Friday, May 30, 2008

Foreign demand for US corporate credit has collapsed

The acute phase of risk management in the current credit crisis has passed, so it is time to ask questions. To find out what went wrong is important for the healing process. We can draw already one conclusion: Risk was supposed to be dispersed but it wasn't.

Brad Sester's Blog quotes Blackrock's Peter Fisher:
“The idea of risk dispersion is nice in theory, but in practice it depends on who risk gets dispersed to. It turns out that we dispersing risk it into strong hands who could hold it through volatility. Rather we were dispersing it to weak hands who couldn’t hold it, and ended up adding to the volatility.”

Exposure to murky subprime mortgages was widely held by the Street. Portfolios from overseas investors were big buyers but sponsored by American- and European institutions who funded their purchases with short term dollar borrowing. The authorities here and abroad are to blame for not having understood the transfer of the liquidity pressure to the banking system according to Donald Kohn.

The result of the implosion in the subprime market, though, aren’t in doubt: “international” demand for US corporate credit has collapsed.

click to enlarge

source: Risk wasn’t dispersed
Brad Sester's Blog: Follow the money
Posted on Friday, May 30th, 2008 by bsetser

source: Vice Chairman Donald L. Kohn
At the Federal Reserve Bank of New York and Columbia Business School Conference on the Role of Money Markets, New York, New York, May 29, 2008

Kohn Signals Wall Street May Get Permanent Access to Fed Loans

He is at odds on this issue with his boss, at least for now:

The Federal Reserve should return to adjusting reserves mainly through purchases and sales of the safest and most liquid assets as soon as that would be consistent with stable, well-functioning markets. In fact, several of the Federal Reserve's new programs are designed to be self-liquidating as markets improve.

The public authorities need to consider several difficult issues with respect to access to the discount window. One is the circumstances under which broker-dealers should be permitted to borrow in the future. One possibility would be to confine such borrowing to circumstances in which the Federal Reserve judges that the stability of the financial system is at risk--as we did in March. Another would be to grant broker-dealers the same sort of regular access enjoyed by commercial banks.

Unquestionably, regulation needs to respond to what we have learned about the importance of primary dealers and their vulnerabilities to liquidity pressures. We need to confront the difficult questions I raised earlier about the scenarios in which it is appropriate to rely on central bank liquidity and the scenarios in which such reliance is inappropriate. And we need to ensure that supervisory guidance regarding liquidity risk management is consistent with the way we answer those questions. Whether broader regulatory changes for broker-dealers are necessary is a difficult question that deserves further study.

source: Vice Chairman Donald L. Kohn
At the Federal Reserve Bank of New York and Columbia Business School Conference on the Role of Money Markets, New York, New York, May 29, 2008

Is Congress helping to restrain insane energy speculation? features an interesting headline, "Did Wall Street Wreck The Economy?". The first part focused on the obvious subprime debacle, but I was interested in the second part referring to an initiative in Congress to break down on excessive speculation in energy markets. The recently passed ominous farm bill, vetoed by the Bush administration, contains a little publicized provision (we have reported in a prior post) that is allowing federal regulators to have more oversight and control over oil futures trades. Rep. John Larson, a democrat from CT, recently spoke with the NYT about his plan to propose legislation that would essentially ban over-the-counter trading of energy futures by traders who don’t plan to take physical delivery of the commodity. While this bill has little chance of passing it still represents the current mood about sky high energy prices among policymakers in Washington.

But this time, it’s Wall Street and the newly public commodity exchanges that are sharing the Congressional spotlight. Senate Democrats have already proposed legislation that would impose stiffer margin requirements on energy trading. Senator Jeff Bingaman, chairman of the Senate Energy and Natural Resources Committee, wants to tighten oversight of energy trading that takes place over the counter or outside of exchanges like the Nymex, which is regulated by the Commodity Futures Trading Commission.

“But there is a widespread feeling amongst the leadership in Congress and the rank and file that something has got to be done in this area,” Larson says. “And this situation requires bold action.”

Let's hope this is not just election talk and we get some real results that help to restrain insane energy speculation.

source: Energy Speculators Draw the Heat
By NELSON D. SCHWARTZ, NYT, May 25, 2008

source: Did Wall Street Wreck The Economy? Congress, regulators start to connect the dots
By Mark Huffman,, May 29, 2008

read also: CFTC Announces Multiple Energy Market Initiatives
Thursday, May 29, 2008

read also: The hunt is on - speculators beware!
Wednesday, May 21, 2008

Thursday, May 29, 2008

Long Island car sales up in the first quarter 2008

Long Islanders purchased more cars in the first quarter of 2008. Vehicle sales were up 10.3 percent compared to a year earlier. That is better than the national trend which saw registrations falling by 6.9 percent. In Long Island sales for both categories, pickups/SUVs and cars, gained. Relative low unemployment and stable home prices have kept the auto market healthy in the New York region. This trend seems to be broken in April.

Indeed, Jeffrey Foltz, a local market analyst for the Greater New York Automobile Dealers Association, said there are signs the car business locally slowed down in April. And some dealers say credit is tight, especially for customers who are "upside down" -- owing more on the present cars than they are worth in trade.

source: New car sales climb on LI, despite decline nationally
BY TOM INCANTALUPO,, May 29, 2008,0,7259305.story

We truly live in interesting times - see Case/Shiller HPI

as the Case/Shiller HPI shows:

Now Robert Shiller, an economist at Yale University and co-inventor of the index, has compiled a version that stretches back over a century. This shows that the latest fall in nominal prices is already much bigger than the 10.5% drop in 1932, the worst point of the Depression.

source: America's house prices are falling even faster than during the Great Depression
from, May 29th 2008

Ahead of the curve - States lead on climate change

A short documentary gives hope to a change in US leadership:
In the absence of strong U.S. federal leadership on climate change, citizens and elected officials across America are discovering reasons to be hopeful about the future of our planet, and are taking matters into their own hands. This short documentary celebrates America at its best--and shows why Washington should be paying close attention.

click for video

source: Ahead of the curve - States lead on climate change
Sea Studios Foundation

CFTC Announces Multiple Energy Market Initiatives

Crude oil fell 7 USD from an intraday high of $133.12 to close at $126.25 in NYMEX trading today. This record drop despite a record decline in weekly crude inventory can be attributed to a timely CFTC announcement of "multiple energy market initiatives". The CFTC allert by record high oil prices and a Senate pannel hearing finally steps into action and is increasing oversight of energy futures markets.

