Page 2 of 2 CREDIT BUBBLE BULLETIN The funds are flowing By Doug Noland
coming ... The direction we seem to be on in terms of adding liquidity to a
financial system that already has plenty of liquidity risks putting us in a
scenario in which the Fed might have to constrain monetary expansion very
drastically at some point down the road."
September 19 The Wall Street Journal (Greg Ip ): "Federal Reserve chairman
Ben Bernanke moved aggressively to stop the spreading credit crunch from
sinking the nation's economy with a surprising half-percentage-point cut in
interest rates, casting aside for now worries about appearing to bail out
investors. The cut, which exceeded the quarter-point reduction most economists
had expected, signals that Mr Bernanke, fearing broad damage from the market
turmoil that erupted a month ago, preferred to risk doing too much rather than
too little. The move came amid a sizable drop in home sales, construction and
prices that could
send mortgage defaults higher and damp consumer spending. With yesterday's
move, Mr Bernanke may have shown himself closer in style and tactics to
predecessor Alan Greenspan than some market watchers had suspected. That
carries risks: Critics may start referring to the 'Bernanke put', as they once
spoke of the 'Greenspan put' under the former Fed chairman ... "
September 18 Bloomberg (Christian Vits): "European Central Bank council
member Axel Weber said he expects stronger economic growth and rising oil
prices to stoke inflation. 'We have to expect somewhat higher inflation rates
for the rest of the year,' Weber, who also heads Germany's Bundesbank, said
..."
September 1 - Market News International (Steven K. Beckner): "There are many
interesting aspects of former Federal Reserve Chairman Alan Greenspan's
just-released book, but perhaps the most important are his warnings about
inflation ... from a Fed watchers' standpoint, Greenspan's premonitions about
inflation and long-term interest rates are the most timely ... Greenspan
ascribes much of the Fed's ability to get inflation under control in recent
years to globalization. 'The continuing acceleration of the flow of workers to
competitive markets during the past decade has been a potent disinflationary
force ...' This disinflation has in turn helped hold down long-term interest
rates ... But he writes that 'the rate of flow of workers to competitive labor
markets will eventually slow, and as a result, disinflationary pressures should
start to lift. China's wage-rate growth should mount, as should its rate of
inflation'.
Chinese export prices ... will rise further, he predicts. The result will be 'a
pickup of price inflation and wage growth in the United States', writes
Greenspan, adding, 'the burden of managing this shift will fall on the Federal
Reserve'. 'How significant - and how corrosive - these price pressures will
become for the American economy will depend in large part on the Fed's ability
to respond', he writes, adding, 'The degree of monetary restraint required to
contain any given rate of inflation will increase'."
September 19 Bloomberg (Pimm Fox and Kevin Carmichael): "Paul O'Neill, a
former US Treasury secretary and now a special adviser to Blackstone Group LP,
comments on the Federal Reserve's decision yesterday to lower interest rates
... ' The markets were very fearful of the liquidity crunch. Markets basically
stopped trading. They were reassured by the chairman's action yesterday. One
might say Ben put the punch back in the punchbowl. There was nothing in the
punchbowl. He succeeded in reassuring the markets that the Fed was not going to
let this linger on. I think that's what we needed'."
California watch
September 21 Bloomberg (William Selway): "A majority of Californians expect
the economy to worsen in the most populous US state over the next year as
housing sales plunge and more residents lose their homes to foreclosure, the
results of a poll released today show. Fifty-nine percent of adults expect 'bad
times' financially over the next 12 months, a jump of 10 percentage points
since June ... "
GSE watch
September 18 Bloomberg (James Tyson): "Federal Reserve Chairman Ben S
Bernanke opposed a push to allow Fannie Mae and Freddie Mac to buy mortgages
higher than $417,000, saying it may undermine efforts to strengthen regulation
of the two largest US mortgage finance companies. A proposal in Congress to
increase the limit 'would be ill-advised if it has the practical effect of
reducing the incentives to achieve meaningful' regulatory tightening over the
companies, Bernanke said ... [Representative] Frank and other Democrats,
seeking to reverse the biggest housing market slump in 16 years, have called on
the Bush administration to allow Fannie Mae and Freddie Mac to buy bigger
mortgages and expand their $1.5 trillion investment portfolios. The companies
regulator announced today it will allow the companies to annually increase
their purchases of home loans and mortgage bonds by 2%. Bernanke in the letter
written two days ago said ... 'Both the size and composition of the portfolios
should be tied to reforms that both reduce the systemic risks posed by the
portfolios and also clarify the public purpose', Bernanke said ..."
