally cost more than the raw material, crude oil, to reflect the cost of refinery processing.”

End-of-Day Market Update

From Bloomberg:  “U.S. stocks rallied the most in five years as earnings from Lehman Brothers Holdings Inc. and Goldman Sachs Group Inc. allayed concern investment banks are collapsing and the Federal Reserve cut its benchmark rate.  Lehman, the fourth-biggest securities firm, had its steepest advance ever and helped lead financial stocks to their biggest gain since 2000. Goldman, the largest securities firm, rallied the most in nine years. All 10 industry groups in the Standard & Poor's 500 Index added at least 1 percent after the Fed cut the target rate for overnight lending by 0.75 percentage point, helping the market erase a two-day tumble that wiped out $767 billion following Bear Stearns Cos.'s collapse. ``The run on the investment banks would appear to be over,… It seems certain we are going to finish the week with the four investment banks we started with, and we couldn't be sure of that Monday morning. The Fed decision is actually a bit of a sideshow.''      The S&P 500 rose 54.14 points, or 4.2 percent, to 1,330.74. The Dow Jones Industrial Average climbed 420.41, or 3.5 percent, to 12,392.66, its fourth-biggest point gain ever. The Nasdaq Composite Index increased 91.25, or 4.2 percent, to 2,268.26. Sixteen stocks rose for every one that fell on the New York Stock Exchange. Treasuries dropped and the dollar surged the most in almost four years against the yen.  Financial shares in the S&P 500 gained 8.5 percent as a group, the top advance among 10 industries, after the better- than-forecast earnings at Lehman and Goldman assuaged concern that Wall Street firms were overvalued. The Fed reduced its benchmark rate to the lowest level in more than three years. The central bank has cut the rate six times and slashed the discount rate for direct loans to banks eight times since the middle of August, when the collapse of subprime mortgages started to infect markets around the world. Goldman surged $24.57, or 16 percent, to $175.59. Net income fell to $1.51 billion, or $3.23 a share, in the three months ended Feb. 29 from $3.2 billion, or $6.67, a year earlier, Goldman said in a statement. The average estimate of 17 analysts surveyed by  Bloomberg was for $2.59 a share, with forecasts ranging from $1.95 to $3.40. Lehman, which lost 19 percent yesterday, climbed 46 percent today to $46.49. First-quarter net income declined to $489 million, or 81 cents a share, from $1.15 billion, or $1.96, a year earlier, the New York-based firm said. That beat the 72- cent average estimate of 16 analysts surveyed by Bloomberg. Earnings were depressed by a $1.8 billion writedown caused by the slump in the mortgage market. Assuming Lehman will fail because Bear Stearns did is ``a bad bet to make,'' …While both are involved in mortgage securities, Lehman has more diversity from overseas operations, money-management businesses and high-profile deals…Citigroup Inc., the biggest U.S. bank, advanced $2.09 to $20.71. JPMorgan Chase & Co., the third-largest U.S. bank, gained 6 percent. Merrill Lynch & Co., the third-biggest securities firm, added 13 percent.  U.S. financial stocks are getting closer to ``bottoming out,'' analysts at Morgan Stanley said.  ``We view the banks as vulnerable to the credit cycle, with Fed rate cuts only a partial offset,'' the analysts, led by Nigel Dally, wrote in a report to clients. ``But some of these risks are now in the stocks.''      Financial shares tumbled to their lowest level in almost five years yesterday on concern Wall Street's biggest firms may be overvalued following the $2-a-share takeover of Bear Stearns by JPMorgan.”

From Bloomberg:  “The dollar surged the most in nine years against the yen and gained against the euro after the Federal Reserve cut interest rates by 0.75 percentage point in a bid to boost the economy and confidence in financial markets… The ``interest-rate differential is less negative for the dollar,'' … ``The currency market had completely discounted'' a full-point cut.… The U.S. currency has lost 15 percent against the yen and euro in the past year…”

From UBS:  “Treasuries sold off most of the day as better-than-expected earnings from Goldman and Lehman eased the market's worries. The news that OFHEO was planning to reduce the GSEs' excess capital requirements also breathed life into Agency spread product. When the Fed rate cut proved smaller than many expected, yields shot up even more in the front end, and the 2s30s curve flattened nearly 22bps by 3pm… TIPS recovered some of their losses from the last few days, with January 2009 breakevens out by 18bps and the breakeven curve flattening 15bps. Crude was up more than $3/barrel on the day, and stocks finished with large gains notwithstanding a slight hiccup after the Fed. Treasury volume was 97% of the 30-day average… Swaps saw light flows, and front end spreads narrowed significantly on the feeling that the Fed will continue to swoop in to save the credit markets and the banks, if needed. Swap spreads across the board did bounce off their tights of the day after the Fed only eased 75bps, however. Agencies shot up as speculation abounded about the easing of capital constraints on the GSEs', with Fannie stock up 30%. At one point, 10-year agencies were 30bps tighter to Treasuries and 25 tighter to swaps, but have come in about 5bps from their tights. Even so, today's spread tightening in 10yr Agencies versus swaps is one of the biggest moves ever. Mortgages opened a lot tighter on short covering, but prices got pushed so high it brought about billions in origination. MBS went from 12 ticks tighter to Treasuries pre-Fed to 5 wider post-Fed. After some new buyers showed up, they are now 3 tighter to Treasuries.”

Three month T-Bill yield fell 20 bp to 0.87% 

Two year T-Note yield rose 26 bp to 1.60% 

Ten year T-Note yield rose 15 bp to 3.46% 

Dow rose 420 to 12,393  

S&P 500 rose 54 to 1331  

Dollar index rose 0.38 to 71.83

Yen at 99.8 per dollar 

Euro at 1.564

Gold fell $25 to $977.5

Oil rose $3.09 to $108.80 

*All prices as of 4:15 PM

Core PPI Much Higher Than Expected in February +2.4% YoY

Headline PPI was better than expected in February, but core was much worse than expected.  Headline inflation rose +.3% MoM (consensus +.4% MoM, prior +1% MoM), and the annual rate fell a full basis point to 6.4% from the 25-year high rate in January of +7.4% YoY.  Conversely, core PPI, which excludes food and energy, rose +.5% MoM (consensus +.2% MoM, prior +.4% MoM), and the annual rose to +2.4% YoY from +2.3% YoY the prior month, consensus had looked for the level to fall back to +2.1% YoY.  The annual core CPI rate peaked last year at +2.6% YoY in October.  The monthly rise in core was the largest since November 2006.  The price increases were broadbased in February, as everything from tableware to toilet paper saw price increases.

 

Energy cost increases slowed to +.8% MoM from the +1.5% MoM gain the prior month.  Gasoline prices rose +2.9% MoM for the second month in a row, while residential gas prices shot up +5.7% MoM in February versus only growing by +.7% MoM in January.  Residential electricity costs fell -.4% MoM.  Over the past year, energy prices have risen +19.6% YoY, with gasoline prices +43% YoY.  Residential gas and electricity prices are both us less than 3.5% YoY.  Food prices fell -.5% MoM, but remain +6% higher YoY.  Both food and energy prices are expected to rise in March.

 

Consumer goods prices rose +.3% MoM and are up +7.8% YoY.  Prescriptions (+1.3% MoM, +6.4% YoY) were the only category, other than energy related products, to increase over 1% MoM last month.  Passenger cars showed a resurgence, rising +.8% MoM.  There had been some thought that higher incentives would keep this growth restrained.  Car sales have been weak so far this year. Durable goods prices rose +.5% MoM and non-durable goods rose +.7% MoM.  Core consumer goods prices rose +.6% MoM, and are up +2.9% YoY.

 

Capital equipment prices rose +.5% MoM (+1.9% YoY).  Light truck prices rose +.8% MoM, but are unchanged YoY.  Computer equipment continues to get cheaper, falling -24% YoY.

 

The prices of crude goods accelerated to +3.7% MoM in February from +2.5% MoM in January and +1.1% MoM in December.  Over the past year, crude goods prices have risen +24.6% YoY.  Within crude goods, energy has risen +30% YoY and food has risen +18.5% YoY. 

 

At the intermediate goods level, prices rose a more restrained +.8% MoM, down from +1.4% MoM in January.  Year-over-year, intermediate producer prices have risen +8.8% YoY, with energy rising +22.6% YoY and food +18.7% YoY.

 

The link between producer and consumer price rises is not tight, so the increase in producer prices while consumer prices eased last month, may indicate further squeezing of profit margins as companies find it difficult to pass on rising input prices to consumers.

