Page 1 of 5 CREDIT BUBBLE BULLETIN Ponzi dynamics still at play
Commentary and weekly watch by Doug Noland
US gross domestic product expanded expanded at a 3.3% pace in the second
quarter, the strongest since 2007's Q3 4.8%. Durable Goods Orders, Existing
Home Sales, and the Chicago Purchasing Managers' index were all reported
"stronger-than-expected". And with commodity prices almost 20% off July highs -
and crude oil notably unimpressive this week in the face of a major Gulf
hurricane - the markets seem to lend support to the waning inflation viewpoint.
The dollar rallied further last week. Meanwhile, despite Friday's downdraft,
Freddie Mac gained 60% this week and Fannie Mae advanced 37%. Monoline insures
MBIA and Ambac surged 59% and 35%, respectively. MBIA saw its stock price more
than
double during August, to surpass US$16. The Bank index jumped 3.1% this week
and the Broker/Dealers rallied 4.0%. Homebuilding stocks were up 9%.
Investors are increasingly willing to accept that the worst of the credit
crisis has passed. Talk that the nation's housing markets are bottoming becomes
louder each week. And every day market participants seem more receptive to the
"economic resiliency" thesis.
First of all, I am certainly of the view that the economy is much weaker than
the headline 3.3% growth rate. At the minimum, I am skeptical that the 1.2%
annualized increase in the GDP price index accurately captures what I believe
is a significant inflationary component in current "output". It is worth noting
that the favored inflation gauge of former Federal Reserve chairman Alan
Greenspan and the Fed, the PCE Deflator, was up 4.5% from a year earlier, the
strongest year-over-year increase since 1991.
There is bountiful wishful thinking when it comes to our nation's mortgage and
housing crises. Granted, many of the burst bubble markets - including some
spectacular busts throughout California, Florida, Nevada, and Arizona - have in
some cases seemingly reached somewhat of a "clearing price". Transaction
volumes are up significantly in many of the locations with the greatest y-o-y
price declines. I'll suggest, however, that it is unwise to extrapolate trading
dynamics in these burst markets to national housing trends more generally. I
believe the vast majority of markets around the country are more aptly
described as bubbles leaking air, as opposed to the collapsed markets that
garner the greatest media attention.
I'll turn more constructive on home prices and housing markets generally when
mortgage credit availability begins to loosen. It remains my view that credit
continues in a tightening dynamic. Notably, the growth in Fannie and Freddie's
combined books of business slowed sharply to a 3.7% rate during July, the
slowest pace in two years. And while there is nothing really in the works to
compare with the abrupt credit tightening that emanated from collapsing
subprime and Alt-A securitization markets, I'll argue today's tighter credit is
a more subtle dynamic resulting from various types of lending institutions
restricting, on the margin, loans to even prime credits.
From Wall Street firms down to the small community banks, tighter lending terms
are leading to higher downpayments and less-flexible payment terms for even
high-quality borrowers. While the nature of this dynamic specifically does not
lead to collapses for the relatively stable housing markets around the country,
it nonetheless will definitely continue to pressure prices. And downward home
prices will, over time, lead to only more lender nervousness and restraint.
Despite the lull, vulnerable housing markets do remain acutely susceptible to
any worsening in the crisis of government-sponsored enterprises (GSEs) such as
Fannie and Freddie. With spread on mortgage-backed securites (MBS) having
tightened somewhat during August, I'll assume Fannie and Freddie resumed
aggressive mortgage purchases in the marketplace after somewhat slowing their
buying during July.
Importantly, overall marketplace liquidity has deteriorated to the point where
the GSEs must expand aggressively in order to forestall another major leg down
in the ongoing housing crisis. As such, the marketplace of late is involved in
a dangerous game of "chicken" with both the GSEs and Treasury. These days, any
time the GSEs slow their marketplace buying of mortgage paper (back away from
their "backstop bid"), spreads widen sharply and fears of a liquidity crisis -
and forced Treasury bailout - intensify. So, I'll assume the GSEs have resorted
again to ballooning their exposure aggressively - recklessly.
There has been a lot of talk about the GSEs being "privatized". As the thinking
goes, Fannie and Freddie should be temporarily nationalized, recapitalized,
split up and then released as responsible participants in the free marketplace
- credit providers no longer posing a risk to the American taxpayer. This all
sounds wonderful in theory - yet is completely impractical in reality. I fully
expect the GSEs to be nationalized. But I suspect the federal government will
be running - and recapitalizing - these institutions for many years to come.
The private mortgage marketplace self-destructed, and now the entire "prime"
mortgage/housing market is dependent upon ongoing cheap mortgage finance
available only through American taxpayer backing and subsidies. The private
sector simply cannot today - or at any time in the foreseeable future - provide
the hundreds of billions of dollars of cheap ongoing new mortgage credit
necessary to forestall a systemic housing/economic/financial collapse.