CFTC Acting Chairman Walt Lukken and Commissioners Michael Dunn, Jill Sommers and Bart Chilton announced following agreements:

I. Expanded International Surveillance Information for Crude Oil Trading

  • Immediately implementing expanded information-sharing to provide the CFTC with daily large trader positions in the UK WTI crude oil contract;

  • Extending trader information sharing to provide crude oil large trader position data for all contract months in the WTI contract, not just the nearby months;

  • A near-term commitment to enhance trader information to permit more detailed identification of market end users;

  • A near-term commitment to provide improved data formatting so trading information can be seamlessly integrated into the CFTC’s surveillance system; and

  • ICE Futures Europe will notify the CFTC when traders exceed position accountability levels, as established by U.S. designated contract markets, for WTI crude oil contracts.
II. Increased Transparency of Trading in U.S. Energy Markets
  • Improve Transparency for Energy Markets Index Trading Activity: The Commission will begin to require traders in the energy markets to provide the agency with monthly reports of their index trading to help the CFTC further identify the amount and impact of this type of trading in the markets.

  • Review of Trader Reporting and Classification: The Commission will develop a proposal to routinely require more detailed information from index traders and swaps dealers in the futures markets, and to review whether classification of these types of traders can be improved for regulatory and reporting purposes.

  • Examine Trading Practices for Index Traders: The Commission will review the trading practices for index traders in the futures markets to ensure that this type of trading activity is not adversely impacting the price discovery process, and to determine whether different practices should be employed.
III. Continuation of Ongoing CFTC Nationwide Crude Oil Investigation


source: CFTC Announces Multiple Energy Market Initiatives
CFTC, May 29 2008

read also: The hunt is on - speculators beware!
Wednesday, May 21, 2008

U.S. first quarter GDP revised higher to 0.9 percent

Weak points:
Consumer spending (durables and non durables down, services holding up for now)
Government expenditures on the State and local level (rising inflation and lower revenue squeeze purchasing power) and of course,
residential domestic investment (no signs of recovery there)

Merryl Lynch North American economist David Rosenberg notes that a key indicator of the domestic economy, final sales to domestic purchasers (GDP ex trade and inventories), remains negative at -0.1% QoQ (was -0.4%).

FDIC: bank earnings decline 46 percent in first quarter 2008

FDIC sees banking industry earnings declining by almost 50 percent, with loan loss provisions increasing and troubled loans accumulating (especially in real estate). Loans secured by 1-4 family residential properties declined for the first time since the fourth quarter of 2003, falling by $26.5 billion (1.2 percent). However, the industry still earned a total of $19.3 billion in the first quarter. This is surprising given all the doom and gloom in the forecast. A possible explanation is the fact that the four largest institutions are responsible for more than 50 percent of the shortfall. The restatements in fourth quarter earnings are not encouraging in that sense either.

QBP first quarter 2008:
Real Estate Troubles Hold Down Earnings
Deteriorating asset quality concentrated in real estate loan portfolios continued to take a toll on the earnings performance of many insured institutions in first quarter 2008. Higher loss provisions were the primary reason that industry earnings for the quarter totaled only $19.3 billion, compared to $35.6 billion a year earlier.

Restatements Shrink Fourth Quarter 2007 Profits Substantially
Industry earnings for the fourth quarter of 2007 were previously reported as $5.8 billion, but sizable restatements by a few institutions caused fourth quarter net income to decline to $646 million. This is the lowest quarterly net income for the industry since insured institutions posted an aggregate net loss in the fourth quarter of 1990.

Market-Sensitive Revenues Remain Weak at Large Institutions
In addition to the sharp increase in loan-loss provisions, lower noninterest income also contributed to the decline in industry earnings in the first quarter. Noninterest revenues fell on a year-over-year basis for a second consecutive quarter, declining by $1.7 billion (2.8 percent).

Charge-Off Rate Climbs to Five-Year High
Insured institutions charged-off $19.6 billion (net) during the first quarter, an increase of $11.4 billion (139.1 percent) over the first quarter of 2007. This is the second consecutive quarter of very high net charge-offs -- fourth-quarter charge-offs totaled $16.4 billion. The annualized net charge-off rate in the first quarter rose to 0.99 percent, more than double the 0.45 percent rate of a year earlier and the highest quarterly net charge-off rate since the fourth quarter of 2001.

Noncurrent Loan Growth Remains High
Even with the heightened level of charge-offs, the amount of loans and leases that were noncurrent (90 days or more past due or in nonaccrual status) rose by $26.0 billion (23.6 percent) in the first quarter, following a $27.0-billion increase in the fourth quarter of 2007.

Reserve Coverage Loses Ground
However, the growth in loss reserves was outstripped by the rise in noncurrent loans,
and the industry’s “coverage ratio” fell for the eighth consecutive quarter, to 89 cents in reserves for every $1.00 of noncurrent loans from 93 cents at the end of 2007. This is the lowest level for the coverage ratio since the first quarter of 1993.

Growth in Credit Slows
Total loans and leases increased by just $61.4 billion (0.8 percent) during the quarter. Loans secured by real estate rose by $20.5 billion (0.4 percent), the smallest quarterly increase since the first quarter of 2003. Loans secured by 1-4 family residential properties declined for the first time since the fourth quarter of 2003, falling by $26.5 billion (1.2 percent).

click to enlarge

source: Quarterly Banking Profile, First Quarter 2008

Wednesday, May 28, 2008

Energy Crisis - the Fed's fault?

Kimberly-Clark announced plans to raise prices on Huggies diapers, Kleenex tissue and other consumer products in an attempt to offset rising energy costs. Today Dow Chemical said it will raise product prices by up to 20 percent because of soaring energy and raw material costs. The company casts guilt on authorities in Washington for a failure to address rising energy costs and creating a "true energy crisis". Another industry in a deep crisis, the airline industry, is "not build for $130 oil".

The blame game is on, and its going to get a lot worse, so who are the authorities we are talking about here. The Federal Reserve, the authority that is supposed to watch out after the nations currency, is certainly an important part of it. Bill Gross in his latest IO from June 2008 pleads for joining him in lobbying for change "in the market’s assumption of low relative U.S. inflation in comparison to our global competitors". As a first step "a change in U.S. leadership" will be necessary to make a change for the better.

The chart below compares foreign CPI composite with Just Foolin' US headline CPI.
click to enlarge ( source: Gross, IO June 2008)

Paul Van Eeden, president of Cranberry Capital, thinks it is the Fed's fault that we have an energy crisis. His views are somewhat radical but hit right into the nerve center of monetary authorities. The constant urge of asset price deflation is met with expanding money supply and this is causing inflation.

