Interest Rate Roundup

Monday, June 30, 2008

Home Depot, Fortune Brands hit the skids

A few more late-breaking developments worth noting:

Shares of Home Depot just broke below their January spike low. If you're a technically inclined type, you might remark that there doesn't appear to be much in the way of support until the bear market low (around $20 way back in January 2003).

Meanwhile, Fortune Brands just warned about the deteriorating earnings outlook. The company makes everything from Titleist golf balls to Jim Beam bourbon to Moen faucets. I've included an excerpt from the company's release, with my emphasis of certain comments in bold. What jumps right out at you is the striking admission that business deteriorated throughout the quarter, with April good, May worse, and June worse still …

“The environment has become more challenging for our brands and the second quarter is shaping up to be more difficult than we had anticipated,” said Fortune Brands president and chief executive officer Bruce Carbonari. “April was a solid month that tracked with our expectations, followed by softer-than-anticipated results in May. We’ve seen continued softness in June and it’s now clear that we will not make up the May shortfall.

“With the rapid spike in gasoline prices and the decline in consumer confidence, we’re seeing American consumers pull back. At the same time, the correction in the U.S. housing market has intensified. Together, this means that home improvement purchases and homebuilding remain soft, that many golfers are deferring ‘big ticket’ purchases of golf clubs, and that trading up to premium spirits brands continues in the U.S. but at a more moderate pace,” Carbonari continued. “Meanwhile, higher costs for commodities such as petroleum-based materials, glass and steel are adding to the pressures facing manufacturers.”

Late day ratings downgrades at XL, Genworth

A couple of noteworthy ratings downgrades hit the tape this afternoon. First, Fitch Ratings lowered its ratings outlook on XL Capital to "negative." XL is currently rated A+ by Fitch, but Fitch is concerned about losses the insurer may suffer due to its business ties to the bond guarantee firm Security Capital Assurance. From the Fitch note:

"Fitch Ratings has placed the ratings of XL Capital Ltd (XL) and its property/casualty (re)insurance subsidiaries, including the Issuer Default Rating (IDR) and the Insurer Financial Strength (IFS) rating of lead (re)insurance companies XL Insurance (Bermuda) Ltd and XL Re Ltd. on Rating Watch Negative.

"The rating action reflects Fitch's concerns regarding XL's exposure to Security Capital Assurance (SCA). XL has an ongoing exposure to SCA via a facultative reinsurance contract, an excess of loss reinsurance contract, and an unlimited guaranty in support of any losses payable on the pre-August 2006 initial public offering (IPO) financial guaranty portfolio. This guaranty is triggered upon the occurrence of both of the following events: default on payments of interest and principal by the underlying guaranteed obligation and failure of XL Financial Assurance (XLFA) to meet its obligations to XL Capital Assurance (XLCA) under its facultative quota share reinsurance agreement with XLCA.

"XL is actively working to resolve its exposure to SCA and while Fitch views successful resolution of this exposure as a positive, the size of any charges, and the manner in which XL funds any charges, could have an impact on the ratings. Fitch envisions if a large charge is ultimately taken that is not offset by an equity-like capital raise, ratings would likely be downgraded by one notch. If there are no additional charges or they are modest, or if a capital raise is executed in the event of a larger charge, Fitch would likely affirm the ratings and return to a Stable Outlook."

Next up in the ratings agency firing line: Genworth Financial, the mortgage, life, and long-term health care insurance firm spun off by General Electric in May 2004. Moody's Investors Service downgraded the insurance financial strength ratings of Genworth's mortgage insurance unit to Aa3 from Aa2 (wondering how the Moody's credit ratings scale works? Check out this page). Genworth is the fourth-largest mortgage insurer. Here's a brief excerpt from the Moody's note:

"Moody's Investors Service has downgrade to Aa3, from Aa2, the insurance financial strength ratings of Genworth Mortgage Insurance Corporation (GMICO) and supported affiliates, reflecting its weakened credit profile as a result of historically high mortgage defaults and uncertainty about ultimate losses, mitigated in part by the group's limited exposure to the highest risk mortgage products, robust capital adequacy, and ownership by a strong and diversified parent. The rating agency added that the firm is well positioned to take advantage of current new business opportunities given its strong credit profile relative to peers. The rating outlook is negative. "

Multiple reports: The world is coming to an end

Okay, just kidding. That's not really what the papers and wires are saying this morning. But it sure is how some of those stories read. Just consider:

* The Bank for International Settlements (no hyperbolic, doom-and-gloomers there) is out with an annual report that sounds downright bearish. A few key quotes ...

On the credit crisis - "The difficulties in the subprime market were a trigger for, rather than a cause of, all the disruptive events that have followed ... the magnitude of the problems yet to be faced could be much greater than many now perceive."

On weak growth and high inflation -- "The global economy now seems to be experiencing both unwelcome phenomena at the same time."

