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5 CREDIT BUBBLE
BULLETIN The
breakdown of Wall Street
alchemy Commentary and weekly review by Doug
Noland
overriding flaw was to ignore that a
runaway bubble in market-based finance ensured
that various market and credit risks all coalesced
into one massive,unmanageable, highly correlated,
unhedgable, undiversifiable association of
interrelated systemic risks.
WEEKLY
WATCH
During yet another volatile week,
the Dow (down 6.9% y-t-d) and the S&P500 (down
8.1%) each rose 1.4%. The Utilities gained 1.2%
(down 7.2%), while the Transports dipped 0.2% (up
2.9%). The Morgan Stanley Cyclical index increased
1.2% (down 6.0%), and the Morgan Stanley Consumer
index advanced 1.4% (down
6.3%). The small cap Russell 2000
added 0.4% (down 8.4%), and the S&P400
Mid-Caps increased 0.2% (down 7.3%). The NASDAQ100
gained 0.4% (down 14.6%), and the Morgan Stanley
High Tech index rallied 1.5% (down 13.3%). The
Street.com Internet Index gained 1.3% (down
10.2%), while the Semiconductors declined 0.6%
(down 14.8%). The NASDAQ Telecommunications index
gained 0.7% (down 11.5%). The Biotechs added 0.2%
(down 7.5%). The Broker/Dealers declined 0.8%
(down 6.9%) and the Banks dipped 0.6% (down 1.2%).
With Bullion declining $20, the HUI Gold index
dropped 1.9% (up 6.3%).
A steep yield
curve turned steeper. Three-month Treasury bill
rates fell 5 bps this past week to 2.19%. Two-year
government yields declined 2 bps to 1.91%.
Meanwhile, five-year T-note yields rose 7 bps to
2.76%, and ten-year yields jumped 12.5 bps to
3.77%. Long-bond yields rose 15.5 bps to 4.58%.
The 2yr/10yr spread ended the week at a notable
186 bps. The implied yield on 3-month December '08
Eurodollars rose 2.5 bps to 2.355%. Benchmark
Fannie MBS yields surged 32 bps to 5.51%, this
week dramatically under-performing Treasuries.
Agency debt also performed poorly. The spread on
Fannie's 5% 2017 note widened 11 to 71 bps and
Freddie's 5% 2017 note widened 10 to 68 bps. The
10-year dollar swap spread increased 6.25 to
72.75, the widest since year-end. Corporate bond
spreads were wider, with an index of junk bonds
rising 24 bps.
Debt issuance slowed to a
trickle. Investment grade sales included credit
Suisse $2.0bn, Procter & Gamble $1.5bn, Nabors
Industries $575 million, PNC $375 million, and RPM
International $250 million.
Junk issuance
included Goodman Global $500 million.
Convert issuance included Vertex
Pharmaceuticals $288 million, GMX Resources $105
million, and Glotek $100 million.
German
10-year bund yields jumped 9 bps to 3.95%, while
the DAX equities index rallied 0.8% (down 15.5%
y-t-d). Japanese "JGB" yields increased 3.5 bps to
1.45%. The Nikkei 225 recovered 3.1% (down 11%
y-t-d and 23.9% y-o-y). Emerging debt and equities
markets were mixed-to-higher - and volatile.
Brazil's benchmark dollar bond yields declined 4
bps to 5.95%. Brazil's Bovespa equities index
rallied 3.7% (down 4.1% y-t-d). The Mexican Bolsa
gained 2.0% (down 2.7% y-t-d). Mexico's 10-year $
yields rose 5 bps to 5.28%. Russia's RTS equities
index jumped 6.3% (down 13.2% y-t-d). India's
Sensex equities index rose 3.7% (down 10.7%
y-t-d). After the Lunar New Year break, China's
Shanghai Exchange declined 2.2% this week (down
14.5% y-t-d).
Freddie Mac posted 30-year
fixed mortgage rates rose 5 bps this week to 5.72%
(down 58bps y-o-y). Fifteen-year fixed rates
jumped 10 bps to 5.25% (down 78bps y-o-y).
One-year adjustable rates dipped 3 bps to 5.00%
(down 52bps y-o-y).
Bank credit surged
$51.4bn during the most recent data week (2/6) to
a record $9.341 TN. Bank credit has posted a
29-week surge of $697bn (14.5% annualized) and a
52-week rise of $986bn, or 11.8%. For the week,
Securities Credit jumped $45bn. Loans & Leases
increased $6.3bn to a record $6.884 TN (29-wk gain
of $560bn). C&I loans fell $7.8bn, with
one-year growth of 20.8%. Real Estate loans gained
$10.2bn (up 7.6% y-o-y). Consumer loans added
$2.6bn. Securities loans rose $3.6bn, while Other
loans declined $2.3bn. Examining the liability
side, "Borrowings from Other" jumped $40bn.
M2 (narrow) "money" supply jumped $33.8bn
to a record $7.569TN (week of 2/4). Narrow "money"
expanded $107bn over the past five weeks, with a
y-o-y rise of $473bn, or 6.7%. For the week,
Currency added $0.2bn and Demand & Checkable
Deposits increased $19.9bn. Savings Deposits
declined $11.8bn, while Small Denominated Deposits
gained $2.5bn. Retail Money Fund assets surged
$22.9bn.