Here are some of his thoughts:
Oil price:
"Adjusted for currency and inflation oil would have been 13 dollar if it was not for the increase in the money supply since 1970. Oil went from 3 dollars in the 1970s to 13 dollars but it is at 130 dollars today, so 90% of the rise in the price of oil is merely the expansion of the money supply, which is under the control of the Fed."

money supply and the growth in the economy:
"...if the money supply does not increase as the economy grew than any productivity gains that manifest in the economy would cause prices to decline. The smaller amount of money in circulation would just go a longer way, your money would buy more goods and services."

inflation statistics:
"For a long time now head line inflation is pulling away from core inflation. The reason for that is that hedonic adjustment and geometric averaging does not impact things like food and oil.

Fed and monetary aggregates:
Murray Rothbard created an aggregate called TMS (true money supply). Since 1980 TMS has increased by a compound annual rate of 6.8 percent which is identical to the annual increase in M3 money supply. So there is something to these monetary aggregates and the fact that the Fed don't want to use them well that's their decision."

click for video

video: Oil Crisis: Blame It on the Fed?
Discussing whether the Fed is to blame for the current oil crisis, with Paul Van Eeden, of Cranberry Capital, and CNBC's Steve Liesman

Investment Outlook, Bill Gross | June 2008

Tuesday, May 27, 2008

Whitney says credit crunch 'far from over'

Oppenheimer analyst Meridith Whitney on the credit crisis, the shut down in the securitization market and its impact on the consumer.

There has been an over reliance on consumer liquidity coming from the securitization market. For every one dollar of mortgages that has been put on bank balance sheets seven dollars of mortgages have been securitisised. When securitization market shuts down the bigger issue is it constrains consumer liquidity.

Regulator will make it so prohibitive for credit card lenders to make profits, maybe that's a good thing long term, but what its going to do is extract over two trillion dollars from the consumer balance sheet. Consumer spending is going to decline and consumer defaults are really going to pick up.
click for video

video: Whitney, Analyst, Says Credit Crunch 'Far From Over'

Monday, May 26, 2008

Lieberman Says Index Speculators Responsible for Increase in Commodity Prices

Last week saw a Senate Committee hearing on financial speculation in commodity markets. WASHINGTON WEEKLY reports:

Senate Committee on Homeland Security and Governmental Affairs Chairman Joe Lieberman (I-CT) said index speculators are responsible for a significant part of commodity price increases and the Committee should see if there is something that can be done. During the Committee’s hearing on financial speculation in the commodity markets, Lieberman said he would consider drafting legislation that would limit the role of institutional investors in the commodity markets and to prohibit large investors from circumventing commodity position limits. The two provisions were recommended during the hearing by Michael Masters, Managing Member and Portfolio Manager, Masters Capital Management, LLC. Masters said the recent migration of investments from other asset groups are driving commodity prices higher and are essentially causing a disservice to the public in the short-term. He recommended Congress modify ERISA regulations to prohibit commodity index replication strategies as unsuitable pension investments. Jeffrey Harris, chief economist, Commodity Futures Trading Commission (CFTC), said the CFTC has the statutory authority to monitor and if necessary take enforcement action against speculation. Benn Steil, director of international economics, Council on Foreign Relations, said there was little evidence that speculation was having a manipulative effect on futures markets. Lieberman said the Committee would hold another hearing on the issue and would invite the Chairman of the CFTC and members of the administration’s economic policy team.

source: Lieberman Says Index Speculators Responsible for Increase in Commodity Prices

read also: Senate panel hearing testimony about bubbilicious commodity prices

Friday, May 23, 2008

Highway miles driven in March fell 4.3 percent from a year earlier

Americans are driving less according to the Department of Transportation:
In a sign that Americans are curbing their driving in the face of record-high gasoline prices, data released on Friday showed highway miles driven in March fell 4.3 percent from a year earlier, the first March decline since the last major oil shock in the late 1970s.
According to the Department of Transportation, Americans drove 11 billion miles less in March 2008 than a year earlier, the first time estimated travel on public roads fell in March since 1979.
The data marks the sharpest year-on-year drop for any month in the history of the agency's reporting, which dates back to 1942.

source: March driving down for 1st time since 1979: government
By Chris Baltimore, Reuters, Fri May 23

Change is in the air - hybrid sales are surging

Automakers in Detroit have long resisted an urge for change. What GM engineers see as a "sea change" looks more like a swell in a lake. GM has plans to reduce annual production of SUVs and pickup trucks by 40 percent to 1 million vehicles from 1.7 million by 2012. On Thursday, Ford said it will cut truck and SUV production by as much as 40% in the second half of this year, because of a "fundamental shift" by U.S. consumers away from trucks and large SUVs.

For the Big3 it seems that the train has long left the station. Sales of hybrid cars are surging. "The day the car comes in is the day the car goes out," says a dealer.

Although hybrid cars account for only about 3% of U.S. car sales, their share is growing rapidly. Sales of hybrid cars surged 25% during the first four months of this year compared with the same period last year. And the pace accelerated last month, when sales jumped 58%. That outpaced the overall April sales gain of 18% for small fuel-efficient cars and comes as total new-vehicle sales are slumping.

The shortage is pushing up prices. A month ago, Priuses were selling for an average of $25,147, slightly below the sticker price. Today, some dealers are slapping $3,000 premiums on the car -- pushing prices well over $28,000, according to Jesse Toprak, Edmunds' head of industry analysis.

The reason for this sudden surge in sales is simply the high price for gasoline and the attractive fuel efficiency of hybrid cars. The Toyota Prius hybrid runs 48 miles per gallon, the Toyota Corolla manual consumes 37 and the Lexus RX 350 on 23 miles per gallon.
click to enlarge

read also: What "sea change"? - GM will still produce 1 million SUVs by 2012
Thursday, May 8, 2008

source: Hybrid sales are zooming
By Martin Zimmerman, Los Angeles Times Staff Writer, May 23, 2008,0,5437081.story?track=rss

Existing home sales down in April 2008 - owners expect real decline in the value of their homes

Existing home sales in the U.S. have slowed some more in April, declining 1.0 percent to a seasonally adjusted rate of 4.89 million units, and are down 17.5 percent from 5.93 million units in April 2007. Inventory keeps rising and is 10.5 percent higher than in March at 4.55 million existing homes available for sale, which represents an 11.2-month supply at the current sales pace, up from a 10.0-month supply in March. Surprisingly the median existing home price was up from March and down 8 percent from a year ago.