FOMC Statement - Cuts 75 points

U.S. Federal Open Market Committee Statement: Text

2008-03-18 14:15 (New York)

March 18 (Bloomberg) -- The following is the full text of
the statement released today by the Federal Reserve:
The Federal Open Market Committee decided today to lower
its target for the federal funds rate 75 basis points to 2 1/4
percent:
Recent information indicates that outlook for economic
activity has weakened further. Growth in consumer spending has
slowed and labor markets have softened. Financial markets remain
under considerable stress, and the tightening of credit
conditions and the deepening of the housing contraction are
likely to weigh on economic growth over the next few quarters.
Inflation has been elevated and some indicators of
inflation expectations have risen. The Committee expects
inflation to moderate in coming quarters, reflecting a projected
leveling-out of energy and other commodity prices and an easing
of pressures on resource utilization. Still, uncertainty about
the inflation outlook has increased. It will be necessary to
continue to monitor inflation developments carefully.
Today's policy action, combined with those taken earlier,
including measures to foster market liquidity, should help to
promote moderate growth over time and to mitigate the risks to
economic activity. However, downside risks to growth remain.
The Committee will act in a timely manner as need to promote
sustainable economic growth and price stability.
Voting for the FOMC monetary policy action were: Ben S.
Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Donald
L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Sandra
Pianalto; Gary H. Stern; Kevin M. Warsh. Voting against were
Richard W. Fisher and Charles I. Plosser, who pursued less
aggressive action at this meeting.
In a related action, the Board of Governors unanimously
approved 75 decrease in the discount rate to 2.5 percent. In
taking this action, the Board approved the requests submitted by
the Boards of Directors of the Federal Reserve Banks of Boston,
New York and San Francisco.
--Washington newsroom +1-202-624-1820. Editor: Brendan Murray
[TAGINFO]

New York Empire Manufacturing Index Falls

The New York Empire Manufacturing Index plummeted, falling to -22.2 from -11.7 in February. The market had looked for an improvement to -7.4. This is the lowest this index has ever been since it started in 2001 (7 years). Any reading below zero indicates contraction. Both new orders and shipments were negative again in March, as the manufacturing sector continues to weaken. The New York survey is considered to be more sensitive to high tech, financial services, and international trade than some of the other regional surveys. New orders were at -4.7, an improvement from the -11.9 ( a 6.5 year low) in February, while shipments fell to -5.2 from -4.9 the prior month. Prices paid rose to 50.6, from 47.4 last month, (1.5 year high) with over half of respondents saying prices had risen. Prices received fell to 15.7 from 17.9. Forty-one percent of respondents indicated conditions had worsened this month versus 34% the prior month. On the brighter side, unfilled orders improved to +1.1 from -1.1. Employment rose to +4.5 from +2.1 in February. Inventories dropped to -4.5 from unchanged the prior month. And looking into the future, the six months expectations index rose to 25.8 from 22.7, but still remains below the levels of last year. Nationwide, manufacturing contracted at the fastest pace in almost five years last month, and this early reading indicates the slowdown is continuing, even for regions which can benefit from the weakening dollar encouraging export growth.

U.S Current Account Deficit Unexpectedly Narrowed in 4th Quarter

The U.S. trade deficit has now narrowed for three quarters in a row as the fourth quarter deficit fell to -$172.9B (consensus 1$183.8B, prior revised down to -$177.4B from 1$178.5B). The deficit for the fourth quarter of 2007 was the smallest in three years. 2007 saw the first annual decrease in the size of the deficit since 2001. The total deficit for 2007 was $738.6B versus $811.6B in 2006, causing the deficit to fall to 5.3% of GDP from 6.2% the prior year. At the current deficit rate, this still indicates that the U.S. is requiring $1.9 billion of foreign inflows a day to fund the deficit. The decline in the dollar is an indication that demand for U.S. assets is declining. The current account deficit is the broadest measure of trade because it includes income from investments and other transfer payments as well as regular goods and services. The trade deficit accounts for about half of the total current account deficit. The weaker dollar has been helping exports to increase. If not for export growth, the economy would have shrunk last year by -0.3%. That would have been the first decline since the last recession in 2001. Export growth was focused on non-agricultural and capital goods. Most of the import increase was due to higher petroleum prices. Foreigners saw a large drop in their income from U.S. investments in the fourth quarter of last year, which was the major reason for the improvement in the current account deficit in the fourth quarter. The income paid to foreigners fell by a third, from $33 billion in the 3rd quarter to $21.3 billion in the fourth quarter. In contrast, the U.S. government paid slightly more to foreigners in the fourth quarter. Part of the reason for the change is the lower dollar exchange rate.

TIC Data Shows Foreign Governments Record Buyers of U.S. Treasuries in January

January TIC data showed foreign governments buying a record amount of U.S. Treasury debt in January. Total purchases of all U.S. financial assets by foreign governments rose to a record $53.4B in January. This helped offset the declining demand for stocks, and enabled total and long-term flows into the US to remain positive at the start of this year. Total holdings of U.S. debt and equities by foreigners rose $62B in January (consensus $60B, prior $56.5B). Holdings with maturities of over a year, a good indication of true investor interest, rose $37.4B (consensus $60B), a notable decline from December's revised higher pace of $72.7B. The investment flows are indicative of continued flight to safety out of stocks and into government backed debt, and concurs with the steady drop in Treasury rates we've seen over the past few months. The Fed cut interest rates twice in January. Equity markets had also been falling for three straight months, after hitting a peak in October, by January. The TIC flows cover U.S. government, agency, and corporate debt, agency mortgages, and stocks. Demand for Treasuries rebounded strongly in January, as ten year interest rates fell over 40bps, thanks to foreign official government demand. Net Treasury positions rose by +$37.6B versus net buys of only $1.4B the prior month. Though the S&P 500 fell -6.1% in January, foreigners continued to buy, snatching up $17.4B, a decrease from the $33.5B pace in December. Agency holdings rebounded in January (+$19.3B), after declining in December (-$3.3B). U.S. investors also increased their demand for foreign assets in January, buying a net $19.2 compared to $12.6B in December. Corporate bond demand plummeted down to $6.9B from $37.5B the prior month. Private investors slowed their demand for U.S. long-term assets from $33.3B in December to $27.8B in January. This was more than offset by a rise in official purchases (central banks) of $53.4B from $35.8B in December. China (+$15B), Japan (+$5.7B), Brazil (+$11.8B), the UK (+$2.6B), and major oil exporters (+2.8B), all increased their holdings of U.S. Treasuries. Caribbean banks, which are heavily allied with hedge funds, were net sellers of $8.3B of Treasuries.

Industrial Production Contracts in February

Industrial production fell -.5% MoM in February, this was a much larger decline than the -.1% predicted by consensus. This was the first decline since the -.6% MoM drop in October of last year. In addition, the capacity utilization rate was much weaker than expected at 80.9% (consensus 81.2%, prior 81.5%), and the lowest reading since 2005. The major reason for the surprisingly large decline was large -3.7% MoM drop in utility usage. This caused the headline figure to decline by -.4% MoM all by itself. Slower auto production (-1% MoM) eased manufacturing lower by -.2% MoM. Excluding vehicles, factory output fell -.2% MoM and industrial production fell -.5% MoM. Furniture and other wood products production each fell around 3% MoM as the housing slump continues. Overall, manufacturing fell -.2% MoM, with machinery orders the bright spot at +.3% MoM +2.2% YoY). Over the past year, industrial production has risen +1% YoY. Excluding high-tech and vehicle production, industrial production has risen +1.5% YoY. Manufacturing has risen +1.7% YoY, with vehicle production falling -2.7% YoY. Utility production has fallen -5.4% YoY. The main growth over the past year has been in computers, home electronics, and info processing. The largest declines have been in consumer goods and construction supplies. It appears that the weakening domestic economy is now overpowering the rebound in foreign demand, and export growth is no longer able to keep industrial production expanding. This data will further reinforce belief that the U.S. economy has entered a recession.