Mortgage finance bust watch
September 21 - Reuters: "A record 26% of US homeowners say the value of their
homes has fallen during the past year, above the previous peak of 24% seen in
1992, a survey released on Friday showed. Reflecting the extent of the
prolonged housing slump, 21% of homeowners polled in September expect the value
of their home to decline in the year ahead, up from 18% in August, according to
the data from Reuters/University of Michigan Surveys of Consumers. 'Overall,
the data indicate no let-up in the slump in home prices,' said Richard Curtin,
director of the consumer surveys, in a statement."
September 18 Marketwatch (Robert Schroeder): "Reaching out to hard-hit
borrowers in the subprime-mortgage market, the House ... passed a bill that
lowers down payments for borrowers, raises loan limits and boosts funds for
housing counseling. Passed by a vote of 348 to 72, the bill reforms the Federal
Housing Administration and is the latest lifeline thrown to borrowers from
Washington ... About two million loans are expected to reset to higher rates in
the next two years, with defaults expected to follow ... The bill directs up to
$300 million a year into an affordable housing fund. A motion offered by Rep
Jeb Hensarling, R-Texas, to kill the fund was rejected ... Lawmakers also
passed an amendment to the bill offered by [Representative] Frank that would
raise the agency's loan limit from its current $417,000 to as much as $729,750.
'Such an increase would ensure that FHA is a viable option for borrowers who
have payment option and interest-only adjustable rate mortgages (ARMs), which
will be resetting in the next few years,' said Stanford Group Company analyst
Jaret Seiberg."
Foreclosure watch
September 18 Associated Press (Alex Veiga): "The number of foreclosure
filings reported in the US last month more than doubled versus August 2006 and
jumped 36% from July, a trend that signals many homeowners are increasingly
unable to make timely payments on their mortgages or sell their homes amid a
national housing slump. A total of 243,947 foreclosure filings were reported in
August, up 115% from 113,300 in the same month a year ago ... RealtyTrac Inc.
said ... 'The jump in foreclosure filings this month might be the beginning of
the next wave of increased foreclosure activity, as a large number of subprime
adjustable rate loans are beginning to reset now', RealtyTrac Chief Executive
James J Saccacio said ... The latest figures also reflect an increase in the
number of homes going into foreclosure that are not being picked up in estate
sales and are ending up going back to lenders. The number of bank repossessions
jumped to 42,789 in August, compared with 20,116 a year earlier, the RealtyTrac
said. In July, there were 26,842 bank repossessions. Nevada, California and
Florida had the highest foreclosure rates in the country last month, the firm
said ... California's foreclosure rate was one filing for every 224 households.
The state reported the most foreclosure filings of any single state with
57,875, up 48% from July and an increase of more than 300% from August 2006."
September 19 Bloomberg (Bob Ivry): "As many as half of the 450,000 subprime
borrowers whose mortgage payments increase in the next three months may lose
their homes because they can't sell, refinance or qualify for help from the US
government. 'Short of the cavalry riding in over the hill, a lot of these
people are just stuck,' said Christopher Cagan, director of research and
analytics at ... First American CoreLogic ... The number of borrowers whose
mortgage payments jump in the next three months will be the second-highest ever
for a quarter, according to Credit Suisse ... Twenty-seven percent have already
missed a payment, said First American LoanPerformance, which owns the largest
database of US mortgages. That makes them ineligible for the Federal Housing
Administration bailout proposed last month by President George W Bush."