There were some positive remarks in the report. We have noticed an interesting development in the SoCal market where home sales surged 22 percent in April.

from the NAR report:
Existing-home sales slowed in April, partly because restrictive lending practices hampered home buyers. At the same time, a greater number of areas are showing sales gains from a year ago and a recent reversal in mortgage policy means the market is better positioned for a turnaround, according to the National Association of Realtors.

The unusual mix of market conditions around the country continues, but areas showing healthy price gains include Greenville, S.C., and Springfield, Mo., both with solid local economies. “On the other hand, some markets like San Diego, Calif., and Fort Myers, Fla., are experiencing rising sales after sudden double-digit drops in local home prices, so lower prices and low interest rates are starting to generate results,” Yun said.

In a related note a Reuters/University Michigan survey shows that consumer expectations about the value of their home are still unrealistic high albeit lower than a year ago. The results showed the proportion of respondents who expect their home's value to decline during the year ahead rose to 28 percent, double the 14 percent registered in a survey a year ago. Just 17 percent anticipated that the value of their homes would increase, versus 35 percent recorded a year ago. Long term expectations fell to 58 percent from 65. Over the next five years homeowners expect the average annual gains to slide to 2.5 percent from 3.9 percent last year. They also expect a real decline in the value of their homes as long-term inflation expectations reach 3.3 percent.

read also: Homesales in SoCal surged in April 2008 - up 21.9 percent on the month

source: Existing-Home Sales Ease Due to Mortgage Restrictions; Some Markets Rising
NAR, WASHINGTON, May 23, 2008

source: Homeowner sentiment darkens in May: survey
By Burton Frierson, Reuters, Fri May 23, 2008 10:07am EDT

Thursday, May 22, 2008

Mortgage rates are sanguine for now

On April 30 the Federal Reserve cut the target rate and according to the FOMC statement omitted critical parts in the verbatim which led some to suggest the possibility of a pause in this rate cutting cycle. The minutes to the meeting released on May 21 revealed that "most members viewed the decision to reduce interest rates as a close call". In the meantime several Fed speakers have said that they remain concerned with inflation. Futures trading in Fed Funds interest rates show that investors anticipate no more cuts and have increased the chances of a rate hike by around 50 percent as early as November. All this is putting pressure on the mortgage market but this has yet to show up in the appropriate mortgages rates. As the diagram shows 5/1 ARM, 5/1 jumbo ARM and national 30 yr fixed mtg rates have proven to be sanguine. After a dramatic hike in March they are now down to a more tolerable level, in line with the general easing of several credit spreads.
click to enlarge

The lack of transparency in standard bank operations is still concerning

The Federal Reserve has created a multitude of lending facilities (TAF, PCF, TSLF, PDCF) to meet the liquidity requirements of commercial banks and broker dealers. The BoE has followed suit with its own creation the Special Liquidity Scheme (SLS). All these liquidity operations which are outside traditional channels of open market operations beg the important question whether borrowers are prudent in their approach or rather abusive in accessing those facilities.

Data from the BoE, released Wednesday, showed that M4 lending, excluding the effects of securitizations, increased by GBP42.4 billion in April, while lending including the effect of securitizations grew by GBP26.0 billion. The GBP16.4 billion difference between the two numbers was the highest since records began, and led some analysts to speculate that banks were packaging up loans into securities to present to the BOE in return for Treasury bills.

The Bank denies any suspicious wrongdoing on the side of the borrowers since it is not fathomable to estimate lending facilities usage from M4. While this might be correct the fact that there is no real transparency is still disconcerting, especially in the light of shortfalls of many banks in the subprime debacle.

Factors affecting Reserve Balances May22

A Bloomberg article from today puts the spotlights back on the banks in a somewhat different but equally disconcerting matter. Even after the credit crisis unfolded banks are still taking advantage of "Enron accounting". The Financial Accounting Standards Board (FASB) is being blamed of not closing accounting loopholes after Enron Corp. went bankrupt in 2001.

"They never got the real problem fixed after Enron,'' said Lynn Turner, the chief accountant for the Securities and Exchange Commission when the Enron scandal was exposed. ``When people find out how little FASB did, they're going to be shocked. FASB needs to be taken out behind the woodshed and given a good whoopin'.''

Variable interest entities (VIEs), a post-Enron version of special-purpose vehicles, were set up by banks to hold an undisclosed amount in off-balance sheet funds mostly collateral debt obligations. Many of these securities have gone sour since last August when the credit crisis began. The concern now is whether lack of transparency in off balance sheet securities conceals the amount of how many of these sour investments are still hidden away in VIEs. Banks are not required to disclose the assets they sell to their own VIEs, what price was paid, or whether they have lost value, making it harder for investors to determine when the subprime crisis will end.

Citigroup, Merrill Lynch & Co., UBS AG and other banks created more than $1.5 trillion of collateralized debt obligations like Bonifacius, keeping an undisclosed amount in off-balance-sheet funds called variable interest entities. Bonifacius and $190 billion of similar securities have gone bust since October, spotlighting loopholes the Financial Accounting Standards Board failed to close when Enron Corp. went bankrupt in 2001 after disclosing investments that weren't on its books.

Citigroup spokeswoman Danielle Romero-Apsilos declined to say whether Bonifacius was put in a VIE. The New York-based bank also didn't say if any losses from the security were included in the $7.4 billion it wrote down from the ventures since September.

source: Citigroup's `Last Roman' CDO Spotlights Banks' Enron Accounting
By Mark Pittman

source: BOE: Not Possible To Estimate Lending Facility Usage From M4

read also: New tools at the Fed - curse or blessing?

OFHEO first quarter purchase HPI dropped 1.7 percent from the fourth quarter

The OFHEO home price index (HPI) measures prices of houses in refinancing operations and purchase-only transactions. On a month over month basis the purchase-only figures were down 0.4 percent nationally, and 3.7 percent below the April 07 peak. Eight states posted quarterly price declines above 3 percent; two states — California and Nevada — saw prices fall more than 8 percent. However on a refinancing basis home prices were essentially flat compared to the same time last year. This divergence is interesting and some analysts call it a "smoking gun" that points towards an appraising practice of inflating home prices.

A look at the effect of appraisal data from refinance loans on the OFHEO HPI (right) shows that refinancing led the OFHEO HPI to significantly overshoot the purchase-only HPI during the housing boom, and that now refinancing activity is leading the HPI to undershoot purchase-only transactions during the bust.

“I’d call that [graph] a smoking gun,” said one MBS analyst, who asked that his name not be used. “Appraisers were inflating home values on refis during the boom, enabling the home ATM, and now they’re faced with trying to keep homeowners in their home in many cases.”

click to enlarge

On a related note S&P reports today that subprime delinquencies continue to climb in April.

