Page 1 of 3 CREDIT BUBBLE BULLETIN Fair it is not
Commentary and weekly watch by Doug Noland
CNBC's impassioned Rick Santelli suffered an impromptu "mad as hell and not
gonna take it any more" moment. And there is definitely plenty of dry kindling
lying around awaiting a spark. Santelli's outburst could very well mark a
turning point for national policy debate. Hopefully it is not used as a battle
cry for more rage and open "class warfare". Public outrage, as understandable
as it is, is a troubling facet of the new post-bubble landscape.
There's no way around the reality that government bailouts and stimulus
packages are inequitable and unjust for most of us. There is hope that they
bolster stability for the system overall. The majority of us are begrudgingly
willing to pay a significant price to ensure stability. Policymakers will, of
course, craft policy in hope of stabilizing an acutely unstable system.
"Implosion" will never
be an option for politicians and other policymakers. At the same time, the
government's (predictable) responses to a breakdown in market mechanisms
provide such an easy target. As I tried to touch upon last week, policy debate
that jolts deep ideological hot buttons is messy business.
The nuts and bolts of today's reflationary policies will not be received warmly
by the majority of taxpayers who work hard, live within their means, and pay
their bills. Post-bubble policymaking, by its nature, can be reliably counted
upon to throw good "money" after bad. And the bigger the bubble the greater the
amount that will find its way down the rat hole.
In a highly inflated system, it matters little that, say, 90% of an economy's
loans are sound. The problematic (say) 10% remains more than sufficient to
bring down a highly leveraged and fragile financial sector - which risks
collapse for the entire bubble economy and credit system. So, inevitably,
policy focus will be on the minority "10%" group of problem borrowers,
institutions and their loans. And it certainly doesn't help the tone of policy
discourse that this group is comprised of an indeterminable blend of millions
of misfortunates and miscreants.
It is fair to suggest that the greater the public outrage the less compassion
forthcoming for the unfortunates and the greater the hostility directed toward
policies viewed as benefiting the undeserving. And the bottom line is that the
post-bubble policymaking focus is, by its nature, unjust and inequitable.
Moreover, it comes on the heels of a bubble period recognized in hindsight as
especially unjust and inequitable. It all creates a quite complex and volatile
mix of finance, economics, policymaking and social tension. At the same time,
an increasingly emboldened government - with its simple mandate to make things
better - mobilizes massive financial and real resources in its
less-than-studied effort to fulfill its newfound role as system stabilizer of
last resort.
I will not jump into the fray regarding the merits (and fairness) of modifying
millions of troubled mortgages. Instead, I this evening want to address the
administration's less arousing announcement that it is boosting the taxpayers'
commitment to Fannie Mae and Freddie Mac recapitalization from $200 billion to
$400 billion. Consistent with the overarching goal of not bankrupting our
nation, it is disconcerting that the government sponsored enterprises have
apparently once again evolved into primary tools of government reflationary
measures.
It is worth noting that Fannie's and Freddie's combined books of business
(mortgages held and guaranteed) jumped $31.3 billion during December to a
record $5.319 trillion (strongest growth since July). For the year, their books
of business jumped $326 billion (6.5%), as their combined balance sheet assets
rose 10.2% to $1.592 trillion.
In just two years, Fannie and Freddie's combined books of business ballooned by
$964 billion, or 22%. Embedded taxpayer losses are now expanding exponentially.
I am protesting the use (once again) of the GSEs as mechanisms for systemic
reflation. These institutions were at the heart of the US credit bubble, a
bubble that severely distorted the US financial sector and economy - only to
then set its sights on inflating the world. Today's synchronized busts create a
precarious global policymaking dilemma at home and abroad. My greatest fear at
this point is a government finance bubble that insidiously destroys our
government's credit worthiness, similar to what occurred on Wall Street.
I understand the argument for temporary government deficit spending. I
appreciate the recent imperative for expansion of the Federal Reserve's balance
sheet to accommodate financial sector delivering. These hopefully temporary
fiscal and monetary policy measures can be quantified, monitored, debated and
regulated. Conversely, the GSEs are financial blackholes. Their operations are
today dictated by political goals, yet have seemingly no objective oversight
("we're all inflationists now"). And being too big to really fail, the markets
freely finance these failed institutions.