Today's Tidbits

3m T-Bill Yield

Market Believes Fed “Engineered” JPM’s Purchase of Bear Stearns
From RBSGC: “As expected, Sunday evening proved to be a very interesting time. It was clear as everyone left for the weekend that the Fed was intent on getting something done with respect to Bear Stearns before the markets opened. Just as Asia was getting into the office, it was announced that JP Morgan Chase was buying Bear for the low low price of about $250 million ($2 a share). The Fed also let us know that the discount window line offered to JPM to prevent an unruly Bear liquidation will be as much as $30 billion. Reading between the lines of the various articles on the deal, my sense is that the Fed a) forced Bear to sell and to get it done over the weekend (shareholders may have preferred Chapter 11 or stringing the process out a few more days to getting $2 a share, but the Fed wanted market participants to know the score by Monday morning), b) wanted JPM to be the buyer rather than a hedge fund or a private equity shop (this way, the Fed has more oversight/control over the unwind process). There are two questions about the Fed's role in this episode that will be explored for many years. 1) Was it an appropriate exercise of the Fed's authority to force Bear to sell itself to JP Morgan Chase at such a rock-bottom price? The Fed's urgency to get something (anything) done before the Asia open clearly did Bear's shareholders no favors. In addition, while I know nothing beyond press reports, my sense from reading the newspapers articles is that the Fed basically told everyone else rooting around in Bear's offices over the weekend that JPM would be the buyer and the rest of you can go home. If we are lucky enough to be back to a relatively normal environment 6 or 12 months from now, JPM will probably have made a LOT of money off of this deal, with a huge assist from the Fed. Second, did the Fed's action do more harm than good? Did the Fed cause more panic by forcing a Bear deal at $2/share? It is interesting that 2-year Treasury yields sank after the news last night, in contrast to the past 3 or 4 times that the Fed has announced some new liquidity measure. Again, this will probably be debated for a long time.”
From Time: “The last-minute buyout was aimed at averting a Bear Stearns bankruptcy and a spreading crisis of confidence in the global financial system. The Federal Reserve and the U.S. government swiftly approved the all- stock deal, showing the urgency of completing the deal before world markets opened. Bear Stearns shares closed Friday at $30 a share. At their peak, the shares traded at $159.36…The deal marked a 93.3 percent discount to Bear Stearns' market capitalization as of Friday, and roughly a 98.8 percent discount to its book value as of Feb. 29…After days of denials that it had liquidity problems, Bear was forced into a JPMorgan-led, government-backed bailout on Friday. The arrangement, the first of its kind since the 1930s, resulted in Bear getting a 28-day loan from JPMorgan with the government's guarantee that JPMorgan would not suffer any losses on the deal. This is not the first time Bear Stearns has earned a place in Wall Street history. A decade ago, Bear Stearns refused to help bail out a hedge fund that was deemed "too big to fail." On Friday, the tables had turned, with the now-struggling investment bank in need of the same kind of aid. ”
From SunTrust: “Lehman shares are off 35% today as investors fear additional write-downs will take the broker the way of Bear Stearns.”
History of Government Intervention in Markets During Times of Crisis
From Bloomberg: “With Bear Stearns Cos.' temporary rescue in place, the $200 billion subprime crisis joins the history of government bailouts to preserve jobs, homes and savings when economic disaster looms. Ever since Treasury Secretary William Gibbs McAdoo shut the New York Stock Exchange for four months in 1914, to prevent foreign investors from cashing out and throwing the U.S. into financial chaos at the outset of World War I, American policy makers routinely have suspended their support for free markets when confronted by economic peril. ``I think the systemic risks dominate right now, which means you've got to put your finger in the dike,'' says William Silber, a finance professor at New York University's Stern School of Business…Bailouts can buy time while policy makers try to defuse panic…Just over 100 years ago, John Pierpont Morgan himself, the namesake of what was then known as the House of Morgan, came to the rescue when panic selling in October 1907 convulsed the New York Stock Exchange and threatened several banks and trusts. Morgan, 70 and semi-retired, obtained an emergency pledge of $25 million from the U.S. Treasury. He persuaded New York's leading bankers and trust executives to put up another $25 million, after locking them in his library all night, according to ``The House of Morgan: An American Banking Dynasty and The Rise of Modern Finance,'' by Ron Chernow …By the force of his personality, Morgan restored order to the market. His intervention also convinced Congress and President Theodore Roosevelt of the need for a central bank. Booms and busts define economic cycles, forming a familiar pattern to historians while surprising investors, policy makers and financiers. Congress authorized $250 million in loan guarantees to rescue Lockheed Aircraft Corp. in August 1971, over the objections of the late Democratic Senator William Proxmire of Wisconsin. By today's standard, the stakes were small: about $1 billion in potential losses and 60,000 jobs. The costs have risen steadily since, from the $1.2 billion in loan guarantees Congress provided Chrysler Corp. in 1979 to the $116.5 billion taxpayers spent to resolve the savings-and- loan industry's collapse by 1995. The New York Fed averted a subsequent threat in September 1998 by persuading 14 banks to lend $3.65 billion to help unwind the leveraged trades of the Greenwich, Connecticut, hedge fund Long Term Capital Management. That was roughly equivalent to the $3.6 billion that the New York Fed loaned Chicago-based Continental Illinois National Bank & Trust Co. in 1984, in the largest rescue in U.S. banking history.
Yet the Treasury's shutdown of the New York Stock Exchange in 1914, a year after Morgan's death, remains one of the bluntest interventions by U.S. officials to head off a crisis. It is also one of the largest departures in American history from the capitalist creed of letting free markets sort out problems. European investors held much of New York City's public debt. As foreigners cashed out, converting their securities to gold, the Treasury realized that its ability to maintain the dollar's link to bullion was being undermined, Silber wrote. ``Treasury Secretary McAdoo succeeded in August 1914 because he did not hesitate to bludgeon the crisis with a sledgehammer,”…The decision served as a precedent for Franklin Delano Roosevelt, who closed the banks for a week on his first day as president in March 1933. When lenders reopened… depositors who had stood in line to withdraw their money queued up to put it back in. On both occasions, Silber says, government policy makers offered more-lasting solutions to ease market fears. In 1914, McAdoo moved to increase agricultural exports, bringing foreign capital into the country. In 1933, Roosevelt offered federal loan guarantees during the bank holiday to stimulate credit.”
Questions Emerging About Fed’s Ability To Abate an Economic Downturn
From Bloomberg: “Federal Reserve Chairman Ben S. Bernanke may be facing something worse than a loss of personal credibility on Wall Street and in Washington: waning faith in the ability of the institution he leads to turn around the economy and the financial markets anytime soon. Bernanke has reached deep into the Fed's toolkit to come up with innovative ways to head off a recession and restore some calm in credit markets. While many have initially been greeted with rallies in stocks, cumulatively they haven't yet had lasting impact on bringing down credit costs and setting the stage for economic recovery…``Yet many of the problems facing us are beyond its reach.'' Home buyers are unlikely to put down offers on houses that they think will lose value -- no matter how much the Fed does to lower mortgage costs. Banks with mounting loan losses will shy away from lending to borrowers they think might go bust – no matter how much money the Fed pumps into the financial system. And investors will remain jittery -- even after the Fed throws a lifeline to struggling financial institutions, as it did last week with Bear Stearns Cos. ``The Fed is attempting to catch some of the spillover and plug some of the holes in the system,'' says Louis Crandall, chief economist …Wrightson ICAP …the world's largest broker for banks and other financial institutions. ``But the amount of pressure in the system is still building and could exceed the Fed's traditional resources.'' Yesterday the Fed said it would provide financing for JPMorgan Chase & Co.'s purchase of Bear Stearns Cos. for as much as $270 million after a run on the company ended 85 years of independence for Wall Street's fifth-largest securities firm. The Fed also reduced the rate on direct loans to commercial banks by a quarter percentage point and said it will allow primary dealers to borrow at the rate in exchange for a ``broad range'' of investment-grade collateral. It extended the maximum term of discount-window loans to 90 days from 30 days…Financial markets are in ``uncharted waters,'' former U.S. Treasury Secretary Robert Rubin said in a March 14 speech in Washington. ``The outlook for credit markets and the economy is uncertain'' and the government may need to take ``substantial additional action'' to help homeowners, said Rubin, now chairman of Citigroup Inc.'s executive committee. Fed officials insist they aren't impotent and say they have moved to cushion a further weakening of the economy. They argue the economy and the markets would be worse off if the central bank hadn't cut interest rates and acted to relieve strains in the financial system…As stock and bond prices drop, banks demand more margin from borrowers, prompting them to sell assets to raise cash and driving prices even lower. At least a dozen hedge funds have closed, sold assets or sought fresh capital in the past month. Finally, falling asset prices erode borrowers' net worth and make lenders even more reluctant to give them money. Countrywide Financial Corp., the biggest U.S. mortgage lender, made no subprime loans last month, down from $2.6 billion in February 2007. The housing market so far has proven resistant to the Fed's monetary medicine…Lawmakers acknowledge limits to the Fed's ability to aid the economy. Barney Frank, the Massachusetts Democrat who heads the House Financial Services Committee, praises Bernanke as doing a ``very good job,'' while adding there is only so much he can do. ``We have taken fiscal and monetary policy as far as they can go,'' Frank told the American Bankers Association March 12.
He unveiled legislation the next day to expand the government's role in helping homeowners avoid losing their houses. Bernanke himself has tacitly admitted the Fed's leeway is limited by backing the $168 billion stimulus package passed by Congress last month and calling on banks to write down the principal on some of their mortgage loans. ``We must be cautious in our expectations of what monetary policy can accomplish,'' Kansas City Fed President Thomas Hoenig said in a March 7 speech.”