On how policymakers should respond -- "With inflation a clear and present threat, and with real policy rates in most countries very low by historical standards, a global bias towards monetary tightening would seem appropriate."

This is one mega-document you don't want to read unless you have lots and lots of time on your hand. A shorter digest of its contents can be found courtesy of the Wall Street Journal.

* Meanwhile, the International Monetary Fund has chimed in with cheery news on the dollar: Specifically, the greenback now makes up the smallest percentage of global foreign-exchange reserves ever (Data is available via this web page).

Governments and central banks were only holding 63% of their reserves in dollars as of the first quarter of this year, per Bloomberg. That's down from 64% in Q4 2007 and the lowest since the IMF started releasing quarterly figures in 1999. The euro is capturing an all-time high share of 26.8%.

* And of course, the stories of ongoing turmoil in the housing and mortgage markets keep on coming. Here's just one from the New York Times over the weekend:

"When Congress started fashioning a sweeping rescue package for struggling homeowners earlier this year, 2.6 million loans were in trouble. But the problem has grown considerably in just six months and is continuing to worsen.

"More than three million borrowers are in distress, and analysts are forecasting a couple of million more will fall behind on their payments in the coming year as home prices fall further and the economy weakens.

"Those stark numbers not only illustrate the challenges for the lawmakers trying to provide some relief to their constituents but also hint at what the next administration will be facing after the election. While the proposed program would help some homeowners, analysts say it would touch only a small fraction of those in trouble — the Congressional Budget Office estimates it would be used by 400,000 borrowers — and would do little to bolster the housing market.

“It’s not enough, even in the best of circumstances,” said Mark Zandi, chief economist of Moody's The number of people who will be helped “is going to be overwhelmed by the three million that are headed toward default.”

Not enough for ya? How about news that inflation in the Eurozone climbed to 4% in June from 3.7% in May, the highest level in more than 16 years? Or more chatter and other reports that hint at a potential conflict with Iran? Combine all of that with the annoying computer problems I'm dealing with and maybe the best course of action is to just go back to bed!

Friday, June 27, 2008

Report: Manhattan real estate market loosening up

The credit crisis is having serious impacts on many different markets. It now appears the crisis is softening up Manhattan's commercial property market. As a Bloomberg story chronicles today ...

"Manhattan office rents fell 2.2 percent in the second, the first decline in the most expensive U.S. office market since 2005, according to real estate broker Studley Inc.

"The decline was 4.4 percent for Class A office space, according to a preliminary second-quarter New York market report by Studley, which represents tenants. The broker blamed a 'malaise' among Wall Street securities firms, which hadn't previously stopped the rise in rents, in a report by Steven Coutts, Studley's senior vice president for national research services. The full report will be released next week."

Also from the story: New York City's Independent Budget Office recently forecast that the city would shed 33,000 jobs in the finance industry, good for a drop of just over 7% from the 2007 peak.

Friday morning bits on income, bank capital and more

Yesterday was one of the nastiest days for the stock market in a while. And the market as a whole is on track for its worst June since the Great Depression, according to Bloomberg. That's not exactly the kind of news you want to read while you're drinking your coffee and munching on your bagel. But it is what it is.

What else has caught my eye this morning?

First, the regulators are trying to do anything they can to encourage the funneling of capital into the banking system. Why? Banks need all the help they can get to shore up their balance sheets amid billions and billions of writedowns and loan and securities losses. Now, it looks like the Fed may allow bigger infusions of capital from private equity firms. Per the Wall Street Journal:

"The Federal Reserve may soon make it easier for private-equity firms and others to invest in the nation's ailing banks, according to people familiar with the matter.

"With bank stocks crumbling and the second quarter drawing to a close Monday, the changes could offer a lifeline to cash-strapped lenders desperate to secure capital.

"This would be a bit of a sea change for the Fed," said Gregory Lyons, head of the financial-services practice at law firm Goodwin Procter LLP. "A number of banks would love to access the private-equity pool. It's a clean slug of money."

"The move comes as regulators grow increasingly worried about the ability of many banks to replenish capital amid the worst banking crisis in decades. Small and regional lenders are expected to have a tougher time lining up new investors, particularly since some recent capital infusions have stuck banks' new shareholders with big losses."

Second, we continue to see elevated loss and writedown forecasts for the country's major financial institutions. One example: Lehman Brothers is forecasting that Merrill Lynch will end up taking another $5.4 billion in writedowns in the second quarter.

Third, personal income and spending wasn't so bad in May. Income jumped 1.9%, more than four times the 0.4% increase economists were expecting. Disposable income jumped 5.7% in the month, the biggest increase since May 1975. Spending rose 0.8%, slightly higher than the 0.7% rise that was expected. The personal consumption expenditures "core" index gained just 0.1%, below the 0.2% forecast (meanwhile, the headline PCE deflator jumped 0.4%, the biggest rise since November).