Total Money Market Fund assets
(from Invest Co Inst) jumped $26bn last week (6-wk
gain $275bn) to a record $3.388 TN. Money Fund
assets have posted a 29-week rise of $804bn (56%
annualized) and a one-year increase of $995bn
(41.6%).
Asset-Backed Securities (ABS)
issuance rose to a still slow $3.0bn. Year-to-date
total US ABS issuance of $29bn (tallied by
JPMorgan) is running about a third the level from
comparable 2007. Still no Home Equity ABS deals
have been sold thus far, compared to $45bn in
comparable 2007. Year-to-date CDO issuance of
$1.5bn compares to the year ago $39bn.
Total Commercial Paper dropped $13.3bn to
$1.835 TN. CP has declined $389bn over the past 27
weeks. Asset-backed CP fell $6.2bn (27-wk drop of
$399bn) to $796bn. Over the past year, total CP
has contracted $198bn, or 9.7%, with ABCP down
$266bn, or 25%.
Fed Foreign Holdings of
Treasury, Agency Debt last week (ended 2/13)
declined $4.7bn to $2.113 TN. "Custody holdings"
were up $56.5bn y-t-d, or 20.4% annualized, and
$302bn year-over-year (16.7%). Federal Reserve
Credit fell $3.4bn last week to $858bn. Fed Credit
has contracted $15.2bn y-t-d, or 12.9% annualized,
while expanding $11.1bn y-o-y (1.3%).
International reserve assets (excluding
gold) - as accumulated by Bloomberg's Alex Tanzi -
were up $1.350 TN y-o-y, or 27%, to a record
$6.340 TN.
Global Credit Market
Dislocation Watch February 14 - Financial
Times (Paul J Davies and Michael Mackenzie): "The
world of synthetic collateralised debt obligations
is suffering as the cost of protecting corporate
debt against default via credit derivatives - from
which these CDOs are created - continues to be
pushed higher. But there is another problem
building, and some fear it could lead to a repeat
of the correlation crisis of 2005, which saw hedge
funds and investment banks suffer hundreds of
millions of dollars worth of losses. The problem
then was that investment banks and hedge funds had
built up large exposures to the riskiest equity
tranches of synthetic CDOs, which pay the highest
returns but bear the first losses from any
defaults in an underlying pool of credit
derivatives. When sentiment changed suddenly after
the shock downgrades of US carmakers GM and Ford,
these investors found that there was no market for
the risk they held. Now a similar correlation
pattern has emerged as hedge funds have loaded up
on the same risk by selling protection on equity
tranches. However, this time the patterns of
pricing in the CDO market, or the movements in
correlation, have also been fuelled by what is
occurring at the other end of the risk spectrum.
Here, large banks worried about systemic risk and
the potential collapse of the monoline industry
have been busily trying to buy as much protection
as possible on the safest senior tranches….
'Correlation now is even more unbalanced than it
was in 2005,' says Alberto Gallo, credit
derivatives strategist at Bear Stearns. 'Most of
the money in the long correlation trade [for
example selling protection on equity ranches] is
from hedge funds.'"
February 15 - The New
York Times (Jenny Anderson and Vikas Bajaj): "Some
well-heeled investors got a big jolt from Goldman
Sachs this week: Goldman…refused to let them
withdraw money from investments that they had
considered as safe as cash. The investments at
issue are so-called auction-rate securities,
instruments at the center of the latest squeeze in
the credit markets. Goldman, Lehman, Merrill Lynch
and other banks have been telling investors the
market for these securities is frozen — and so is
their cash. The banks typically pitch these
securities to corporations and wealthy individuals
as safe alternatives to cash… The bonds are, in
fact, long-term securities. But the banks hold
weekly or monthly auctions to set the interest
rates and give holders the option of selling the
securities. Only this week almost 1,000 of these
auctions failed. The banks also refused to support
the auctions, leaving many investors wondering
when they will get their money back. 'Investors
have lost confidence in the liquidity of these
instruments,' said G. David MacEwen, the chief
investment officer for fixed income at American
Century Investments… 'These types of instruments
depend on new investors showing up to own the
securities.'"
February 14 - Financial
Times: "The subprime virus has mutated. It has now
infected the municipal market. The same issues
that roiled the asset-backed commercial paper
market in the autumn are cropping up again.
Liquidity risk turns out to be a bigger problem
than credit-focused investors had reckoned with.
And liquidity risk can be fatal. Look at what
happened to structured investment vehicles, a
$300bn or so market that shrivelled away.
Municipal issuers tap the capital markets in
several ways and all of them now look under
varying degrees of stress. The auction rate
securities, a $330bn market according to JPMorgan
Chase, have coupons that reset periodically at
auctions. Now a few are failing, in part because
of jitters around the insurers that support the
credit ratings of municipal debt. There has to be
a good chance that this type of funding vehicle,
like SIVs, will lose its raison d'être."
February 11 - Financial Times (Aline van
Duyn and Michael Mackenzie): "Another day, another
loser in the global game of subprime hide and
seek. As the Group of Seven finance leaders said
over the weekend, there could be $400bn of losses
in the financial system linked to US subprime
mortgages. Yet only $120bn have been revealed so
far. American International Group's confession on
Monday reveals where some more of the losses were
hiding. In December, the US insurer announced a
$1.05bn to $1.15bn charge for October and November
for credit default swap (CDS) insurance it wrote
against collateralised debt obligations… Now,
alongside PwC's conclusion that AIG had a
'material weakness' in its reporting, that charge
has been increased to
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