From UBS: “Last night’s announcement by the Fed of two more initiatives, in the same statement as the approval of the JP Morgan/Bear Stearns deal, does not appear to be inspiring much confidence in financial markets. Indeed, coming less than a week after the creation of the Term Securities Lending Facility, and nine days after the expansion of the TAF and increased repo operations, the limits of the Fed's influence on markets, in the short run at least, are increasingly clear. In the short run, markets are apparently continually re-assessing the negative fallout from the root cause of recent problems--declining home prices. That said, presumably the Fed's actions have had some positive impact and without them markets would be showing even more weakness…In any event, the Fed is clearly in full crisis mode and is trying everything to prevent a collapse. At this point they have clearly lost the battle to prevent a recession and instead the goal is to limit the length and depth of the recession by limiting the fallout in financial markets.”
Old-Timers Worried This May Be Worst Recession Since at Least 1950s
From Bloomberg: “Joseph Granville and Robert Stovall, octogenarians who've seen every financial market downturn since the 1950s, say the current one may be the worst and is far from over. Granville, born in 1923, remembers his banker father's bad
moods following the stock-market crash of 1929. The younger Granville began his career at defunct brokerage E.F. Hutton in 1957, quit in 1963 to begin publishing a weekly newsletter and wrote nine books on investing. ``We're in a crash,'' Granville, 84, said …
``This is the worst I've seen, and I've studied every bit of history all my life.'' U.S. stocks plunged to the lowest since August 2006 today after JPMorgan Chase & Co.'s purchase of Bear Stearns Cos. For less than a 10th of its market value sent financial shares falling around the world. The Standard & Poor's 500 Index neared a so-called bear market drop of 20 percent from its Oct. 9 record. Bear Stearns, the fifth-largest securities firm and once the biggest underwriter of U.S. mortgage bonds, collapsed as the residential real-estate slump led to bank losses approaching $200 billion globally. Stovall, 82, started out as a junior security analyst at E.F. Hutton in 1953 and ascended to head of research. He also held the posts of research director at Nuveen Corp. and director of investment policy at Dean Witter Reynolds Inc. before founding and running his own firm for 15 years and selling it to Prudential Financial Inc. in 2000. He currently chairs the investment strategy committee at Sarasota, Florida-based Wood Asset Management, which oversees $1.6 billion. Granville correctly forecast the bear market of 1977-78. Later, he failed to foresee the rally that started in 1982 and lasted for five years. He also called for losses in 1995 before the so-called Internet bubble began. On March 11, 2000, a day after the Nasdaq Composite Index peaked at 5,048.62, he wrote that investors in technology stocks ``will soon be burned.'' The index, which now gets 42 percent of its value from computer-related shares, sank 78 percent through Oct. 9, 2002…``With confidence at a low ebb, you wonder if this contagion will spread,'' Stovall said in a telephone interview from his
office. ``We have to be concerned about the stability of the whole financial system.''
Falling Dollar Indicates Foreign Demand For U.S. Assets Shrinking
From The Wall Street Journal: “The U.S. is at the receiving end of a massive margin call: Across the economy, wary lenders are demanding that borrowers put up more collateral or sell assets to reduce debts. The unfolding financial crisis -- one that began with bad bets on securities backed by subprime mortgages, then sparked a tightening of credit between big banks -- appears to be broadening further. For years, the U.S. economy has been borrowing from cash-rich lenders from Asia to the Middle East. American firms and households have enjoyed readily available credit at easy terms, even for risky bets. No longer. Recent days' cascade of bad news, culminating in yesterday's bailout of Bear Stearns Cos., is accelerating the erosion of trust in the longevity of some brand-name U.S. financial institutions. The growing crisis of confidence now extends to the credit-worthiness of borrowers across the spectrum -- touching American homeowners, who are seeing the value of their bedrock asset decline, and raising questions about the capacity of the Federal Reserve and U.S. government to rapidly repair the problems. Global investors are pulling money from the U.S., steepening the decline of the U.S. dollar and sending it below 100 yen for the first time in a dozen years. Against a trade-weighted basket of major currencies, the dollar has fallen 14.3% over the past year, according to the Federal Reserve. Yesterday it hit another record low against the euro, falling 2.1% this week to close at 1.567 dollars per euro. Lenders and investors are pushing up the interest rates they demand from financial institutions seen as solid just a few months ago, or demanding that they sell assets and come up with cash. Banks and Wall Street firms are so wary about each other that they're pulling back. Financial markets, anticipating that the Fed will cut rates sharply on Tuesday to try to limit the depth of a possible recession, are questioning the central bank's commitment or ability to keep inflation from accelerating. There are other symptoms of declining confidence. Gold, the ultimate inflation hedge, is flirting with $1,000 an ounce. Standard & Poor's Ratings Services, a unit of McGraw-Hill Cos., predicted Thursday that large financial institutions still need to write down $135 billion in subprime-related securities, on top of $150 billion in previous write-downs. Ordinary Americans are worried: Only 20% think the country is generally headed in the right direction…"As a result, we're seeing capital flow out of the U.S." That is a troubling prospect for a savings-short, debt-heavy economy that relies on $2 billion a day from abroad to finance investment. It is raising the specter of the long-feared crash in the dollar that could further rattle financial markets and boost U.S. interest rates. Though the risks of an unpleasant outcome are worrisome, the effects of Fed interest-rate cuts and fiscal stimulus have yet to be fully felt by the U.S. economy. Moreover, the combination of a weakening dollar -- which remains the world's favorite currency -- and still-growing economies overseas is boosting U.S. exports and offsetting some of the pain of the housing bust and credit crunch. But while cash continues to pour into the U.S. from abroad, this flow has been slowing. In 2007, foreigners' net acquisition of long-term bonds and stocks in the U.S. was $596 billion, down from $722 billion in 2006, according to Treasury Department data. Americans, meanwhile, are investing more of their own money abroad. Hopes are fading fast that the U.S. economy was suffering from a thirst for liquidity that standard Fed remedies could quench. Former Treasury Secretary Lawrence Summers, speaking in Washington yesterday, said he sees "an increasing risk that the principal policy tool on which we have relied -- the Federal Reserve lending to banks in one form or another" -- is like "fighting a virus with antibiotics."…The loss of confidence is now spreading beyond the biggest banks, with their well-publicized losses on subprime and other risky assets, to regional and small banks. In the fourth quarter, U.S. banks reported their smallest net income -- a total of $5.8 billion -- in 16 years, according to the Federal Deposit Insurance Corp…A Wall Street Journal survey of more than 50 economic forecasters in early March found a profound shift toward pessimism: About 70% say the U.S. is currently in recession, and on average they put the odds that this recession will be worse than the past two mild, short recessions at nearly 50%. Most expect house prices to decline into 2009 or 2010.
This couldn't come at a worse time for U.S. homeowners. American household debt has more than doubled in a decade to $13.8 trillion at the end of 2007 from $6.4 trillion in 1999, the vast majority of it in mortgages and home equity lines, according to Fed data. But the value of U.S. householders' biggest asset -- their homes -- is now falling.”
Comparing Standards of Living Over Time
From The Chicago Tribune: “Stuff is cheap. Really. Yes, a gallon of gasoline is far more expensive than it was last year, but adjusted for inflation it costs about what it did in 1981. In fact, lots of things, such as clothing, electronics and restaurant meals, are, by historical standards, inexpensive. In December 1978, newspaper ads listed a VCR at Sears for $795, more than $2,500 in today's dollars. A basic five-cycle washing machine? Back then, $319.95, which translates to about $1,000. It's cheaper now to enjoy an eight-day vacation in Honolulu. So why do we feel so squeezed? It's the reality of our new world order: Stuff is cheap, but the things that truly sustain us are not. Globalization and efficiencies in distribution and retailing have cut production costs and consumer prices widely. Americans now spend about 10 percent of their income on food, down from 18 percent in 1958. But while prices have dropped, so have real wages. Average weekly earnings in the private sector in 2007 were 15 percent below the 1972 peak in real terms, according to the Bureau of Labor Statistics. Along with falling wages, we are paying more for benefits. Health insurance premiums rose 78 percent from 2002 to 2007, according to the Kaiser Family Foundation. And we're spending a lot more on education. Yearly total costs at some private colleges now exceed the U.S. median household income. As we earn less, we want more. In 1970, 36 percent of new homes were less than 1,200 square feet, the National Association of Home Builders reports. Today, 4 percent of new homes are that petite. One in 10 new houses was 2,400 square feet or more in 1970; 42 percent are that large now. The want-more scenario is also the case with cars, which cost more even adjusted for inflation. A 2008, six-cylinder Honda Accord makes greater horsepower (268) than a 1990 Porsche 911 Carrera (247). The price of the Accord's power is gas mileage (19 miles per gallon in the city) that's not much better than that of the Porsche (16 mpg). Because it costs less to produce things, and often costs less to buy them, many of us can easily afford items once considered luxurious. But things we once took for granted as affordable cost us dearly, and for many are out of reach.”
Princeton Economist Paul Krugman on the Housing Market
From Fortune: “I think home prices will fall enough for us to produce about 20 million people with negative equity. That's almost a quarter of U.S. homes. If home prices are rising, or if there's positive equity, you can refinance or sell. But if you have negative equity, you can end up being foreclosed on, and then some people will just find it to their advantage to walk away. We're probably heading for $6 trillion or $7 trillion in capital losses in housing. Some fraction of that will fall on owners of mortgages. I still think the estimates people are putting out there - $400 billion or $500 billion in losses - are too low. I think there'll be $1 trillion of losses on mortgage-backed securities showing up somewhere… My preferred metric is the ratio of home prices to rental rates. By that measure, average home prices nationally got way too high. We'll probably basically retrace all that. So that's about a 25% decline in overall home prices. Only a fraction of that's happened so far. Of course, it varies a lot. In places like Houston or Atlanta, where home prices have not risen much compared with underlying rents, the decline will be relatively small. In places like Miami or Los Angeles, you could be looking at 40% or 50% declines…. The effective borrowing costs for a lot of people are rising, not falling, despite the Fed cuts. The rising spreads are more than offsetting it. The mortgage rates have not been falling as you might hope. And, of course, for many types of people who were able to borrow two years ago, they now can't - at any interest rate. We're looking at the classic pushing-on-a-string problem, where the Fed can cut, but it's not clear it does much for the real economy.”

