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5 CREDIT BUBBLE
BULLETIN At the heart of
disorder By Doug
Noland
COMMENTARY
It was an
eventful week for indications of the real
economy's (waning) soundness. At 15.2 million
annualized, January vehicle sales were the weakest
since October 2005 (that followed more than a year
of very strong sales). A larger-than-expected
increase in weekly initial unemployment claims
(356,000) pushed continuing unemployment claims
rose to the highest level (2.785 million) since
late 2005. The ABC/Washington Post weekly Consumer
Comfort index sank a notable 6 points this week to
negative 33, the lowest
reading since the early nineties.
Importantly, this week's Federal Reserve
survey of senior bank-loan officers provided
confirmation both that bankers have become much
more cautious in lending and that borrowers have
lost enthusiasm for taking on more debt. Moreover,
any indication of general tightening of bank
credit takes on major significance today due to
the seizing up and breakdown of Wall Street
finance. Inarguably, what erupted last year in
subprime has now evolved into a broad-based and
severe credit tightening. Notably, 80% of banks
tightened credit for commercial real estate
lending and better than a third tightened
commercial and industrial (C&I) credit. It is
worthwhile excerpting directly from the Fed's
survey:
In the January survey, significant
numbers of domestic respondents reported that
they had tightened their lending standards on
prime, nontraditional, and subprime residential
mortgages over the past three months; the
remaining respondents noted that their lending
standards had remained basically unchanged.
About 55% of domestic respondents indicated that
they had tightened their lending standards on
prime mortgages, up from about 40% in the
October survey. Of the thirty-nine banks that
originated nontraditional residential mortgage
loans, about 85% reported a tightening of their
lending standards ... compared with about 60% in
October ...
About 60% of domestic
respondents ... indicated that demand for prime
residential mortgages had weakened over the past
three months, and 70% of respondents ... noted
weaker demand for nontraditional and subprime
mortgage loans over the same period ... About
60% of domestic respondents indicated that they
had tightened their lending standards for
approving applications for revolving home equity
lines ... Regarding demand, about 35% of
domestic banks ... reported that demand for
revolving home equity lines of credit had
weakened over the past three
months.
About 10% of respondents - up
from about 5% in ... October - reported that
they had tightened their lending standards on
credit card loans ... About 30% of respondents
noted that they had reduced the extent to which
such loans were granted to customers who did not
meet credit-scoring thresholds ... About 15% of
domestic banks - up from about 5% in ... October
- indicated a diminished willingness to make
consumer installment loans ... About one-third
of domestic banks - up from about one fourth ...
- reported that they had tightened their lending
standards on consumer loans other than credit
card loans ... Regarding loan demand, about 35%
of domestic institutions, on net, indicated that
they had experienced weaker demand for consumer
loans of all types ...
About 80% of
domestic banks reported tightening their lending
standards on commercial real estate loans over
the past three months, a notable increase from
the October survey. The net fraction of domestic
banks reporting tighter lending standards on
these loans was the highest since this question
was introduced in 1990 ...
In the
January survey, one-third of domestic
institutions ... reported having tightened their
lending standards on C&I loans to small as
well as to large and middle-market firms over
the past three months. Significant net fractions
of respondents also noted that they had
tightened price terms on C&I loans to all
types of firms ... Compared with domestic
institutions, larger net fractions of US
branches and agencies of foreign banks reported
having tightened lending standards and terms on
C&I loans ...
With Wall Street's
securitization markets basically closed for
business and even bank credit availability now
tightening meaningfully, January's collapse in the
ISM Non-Manufacturing index should have been less
of shock to the markets. After all, the
services-based US economy is primarily
finance-driven, and our financial system is
floundering.
The ISM Non-Manufacturing
index unexpectedly sank 12.5 points to 41.9 (below
50 indicates contraction), the lowest level since
October 2001. Expectations had the index slipping
only a point or so to a still expansionary 53.
Instead, new orders dropped more than 10 points to
43.5, while the prices component dipped ever so
slightly to a disconcerting 70.7. Alarmingly, the
non-manufacturing employment index sank to 43.9,
the lowest reading since the 43.9 registered in
the month subsequent to the 9/11 terrorist
attacks. This report corroborates the recent
dismal jobs report, where "service-producing" job
growth collapsed from December’s 143,000
(five-month average growth of 138,000) to
January’s 34,000.
It is worth noting that,
despite the bursting of the technology bubble, the
non-manufacturing index remained above 50 (at
50.7) through February 2001. But as credit
problems engulfed the corporate debt market, the
employment component proceeded to drop 6.4 points
in 11 months to fall to 44.3 by early 2002.
Remarkably - and indicative of breadth and
severity of the unfolding credit crises - the
non-manufacturing employment index sank 7.9 points
just last month. Meanwhile, the ISM Manufacturing
Employment index declined 4.7 points in two months
to its lowest level since September 2003. The
bubble economy is now clearly suffocating from
insufficient credit. In particular, the unfolding
corporate credit crisis has begun to impact jobs,
incomes and the overall economy.