I scoffed at the notion of GSE privatization. They were simply much too big. To
be sure, their financial deficits had become as overwhelming as their roles
throughout the mortgage, housing and overall global financial markets. Their
implicit government guarantees were poison for distorting various markets - and
the scope of the ensuing credit bubble ensured that there was no way for
Washington to ever retreat from their backing of these institutions.
It is imperative that the GSEs not be used as stealth mechanisms for system
reflation. The critical issue is not the federal government directing Fannie
and Freddie to modify mortgages. What I fear is another round of massive GSE
balance sheet and guarantee expansion. It is today too politically tempting to
use GSE obligations to reflate. Their debt and guarantees are conveniently not
counted as part of the federal deficit, while the GSEs provide a convenient
mechanism for transferring mortgage risk away from the troubled banking system
and securitization marketplace.
And as long as the markets provide ample cheap GSE financing, the revelation of
the true loss to be absorbed by the American taxpayer can be left (to grow) for
another day.
Besides, it is increasingly clear that policymaking must turn its focus
directly to our troubled banking system. The basket approach of stimulus and
myriad measures to bolster housing and securities markets is doing little to
alleviate concerns for the solvency of some of our major banks. The hope was
that new measures would significantly buoy market confidence and, thus, provide
general support for the banking system. It's just not working. The markets have
grown too accustomed to downplaying every policy move in anticipation of the
next more dramatic one. The markets are forcing policymakers to hit the banking
problem head on.
The markets are now abuzz with "nationalization". "The horse seems to have left
the barn," as they say. One way or another, a reasonably functioning banking
system is an absolute priority. We are in for a fascinating few weeks, as the
US Treasury and Federal Reserve grapple with what dramatic measures would have
the highest probability of effectively restoring confidence in the banking
system. The environment is almost surreal.
WEEKLY WATCH
For the shortened week, the Dow dropped 6.6% (down 16.1% y-t-d) and the
S&P500 sank 7.4% (down 14.7%). The Morgan Stanley Cyclicals were hit for
13.4% (down 25.8%), and the Transports were hammered for 9.6% (down 23.7%). The
Utilities dropped 7.7% (down 10.6%), and the Morgan Stanley Consumer index fell
5.0% (down 12.3%). The S&P400 Mid-Caps dropped 8.3% (down 13.3%), and the
small cap Russell 2000 sank 9.1% (down 17.7%). The NASDAQ100 declined 5.5%
(down 3.2%), and the Morgan Stanley High Tech index fell 7.7% (down 4.2%). The
Semiconductors sank 11.8% (down 7.0%), and the InteractiveWeek Internet index
lost 5.2% (down 0.2%). The Biotechs were hit for 6.9% (up 1.9%). The
Broker/Dealers sank 11.9% (down 12.9%), and the Banks were hammered for 20.3%
(down 51%). With bullion surging $51, the HUI Gold index gained 3.2% (up 6.3%).
One-month Treasury bill rates ended the week at 17 bps, and three-month bills
were at 26 bps. Two-year government yields slipped 2 bps to 0.92%. Five-year
T-note yields ended the week down 5 bps to 1.795%. Ten-year yields declined 10
bps to 2.75%. Long-bond yields fell 6 bps to 3.62%. The implied yield on
3-month December '09 Eurodollars dropped 7.5 bps to 1.465%. Benchmark Fannie
MBS yields dipped one basis point to 4.24%. The spread between benchmark MBS
and 10-year T-notes widened 9 to 145 bps. At the same time, agency 10-yr debt
spreads narrowed 8 to 63 bps. The 2-year dollar swap spread declined 2.25 to
65.75 bps; the 10-year dollar swap spread was unchanged at 25 bps, and the
30-year swap spread declined 3.75 to negative 32.75 bps. Corporate bond spreads
were wider. An index of investment grade bond spreads widened 15 to 235 bps,
and an index of junk spreads widened 50 to 1,227 bps.