TIDBITS
From Bloomberg: “National City Corp…fell the most in 24 years in New York trading, while Washington Mutual Inc., the largest U.S. savings and loan, fell to its lowest since 1995 on waning prospects for takeovers…The banks fell after JP Morgan Chase & Co.'s $240 million purchase of Bear Stearns Cos. removed one major buyer from the market.”
From Lehman: “The NAHB housing index, which measures homebuilder sentiment, held steady at 20 in March. A decline in the Northeast to 21 from 23 and the West to 15 from 16 offset an increase in the South to 26 from 24. Among the components, buyer traffic, which jumped 3 points in February, remained unchanged at 19. The index of present sales held at 20 while the index of future sales fell a point to 26. The housing outlook has remained bleak.”
End-of-Day Market Update:
From Bloomberg: “Treasuries rose and the three-month bill rate plunged to the lowest since the 1950s as the Federal Reserve cut the discount rate at a weekend meeting and backed JPMorgan Chase & Co.'s agreement to buy Bear Stearns Cos. Gains in two-year securities drove yields to the lowest level in almost five years as the Fed reduced the rate on direct loans to banks by a quarter-percentage point to 3.25 percent. Futures contracts on the Chicago Board of Trade show traders are betting the central bank will slash its target interest rate by at least 1 percentage point tomorrow from 3 percent. ``It's very easy to see it's a flight to quality,''… Banks became more reluctant to lend today, according to the so-called TED spread, the difference between what companies and the government pay to borrow for three months. It widened 8 basis points to 168 basis points, the biggest difference this year, before narrowing to 161 basis points. The spread has moved in a range of 90 basis points since Dec. 31, touching a low of 78 basis points on Feb. 12, when investor Warren Buffett offered to take on the municipal liabilities of three bond insurers. Treasuries of all maturities have returned 4.6 percent in 2008, the best start to a year since 1995, as a meltdown in the market for mortgage-backed securities drove investors to the safety of U.S. government debt.”
From Bloomberg: “…speculation that a U.S. recession will stall demand for raw materials…Oil retreated from a record, copper plunged the most in eight weeks and coffee dropped 11 percent. The Reuters/Jefferies CRB Index plunged the most since at least 1956… Demand for raw materials has gained as buyers in China used more grains, metals and energy products. Refined copper and alloy imports by China, the world's biggest user of the metal, fell 1.7 percent in the first two months this year, the Beijing-based customs office said today. Some investors are selling commodities to raise cash to cover losses in equities… ``A lot of hedge funds have been up to their eyes in commodities this year,'' he said. ``It's been a very speculative play and so now they're getting out of it to cover margin calls and losses.'' Crude oil for April delivery fell $4.53, or 4.1 percent, to $105.68 a barrel in New York, after earlier reaching a record $111.80… Gold ended the day higher, after paring earlier gains that sent the metal to a record, as losses in equities and the dollar spurred demand for the precious metal as a haven. ``In this sort of environment where people don't know what is going to happen, gold becomes a safe-haven alternative,''…”
From SunTrust: “Emotion and fear have driven financial markets all over the board today. The market inside 2 years has been especially volatile. For example, the 3 month bill fell from a 1.15 to a low of .65, a level not seen since 1958. Then at auction time, the when-issued 3 month bill was trading at .94, only to see the stop-rate tail back to a 1.10. For Treasuries 2 yrs and longer, volatility has been no worse than recent days. Current coupons throughout the curve have moved within a 10-15 bp range. Looking at markets as a whole, today could have been much worse. Equities are reasonably close to shore other than financials and commodities, which were hit hard. Mortgages and agencies are both trading with tighter spreads, which may be a slight positive reaction to the FED's actions.”
From Lehman: “After a busy weekend that saw a discount rate cut, the introduction of a new Fed lending facility for primary dealers, and the sale of Bear Stearns at a startlingly low price, the treasury market opened in disarray on Monday, and rallied hard on the back of both flight-to-quality and mortgage buying… The yield curve flattened from 2s to 5s today even as investors were talking about the possibility of a 100 bp cut from the FOMC tomorrow. The fed, as we mentioned, sold 2 year notes to dealers outright today, and perhaps the front end suffered from fears of more of the same. That threat did not seem to hurt 5 year notes, though, which were the instrument of choice for buyers for the second straight day. 5s outperformed 2s and 10s by over 5 basis points on the day…”
From UBS: “Treasuries rallied across the board as fallout from the Bear Stearns situation fed a general sense of panic, with financial stocks taking it on the chin. The belly of the curve outperformed, and 3-month Treasury bills traded at their richest levels in more than 50 years when the briefly traded at 0.65%... With the energy complex taking a beating and crude down nearly $7/barrel at its lows, TIPS lagged badly. Breakevens narrowed at least 15bps across the board, and the January 2009 breakevens tightening a whopping 37bps on top of Friday's 32bps compression. Even so, Treasury volume was a surprisingly light 85% of the 30-day average… the Financials were pounded yet again despite the impressive late day comeback in the DJIA. Commodities took a bath as the CRB fell by -4.7%-- the biggest drop in over 50yrs according to Bloomberg…Swap spreads surprisingly collapsed tighter today despite the rising fears about liquidity and solvency. We saw good paying in the belly and front end on both rate and spread--despite tighter spreads. Agencies saw light flows save for one committed seller and Agency bullets generally traded in line with Swaps. Mortgages saw better buying all day, with FNMA 5.5's getting to as much as a point tighter to Treasuries. After some late day profit taking, they went out some 27 ticks tighter to treasuries.”

