Page 1 of 4 CREDIT BUBBLE BULLETIN Too big to suffer a loss
Commentary and
weekly watch by Doug Noland
It is my sense that the financial maelstrom has now reached a new erratic and
highly uncertain stage.
That the Fed would respond to the collapsing US credit bubble with a string of
rapid rate cuts was no surprise.
That the Fed would step up and bail out Bear Stearns, while at the same time
providing liquidity facilities to the Wall Street firms, was similarly
predictable. It was like clockwork when the GSEs responded to market tumult and
the mortgage collapse by heedlessly expanding their obligations. And while I
was surprised that the likes of James Lockhart, director of the Office of
Federal
Housing Enterprise Oversight, and the gents at Pimco proved key enablers for
the GSE's last gasp of recklessness, that the federal government would be
forced to step up and nationalize Fannie and Freddie should have been anything
but a bombshell development. Only the timing of the "bazooka" blast was up in
the air.
Washington has certainly brought out the big guns - resorting to them so early
in the crisis but to alarmingly limited avail. Negative real interest rates and
even unprecedented bailouts do little to address the deep structural
deficiencies that have developed over many years. Sustaining inflated US asset
markets requires massive ongoing growth in credit and speculative trading.
The deeply maladjusted US "services" bubble economy is sustained only through
ongoing credit excess. To be sure, the heart of today's predicament lies in the
reality that a heavily impaired US financial sector is simply incapable of
partaking in the degree of credit excess required to sustain inflated assets
prices, incomes, corporate profits, government receipts and much needed
(restructuring-related) investment spending. The problem is systemic. bailouts
and other government measures have minimal impact because they are not inciting
heightened credit expansion.
And while the media directed its attention to Lehman, the pricing of AIG Credit
Default Swaps (CDSs) exploded this week. This is a company with a trillion
dollar balance sheet and enormous exposure to the CDS market and other
derivatives. And although its balance sheet is only about a third the size of
AIG's, Washington Mutual also saw its CDS blow out. And while most holders of
Fannie and Freddie obligations have come out of the GSE fiasco unscathed (or
better), one can see how this crisis going forward will see more pain meted out
to the corporate bondholder - not just the poor lowly equity owner. Perhaps the
prospect of Lehman debt holders suffering losses has pushed the acutely
vulnerable CDS market to the edge.
The last thing the crippled leveraged speculating community needs right now is
dislocation in the CDS marketplace. Again, the attention this week was on
Lehman, while I believe a much more unwieldy facet of today’s crisis mounts
with the bursting of the historic hedge fund Bubble. Perhaps Sunday we’ll read
news of BofA acquiring Lehman – and perhaps the markets will rally big on such
news. But such a transaction would have little if any impact on crisis dynamics
that have engulfed the leveraged speculating community. The various markets –
global equities, real estate, mortgages, energy and commodities, currencies,
CDS and risk assets generally - have all become an absolute and unmitigated
mess. Money is being lost in waves; scores of favorite trades are being
unwound; redemptions are gathering pace; and the ugly side of Ponzi Finance
Dynamics has taken firm control.
Importantly, there is today no magical cure - no government bailout - that is
going to rejuvenate robust speculator returns. The credit bubble burst, and now
the speculator bubble is bursting. As we have been witnessing of late, stock
market rallies tend to show their greatest force in the sectors where the
speculators are short.
Meanwhile, stock market declines tend to see the favored sectors lead on the
downside. Worse yet, astonishing volatility throughout the markets has created
a backdrop where it has become too easy to "get your face ripped off". Repeated
government interventions have only exacerbated market instability and
vulnerability.
I find it rather odd that secretary Paulson and the administration were keen to
boast that Fannie and Freddie shareholders would not benefit at the expense of
the U.S. taxpayer. Yet it's not as if there were moral hazard issues that had
incentivized these shareholders into risky speculative activities at the
expense of systemic stability. On the other hand, moral hazard played a
fundamental role in Pimco's and others' speculative endeavors in agency debt
and MBS obligations (enabling the GSEs' reckless expansion of risk). And, what
do you know, The Enablers came out the big winners.
There's a lot of talk these days about institutions that are too big to fail.
But this misses the more important point. The heart of the problem is systemic
throughout the credit system, and I'll refer to it as too big to suffer a loss.