MBS/ABS/CDO/CP/money funds and derivatives watch
September 18 Bloomberg (Jody Shenn): "Securities backed by prime US jumbo
mortgages may be riskier than investors think because almost half of the
underlying loans are from California, where home prices may again collapse,
according to Barclays PLC. California accounts for 45% of jumbo mortgages in
securities sold last year, up from 35% in 1989, Barclays mortgage-bond analysts
wrote ... Following a housing boom, home prices in California declined by 12.5%
between 1991 and 1995. Losses after foreclosures on jumbo loans securitized in
1989 rose to 3%, which would be enough to cause many current investment-grade
bonds to default. 'The current housing environment in California appears
similar to the 1990s,' wrote the ... analysts led by Ajay Rajadhyaksha. 'Many
investors believe that jumbo credit is sound. We think that this sense of
security is misplaced'."
Real estate bubbles watch
September 18 Bloomberg (Dan Levy): "San Franciscans soon may have to crane
their necks back a bit farther to gaze up at the city's tallest buildings. City
officials are pushing for construction of two office and residential towers of
1,200 feet or more at least 80 stories. They would dwarf the Transamerica
Pyramid, which at 853 feet has been the tallest building in San Francisco since
1972. The new structures would challenge the 1,250-foot height of the Empire
State Building in New York, the second-tallest US building. It's 'imperative'
for San Francisco to keep pace as super-tall towers spring up around the globe,
Mayor Gavin Newsom said ... 'Tall buildings are symbols of cities that don't
want to be left behind in a competitive world,' architect Daniel Libeskind, who
worked on designs for towers to replace Manhattan's World Trade Center, said
... "
September 17 Bloomberg (Peter Woodifield): "Construction of the London office
tower dubbed 'the Shard' may be delayed because of an increase in borrowing
costs, according to the developer of the building that would be the UK's
tallest. Talks about financing the project 'have, unfortunately, been affected
by the recent adverse credit markets', said Sten Mortstedt, chairman of CLS
Holdings Plc ... Work on the 72-story building, which will cost about 400
million pounds ($799 million), is due to start later this year."
Speculator watch
September 18 Bloomberg (Jesse Westbrook and Jenny Strasburg): "The US
Securities and Exchange Commission is examining hedge funds for signs of
insider trading, demanding information about relationships between managers,
employees, family members and public companies. SEC officials told hedge funds
to list clients and workers who serve as officers or directors of publicly
traded companies, along with the names of any relatives who hold such posts,
according to a 27-page letter to industry executives ... The SEC confirmed its
authenticity."
COMMENTARY Q2 2007 flow of funds:
Considering third-quarter financial market developments, it is tempting to view
Q2 Credit analysis as somewhat less than timely and relevant. Yet the data do
provide evidence of worsening unstable dynamics - in particular, an energized
Financial Sphere expanding at breakneck speed, easily outdistancing the
flagging Economic Sphere. Highlights for the quarter included double-digit
growth rates for both Commercial Bank and Broker/Dealer balance sheets. The ABS
market continued its streak of double-digit growth, and Agency MBS posted
back-to-back quarters of double-digit expansion. The Money Market Complex
expanded at an almost 17% rate. Rest of World (ROW) holdings of US Assets
expanded double-digit rates as well.
Overall, Total Net Borrowing in the Credit Markets increased at a SAAR
(seasonally-adjusted and annualized rate) $3.757 TN during Q2 to $46.573 TN.
This was down only slightly from Q1's SAAR $3.784 TN, and, for perspective,
compares to 2006's growth of $3.825 TN, 2005's $3.380 TN, 2004's $3.085 TN,
2003's $2.767 TN, and 2002's $2.365 TN. Notably, Corporate borrowings expanded
at a 10.7% rate during the quarter, state and local governments 11.9%, and the
Financial Sector 9.8%. Financial sector borrowings built on Q1's brisk pace
(9.7%) to the strongest rate of expansion in a year. And while recent Credit
market turmoil has imposed borrowing restraint, it is worth noting that
first-half corporate debt growth was at the fastest pace since 1999.