Three month T-Bill yield fell 16 bp to 1.00%
Two year T-Note yield fell 13 bp to 1.35%
Ten year T-Note yield fell 17 bp to 3.30%
Dow rose 21 to 11,972
S&P 500 fell 11.5 to 1277
Dollar index 0.20 to 71.45
Yen at 97.44 per dollar
Euro at 1.573
Gold rose $1 to $1004
Oil fell $4.01 to $106.20
*All prices as of 4:53 PM

Download the original attachment
March 17, 2008 TIDBITS
Market Believes Fed “Engineered” JPM’s Purchase of Bear Stearns
From RBSGC: “As expected, Sunday evening proved to be a very interesting time. It was clear as everyone left for the weekend that the Fed was intent on getting something done with respect to Bear Stearns before the markets opened. Just as Asia was getting into the office, it was announced that JP Morgan Chase was buying Bear for the low low price of about $250 million ($2 a share). The Fed also let us know that the discount window line offered to JPM to prevent an unruly Bear liquidation will be as much as $30 billion. Reading between the lines of the various articles on the deal, my sense is that the Fed a) forced Bear to sell and to get it done over the weekend (shareholders may have preferred Chapter 11 or stringing the process out a few more days to getting $2 a share, but the Fed wanted market participants to know the score by Monday morning), b) wanted JPM to be the buyer rather than a hedge fund or a private equity shop (this way, the Fed has more oversight/control over the unwind process). There are two questions about the Fed's role in this episode that will be explored for many years. 1) Was it an appropriate exercise of the Fed's authority to force Bear to sell itself to JP Morgan Chase at such a rock-bottom price? The Fed's urgency to get something (anything) done before the Asia open clearly did Bear's shareholders no favors. In addition, while I know nothing beyond press reports, my sense from reading the newspapers articles is that the Fed basically told everyone else rooting around in Bear's offices over the weekend that JPM would be the buyer and the rest of you can go home. If we are lucky enough to be back to a relatively normal environment 6 or 12 months from now, JPM will probably have made a LOT of money off of this deal, with a huge assist from the Fed. Second, did the Fed's action do more harm than good? Did the Fed cause more panic by forcing a Bear deal at $2/share? It is interesting that 2-year Treasury yields sank after the news last night, in contrast to the past 3 or 4 times that the Fed has announced some new liquidity measure. Again, this will probably be debated for a long time.”
From Time: “The last-minute buyout was aimed at averting a Bear Stearns bankruptcy and a spreading crisis of confidence in the global financial system. The Federal Reserve and the U.S. government swiftly approved the all- stock deal, showing the urgency of completing the deal before world markets opened. Bear Stearns shares closed Friday at $30 a share. At their peak, the shares traded at $159.36…The deal marked a 93.3 percent discount to Bear Stearns' market capitalization as of Friday, and roughly a 98.8 percent discount to its book value as of Feb. 29…After days of denials that it had liquidity problems, Bear was forced into a JPMorgan-led, government-backed bailout on Friday. The arrangement, the first of its kind since the 1930s, resulted in Bear getting a 28-day loan from JPMorgan with the government's guarantee that JPMorgan would not suffer any losses on the deal. This is not the first time Bear Stearns has earned a place in Wall Street history. A decade ago, Bear Stearns refused to help bail out a hedge fund that was deemed "too big to fail." On Friday, the tables had turned, with the now-struggling investment bank in need of the same kind of aid. ”
From SunTrust: “Lehman shares are off 35% today as investors fear additional write-downs will take the broker the way of Bear Stearns.”
History of Government Intervention in Markets During Times of Crisis
From Bloomberg: “With Bear Stearns Cos.' temporary rescue in place, the $200 billion subprime crisis joins the history of government bailouts to preserve jobs, homes and savings when economic disaster looms. Ever since Treasury Secretary William Gibbs McAdoo shut the New York Stock Exchange for four months in 1914, to prevent foreign investors from cashing out and throwing the U.S. into financial chaos at the outset of World War I, American policy makers routinely have suspended their support for free markets when confronted by economic peril. ``I think the systemic risks dominate right now, which means you've got to put your finger in the dike,'' says William Silber, a finance professor at New York University's Stern School of Business…Bailouts can buy time while policy makers try to defuse panic…Just over 100 years ago, John Pierpont Morgan himself, the namesake of what was then known as the House of Morgan, came to the rescue when panic selling in October 1907 convulsed the New York Stock Exchange and threatened several banks and trusts. Morgan, 70 and semi-retired, obtained an emergency pledge of $25 million from the U.S. Treasury. He persuaded New York's leading bankers and trust executives to put up another $25 million, after locking them in his library all night, according to ``The House of Morgan: An American Banking Dynasty and The Rise of Modern Finance,'' by Ron Chernow …By the force of his personality, Morgan restored order to the market. His intervention also convinced Congress and President Theodore Roosevelt of the need for a central bank. Booms and busts define economic cycles, forming a familiar pattern to historians while surprising investors, policy makers and financiers. Congress authorized $250 million in loan guarantees to rescue Lockheed Aircraft Corp. in August 1971, over the objections of the late Democratic Senator William Proxmire of Wisconsin. By today's standard, the stakes were small: about $1 billion in potential losses and 60,000 jobs. The costs have risen steadily since, from the $1.2 billion in loan guarantees Congress provided Chrysler Corp. in 1979 to the $116.5 billion taxpayers spent to resolve the savings-and- loan industry's collapse by 1995. The New York Fed averted a subsequent threat in September 1998 by persuading 14 banks to lend $3.65 billion to help unwind the leveraged trades of the Greenwich, Connecticut, hedge fund Long Term Capital Management. That was roughly equivalent to the $3.6 billion that the New York Fed loaned Chicago-based Continental Illinois National Bank & Trust Co. in 1984, in the largest rescue in U.S. banking history.
Yet the Treasury's shutdown of the New York Stock Exchange in 1914, a year after Morgan's death, remains one of the bluntest interventions by U.S. officials to head off a crisis. It is also one of the largest departures in American history from the capitalist creed of letting free markets sort out problems. European investors held much of New York City's public debt. As foreigners cashed out, converting their securities to gold, the Treasury realized that its ability to maintain the dollar's link to bullion was being undermined, Silber wrote. ``Treasury Secretary McAdoo succeeded in August 1914 because he did not hesitate to bludgeon the crisis with a sledgehammer,”…The decision served as a precedent for Franklin Delano Roosevelt, who closed the banks for a week on his first day as president in March 1933. When lenders reopened… depositors who had stood in line to withdraw their money queued up to put it back in. On both occasions, Silber says, government policy makers offered more-lasting solutions to ease market fears. In 1914, McAdoo moved to increase agricultural exports, bringing foreign capital into the country. In 1933, Roosevelt offered federal loan guarantees during the bank holiday to stimulate credit.”
Questions Emerging About Fed’s Ability To Abate an Economic Downturn
From Bloomberg: “Federal Reserve Chairman Ben S. Bernanke may be facing something worse than a loss of personal credibility on Wall Street and in Washington: waning faith in the ability of the institution he leads to turn around the economy
and the financial markets anytime soon. Bernanke has reached deep into the Fed's toolkit to come up with innovative ways to head off a recession and restore some calm in credit markets. While many have initially been greeted with rallies in stocks, cumulatively they haven't yet had lasting impact on bringing down credit costs and setting the stage for
economic recovery…``Yet many of the problems facing us are beyond its reach.'' Home buyers are unlikely to put down offers on houses that they think will lose value -- no matter how much the Fed does to lower mortgage costs. Banks with mounting loan losses will shy away from lending to borrowers they think might go bust – no matter how much money the Fed pumps into the financial system. And investors will remain jittery -- even after the Fed throws a lifeline to struggling financial institutions, as it did last week with Bear Stearns Cos. ``The Fed is attempting to catch some of the spillover and plug some of the holes in the system,'' says Louis Crandall, chief economist …Wrightson ICAP …the world's largest broker for banks and other financial institutions. ``But the amount of pressure in the system is still building and could exceed the Fed's traditional resources.'' Yesterday the Fed said it would provide financing for JPMorgan Chase & Co.'s purchase of Bear Stearns Cos. for as much as $270 million after a run on the company ended 85 years of independence for Wall Street's fifth-largest securities firm. The Fed also reduced the rate on direct loans to commercial banks by a quarter percentage point and said it will allow primary dealers to borrow at the rate in exchange for a ``broad range'' of investment-grade collateral. It extended the maximum term of
discount-window loans to 90 days from 30 days…Financial markets are in ``uncharted waters,'' former U.S. Treasury Secretary Robert Rubin said in a March 14 speech in