At the end of April, delinquencies among 2005 vintage loans reached 36.8 percent, an increase of 2 percent from the previous month. Delinquent loans from 2006 totaled 37.1 percent, a 4 percent jump from March. About 25.9 percent of loans from 2007 were delinquent at the end of April, a 6 percent increase from a month earlier.

Loans from 2007 continue to be the worst-performing of the bunch, S&P said in a statement. After 12 months, cumulative losses in 2007 represent 0.49 percent of the original aggregate size of securities. After a similar period, 2006 vintage loans cumulative losses were 0.29 percent.
(emphasize added to keep it in perspective)

source: Home Purchase Prices Fall At Record Pace; Refis Tell Another Story

source: S&P: Subprime delinquencies continue to climb
AP, Thursday May 22, 11:28 am ET

There is no doubt that there is a bubble

says Stephen Schork from the Schork Report. He has also an interesting explanation for a most recent peculiar phenomenon in the futures market:

Crude oil for delivery Dec 2016 has jumped 17% in the past four days. This has nothing to do with fundamentals, because fundamentals don't move that fast, its impossible. Someone in this market is getting squeezed. We are going to hear their name whether its this afternoon, a week from now or a month from now . Someone is going bankrupt by now because they are stuck in the back of the board and get squeezed out.

click for video

video: Schork Says 'Fear and Greed' Driving Oil Market
Stephen Schork, The Schork Report

A good time to buy the instrument for the immortals - a Steinway

The number of new pianos sold declined 19% in 2007, the second consecutive annual decline in unit sales. Does this sound familiar? The WSJ writes:

To my surprise, I found loads of used Steinways for sale, perhaps reflecting the sorry state of the economy. Fewer people buy such pricey instruments when money grows tight. And more people with grand pianos gathering dust in their living rooms "take a second look" at the hulking instruments when they consider liquidating some assets, says Rochester, N.Y., piano technician Joe Ross, who runs piano-sales Web site "If you're in the market for a used piano, this is a good time for you."

source: For a Steinway, I Did It My Way

Wednesday, May 21, 2008

The hunt is on - speculators beware!

On Wednesday the House voted to override a Presidential veto on a $300 billion farm bill. The Senate is scheduled for a vote on Thursday. It is widely believed that there are enough votes for the bill to be written into law. It would be the second override of 10 vetoes by Bush.

Hidden in the bill is a very important passage that reauthorizes the CFTC to extend its regulatory oversight over electronic trading in energy futures.

The plan also lowers taxes for companies including Weyerhaeuser Co., North America's largest timber producer, and reauthorizes the Commodity Futures Trading Commission, ending the so-called "Enron loophole'' by extending regulatory power over electronic trading on energy markets.

Another bill introduced on May 7 by Senate Majority Leader Harry Reid and other Senate colleagues aims at the same target. The Consumer First Energy Act of 2008 focuses on the main causes behind the recent record-high gas prices.

If passed, the legislation would impose windfall profit taxes on oil companies, eliminate tax breaks for oil and gas companies and suspend shipments to the strategic petroleum reserve.

It would also limit speculation in oil futures and give the government the power to prosecute price gougers.

read also: Consumers first - oil futures later

Is Brazil's Petrobras the answer to 'peak oil'?

In April Brazil's National Petrolium Agency announced the discovery of a huge new oil field, Carrioca, holding about 30 billion barrels of oil equivalent. Today the CEO of Petrobras answers questions from CNBC's Maria Bartiromo.

"We have several exploratory wells drilled and we are finding very good results, however we cannot give precise data because we are still analysing data. We have discoveries in Anjupta , Tupi, Carrioca and other fields that are in the area. We are in the final stages of appraisal."
"...we are planning to increase production to 4.2 mln a day by 2015, after the discoveries we are going to have even higher targets and these are going to be beyond 2015."

"....if we have $35 per barrel (in free cash flow) in the long run we can generate something like 105 billion as free cash flow in the next four years."

click for video

video: Powering Brazil's Economy
Petrobras, Brazil's state-controlled oil producer, is rapidly emergin as a major player in the global energy empire, with Jose Sergio Gabrielli de Azevedo, Petrobras CEO and CNBC's Maria Bartiromo.

Exxon proxy fight - the sequel

The big May meeting for Exxon Mobile shareholders is coming up and the familiar proxy fight is again on the table. The Rockefeller family chimed in to this discussion as well, the point being that the board should be broken up into an independent chair separated from the position of CEO, which is filled by Rex Tillerson. The main reason behind this initiative is the lack of the energy giant's spending on alternative energy, which is in reality non existent.
Hilary Kramer as the founder of Greentech Research takes the cooperate site, which makes one wonder if she understands the concept of green/alternative technology.

George Dallas, Director of Corporate Governance, F&C Asset Management, and Hilary Kramer, Greentech Research Founder, discuss why Exxon shareholders are upset.

click for video

click for video

video: Exxon Proxy Fight Grows Pt. 1

video: Exxon proxy fight grows pt. 2

read also: Exxon's first quarter earnings and the Rockefellers

read also: ExxonMobil's R&D spending is 'tiny'

The yield of a barrel of oil

For the first time a barrel of oil costs more than $130. A look at the NYMEX Light Crude Oil contract monthly price chart reveals a closing price at the end of March 1999 of $16.76 with a volume of about 3.5 mln contracts traded during the month. In stark contrast the same product closed at $113.46 on a staggering volume of about 11 mln contracts at the end of April 2008.

Month of:03/31/1999 O=12.35 H=17.05 L=12.18 C=16.76 V=3492519
Month of:04/30/2008 O=99.80 H=119.90 L=99.70
C=113.46 V=10973879

A barrel of oil yields about 44 gallons of various refined products. So where does that oil go?

22.6 gallons of gasoline - enough to drive 622 miles in the average American car
6.7 gallons of diesel - enough to drive 41.7 miles in a tractor-trailer

5.5 gallons of jet fuel - not enough to fly a fully loaded 747 one mile. You'll get about 0.95 miles

2.4 gallons of "still gas," a mixture of gas produced in refineries
2.2 gallons of "marketable coke," a residue used in the production of aluminum anodes, furnace electrodes and liners and shaped graphite products

1.5 gallons of fuel oil, often used for heating or for fueling locomotives, ships and for power generation systems

1.2 gallons of liquefied gas, which is used in heating appliances and vehicles, and replacing chlorofluorocarbons as an aerosol propellant and a refrigerant

0.8 gallons of asphalt

0.4 gallons of lubricants, often placed in greases
0.7 gallons of other products

Real items made from the barrel:

4 pounds of charcoal briquettes
12 cylinders of propane
170 wax birthday candles

A quart of motor oil

Petrochemicals used in the productions of all kinds of pharmaceuticals, plastics, cosmetics and foodstuffs.

source: Where Does That Oil Go?
A Look at What's Inside a Barrel of Oil and What Products Come From It
By DANIEL ARNALL, ABC NEWS Business Unit, February 27, 2008

Tuesday, May 20, 2008

Senate panel hearing testimony about bubbilicious commodity prices

Sen. Joseph Lieberman, a ranking member of the Senate Governmental Affairs Committee, discusses speculation in the commodities market. A vote on the Consumer-First Energy Act, which addresses the speculative bubble among energy traders, is expected before Memorial Day.

