Page 1 of 3 CREDIT BUBBLE BULLETIN A divergence
Commentary and weekly watch
by Doug Noland
The 2009 stock market has quickly come face-to-face with the reality that the
worst of our banking system's problems has yet to pass. Today, Citigroup
reported an US$8.3 billion fourth-quarter loss, about double what was expected.
Bank of America posted a quarterly loss of $1.8 billion (its first loss since
1991). In both cases, huge additional governmental support has been required.
The breakup of the great global "financial supermarket" is now moving briskly.
Citi management at the weekend announced a plan to create a new entity ("bad
bank"?) to aggregate "non-core" assets. This entity - including Citi Financial,
Citi Mortgage, the
company's asset management business and a pool of securities - will account for
approximately $850 billion of Citi's $1.95 trillion of total assets. The
government has directly invested $45 billion in the bank and is now backing
$301 billion of Citi's real estate loans and securities.
From Bank of America came the news of additional "emergency" governmental
support necessary to consummate the acquisition of troubled Merrill Lynch. The
government will inject an additional $20 billion of "capital" into the deal (on
top of an earlier $25 billion), along with guarantees on an $118 billion pool
of risk assets (said to include mostly Merrill residential and commercial
mortgage-backed securities, and credit default swaps).
Bill Gross's current investment thesis "buy what they [the government] buy"
seems only to apply to fixed income. In the stock market, investors are
scurrying away from the banking sector where it has become apparent that the
government will be taking an ever-increasing role in ownership and Credit
Policy.
It remains my view that our maladjusted economy is in the earliest stage of
what will prove a grueling and protracted adjustment period. And with Wall
Street finance incapacitated, there will be no alternative than for the banking
system to aggressively expand credit. In rough terms, bank credit will need to
expand in the trillion dollar range (10% growth) this year if there is any hope
of stemming depressionary forces and stabilizing the system. The way I see it,
system-wide credit expansion of $2.0 trillion or so will likely be required, of
which about half will be forthcoming from federal borrowings.
Keep in mind, however, that while a Washington stimulus would be expected to
support general spending throughout the economy, it will be the almost sole
responsibility of the banking system (with governmental support) to extend the
necessary credit to reverse the downward spiral in our nation's troubled asset
markets. This will be no small feat. Yet it may be a case that the banks are
today in such awful shape that they have no option but to accept massive
federal government aid and, along with it, a likely new mandate to get out and
lend. Expect the new White House administration to hit the ground running.
Candidly, the current environment presents the most difficult macro analysis of
my career. The collapse of Lehman Brothers was a seminal event in US and global
finance. Overnight, trillions of dollars of Wall Street's financial claims lost
their "moneyness". Trust in history's most powerful mechanism of credit
expansion was shattered - and for years to come will remain shuttered. Near-
and long-term ramifications are momentous, especially when it comes to the
performance of asset markets.
But, at the same time, the collapse of the historic credit bubble has also
granted global policymakers an unprecedented mandate to inflate governmental
debt and obligations. The promise of basically unlimited deficits and credit
guarantees is required to shore up the "moneyness" of the core of monetary
systems both at home and abroad.
Will these deficits and guarantees be sufficient to stabilize financial and
economic systems? What are the inflationary ramifications of such policymaking?
How long will the markets so contentedly accommodate the unmatched expansion of
government obligations - and along with it governmental intrusion into all
things financial and economic? There is no easy analysis or clear answer. Is
the renewed collapse in bank stocks a harbinger of a dramatic worsening of
economic prospects? Or could it perhaps be more a case of stock declines
discounting future shareholder dilution and other issue related to larger
governmental ownership and control?
As gloomy as economic reports and news headlines have been, there have actually
been scattered hopeful signs of system stabilization. Corporate debt markets
are showing unequivocal signs of life. January is on pace for the strongest
month of corporate debt issuance since May. And even the junk bond market is
showing a dim pulse. At the same time, municipal debt issuance this past week
was the most robust since the Lehman collapse.
It is worth noting that many key debt spreads remain significantly below the
levels from the dark days of November. At about 220 basis points (bps),
investment grade spreads are 60 bps below November highs. Junk spreads narrowed
30 bps this week. And credit default swap pricing for many topping the list of
credit problem children - including MBIA, Ambac, MGIC, Sears, GMAC, Ford Motor
Credit, and ResCap - are today significantly below the crisis levels from a
couple months back.
At 93 bps, agency debt spreads are about half the level of the November spike.
Agency long-term borrowing costs have sunk from above 5% during the fourth
quarter to today's 3.25%. It is also worth noting that benchmark agency MBS
yields are now below 4.0% after surpassing 6.0% in November. While mortgage
rates are no longer the invaluable indicator they were during the mortgage
finance bubble, I don't want to completely discount them either. There has
already been a meaningful jump in mortgage refinancings. I would also expect
these rates to somewhat support housing transactions, although the weak stock
market and a barrage of job cut announcements weigh further on confidence.
In short, it is not so easy to discern an area of acute systemic crisis
commensurate with the pounding taken this past week or so by the banks and
financials. I'll this evening label this dynamic "A Divergence." It is possible
that there is acute stress out there not visible to the naked eye. Perhaps the
major banks are in worse shape than they appear. And housing and the economy
could be taking additional legs down, although this would be a surprising
development considering the current financing environment.