Washington. ``The outlook for credit markets and the economy is uncertain'' and the government may need to take ``substantial additional action'' to help homeowners, said Rubin, now chairman of Citigroup Inc.'s executive committee. Fed officials insist they aren't impotent and say they have moved to cushion a further weakening of the economy. They argue the economy and the markets would be worse off if the central bank hadn't cut interest rates and acted to relieve strains in the financial system…As stock and bond prices drop, banks demand more margin from borrowers, prompting them to sell assets to raise cash and driving prices even lower. At least a dozen hedge funds have closed, sold assets or sought fresh capital in the past month. Finally, falling asset prices erode borrowers' net worth and make lenders even more reluctant to give them money. Countrywide Financial Corp., the biggest U.S. mortgage lender, made no subprime loans last month, down from $2.6 billion in February 2007. The housing market so far has proven resistant to the Fed's monetary medicine…Lawmakers acknowledge limits to the Fed's ability to aid the economy. Barney Frank, the Massachusetts Democrat who heads the House Financial Services Committee, praises Bernanke as doing a ``very good job,'' while adding there is only so much he can do. ``We have taken fiscal and monetary policy as far as they can go,'' Frank told the American Bankers Association March 12.
He unveiled legislation the next day to expand the government's role in helping homeowners avoid losing their houses. Bernanke himself has tacitly admitted the Fed's leeway is limited by backing the $168 billion stimulus package passed by Congress last month and calling on banks to write down the principal on some of their mortgage loans. ``We must be cautious in our expectations of what monetary policy can accomplish,'' Kansas City Fed President Thomas Hoenig said in a March 7 speech.”
From UBS: “Last night’s announcement by the Fed of two more initiatives, in the same statement as the approval of the JP Morgan/Bear Stearns deal, does not appear to be inspiring much confidence in financial markets. Indeed, coming less than a week after the creation of the Term Securities Lending Facility, and nine days after the expansion of the TAF and increased repo operations, the limits of the Fed's influence on markets, in the short run at least, are increasingly clear. In the short run, markets are apparently continually re-assessing the negative fallout from the root cause of recent problems--declining home prices. That said, presumably the Fed's actions have had some positive impact and without them markets would be showing even more weakness…In any event, the Fed is clearly in full crisis mode and is trying everything to prevent a collapse. At this point they have clearly lost the battle to prevent a recession and instead the goal is to limit the length and depth of the recession by limiting the fallout in financial markets.”
Old-Timers Worried This May Be Worst Recession Since at Least 1950s
From Bloomberg: “Joseph Granville and Robert Stovall, octogenarians who've seen every financial market downturn since the 1950s, say the current one may be the worst and is far from over. Granville, born in 1923, remembers his banker father's bad
moods following the stock-market crash of 1929. The younger Granville began his career at defunct brokerage E.F. Hutton in 1957, quit in 1963 to begin publishing a weekly newsletter and wrote nine books on investing. ``We're in a crash,'' Granville, 84, said …
``This is the worst I've seen, and I've studied every bit of history all my life.'' U.S. stocks plunged to the lowest since August 2006 today after JPMorgan Chase & Co.'s purchase of Bear Stearns Cos. For less than a 10th of its market value sent financial shares falling around the world. The Standard & Poor's 500 Index neared a so-called bear market drop of 20 percent from its Oct. 9 record. Bear Stearns, the fifth-largest securities firm and once the biggest underwriter of U.S. mortgage bonds, collapsed as the residential real-estate slump led to bank losses approaching $200 billion globally. Stovall, 82, started out as a junior security analyst at E.F. Hutton in 1953 and ascended to head of research. He also held the posts of research director at Nuveen Corp. and director of investment policy at Dean Witter Reynolds Inc. before founding and running his own firm for 15 years and selling it to Prudential Financial Inc. in 2000. He currently chairs the investment strategy committee at Sarasota, Florida-based Wood Asset Management, which oversees $1.6 billion. Granville correctly forecast the bear market of 1977-78. Later, he failed to foresee the rally that started in 1982 and lasted for five years. He also called for losses in 1995 before the so-called Internet bubble began. On March 11, 2000, a day after the Nasdaq Composite Index peaked at 5,048.62, he wrote that investors in technology stocks
``will soon be burned.'' The index, which now gets 42 percent of its value from computer-related shares, sank 78 percent through Oct. 9, 2002…``With confidence at a low ebb, you wonder if this contagion will spread,'' Stovall said in a telephone interview from his
office. ``We have to be concerned about the stability of the whole financial system.''
Falling Dollar Indicates Foreign Demand For U.S. Assets Shrinking
From The Wall Street Journal: “The U.S. is at the receiving end of a massive margin call: Across the economy, wary lenders are demanding that borrowers put up more collateral or sell assets to reduce debts. The unfolding financial crisis -- one that began with bad bets on securities backed by subprime mortgages, then sparked a tightening of credit between big banks -- appears to be broadening further. For years, the U.S. economy has been borrowing from cash-rich lenders from Asia to the Middle East. American firms and households have enjoyed readily available credit at easy terms, even for risky bets. No longer. Recent days' cascade of bad news, culminating in yesterday's bailout of Bear Stearns Cos., is accelerating the erosion of trust in the longevity of some brand-name U.S. financial institutions. The growing crisis of confidence now extends to the credit-worthiness of borrowers across the spectrum -- touching American homeowners, who are seeing the value of their bedrock asset decline, and raising questions about the capacity of the Federal Reserve and U.S. government to rapidly repair the problems. Global investors are pulling money from the U.S., steepening the decline of the U.S. dollar and sending it below 100 yen for the first time in a dozen years. Against a trade-weighted basket of major currencies, the dollar has fallen 14.3% over the past year, according to the Federal Reserve. Yesterday it hit another record low against the euro, falling 2.1% this week to close at 1.567 dollars per euro. Lenders and investors are pushing up the interest rates they demand from financial institutions seen as solid just a few months ago, or demanding that they sell assets and come up with cash. Banks and Wall Street firms are so wary about each other that they're pulling back. Financial markets, anticipating that the Fed will cut rates sharply on Tuesday to try to limit the depth of a possible recession, are questioning the central bank's commitment or ability to keep inflation from accelerating. There are other symptoms of declining confidence. Gold, the ultimate inflation hedge, is flirting with $1,000 an ounce. Standard & Poor's Ratings Services, a unit of McGraw-Hill Cos., predicted Thursday that large financial institutions still need to write down $135 billion in subprime-related securities, on top of $150 billion in previous write-downs. Ordinary Americans are worried: Only 20% think the country is generally headed in the right direction…"As a result, we're seeing capital flow out of the U.S." That is a troubling prospect for a savings-short, debt-heavy economy that relies on $2 billion a day from abroad to finance investment. It is raising the specter of the long-feared crash in the dollar that could further rattle financial markets and boost U.S. interest rates. Though the risks of an unpleasant outcome are worrisome, the effects of Fed interest-rate cuts and fiscal stimulus have yet to be fully felt by the U.S. economy. Moreover, the combination of a weakening dollar -- which remains the world's favorite currency -- and still-growing economies overseas is boosting U.S. exports and offsetting some of the pain of the housing bust and credit crunch. But while cash continues to pour into the U.S. from abroad, this flow has been slowing. In 2007, foreigners' net acquisition of long-term bonds and stocks in the U.S. was $596 billion, down from $722 billion in 2006, according to Treasury Department data. Americans, meanwhile, are investing more of their own money abroad. Hopes are fading fast that the U.S. economy was suffering from a thirst for liquidity that standard Fed remedies could quench. Former Treasury Secretary Lawrence Summers, speaking in Washington yesterday, said he sees "an increasing risk that the principal policy tool on which we have relied -- the Federal Reserve lending to banks in one form or another" -- is like "fighting a virus with antibiotics."…The loss of confidence is now spreading beyond the biggest banks, with their well-publicized losses on subprime and other risky assets, to regional and small banks. In the fourth quarter, U.S. banks reported their smallest net income -- a total of $5.8 billion -- in 16 years, according to the Federal Deposit Insurance Corp…A Wall Street Journal survey of more than 50 economic forecasters in early March found a profound shift toward pessimism: About 70% say the U.S. is currently in recession, and on average they put the odds that this recession will be worse than the past two mild, short recessions at nearly 50%. Most expect house prices to decline into 2009 or 2010.
This couldn't come at a worse time for U.S. homeowners. American household debt has more than doubled in a decade to $13.8 trillion at the end of 2007 from $6.4 trillion in 1999, the vast majority of it in mortgages and home equity lines, according to Fed data. But the value of U.S. householders' biggest asset -- their homes -- is now falling.”
Comparing Standards of Living Over Time