Index-speculators, large and institutional investors, are having a very significant effect on the dramatic increase in commodity prices that is really creating a lot of stress among average families and terrible suffering among people who are poor both here in America and throughout the world. So the testimony was really quite riveting.

....the most impressive testimony we heard today said that financial speculators are the largest single factor in the increase in commodity prices and that we and the government have to do something about that. We may take action which we will now consider to block some of the ways in which speculation in commodities is going on.

click for video

video: The Senate, Commodities & Speculation
CNBC, Last Update: Tues. May 20 2008 | 1:15 PM

read also: Consumers first - oil futures later

further reading: Democrats: Close speculation loophole
Senate Democrats look to end U.S. electronic oil trading in foreign exchanges to reduce the speculative inflation of oil prices.
By David Goldman, staff writer, Last Updated: May 8, 2008: 12:00 PM EDT

Fox Business news - only soft headlines

A look at a common news aggregator,, reveals a small yet curious detail about how today's news are presented by major publishers. By simply looking at the headlines it becomes obvious that Fox Business news, the new business channel of media mogul Murdoch, skips the important issues of the day. This is of course a rough estimate since I am unable to determine whether this is a coincidence or simply an issue with the aggregator. The following is an excerpt of the faq section from the website and basically states that news are aggregated from the latest news feeds. They should therefore be a representation of news from the respective news service.

- newsflashr auto-generates every 15 minutes resulting in a new display of the most popular keywords (topics) in the headlines. These topics are extracted from all the latest news feeds. Each category results in a different 'cloud' of top topics.

click to enlarge

source: newsflashr, a faster way to track headline news

El Paso - anatomy of housing boom and bust

The following is a typical anatomy of a housing boom and bust: example, Texas-Mexican boarder town El Paso

When an independent commission recommended military base closures and realignments in 2005, the area was relieved to learn that nearby Fort Bliss wouldn't have to shut down. In fact, it would receive an influx of troops and families.

Since then, the area has begun to prepare for the arrivals. Initially, it was supposed to be 11,000 soldiers; the figure has since grown to about 37,000, says Dan Olivas, president of the Greater El Paso Association of Realtors.

The local housing market benefited immediately. After the Fort Bliss announcement, "People jumped on the bandwagon," says James Gaines, an economist at Texas A&M University's Real Estate Center. "It created this boom mentality, and things went really well for a while."

Investors, particularly from California, rushed in to buy homes, Olivas says. Prices shot up. Then reality set in. The investors had trouble unloading their homes at a profit, once it became clear that Fort Bliss wouldn't absorb an influx of troops for some time.

source: El Paso: Home sales future looks promising

Monday, May 19, 2008

Homesales in SoCal surged in April 2008 - up 21.9 percent on the month

Jan Hatzius, the man who called a 2 trillion dollar loss on "pipeline effects" from the subprime debacle, on housing, the economy, commodities, and the Fed:

As home prices continue to fall and push people into negative equity, that's going to show up in bigger mortgage credit losses. Homeprices falling another 10% to 15% from here, which basically gets you back to valuations on trend of last 30 years. If you look at ratio of homeprices to rent if you get another 10 to 15% you are back to trend line.

click for video

HW reports about a remarkable development in Southland, SoCal, the epicenter of the nations foreclosure mess. Sales in April surged higher.

Home sales in Southern California surged to their highest level since August of last year this past April, rising an astounding 21.9 during April compared to one month earlier, real estate information service DataQuick Information Systems reported Monday. While the monthly comparison is not seasonally-adjusted, sales typically rise by an average of 1.2 percent between the two months, the company said. Sales remained 19 percent below year-ago levels, and the bump in activity came despite record foreclosure activity within the state.

A total of 15,615 new and resale houses and condos sold in Los Angeles, Riverside, San Diego, Ventura, San Bernardino and Orange counties during April, DataQuick said.

The median price paid for a Southland home was $385,000 last month, unchanged from March and down 23.8 percent from the peak median of $505,000 in April of last year. Last month was the first in eight months that the median price in Southern California did not decline on a month-to-month basis.

source: Don’t Look Now, But SoCal Home Sales Surged in April

High prices are a disincentive to look for more oil

Oil bulls point to high production costs as one justification for higher prices. The idea being that high prices and therefore record profits provide the incentive to find new resources and bring them on stream so that today's insatiable energy needs can be satisfied. It is a brilliant logic easy for everyone to understand. Of course, if you are a skeptic and you don't believe everything that is coming out of the pits, you might just take the other side. In search for this very other side a paragraph in a Bloomberg article, "Not Enough Oil Is Lament of BP, Exxon on Spending", caught my attention. It confirms what I had been suspecting for quite a while. High prices provide actually a disincentive to look for new resources. This helps twofold, by preserving capital and keeping OPEC's charade alive.

Even as countries reclaim their reserves, many are relying on high oil prices rather than increased production to meet government budgets. Output in Russia is expected to fall for the first time in a decade, and Saudi Arabia's decision this month to increase output by 300,000 barrels a day still won't offset a 390,000 barrel-a-day drop in monthly OPEC production in April.

I have linked to the Bloomberg article, but have not done any research myself about their numbers and their significance. I have chosen the above paragraph for the purpose of making a specific point.

source: Not Enough Oil Is Lament of BP, Exxon on Spending (Update1)
By Grant Smith and Jim Kennett

NYU professor - 10% to 15% house price decline 'still to go'

video: No Bottom in Sight: Home Prices to Fall Another 10-15 Percent, Says NYU Prof
Posted May 19, 2008 07:30am EDT by Aaron Task,WM

Chip Mason: Let's not declare victory yet.