Total Non-Financial Debt expanded at a SAAR $2.080 TN (to $29.869TN), down
somewhat from Q1's $2265 TN. By sector, Household debt expanded SAAR $926bn
(vs. Q1's $908bn) to $13.292 TN; Non-Financial Corporations SAAR $626bn (vs.
Q1's $520bn) to $6.050 TN; Non-Farm Non-Corporate SAAR $348bn (vs. Q1's 267bn)
to $3.260 TN; Farm Business SAAR $5.1bn (vs. $20.6bn) to $210bn; and State
& Local Govt. SAAR $246bn (vs. $224bn) to $2.130 TN. Accounting for more
than all of Q2's decline in Non-Financial Debt Growth, Federal Government
borrowings actually contracted SAAR $71bn, compared to Q1's expansion of SAAR
$326bn. Federal government fiscal improvement will be fleeting.
Continuing a trend that became quite pronounced last year, near double-digit
financial sector growth far exceeds that of the real economy. Financial Sector
Credit Market Borrowings (FCMB) increased SAAR $1.423 TN (up from Q1's $1.377
TN) to $14.866 TN. For perspective, FCMB expanded $1.282 TN during 2006, $1.092
TN in 2005, $980bn in 2004, $1.053 TN in 2003, and $869bn in 2002. It is
illuminating to note the type of Credit instruments that financed the financial
sector expansion. During the quarter, "Open Market Paper" increased SAAR
$360bn, "GSE Issues" SAAR $99bn, Agency-and GSE-backed securities SAAR $544bn,
Corporate bonds SAAR $365bn, Bank Loans SAAR $47bn, and (bank liabilities)
Mortgages SAAR $8.2bn. It will likely be some time before "Open Market Paper"
and corporate bonds expand at such rates.
The Wall Street bubble was alive and well during Q2. The Broker/Dealers
expanded Assets at SAAR $703bn to $3.155 TN. Broker/Dealer Assets inflated
$413.1bn (nominal) during the first half, or 30.1% annualized. This expansion
was second only to 2006's full-year $615bn growth. For perspective,
Broker/Dealer Assets increased $282bn during 2005, $232 in 2004, and $278 in
2003 and actually contracted $130bn during 2002. Examining the nature of
Asset growth during the quarter, Corp & Foreign bonds increased SAAR $84bn,
Securities Credit SAAR $219bn, and "Miscellaneous" SAAR $621bn. Treasury
holdings declined SAAR $157bn and Agency/GSE MBS fell SAAR $101bn. On the
Liability Side, Miscellaneous Liabilities increased SAAR $525bn, Securities
Credit SAAR $95bn, and Trade Payables $55bn.
Wall Street "structured finance" enjoyed a booming and, perhaps, foretelling
Q2. GSE Assets expanded SAAR $176bn (to $2.923TN), the strongest growth in a
year. Still, GSE assets were up only 1.1% y-o-y. Agency MBS surged SAAR $544bn,
up from Q1's $499bn and the year earlier $300bn. Agency MBS expanded at a 12.3%
rate during the quarter, with one-year gains of 10.8%. Asset-Backed Securities
expanded SAAR $545bn (to $4.295 TN), down only modestly from Q1's $574bn. And
despite the slowest quarter in some time, the ABS market still enjoyed a 13.3%
growth rate for the quarter and 18.1% growth over the past year. The ABS market
has expanded 63% during the past 10 quarters, extraordinary growth that hit the
wall with a thud with the homecoming of market tumult in Q3.
Interestingly, Total Mortgage Debt (TMD) expanded SAAR $1.167 TN (to $13.982
TN), up from Q1's SAAR $1.087 TN. TMD actually expanded at a robust 9.0% rate,
the largest expansion since Q3 2006 - suggesting that ultra-easy Credit
Conditions endured outside of subprime. Even Home Mortgage debt growth
accelerated, rising to a 7.7% rate from Q1's 7.3%. Meanwhile, the Commercial
Mortgage lending boom went to "blow-off" extremes expanding at a 15.6% pace
(vs. Q1's 10.1%). For the quarter, Home Mortgage lending expanded SAAR $756bn
to $10.750 TN and Commercial Mortgage a record SAAR $344bn to $2.344 TN. Total
Mortgage debt has expanded 9.2% over the past year and 24% over two years, with
Commercial mortgage debt up 13.9% y-o-y and 31%. It will be fascinating to
learn how dramatically mortgage debt growth slowed during Q3. Credit restraint
hit all sectors.