February 18 - Bloomberg (Gabrielle Coppola and Pierre Paulden): "Roche Holding
AG sold $16 billion of bonds to finance its acquisition of Genentech Inc. in
the second- largest corporate bond offering ... The sale propelled US corporate
debt issuance to a daily record of $32.55 billion in a sign of thawing credit
markets."
February 20 - Bloomberg (Bryan Keogh and Josh Fineman): "Corporate bond trading
in the US is rising to the highest in two years ... An average $17.1 billion of
corporate bonds traded daily this month ... The business is up from last year's
low of $9.4 billion in August and reached the highest level since February
2007, Finra data show."
Investment grade issuance included Roche $17.5bn, JPMorgan $10bn, Dupont $900
million, Union Pacific $750 million, Coca-Cola Enterprises $600 million,
Goodrich $300 million, Private Export Funding $325 million, Snap-On $300
million and Amherest College $100 million.
Junk issuers included DCP Midstream $450 million.
International debt issues this week included SFEF $5.5bn, Canadian National
Railroad $550 million, and Banco Bilbao $270 million.
U.K. 10-year gilt yields dropped 14 bps to 3.41%, and German bund yields fell 9
bps to 3.01%. The German DAX equities index sank 9.0% (down 16.5%). Japanese
10-year "JGB" yields ended the week up 2 bps to 1.275%. The Nikkei 225 dropped
4.7% (down 16.3%). Emerging markets were under pressure. Brazil's benchmark
dollar bond yields rose 12 bps to 6.93%. Brazil's Bovespa equities index
declined 7.1% (up 3.1% y-t-d). The Mexican Bolsa lost 5.4% (down 18.1% y-t-d).
Mexico's 10-year $ yields dipped one basis point to 6.63%. Russia's volatile
RTS equities index sank 17.1% (down 18.1%). India's Sensex equities index
dropped 8.2% (down 8.3%). China's Shanghai Exchange gave back 2.6% (up 24.2%).
Freddie Mac 30-year fixed mortgage rates dropped 12 bps to 5.04% (down 100bps
y-o-y). Fifteen-year fixed rates declined 13 bps to 4.68% (down 96bps y-o-y).
One-year ARMs sank 14 bps to 4.80% (down 18bps y-o-y). Bankrate's survey of
jumbo mortgage borrowing costs had 30-yr fixed jumbo rates up 18 bps this week
to 7.08% (up 32bps y-o-y).
Federal Reserve Credit surged $76.9bn to $1.907 TN. Fed Credit expanded $1.040
TN over the past 52 weeks (120%). Elsewhere, Fed Foreign Holdings of Treasury,
Agency Debt last week (ended 2/18) jumped $15.3bn to a record $2.576 TN.
"Custody holdings" were up $446bn over the past year, or 21%.
Bank Credit increased $12.7bn to $9.817 TN (week of 2/11). Bank Credit expanded
$506bn year-over-year, or 5.4%. Bank Credit jumped $425bn over the past 23
weeks. For the week, Securities Credit slipped $1.9bn. Loans & Leases
jumped $14.4bn to $7.165 TN (52-wk gain of $315bn, or 4.6%). C&I loans
dropped $10.4bn, with 52-wk growth of 8.4%. Real Estate loans jumped $13.3bn
(up 6.1% y-o-y). Consumer loans were little changed, while Securities loans
rose $11bn. Other loans added $0.3bn.
M2 (narrow) "money" supply increased $11.2bn to $8.261 TN (week of 2/9). Narrow
"money" has now inflated at an 18% rate over the past 21 weeks and has jumped
$735bn over the past year, or 9.8%. For the week, Currency increased $2.6bn,
while Demand & Checkable Deposits declined $1.0bn. Savings Deposits gained
$14.2bn, while Small Denominated Deposits slipped $1.4bn. Retail Money Funds
fell $3.1bn.
Total Money Market Fund assets (from Invest Co Inst) fell $24bn to $3.879 TN,
with a 52-wk expansion of $471bn, or 13.8% annualized.
Total Commercial Paper outstanding slumped $32.7bn this past week to a 13-wk
low $1.521 TN. CP has declined $160bn y-t-d
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