Chip Mason on the credit crunch, the Fed and acquisitions:

click for video

Chip Mason on regulation, commodity prices and the US economy:
From the stock market standpoint I certainly hope so (there is a bubble in commodities prices forming)
I assume that the cost of a barrel of oil is still at $40. The price (of oil) has gotten to a point where they are creating economic imbalances, they are causing the poor countries to suffer a lot, they are causing major economies to go through big shifts.
I suspect the US economy in a recession, looks to be more on the shallow side......but its gonna be a longer pullout than people are gonna want.

click for video

USD, probably bottomed
BX, no opinion
oil, assume near the top
US universities, yes
India, great potential
Citi, work through it
Print news, I assume they find pricing
US house prices, ought to go back to where they were 2.5 years ago
Barrack Obama, presidency I don't know, damaged from his pastor
Bill Miller, work through it

video: Chip Mason on the credit crunch, the Fed and acquisitions

video: Chip Mason on regulation, commodity prices and the US economy

Sunday, May 18, 2008

EA March 2008 preliminary trade deficit - 2.3 bn euro

Eurostat released preliminary data for EU trade balance:

The first estimate for the euro area (EA15) trade balance with the rest of the world in March 2008 gave a 2.3 bn euro deficit, compared with +7.5 bn in March 2007. The February 2008 balance was +0.8 bn, compared with -1.6 bn in February 2007. In March 2008 compared with February 2008, seasonally adjusted exports fell by 2.9% while imports remained stable.

click to enlarge

source: March 2008, Euro area external trade deficit 2.3 bn euro, 20.5 bn euro deficit for EU27
Eurostat, the Statistical Office of the European Communities.

Friday, May 16, 2008

Consumers first - oil futures later

Finally Congress gets its act together and starts to address the problems brewing among speculators in the oil pits. The Consumer-First Energy Act introduced a couple of weeks ago comes to the floor and a vote is expected before Memorial Day. The proposal is supposed to address the speculative bubble among energy traders. First on the list is greater oversight for energy futures trading and second, a proposal to mandate higher cash collateral for margin requirements.

Here are some tidbits of info that show how speculative the market for energy future trading has become:

There are now 634 energy hedge funds, up from just 180 in October, 2004.

Of the total funds, 210 are strictly energy commodity funds trading oil or oil futures and options, as opposed to the stocks of energy companies.

The global futures market in petroleum is currently valued at about $500 billion. Trading in the electronic or over-the-counter (OTC) market, which neither the U.S. nor the U.K. regulates, is valued at between $1.5 and $3 trillion.

As far back as June 2006 the US Senate noted in an investigation that there is substantial evidence supporting the conclusion that a large amount of speculation has significantly increased oil and gas prices. The report also cited the US Commodity Exchange Act (CEA) which mandates the CFTC to ensure that prices on futures reflect the laws of supply and demand rather than manipulative practices or excessive speculation. The senate report was ignored by the media and congress, but now that luck seems to change.

NYMEX traders are required to keep records of all trades and report large trades to the CFT together with daily trading data providing price and volume information. In contrast traders on unregulated OTC electronic exchanges are exempt from CFTC oversight.

In January 2006 the Bush administration opened the door to potential oil price manipulation by permitting the ICE, the largest electronic energy trading exchange, to trade US crude oil futures (WTI) on the London exchange. Despite the fact that US traders were trading US oil, gasoline and heating oil futures contracts, on the ICE exchange within the United States, the CFTC has no oversight. Basically what it boils down to is this:

Persons within the United States seeking to trade key US energy commodities - US crude oil, gasoline and heating oil futures - are able to avoid all US market oversight or reporting requirements by routing their trades through the ICE Futures exchange in London instead of the NYMEX in New York.

In June 2006, the senate investigation estimated that of oil traded in futures markets at some $60 a barrel, about $25 of that was due to pure financial speculation. One analyst estimated in August 2005 that US oil inventory levels suggested WTI crude prices should be around $25 a barrel, and not $60.

That would mean today that at least $50 to $60 or more of today's $115 a barrel price is due to pure hedge fund and financial institution speculation. However, given the unchanged equilibrium in global oil supply and demand over recent months amid the explosive rise in oil futures prices traded on Nymex and ICE exchanges in New York and London, it is more likely that as much as 60% of the oil price today is pure speculation. No one knows officially except the tiny handful of energy trading banks in New York and London, and they certainly aren't talking.

source: Oil Traders Draw Congress' Ire
by Moira Herbst, BusinessWeek

Speculators knock OPEC off oil-price perch
By F William Engdahl, May 6, 2008

Is the crisis over? - experts speak out

Scholes, Nobel Laureate, Says Credit Crisis May Not Be Over.
"From my perspective, I think that we don't know if the storm has passed or if we are still in the eye of the storm. Are there other shoes to drop and new events or new shocks that will come to the fore?''

Ben S. Bernanke in a speech this week said financial markets remain "far from normal.''

Credit Suisse Group Chief Executive Officer Brady Dougan said markets are too optimistic that the credit crisis is nearing an end.
"I think that the markets are overly optimistic right now. There continue to be challenges and that's going to play out over the next six to eight weeks. There continue to be issues on the liquidity side.''

Describing housing as "the quintessential leading indicator", Rosenberg Merrill's North American economist, a long-time bear on the U.S. economy, said he expected home prices to fall another 15-20 percent before stabilizing. He also predicted inflation in the United States would slow as consumer spending weakens, and that the Federal Reserve would be forced to cut rates further to deal with the recession.
"No asset class security is priced today for a recession scenario, which is why he was bullish on U.S. Treasuries but bearish on stocks."

Treasury Secretary Henry Paulson said Friday that financial markets are "considerably calmer" now than they were two months ago. He predicted the economy will be rebounding by the second half of this year.
"In my judgment, we are closer to the end of the market turmoil than the beginning. Looking forward, I expect that financial markets will be driven less by the recent turmoil and more by broader economic conditions and, specifically, by the recovery of the housing sector."

Thursday, May 15, 2008

What is behind the revival of the greenback?

Since its April 22 low against the euro, the dollar has risen about 5% vs. the euro, 2.6% vs. the British pound and about 4% compared with the Swiss franc. The U.S. dollar index, which reflects the dollar's moves against a basket of six currencies, has gained 3.8% since its March 17 low.

On April 11 the Group of Seven financial ministers noted in their statement that they are concerned about "sharp fluctuations in major currencies". The impact on the EUR/USD currency cross was muted at the time. Currency analysts are now looking to the G7 statement for some clues. Analysts are guessing that the U.S. and Europe have been successful in convincing central banks from the BRIC countries and sovereign-wealth funds to temporarily stop converting their accumulated U.S. dollar-holdings to the euro. And that pressure has contributed to the dollar's stabilization.