There will be no happy "recapitalize and privatize" ending to this saga. The
bill to the taxpayer is now growing rapidly - along with GSE exposure - and
will balloon into the trillions over the coming years and decades. And for how
long the holders of GSE debt and MBS will be allowed such handsome returns at
taxpayer expense is a quite intriguing question.
I also read and hear too much about the continued need for "Keynesian"
stimulus. Regrettably, the system has been in non-stop government (fiscal and
monetary) stimulus mode for years now. It may have been indirect at the time,
but it is now apparent that GSE obligations should be included today right
along with debt owed directly by the Treasury.
Before all is said and done, the taxpayer will also be on the hook for enormous
losses from various federal guarantees of deposits, student loans, pensions,
and the like. The bottom line is that a whole range of direct and indirect
federal guarantees - especially since the 2001/02 recession - have played an
integral role in spurring credit and economic bubbles. "Keynesian" ammunition -
fired way too early and freely in order to sustain multiple bubbles - has
definitely buoyed the US bubble economy, although such measures will have only
limited effect down the road when they're sorely needed.
Returning back to my initial paragraph, these days the economy and markets
don't appear all that bad - certainly nothing as nasty as we dour
prognosticators have been forecasting. I'll warn, however, that there are some
very dangerous "Ponzi finance" dynamics still very much at play. The most
obvious resides with the GSEs. There are also closely related bubbles
throughout the agency and Treasury bond arena.
Meanwhile, a view has gained adherents that the US economy is actually in much
better shape than Europe and elsewhere. The reality that Europe is not buoyed
by their own government-sponsored mortgage behemoths and that their economies
are more manufacturing based (and thus vulnerable to cyclical downturns) are
only short-term relative disadvantages.
WEEKLY WATCH
For the week, the Dow (down 13.0% y-t-d) and S&P500 (down 12.6%) both
declined 0.7%. The Transports added 0.9% (up 11.7%), while the Morgan Stanley
Cyclicals dipped 0.3% (down 12.7%). The Morgan Stanley Consumer index declined
1.1% (down 6.7%), and the Utilities fell 0.7% (down 11.9%). The broader market
made a better showing. The small cap Russell 2000 added 0.3% (down 3.5%), and
the S&P400 Mid-Caps added 0.1% (down 5%). Technology stocks were weak. The
NASDAQ100 slumped 3.1% (down 10.2%), and the Morgan Stanley High Tech index
fell 2.6% (down 10%). The Semiconductors were hit for 3.7% (down 13.5%), The
Street.com Internet Index 2.0% (down 6.5%), and the NASDAQ Telecommunications
index 3.2% (down 4.2%). The Biotechs declined 2.5% (up 5.7%). Financial Stocks,
on the other hand, rallied sharply. The Broker/Dealers jumped 4.0% (down 27%),
and the Banks gained 3.1% (down 25.5%). With Bullion up $7.30, the HUI
recovered 0.4% (down 16%).
One-month Treasury bill rates dropped 10 bps this week to 1.61%, and 3-month
yields fell 9 bps to 1.72%. Two-year government yields dipped 3 bps to 2.375%.
Five-year T-note yields declined 5 bps to 3.10%, and 10-year yields fell 6 bps
to 3.81%. Long-bond yields declined 4 bps to 4.42%. The 2yr/10yr spread
declined about two to 144 bps. The implied yield on 3-month December '09
Eurodollars sank 12.5 bps to 3.565%. Benchmark Fannie MBS yields dropped 12 bps
to 5.82%. The spread between benchmark MBS and 10-year T-notes narrowed 6 to a
one-month low 200 bps. The spread on Fannie's 5% 2017 note widened 12 bps to
77.6 bps, and the spread on Freddie's 5% 2017 note widened 11 bps to 76.2 bps.
The 10-year dollar swap spread declined 4.25 to 67.75. Corporate bond spreads
were mixed to narrower. An index of investment grade bond spreads widened 11 to
162 bps, and an index of junk bond spreads widened 3 bps to 571 bps.
It was another an extremely light week of debt issuance. Investment grade
issuance this week included Sierra Pacific Power $250 million and McCormick
& Co. $250 million.
I saw no junk or convertible issuance this week.
International dollar debt issuers this week included European Investment Bank
$4.0bn, Ontario $1.5bn, Asian Development Bank $1.25bn, and Korea Railroad $500
million.
August 29 - Financial Times (Rachel Morarjee): "Investor
Head
Office: Unit B, 16/F, Li Dong Building, No. 9 Li Yuen Street East,
Central, Hong Kong Thailand Bureau:
11/13 Petchkasem Road, Hua Hin, Prachuab Kirikhan, Thailand 77110