The entire financial system would have come unglued if agency debt and MBS
holders suffered losses - losses that could have triggered another round of
speculative deleveraging - that could have triggered outflows from "bond" funds
- that could have triggered losses in "money" funds and/or a flight from the
dollar.
"Moneyness of credit" remains an invaluable analytical concept. Despite acute
vulnerability, the US credit system - hence the American economy - has resisted
implosion specifically because the heart of the monetary system has retained
its "moneyness".
Indeed, nationalizing Fannie and Freddie was seen as necessary to retain
confidence in the core of contemporary "money" - agency obligations, "repos"
and money fund assets. This highly inflated supply of "money" has become so
large as to almost on its own shoulder the entire US (global?) financial system
and economy. "Money" has become too big and consequential to suffer a loss.
Pimco and others savvy players appreciated this dynamic and exploited it for
all it was worth. Ironically, with all the losses being suffered throughout the
markets, the moral hazard issue has never been as precarious. The government
"printing press" now includes agency debt and MBS. The incentives to enable the
continued rampant inflation of contemporary "money" have never been stronger,
with the consequences of these obligations losing their "moneyness" never even
remotely as consequential. Perhaps Treasury and the administration will stick
to their word and not provide taxpayer funds to save Lehman and others. Yet why
do I feel the next step of government intervention will be to bolster the
"repo" market? Looks like the days of easy government interventions have run
their course.
WEEKLY
WATCH
For the week, the Dow gained 1.8% (down 13.9% y-t-d) and the S&P500
increased 0.8% (down 14.8%). The Utilities rose 2.6% (down 14.8%), and the
Morgan Stanley Consumer index gained 2.2% (down 5.1%). The Transports jumped
3.8% (up 11%), and the Morgan Stanley Cyclical index advanced 3.3% (down
13.2%). The small cap Russell 2000 added 0.2% (down 5.1%), and the S&P400
Mid-Caps increased 0.4% (down 8.1%). The NASDAQ100 was about unchanged (down
15.2%), while the Morgan Stanley High Tech index slipped 0.4% (down 15.6%). The
Semiconductors lost 2.9% (down 21.2%). The Street.com Internet Index declined
0.3% (down 11%), while the NASDAQ Telecommunications index gained 1.7% (down
10.2%). The Biotechs gained 1.0% (up 3%). The financial stocks were mixed. With
Lehman collapsing, the Broker/Dealers sank 11.6% (down 35.9%). Meanwhile, the
Banks gained 3.2% (down 19.9%). With Bullion sinking $37, the HUI Gold index
declined 3.6% (down 29.1%).
One-month Treasury bill rates this week sank 28.5 bps to 1.36%, and 3-month
yields dropped 27.5 bps to 1.46%. Two-year government yields fell 10 bps to
2.21%. Five-year T-note yields declined 3 bps to 2.95%, while 10-year yields
increased 2 bps to 3.73%. Long-bond yields added 2 bps to 4.32%. The 2yr/10yr
spread widened 12 to 152 bps. The implied yield on 3-month December ’09
Eurodollars dropped 8.5 bps to 3.315%. Benchmark Fannie MBS yields sank 30 bps
to 5.32%. The spread between benchmark MBS and 10-year T-notes dropped 33 to
159 bps. The spread on Fannie’s 5% 2017 and Freddie’s 5% 2017 notes collapsed
30 to 46 bps. The 10-year dollar swap spread fell 6.75 to 61.5. Corporate bond
spreads were mostly wider. An index of investment grade bond spreads jumped 6
to 151 bps, and an index of junk bond spreads widened 6 bps to 611 bps.
It was another light week of debt issuance. Investment grade issuance this week
included Barrick $1.25bn, Halliburton $1.2bn, Aetna $500 million, Agrium $500
million, Private Export Funding $400 million, and Consumer Energy $350 million.
I saw no junk issuance this week.
Convertible issuance included Mylan $575 million, Tyson Foods $450 million, and
Shanda Interactive $175 million.
International dollar debt issuers this week included Oester Kontrolbank
$1.75bn.
September 10 – Bloomberg (Lester Pimentel): "Emerging-market bonds fell,
pushing yields relative to Treasuries near their widest since June 2005, as
slowing economic growth in the U.S. and Europe saps demand for commodities. The
extra yield investors demand to own developing nation debt rather than
Treasuries widened 17 bps, or 0.17 percentage point, to 3.32 percentage points…
according to JPMorgan Chase & Co."
