Page 2 of
5 CREDIT BUBBLE
BULLETIN Wrong
call Commentary and weekly
review by Doug Noland
net worth
will have a significant restraining impact on
consumption.
The rest of the world (ROW)
expanded holdings of US financial assets increased
by SAAR $1.132 trillion during Q3 to $15.463
trillion. This was a notable slowdown from Q2's
SAAR $2.507 trillion and Q3 2006's $1.928
trillion, and is largely explained by a
significant (and ominous) decline in the
accumulation of US credit market instruments.
Still, ROW holdings increased $2.251 trillion
over
the past year (17%) and almost doubled since the
beginning of 2003. During the quarter, ROW
holdings of security RPs declined at SAAR $348
billion and open market paper declined SAAR $103
billion. Treasury securities increased SAAR $160
billion and agencies SAAR $155 billion. And in a
notable development, after increasing SAAR $457
billion during Q1 and SAAR $443 billion in Q2,
holdings of US corporate bonds (including
asset-backed securities) reversed and declined
SAAR $69 billion during Q3.
I'm running
out of time this evening, so I will attempt some
concluding comments. First, looking at Q3's record
credit inflation, it is not easy to justify Wall
Street's call for dramatically lower interest
rates. Sure, the pace of fourth-quarter credit
growth will be meaningfully slower, especially in
the mortgage arena. But I believe the key insight
to be drawn from the Q3 2007 "Flow of Funds" is
the recognition of the enormous scope of ongoing
credit creation now required to sustain the US
financial and economic bubbles. I'm tempted to
surmise that the Law of Large Numbers has finally
caught up with the Great Credit Bubble. In
particular, I find it incredibly ominous that the
credit system has faltered so badly in the face
ongoing financial sector expansion.
Things
can clearly get much worse. I don't expect the
Wall Street securitization machine anytime soon to
return as a major force for credit expansion. And
I simply do not view recent spectacular ballooning
and zealous risk intermediation in the banking,
money fund, and GSE sectors as sustainable.
They're clearly fraught with great risk. Messrs
Bernanke, Paulson, Bush, Frank and others will, at
best, manipulate only the pace of the unfolding
credit bust.
WEEK IN REVIEW In
another volatile week, the Dow gained 1.9% (up
9.3% y-t-d) and the S&P500 1.6% (up 6.1%). The
Transports jumped 4.6% (up 6.9%), and the Morgan
Stanley Cyclical index rose 2.8% (up 14.2%). The
Utilities advanced 3.2% (up 19.2%), and the Morgan
Stanley Consumer index added 0.8% (up 9.3%). The
small cap Russell 2000 gained 2.3% (down 0.3%),
and the S&P400 Mid-Cap index jumped 2.9% (up
10.1%). The NASDAQ100 rose 2.0%, increasing 2007
gains to 21.2%. The Morgan Stanley High Tech index
increased 2.7% (up 11.4%) and the Semiconductors
3.5% (down 8.3%). The Street.com Internet Index
added 0.4% (up 16.7%), while the NASDAQ
Telecommunications index declined 1.6% (up 10.1%).
The Biotechs were about unchanged (up 9.7%). The
Broker/Dealers gained 1.0% (down 11.7%), while the
Banks declined 0.7% (down 17.9%). With Bullion
gaining $10.80, the HUI Gold index rose 1.4% (up
21.8%).
Three-month Treasury bill rates
dropped 10 bps this week to 3.07%. At the same
time, two-year government yields rose 10 bps to
3.10%. Five-year T-Note yields jumped 11 bps to
3.50%, and ten-year yields jumped 17 bps to 4.11%.
Long-bond yields surged 19 bps to 4.57%. The
2yr/10yr spread ended the week at 101 bps. The
implied yield on 3-month December ’08 Eurodollars
jumped 19 bps to 3.625%. Benchmark Fannie Mae MBS
yields rose 27 bps to 5.68%, quickly giving back
last week's narrowing to Treasuries. The spread on
Fannie’s 5% 2017 note widened 1 to 61, and the
spread on Freddie’s 5% 2017 note widened 1 to 61.
The 10-year dollar swap jumped 7 bps to 72.
Corporate bond spreads were mixed to narrower,
with the spread on an index of junk bonds ending
the week 7 bps narrower.
December 6 –
Bloomberg (John Glover and Patricia Kuo):"Defaults
by speculative-grade companies will quadruple next
year as the era of ‘easy credit’ comes to an end
and economic growth slows, Moody's ... said ...
The global default rate fell to 1% last month, the
lowest since 1981. The rate will reach 4.2% by
November, assuming the U.S. economy slows without
falling into recession, Kenneth Emery, director of
corporate default research at Moody's, wrote ...
In a recession, the default rate may reach 10%..."
Investment grade debt issuers included
Wells Fargo $3.0 billion, Prudential $3.0 billion,
Transocean $2.5 billion, United Technologies $1.0
billion, CVS Caremark $590 million, Archer Daniels
$500 million, Danaher $500 million, Baxter Intl
$500 million, Harley-Davidson $400 million, Vulcan
Materials $325 million, Regions Financial $300
million,West Penn Power $275 million, Cintas $250
million, Alabama Power $200 million, McCormick
$250 million, and Protective Life $150 million.
Junk issuers included Coso Geothermal $630
million, and Ikon Office Solutions $150 million.
Convertible issuance included Transocean
$6.0 billion, Microchip Technologies $1.0 billion,
and Hologic $1.5 billion.