Quite possibly, Q3 will see record banking sector asset growth, both building
on Q2 momentum and taking up the slack created by the Breakdown of Wall Street
Risk Intermediation. During the second quarter, Commercial Banking Assets
expanded SAAR $1.037 TN to $10.455 TN. For comparison, Bank Assets grew $897bn
during 2006, $763bn in 2005, $762bn in 2004, $495bn in 2003 and $477bn in 2002.
On a percentage basis, Q2 experienced Bank Asset growth of 10.5%, with Loans up
8.9%. Over the past year, Bank Loans have expanded 9.0%, with a two-year gain
of 22.9%. Bank holdings of Mortgage loans expanded at a 9.9% rate during the
quarter (to $3.462TN), with one-year growth of 10.5%. Corporate Bond holdings
jumped $44.4bn (22.1% annualized) to $848bn, with one-year growth of 15.5%.
It's an inopportune time in the Credit Cycle for the banking system to expand
so aggressively.
There were some interesting happenings on the Bank Liability side the new
Credit instruments created in the process of financing robust asset growth.
Total Deposit growth slowed markedly to a 3.3% rate during the quarter to
$6.162 TN (up 7.6% y-o-y). "Fed Funds & Net Repo" Liabilities expanded at a
14.3% pace to $1.327 TN (up 11.7% y-o-y). Credit Market Liabilities expanded at
a brisk 18.5% rate to $1.063 TN (up 19.4% y-o-y). Miscellaneous Bank
Liabilities grew at a 36.3% pace to $1.942 TN (up 10.5% y-o-y), and Bond
Liabilities increased at a 22.9% rate to $625bn (up 18.3% y-o-y). One can make
a strong argument that it has not been the ideal environment to aggressively
expand capital markets liabilities to fund risky loan growth.
Money Market Mutual Funds (MMF) expanded a robust SAAR $442bn to $2.490 TN. MMF
assets were up 16.7% annualized during the quarter, 20.4% y-o-y and 35.9% over
two years. "Security RP" holdings expanded SAAR $85.8bn during the quarter to
$413bn. Credit Market Instruments increased SAAR $350.8bn, with Open Market
Paper up SAAR $90.4bn (to $664bn), Treasury Securities up SAAR $38.7bn (to
$89bn), Agency- and GSE MBS up SAAR $31.1bn (to 126bn), Municipal Securities
SAAR $58.4bn (to $399bn), and Corporate & Foreign Bonds SAAR $132bn (to
$422bn). And it has definitely been a risky backdrop for enormous money fund
intermediation of late-cycle risky credits.
"Open Market Paper" expanded a record SAAR $410bn during Q2 to $2.110 TN. This
was a notable 22.4% rate of expansion during the quarter, with one-year growth
of 16.7%. Virtually all Q2 growth was in Commercial Paper, although this amount
and more will be reversed during the current quarter. The ABS sector issued a
record SAAR $295bn of (asset-backed) Commercial Paper during the quarter (to
$885bn). At SAAR $140.7bn, "Funding Corps" were the largest purchasers of Open
Market Paper. Funding Corp Asset growth slowed during Q2 (to 7.1% ann.),
reducing its first-half growth rate to 20.7% (to $1.681 TN). Fed Funds &
Net Repo Asset growth also slowed (to an 8.2% rate), reducing the pace of
first-half growth to a still blistering 19.0% (to $2.731TN)
Delving briefly into other financial operators, Life Insurance Cos. expanded
Assets at a 10.2% rate during the quarter to $4.868 TN (up 8.7% y-o-y);
Financial Companies at a 0.7% rate to $1.896 TN (up 2.1% y-o-y); Saving
Institutions at a 1.3% rate to $1.673 TN (down 5.4% y-o-y); Credit Unions up at
a 3.9% rate to $749bn (up 6.4% y-o-y); and REIT assets down at a 7.1% rate to
$391bn (up 7.6% y-o-y).