German 10-year bund yields jumped 18 bps to 4.18%. The German DAX equities
index rallied 1.7% (down 22.7% y-t-d). Japanese 10-year “JGB” yields rose 7 bps
to 1.525%. The Nikkei 225 was little changed (down 20.2% y-t-d). Emerging
markets were mostly lower. Brazil’s benchmark dollar bond yields jumped 13 bps
to 6.02%. Brazil’s Bovespa equities index added 0.9% (down 18% y-t-d). The
Mexican Bolsa fell 1.2% (down 13.4% y-t-d). Mexico’s 10-year $ yields gained 4
bps to 5.62%. Russia’s RTS equities index sank 8.7% (down 41.4% y-t-d). India’s
Sensex equities index fell 3.3%, boosting y-t-d losses to 31%. China’s Shanghai
Exchange sank 5.6%, with 2008 losses 60.5%.
Freddie Mac 30-year fixed mortgage rates sank a notable 42 bps to 5.93% (down
38bps y-o-y). Fifteen-year fixed rates fell 36 bps to 5.54% (down 43 bps
y-o-y), while one-year ARMs increased 6 bps to 5.21% (down 45 bps y-o-y).
Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates
this week down 33 bps to 6.93% (up 2bps y-o-y).
Bank Credit dropped $17.4bn (2-wk drop of $43bn) to $9.394 TN (week of 9/3).
Bank Credit has expanded only $181bn y-t-d, or 2.8% annualized. Bank Credit
posted a 52-week rise of $480bn, or 5.4%. For the week, Securities Credit
slipped $1.4bn. Loans & Leases dropped $16.0bn to $6.928 TN (52-wk gain of
$405bn, or 6.2%). C&I loans were little changed, with y-t-d growth of 7.2%.
Real Estate loans sank $20.9bn (up 1.4% y-t-d). Consumer loans declined $1.2bn,
while Securities loans increased $4.6bn. Other loans added $1.7bn.
M2 (narrow) “money” supply fell $5.5bn to $7.716 TN (week of 9/1). Narrow
“money” has expanded $253bn y-t-d, or 5.0% annualized, with a y-o-y rise of
$346bn, or 4.7%. For the week, Currency added $1.2bn, and Demand &
Checkable Deposits jumped$12.8bn. Savings Deposits dropped $21.4bn, while Small
Denominated Deposits increased $2.9bn. Retail Money Funds slipped$0.9bn.
Total Money Market Fund assets (from Invest Co Inst) decreased $3.5bn to $3.582
TN, with a y-t-d increase of $469bn, or 21.8% annualized. Money Fund assets
have posted a one-year increase of $753bn (26.6%).
Asset-Backed Securities (ABS) issuance picked up somewhat this week.
Year-to-date total US ABS issuance of $128bn (tallied by JPMorgan's Christopher
Flanagan) is running at 27% of comparable 2007. Home Equity ABS issuance of
$303 million compares with 2007’s $220bn. Year-to-date CDO issuance of $22bn
compares to the year ago $274bn.
Total Commercial Paper outstanding rose another $11.1bn this week to $1.815 TN,
with CP up $30bn y-t-d. Asset-backed CP increased $2.6bn last week to $780bn,
with 2008 now showing an increase to $7.4bn. Over the past year, total CP has
contracted $102bn, or 5.3%.
Fed Foreign Holdings of Treasury, Agency Debt last week (ended 9/10) declined
$8.5bn to $2.395 TN. “Custody holdings” were up $339bn y-t-d, or 23.2%
annualized, and $414bn y-o-y (20.9%). Federal Reserve Credit declined $5.6bn to
$888bn. Fed Credit has expanded $14.8bn y-t-d (2.4% annualized) and $31bn y-o-y
(3.6%).
International reserve assets (excluding gold) - as accumulated by Bloomberg’s
Alex Tanzi – were up $1.211 TN y-o-y, or 21.1%, to $6.945 TN.
Global Credit Market Dislocation Watch
September 12 – Wall Street Journal (Jon Hilsenrath, David Enrich and Deborah
Solomon): “A year into a credit crisis that started
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