The international backdrop remains problematic. And one should assume there are
more hedge fund shoes to drop. Reasonable analysis would see speculator
de-leveraging and liquidation overhanging the markets for some time to come.
So, it's an especially tough call - and a divergence that beckons for
analytical focus.
WEEKLY WATCH
The S&P500 dropped 4.5% (down 5.9% y-t-d), and the Dow fell 3.7% (down
5.6%). The Transports sank 9.0% (down 11%), and the Morgan Stanley Cyclicals
fell 9.3% (down 5%). The Utilities slipped 0.3% (down 1%), and the Morgan
Stanley Consumer index declined 1.9% (down 3.7%). The broader market wasn't
quite as weak. The small cap Russell 2000 declined 3.1% (down 6.6%), and the
S&P400 Mid-Caps fell 2.6% (down 4%). The Nasdaq100 dipped 2.0% (down 1.1%),
and the Morgan Stanley High Tech index declined 3.3% (up 0.4%). The
Semiconductors slipped 0.4% (up 1%), the Interactive Week Internet index fell
3.8% (down 0.7%), and the Nasdaq Telecommunications index lost 2.6% (up 0.9%).
The Biotechs rose 3.2% (up 1.6%). The Broker/Dealers were hammered for 8.5%
(down 7.1%) and the Banks sank 20.8% (down 28.8%). With Bullion down $12.55,
the HUI Gold index decilned 1.0% (down 9.1%).
One-month Treasury bill rates ended the week at 3 bps and three-month bills at
13 bps. Two-year government yields were little changed at 0.65%. Five-year
T-note yields slipped 2 bps this week to 1.37%. Ten-year yields declined 7 bps
to 2.32%, and long-bond yields dropped 17 bps to 2.93%. The implied yield on
3-month December '09 Eurodollars added one basis point to 1.20%. Benchmark
Fannie MBS yields rose 2 bps to 3.86%. The spread between benchmark MBS and
10-year T-notes widened 9 to 154. Agency 10-yr debt spreads widened 15 to 92.5
bps. The 2-year dollar swap spread increased 6.25 to 60.5 bps; the 10-year
dollar swap spread declined 5.2 to 9.3 bps, and the 30-year swap spread
increased 7.5 to negative 10.5 bps. Corporate bond spreads were mixed. An index
of investment grade bond spreads widened 12 to 214 bps, while an index of junk
bond spreads narrowed 38 to 1,274 bps.
January 14 - Bloomberg (Gillian Wee): "Princeton and Harvard are leading a rush
by US colleges and universities to sell bonds after investment losses cut the
value of endowments by a quarter in the past six months. Princeton University
sold $1 billion of debt ... its first taxable issue since 1994, while the
University of Notre Dame raised $150 million. A sale last month by Harvard
University ... brought in $1.5 billion."
Investment grade issuance included Morgan Stanley $5.9bn, Goldman Sachs $3.5bn,
Staples $1.5bn, Amgen $2.0bn, Fed-Ex $1.0bn, Princeton Univ. $1.0bn, McDonalds
$750 million, Bottling Group $750 million, Reed Elsevier $1.5bn, CSX $500
million, Norfolk Southern $500 million, Emerson Electric $500 million, Indiana
Michigan Power $475 million, Donnelley & Sons $400 million, Metropolitan
Edison $300 million, Campbell Soup $300 million, Berkshire Hathaway $250
million, Zions Bancorp $250 million, and Univ. of Notre Dame $150 million.
Junk issuers included Fresenius $500 million and MetroPCS $550 million.
International issuers included Macquarie Bank $2.5bn, Export-Import Bank of
Korea $2.0bn, Korea Development Bank $2.0bn, Oester Kontrollbank $1.25bn, and
African Development Bank $1.0bn.
January 16 - Bloomberg (Jeremy R. Cooke and Michael McDonald): "US municipal
borrowers sold at least $7.7 billion of fixed-rate bonds this week, the most
since Lehman Brothers Holdings Inc.'s record bankruptcy…"
German 10-year bund yields fell 9 bps to 2.93%. The German DAX equities index
sank 8.7% (down 9.2% y-t-d). The Japanese 10-year "JGB" yield ended the week
down 6 bps to 1.22%. The Nikkei 225 dropped 7.3% (down 7.1% y-t-d). Emerging
bonds and equities were mixed. Brazil's benchmark dollar bond yields rose 16
bps to 6.56%. Brazil's Bovespa equities index fell 5.4% (up 4.8% y-t-d). The
Mexican Bolsa sank 6.5% (down 9.2% y-t-d). Mexico's 10-year $ yields jumped 19
bps to 6.13%. Russia's RTS equities was hit for 10.3% (down 10.3% y-td).
India's Sensex equities index dipped 0.9% (down 3.4% y-t-d). China's Shanghai
Exchange gained 2.6% (up 7.3% y-t-d).
Freddie Mac 30-year fixed mortgage rates dropped 5 bps to a record low 4.96%
(down 73bps y-o-y), with a notable 11-wk decline of 150 bps. Fifteen-year fixed
rates added 3 bps to 4.65% (down 56bps y-o-y). One-year ARMs fell 6 bps to
4.89% (down 37bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs
had 30-yr fixed jumbo rates down 3 bps this week to 6.79% (up 30bps y-o-y).
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