A senior U.S. Treasury official, quoted in The Wall Street Journal Saturday, said the Bush administration was leading an international effort to put a floor under the falling dollar. Two days earlier, the Financial Times quoted unnamed senior officials as saying the U.S. and Europe have a united desire to see the dollar strengthen against the euro.

The falling dollar has contributed to cushion the blow to the U.S. economy from housing and the credit crisis by propping up exports. On the other hand it is also blamed for the ever rising oil and commodity prices and the resulting inflationary pressures put the Federal reserve in a tight spot. It might well have reached a breaking point where the authorities have no choice. In the meantime we can observe a perfectly macro-economic explanation that has led to the resurgence of the greenback.

4/11: The change in the G-7 statement was the most significant since the Boca Raton, Florida, meeting in February 2004, when officials cautioned against ``excess volatility.'' The latest statement didn't explicitly mention the dollar or suggest plans for intervention, in which central banks arrange purchases or sales of foreign exchange.

4/14-18 IB report 1Q results that are better than expected

4/22: Implied volatility on options for the dollar fell to 11.28 percent after the G-7 meeting on April 11. It was 14.5 percent on March 17, the same level at which the G-7 stepped into the market in 1995 to influence prices.

4/23: European stocks fell for a third day, led by banks, on deepening concern about credit-market losses.

4/24: Fed Weighs Pause After Next Rate Cut accdg to Greg Ip WSJ
4/24: The IFO Institute’s measurement of German business confidence fell to 102.4 from 104.8; current assessment fell to 108.4 from 11.5 and expectations to 96.8 from 98.4.

4/28: Economic growth in the euro region will slow to 1.5 percent next year, the commission said today in its spring economic forecast, 0.6 percentage point less than it projected in November and below the 1.7 percent expansion expected for 2008. Inflation will jump to 3.2 percent this year, 0.6 percent more than the commission's February forecast, before easing to 2.2 percent in 2009.

4/28: Moody's assigned 32 negative outlooks to European companies in the first quarter, almost triple the 11 that were positive, the New York-based ratings firm said in a report today. The gap is the widest since 2001 and indicates deteriorating credit quality in 12 to 18 months, Moody's said.

4/29: European Retail Sales Slumped in April to a seasonally adjusted 41.8 from 48.2 in March.

4/29: The S&P/Case-Shiller home-price index dropped 12.7 percent from a year earlier, more than forecast and the most since the figures were first published in 2001.

4/30: FOMC indicates a pause

5/5: European Central Bank President Jean- Claude Trichet, who chaired a meeting of central bankers from the Group of 10 industrialized nations today, said the world economy continues to grow and inflation risks are significant - warns of a rate hike in the future

5/6: Swiss bank UBS, hard hit by the U.S. subprime crisis, reported a first-quarter loss of $10.97 billion and said Tuesday it will slash almost 7 percent of its work force.

5/8: ECB leaves rates unchanged - Trichet warns of protracted period of high inflation

source: Dollar rally, leaks put fresh focus on G7 meetings
By Laura Mandaro, MarketWatch

A smidgen of reality at the Bank of England

B of E Governor Mervyn King delivers a bleak message at the same time when Gordon Brown is upbeat and optimistic. I don't know if I should be happy or sad, but it is certainly refreshing to see a central banker telling it like it is. King's comments are in stark contrast to that of the Federal Reserve, which is obviously more concerned with Wall Street than it is with Main Street.

"The 'nice' decade is behind us," he said. "The credit cycle has turned. Commodity prices are rising. We are travelling along a bumpy road as the economy rebalances. Monetary policy cannot and should not try to prevent that adjustment. Inflation will return to the target and growth will eventually recover to a sustainable rate. But we will have to be patient."

"Rising energy and import prices will almost certainly push inflation up further, possibly significantly, in the coming months," he said. "As those price increases feed through to household bills, they will lead to a squeeze on real take-home pay which will slow consumer spending and output growth, perhaps sharply. It is quite possible that at some point we get an odd quarter or two of negative growth. Recession is not the central projection but clearly further shocks could push us in that direction."

source: Bank of England dashes hopes of interest rate cuts amid inflation threat
By David Litterick, The Daily Telegraph

William Dudley - May You Live in Interesting Times: The Sequel

Today's Fed speak comes from William C. Dudley, NY Fed Executive Vice President. He thinks that balance sheet pressure on banks is behind the persistent widening in term money market spreads, and disputes that increased counterparty risks and/or diversification of money market mutual funds are the prevailing factor. He concludes if so there are limits what the Federal Reserve can accomplish. The reintermediation and deleveraging process has further to go in his opinion.

So what has been driving the recent widening in term funding spreads? In my view, the rise in funding pressures is mainly the consequence of increased balance sheet pressure on banks. This balance sheet pressure is an important consequence of the reintermediation process. Although banks have raised a lot of capital, this capital raising has only recently caught up with the offsetting mark-to-market losses and the increase in loan loss provisions. At the same time, the capital ratios that senior bank managements are targeting may have risen as the macroeconomic outlook has deteriorated and funding pressures have increased.

Consider, for example, the spread between jumbo fixed-rate mortgages and conforming fixed-rate mortgages, which is shown in the next slide. As can be seen, this spread has widened sharply in recent months, tracking the rise in the LIBOR/OIS spreads. ... Because the credit risk of jumbo mortgages is likely to be comparable to the credit risk of conforming mortgages, the increase in the spread between these two assets is likely to mainly reflect an increase in the shadow price of bank balance sheet capacity.

If balance sheet capacity is the main driver of the widening in spreads, this suggests that there are limits to what the Federal Reserve can accomplish in terms of narrowing such funding spreads. After all, the Fed’s actions cannot create bank capital or ease balance sheet constraints materially.

The Fed's major backstop initiatives (TAF, PCF, TSLF, PDCF) have been successful in bringing down the LIBOR-OIS spread. Dudley goes on:

Perhaps this just represents an announcement or placebo effect. More study is obviously needed. However, it is interesting that those market participants who are the patients have been clamoring for more medicine in the form of both an increase in the size of the TAF auctions and auctions with longer maturities.

It will take time for market function to return to normal. The reintermediation and deleveraging process has, in my view, a considerable ways to go. The Federal Reserve is committed to supplying liquidity to banks and primary dealers as needed to ensure an orderly adjustment.

click here for chart porn

source: May You Live in Interesting Times: The Sequel
William C. Dudley, NY Fed Executive Vice President, May 15, 2008

source: Funding Pressures and the Federal Reserve’s Liquidity Facilities
William Dudley, Head of Markets Group, Federal Reserve Bank of New York, May 2008