It was,
as well, an eventful week for indications of the
soundness of the US and global financial systems.
On the inflation front, major commodities indices
(including the CRB and the UBS/Bloomberg Constant
Maturity) surged to record highs. Platinum jumped
7% this week to a record on tight supplies and
power shortages in South Africa. Lead gained 5%.
Copper jumped 7.5% (biggest gain in almost a
year), increasing year-to-date gains to almost
16%. Palladium rose to the highest price since
2002. Sugar rose 5% on Friday, and I’d be remiss
not to note crude’s 4% one-day surge.
But
when it comes to spectacular moves, wheat takes
the cake. Prices surged to yet another record high
(up 30% y-t-d), as forecasts have US stockpiles
falling to the lowest level since 1948. Global
supplies are said to be the lowest since 1978.
Alarmingly, wheat increased the 30 cent daily
limit in Chicago trading for five straight
sessions, with Bloomberg reporting this week’s 16%
gain as the "biggest in history''. Prices are now
up 140% y-o-y. Along for the ride, soybeans rose
4% this week to a near-record ( US inventories at
four-yr low), increasing one-year gains to 80%.
Corn prices gained 2% (having doubled in the past
two years), also trading at record highs.
Production and inventory concerns saw coffee
prices rise 5.8% this week to the highest level
since 1999. Cocoa gained 3.8% this week (37%
one-year gain).
The question remains: how
much will the Chinese, Indians, Russians, American
consumers and others be willing to pay for wheat
and other vital commodities? For energy? For
stores of value such as gold, silver and the other
(increasingly) precious metals in an age of
unregulated, unrestrained, unanchored,
electronic-based, securities-based, and
market-driven global "money" and credit. With
trillions of dollar liquidity sloshing vagariously
around the global financial "system", there is
clearly more than ample high-octane inflationary
fuel to destabilize markets for myriad essential
things of limited supply. And, increasingly, there
is talk of problematic margin calls and
derivative-related issues impacting commodities
trading conditions.
The talk is of trading
dislocations and nervous "bankers" pulling away
from the financing of hedging activities in
various markets. Or, in short, we are witnessing a
precarious ratcheting up of monetary disorder - in
a multitude of key markets and on a global basis.
At the heart of monetary disorder, we have
a leveraged speculating community increasingly on
the ropes. January was a tough month for the hedge
fund community. In particular, it appears the
(overhyped) "long/short" (holding both long and
short positions) and (overhyped) "quant" funds had
an especially tough go of it. To begin the New
Year, last year’s favorite stocks (ie technology,
emerging markets, energy, and utilities) were
hammered, while the heavily shorted sectors have
significantly outperformed (ie homebuilders,
banks, retailers, "consumer discretionary", and
transports). The yen and Swiss franc (currencies
traders had shorted to finance higher yielding
"carry trades") have rallied. Even the dollar has
rallied somewhat. Many speculators have been
(caught) short commodities, having expected
negative ramifications from the bursting of the US
credit bubble. Others have been caught
over-exposed to emerging equities and debt
markets. And, increasingly, it appears various
trades throughout the complex corporate credit
arena have run amuck.
Friday, various
indices of corporate credit risk moved to record
highs, including the previously stalwart
"investment grade" sector. Leveraged loan prices
fell to record lows late in the week, as talk of
further bank and hedge fund liquidations
captivated the marketplace. While the status of
the (monoline) credit insurers is now a central
focus, behind the scenes there is increasing angst
at the prospect for a disorderly unwind of various
leveraged trading strategies in corporate credits
and credit derivatives. "Synthetic" CDOs
(collateralized debt obligations) - pools of
credit default swaps and other derivatives - are
especially vulnerable and problematic for the
system. In short, the corporate credit crisis took
a decided turn for the worse this week. There is,
with the economy sinking rapidly and the leveraged
speculating community faltering abruptly, little
prospect at this point for stabilization. The
downside of the credit cycle is attaining
overwhelming momentum.
The Wall Street
punditry seems to go out of its way to get things
wrong. The latest talk is that the market will
simply look over the "valley" and begin focusing
on a recovery from what will be, at worst, a brief
and mild recession. The relative strong
performance of the banks, retailers, homebuilders,
and transports is accepted as confirmation of the
bullish view. I’ll instead take the view that the
recent major squeeze in the heavily shorted stocks
and sectors is only further destabilizing and
indicative of dynamics troubling to the leveraged
speculating community and the credit system more
generally. "Hedges" have stopped working, creating
a backdrop of angst and forced liquidations.
Despite last year’s subprime collapse and
mortgage turmoil, the leveraged speculating
community overall chalked up another stellar year
of performance. Actually, the community in total
likely boosted returns with bets against subprime
and mortgage credit more generally. Certainly, the
hedge funds profited nicely from shorts on the
financial and consumer sectors. Ironically, the
initial stage of the bursting of the credit bubble
proved a favorable backdrop for many of the major
players and the community in general. The deluge
of industry inflows ran unabated through
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