Foreign dollar
bond issuance included British Telephone $1.2
billion.
German 10-year bund yields rose
7.5 bps to 4.20%, while the DAX equities index
gained 1.6% for the week (up 21.2% y-t-d).
Japanese"JGB" yields jumped 9 bps to 1.56%. The
Nikkei 225 recovered 1.8%, reducing 2007 losses to
7.4%. Most emerging debt and equities markets
rallied. Brazil’s benchmark dollar bond yields
fell 6 bps to 5.62%. Brazil’s Bovespa equities
index jumped 4.2% (up 47.6% y-t-d). The Mexican
Bolsa surged 5.0% (up 18.2% y-t-d). Mexico’s
10-year $ yields added 2 bps to 5.42%. Russia's
RTS equities index gained 3.0% (up 18.9% y-t-d).
India’s Sensex equities index rose 3.1% (up 44.8%
y-t-d). China's Shanghai Exchange rallied 4.5%,
increasing y-t-d gains to 90.3%. Freddie Mac
posted 30-year fixed mortgage rates sank 14 bps
this week to 5.96% (down 44bps in 7 wks and 15bps
y-o-y). Fifteen-year fixed rates declined 8 bps to
5.65% (down 19bps y-o-y). One-year adjustable
rates rose 3 bps to 5.46% (up 3bps y-o-y).
Bank Credit gained $5.8 billion during the
week (11/28) to a record $9.212 trillion. Bank
Credit has posted a 19-week gain of $568 billion
(18% annualized) and a y-t-d rise of $915 billion,
a 12.0% pace. For the week, Securities Credit
added $2.9 billion. Loans & Leases increased
$2.9 billion to $6.730 trillion (19-wk gain of
$405 billion). C&I loans rose $4.4 billion
(2007 growth rate 21.7%). Real Estate loans jumped
$9.9 billion. Consumer loans increased $4.5
billion. Securities loans added $0.9 billion,
while Other loans dropped $16.7 billion. On the
liability side, (previous M3) Large Time Deposits
slipped $2.9 billion.
M2 (narrow)"money"
supply surged $40.5 billion to a record $7.465
trillion (week of 11/26). Narrow"money" has
expanded $421 billion y-t-d, or 6.5% annualized,
and $463 billion, or 6.6%, over the past year. For
the week, Currency slipped $0.9 billion, while
Demand & Checkable Deposits gained $4.5
billion. Savings Deposits jumped $22.5 billion,
and Small Denominated Deposits added $0.2 billion.
Retail Money Fund assets rose $14.2 billion.
Total Money Market Fund Assets (from
Invest. Co Inst) jumped $45 billion last week to a
record $3.118 trillion. Money Fund Assets have now
posted an unprecedented 19-week surge of $534
billion (57% annualized) and a y-t-d increase of
$736 billion (32.8% annualized). Money fund assets
have ballooned $760 billion, or 32.2%, over the
past year.
Total Commercial Paper declined
$10.1 billion to $1.844 trillion. CP is now down
$379 billion over the past 17 weeks. Asset-backed
CP fell $9.0 billion (17-wk drop of $342 billion)
last week to $832 billion. Year-to-date, total CP
has contracted $130 billion, with ABCP down $252
billion. Over the past year, Total CP has declined
$89 billion, or 4.6%.
Asset-Backed
Securities (ABS) issuance slowed this week to a
measly $2.8 billion. Year-to-date total US ABS
issuance of $526 billion (tallied by JPMorgan) is
running 38% behind comparable 2006. At $224
billion, y-t-d Home Equity ABS sales are off 57%
from last year’s pace. Year-to-date US CDO
issuance of $290 billion is now 19% below
comparable 2006.
Fed Foreign Holdings of
Treasury, Agency Debt last week (ended 12/5)
gained $5.3 billion to a record $2.037
trillion."Custody holdings" were up $285 billion
y-t-d (17.2% annualized) and $324 billion during
the past year, or 18.9%. Federal Reserve Credit
declined $2.7 billion last week to $867 billion.
Fed Credit has increased $14.8 billion y-t-d and
$24.6 billion over the past year (2.9%).
International reserve assets (excluding
gold) - as accumulated by Bloomberg’s Alex Tanzi –
were up $1.240 trillion y-t-d (27% annualized) and
$1.258 trillion year-over-year (26%), surpassing
$6.0 trillion for the first time.
Credit Market Dislocation
Watch December 5 – Financial Times (Deborah
Brewster):"Chip Mason, chief executive and founder
of Legg Mason, one of the world's biggest money
managers, said yesterday that the credit markets
are in the worst state he has seen in his 47 years
in the business. ‘It is a very unusual situation.
I have not seen anything like this, where nothing
is traded,’ said Mr Mason. Legg has more than
$1,000 billion in assets under management,
including several large money market funds...
Isaac Souede, the founder of Permal, another Legg
subsidiary which is one of the largest hedge fund
of funds, said this year had also been the most
challenging he had experienced in his 21 years in
the industry. ‘There is a very distinct
dislocation of capital which is unprecedented,’ he
said."
December 7 – Dow Jones (Damian
Paletta):"Some lawmakers are concerned loan
servicers might be sued by investors if they
modify the terms of certain subprime loans as part
of the Bush administration's plan to fix the
problem. Many lawmakers and regulators have been
hesitant to break open the contracts that are made
when loans are bundled into securities and sold to
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