From The Chicago Tribune: “Stuff is cheap. Really. Yes, a gallon of gasoline is far more expensive than it was last year, but adjusted for inflation it costs about what it did in 1981. In fact, lots of things, such as clothing, electronics and restaurant meals, are, by historical standards, inexpensive. In December 1978, newspaper ads listed a VCR at Sears for $795, more than $2,500 in today's dollars. A basic five-cycle washing machine? Back then, $319.95, which translates to about $1,000. It's cheaper now to enjoy an eight-day vacation in Honolulu. So why do we feel so squeezed? It's the reality of our new world order: Stuff is cheap, but the things that truly sustain us are not. Globalization and efficiencies in distribution and retailing have cut production costs and consumer prices widely. Americans now spend about 10 percent of their income on food, down from 18 percent in 1958. But while prices have dropped, so have real wages. Average weekly earnings in the private sector in 2007 were 15 percent below the 1972 peak in real terms, according to the Bureau of Labor Statistics. Along with falling wages, we are paying more for benefits. Health insurance premiums rose 78 percent from 2002 to 2007, according to the Kaiser Family Foundation. And we're spending a lot more on education. Yearly total costs at some private colleges now exceed the U.S. median household income. As we earn less, we want more. In 1970, 36 percent of new homes were less than 1,200 square feet, the National Association of Home Builders reports. Today, 4 percent of new homes are that petite. One in 10 new houses was 2,400 square feet or more in 1970; 42 percent are that large now. The want-more scenario is also the case with cars, which cost more even adjusted for inflation. A 2008, six-cylinder Honda Accord makes greater horsepower (268) than a 1990 Porsche 911 Carrera (247). The price of the Accord's power is gas mileage (19 miles per gallon in the city) that's not much better than that of the Porsche (16 mpg). Because it costs less to produce things, and often costs less to buy them, many of us can easily afford items once considered luxurious. But things we once took for granted as affordable cost us dearly, and for many are out of reach.”
Princeton Economist Paul Krugman on the Housing Market
From Fortune: “I think home prices will fall enough for us to produce about 20 million people with negative equity. That's almost a quarter of U.S. homes. If home prices are rising, or if there's positive equity, you can refinance or sell. But if you have negative equity, you can end up being foreclosed on, and then some people will just find it to their advantage to walk away. We're probably heading for $6 trillion or $7 trillion in capital losses in housing. Some fraction of that will fall on owners of mortgages. I still think the estimates people are putting out there - $400 billion or $500 billion in losses - are too low. I think there'll be $1 trillion of losses on mortgage-backed securities showing up somewhere… My preferred metric is the ratio of home prices to rental rates. By that measure, average home prices nationally got way too high. We'll probably basically retrace all that. So that's about a 25% decline in overall home prices. Only a fraction of that's happened so far. Of course, it varies a lot. In places like Houston or Atlanta, where home prices have not risen much compared with underlying rents, the decline will be relatively small. In places like Miami or Los Angeles, you could be looking at 40% or 50% declines…. The effective borrowing costs for a lot of people are rising, not falling, despite the Fed cuts. The rising spreads are more than offsetting it. The mortgage rates have not been falling as you might hope. And, of course, for many types of people who were able to borrow two years ago, they now can't - at any interest rate. We're looking at the classic pushing-on-a-string problem, where the Fed can cut, but it's not clear it does much for the real economy.”
TIDBITS
From Bloomberg: “National City Corp…fell the most in 24 years in New York trading, while Washington Mutual Inc., the largest U.S. savings and loan, fell to its lowest since 1995 on waning prospects for takeovers…The banks fell after JP Morgan Chase & Co.'s $240 million purchase of Bear Stearns Cos. removed one major buyer from the market.”
From Lehman: “The NAHB housing index, which measures homebuilder sentiment, held steady at 20 in March. A decline in the Northeast to 21 from 23 and the West to 15 from 16 offset an increase in the South to 26 from 24. Among the components, buyer traffic, which jumped 3 points in February, remained unchanged at 19. The index of present sales held at 20 while the index of future sales fell a point to 26. The housing outlook has remained bleak.”
End-of-Day Market Update:
From Bloomberg: “Treasuries rose and the three-month bill rate plunged to the lowest since the 1950s as the Federal Reserve cut the discount rate at a weekend meeting and backed JPMorgan Chase & Co.'s agreement to buy Bear Stearns Cos. Gains in two-year securities drove yields to the lowest level in almost five years as the Fed reduced the rate on direct loans to banks by a quarter-percentage point to 3.25 percent. Futures contracts on the Chicago Board of Trade show traders are betting the central bank will slash its target interest rate by at least 1 percentage point tomorrow from 3 percent. ``It's very easy to see it's a flight to quality,''… Banks became more reluctant to lend today, according to the so-called TED spread, the difference between what companies and the government pay to borrow for three months. It widened 8 basis points to 168 basis points, the biggest difference this year, before narrowing to 161 basis points. The spread has moved in a range of 90 basis points since Dec. 31, touching a low of 78 basis points on Feb. 12, when investor Warren Buffett offered to take on the municipal liabilities of three bond insurers. Treasuries of all maturities have returned 4.6 percent in 2008, the best start to a year since 1995, as a meltdown in the market for mortgage-backed securities drove investors to the safety of U.S. government debt.”
From Bloomberg: “…speculation that a U.S. recession will stall demand for raw materials…Oil retreated from a record, copper plunged the most in eight weeks and coffee dropped 11 percent. The Reuters/Jefferies CRB Index plunged the most since at least 1956… Demand for raw materials has gained as buyers in China used more grains, metals and energy products. Refined copper and alloy imports by China, the world's biggest user of the metal, fell 1.7 percent in the first two months this year, the Beijing-based customs office said today. Some investors are selling commodities to raise cash to cover losses in equities… ``A lot of hedge funds have been up to their eyes in commodities this year,'' he said. ``It's been a very speculative play and so now they're getting out of it to cover margin calls and losses.'' Crude oil for April delivery fell $4.53, or 4.1 percent, to $105.68 a barrel in New York, after earlier reaching a record $111.80… Gold ended the day higher, after paring earlier gains that sent the metal to a record, as losses in equities and the dollar spurred demand for the precious metal as a haven. ``In this sort of environment where people don't know what is going to happen, gold becomes a safe-haven alternative,''…”
From SunTrust: “Emotion and fear have driven financial markets all over the board today. The market inside 2 years has been especially volatile. For example, the 3 month bill fell from a 1.15 to a low of .65, a level not seen since 1958. Then at auction time, the when-issued 3 month bill was trading at .94, only to see the stop-rate tail back to a 1.10. For Treasuries 2 yrs and longer, volatility has been no worse than recent days. Current coupons throughout the curve have moved within a 10-15 bp range. Looking at markets as a whole, today could have been much worse. Equities are reasonably close to shore other than financials and commodities, which were hit hard. Mortgages and agencies are both trading with tighter spreads, which may be a slight positive reaction to the FED's actions.”
From Lehman: “After a busy weekend that saw a discount rate cut, the introduction of a new Fed lending facility for primary dealers, and the sale of Bear Stearns at a startlingly low price, the treasury market opened in disarray on Monday, and rallied hard on the back of both flight-to-quality and mortgage buying… The yield curve flattened from 2s to 5s today even as investors were talking about the possibility of a 100 bp cut from the FOMC tomorrow. The fed, as we mentioned, sold 2 year notes to dealers outright today, and perhaps the front end suffered from fears of more of the same. That threat did not seem to hurt 5 year notes, though, which were the instrument of choice for buyers for the second straight day. 5s outperformed 2s and 10s by over 5 basis points on the day…”
From UBS: “Treasuries rallied across the board as fallout from the Bear Stearns situation fed a general sense of panic, with financial stocks taking it on the chin. The belly of the curve outperformed, and 3-month Treasury bills traded at their richest levels in more than 50 years when the briefly traded at 0.65%... With the energy complex taking a beating and crude down nearly $7/barrel at its lows, TIPS lagged badly. Breakevens narrowed at least 15bps across the board, and the January 2009 breakevens tightening a whopping 37bps on top of Friday's 32bps compression. Even so, Treasury volume was a surprisingly light 85% of the 30-day average… the Financials were pounded yet again despite the impressive late day comeback in the DJIA. Commodities took a bath as the CRB fell by -4.7%-- the biggest drop in over 50yrs according to Bloomberg…Swap spreads surprisingly collapsed tighter today despite the rising fears about liquidity and solvency. We saw good paying in the belly and front end on both rate and spread--despite tighter spreads. Agencies saw light flows save for one committed seller and Agency bullets generally traded in line with Swaps. Mortgages saw better buying all day, with FNMA 5.5's getting to as much as a point tighter to Treasuries. After some late day profit taking, they went out some 27 ticks tighter to treasuries.”

Three month T-Bill yield fell 16 bp to 1.00%
Two year T-Note yield fell 13 bp to 1.35%
Ten year T-Note yield fell 17 bp to 3.30%
Dow rose 21 to 11,972
S&P 500 fell 11.5 to 1277
Dollar index 0.20 to 71.45
Yen at 97.44 per dollar
Euro at 1.573
Gold rose $1 to $1004
Oil fell $4.01 to $106.20
*All prices as of 4:53 PM
3m T-Bill Yield