As always, the Household (& Non-Profit) Balance Sheet illuminates powerful
Credit Bubble dynamics. The value of Household Assets inflated $1.510 TN
(nominal) during the quarter, or 8.6% annualized, to $71.672 TN. And with
Household Liabilities increasing "only" $301bn, or 8.9% annualized, to $13.813
TN, Household Net Worth inflated an additional $1.206 TN, or 8.5% annualized,
during the quarter to a record $57.859 TN. Expanding at an 11% annualized rate,
Financial Assets increased $1.186 TN (nominal) to $44.284 TN. Real Estate
Assets grew a moderate $274bn, or 4.8% annualized, to $23.193 TN.
Over the past year, Financial Asset holdings have increased $3.980 TN, or 9.9%,
and Real Estate Assets $1.135 TN, or 5.1%. Total Household Assets have
ballooned $5.271 TN, or 7.9%, in four quarters. With Liabilities up $1.076 TN,
or 8.5%, Household Net Worth has inflated $4.195 TN over the past year, or
7.8%. Household Net Worth is up $8.512 TN, or 17.2%, in two years, certainly
supporting consumer confidence and expenditures.
The Rest of World (ROW) Balance Sheet also typically exposes Credit Bubble
effects. This quarter's report, unfortunately, is somewhat convoluted and
with major revisions to confuse the issue. For the quarter, the ROW acquired US
Financial Assets at an unprecedented SAAR $2.535 TN, while ROW US Liabilities
increased a record SAAR $1.934. In nominal dollars for Q2, ROW Assets holdings
increased an enormous $522bn, or 14.1% annualized, to (a heavily revised)
$15.366 TN. Credit Market holdings increased $215bn, or 15% annualized, to
$6.947 TN. Treasury Holdings dipped $7.8bn to $2.185 TN, while Agencies jumped
$86bn to $1.134 TN. Corporate Bond holdings rose $111bn to $2.990 TN.
Over the past year, ROW holdings of U.S. Assets were up an unfathomable $2.659
TN, or 20.9% (ROW Liabilities up $1.172 TN to $6.877 TN). Credit Market
holdings have increased $919bn, or 15.2%. Elsewhere, Security Repos increased
$265bn (28.2%) y-o-y, and Direct Investment rose $226bn (11.5%). Corporate
Bonds (that include ABS) increased $787bn, while "Other" Assets were up almost
$400bn and Deposits $118bn.
Second quarter numbers suggests the scope of global dollar "recycling"
requirements has inflated substantially. The Federal Reserve's aggressive rate
cuts last week definitely only exacerbate what is becoming an untenable outward
flow of dollar liquidity from the U.S. financial system to the Rest of World
(that must, at a price, be "recycled" back into US assets).
We believe the current course of Fed policy is an attempt to sustain the
unsustainable. The Q2 Flow of Funds report certainly confirms the enormity of
ongoing Credit creation, intensive Risk Intermediation, and Financial Sector
Ballooning Classic Credit Bubble Dynamics. The bottom line is that only
extreme levels of Credit expansion and intermediation now sustain bloated and
maladjusted financial, economic and asset market structures. As we've
witnessed, any interruption in the Credit creation process will almost
immediately instigate financial dislocation. The Fed has chosen aggressive
action in hopes of resuscitating Credit excess and Bubble Perpetuation. A less
risky strategy for our system and currency would necessitate air flowing in the
other direction - out of Credit, asset and economic Bubbles. Postponing the
adjustment process at this point ensures greater future financial tumult and
economic hardship.
Doug Noland is a market strategist for the Prudent Bear Funds.
(Republished with permission from PrudentBear.com.
Copyright 2005-2007 David W Tice & Associates. All rights reserved.)
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