One problem: The tax rebates were the driving force behind the surge in incomes. As the Bureau of Economic Analysis notes:

"The May and April changes in disposable personal income (DPI) -- personal income less personal current taxes -- were boosted as a result of provisions of the Economic Stimulus Act of 2008. The federal government issued rebate payments of $48.1 billion in May ($577.1 billion at an annual rate) and $1.9 billion in April ($23.3 billion at an annual rate). These payments reduced personal current taxes and increased government social benefit payments. As a result, disposable personal income increased substantially. Excluding these special factors, which are discussed more fully below, disposable personal income increased $46.4 billion or 0.4 percent in May, after increasing $16.6 billion, or 0.2 percent, in April."

Thursday, June 26, 2008

Bank of America to lay off 7,500 after Countrywide deal closes

Some breaking news out of Bank of America: The company plans to get rid of 7,500 employees after it consummates its deal to buy Countrywide Financial. That's expected to happen July 1 now that Countrywide shareholders have voted in favor of the deal. Personally, I think this is a high risk deal that could prove to be one of the worst deals in the history of modern banking -- right up there with Wachovia buying Golden West Financial or First Union buying The Money Store (and merging with CoreStates, for that matter). But so be it.

May existing home sales climb 2%

We just got May existing home sales data from the National Association of Realtors. Here's what the numbers looked like ...

* Sales climbed 2% to a seasonally adjusted annual rate of 4.99 million in May from 4.89 million in April. That was slightly better than the average forecast of 4.95 million home sales. Sales were down 15.9% from the year-earlier reading of 5.93 million.

* By region, sales rose 4.6% in the Northeast, 5.5% in the Midwest, and 2% in the West. They fell 0.5% in the South. By property type, sales climbed 1.6% in the single-family market and 5.5% in the condo arena.

* The supply of homes for sale dipped 1.4% to 4.49 million units in May from 4.55 million in April, but climbed from 4.378 million a year earlier. On a months supply at current sales pace basis, inventory dipped to 10.8 months from 11.2 months in April, but rose from 8.9 a year earlier.

* Median home prices rose 3.7% to $208,600 in May from $201,200 in April (previously reported as $202,300). But they fell 6.3% from $222,700 a year earlier.

The May existing home sales figures were a bit better than expected. Sales improved modestly, the supply of homes for sale shrank a bit, and median prices increased on a monthly basis.

The problem: I think the improvement will prove short-lived. The existing home sales figures track closings, not contract signings. So they're a bit of a lagging indicator. In fact, they just confirmed what we already knew from April's pending sales data and April's new home sales figures (which track signings) -- namely that the market ticked higher that month.

Since then, it appears the housing market has downshifted again. New home sales dipped in May ... the NAHB index tagged its cycle low in June ... and the Mortgage Bankers Association's purchase applications index just sank to its lowest level since February 2003. None of that is encouraging. Neither is the commentary from key home builders. Lennar, for one, said just this morning that "the housing market has continued its downward trend throughout out second quarter."

Finally, there's the deteriorating broad economy. Gas has climbed above $4 a gallon. The unemployment rate is rising. Lenders are tightening mortgage standards. Consumers are the gloomiest about the economy's future that they've been in the past four decades. And house prices continue to decline in broad swaths of the country.

All of these factors suggest housing will remain weak for the balance of 2008 -- and that a longer-lasting recovery remains over the horizon.

Wednesday, June 25, 2008

Fed keeps rates on hold, plus thoughts on the post-meeting statement

Here's the statement. First read: Seems "not hawkish enough" to me. We'll see ...

"The Federal Open Market Committee decided today to keep its target for the federal funds rate at 2 percent.

"Recent information indicates that overall economic activity continues to expand, partly reflecting some firming in household spending. However, labor markets have softened further and financial markets remain under considerable stress. Tight credit conditions, the ongoing housing contraction, and the rise in energy prices are likely to weigh on economic growth over the next few quarters.

"The Committee expects inflation to moderate later this year and next year. However, in light of the continued increases in the prices of energy and some other commodities and the elevated state of some indicators of inflation expectations, uncertainty about the inflation outlook remains high.

"The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time. Although downside risks to growth remain, they appear to have diminished somewhat, and the upside risks to inflation and inflation expectations have increased. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.

"Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh. Voting against was Richard W. Fisher, who preferred an increase in the target for the federal funds rate at this meeting."

UPDATE: What's the early market reaction? Lots of fluctuations, that's what. Dollar popped, then reversed. Crude oil is rallying off its lows. Bond futures are down a few ticks post-Fed. Stocks are up, but not huge. Two-year yields essentially where they were pre-Fed (up about 6 bps).

UPDATE2: Here are some more of my thoughts on the Fed's statement ...

“My sense is that the Fed wasn’t hawkish enough. Officials talked quite a bit about elevated inflation. But they didn’t appear to shift fully to a “tightening bias.” Indeed, the Fed looks like it’s continuing to try to thread the needle. It doesn’t want to raise rates because doing so could exacerbate the housing downturn and the economic slump. But with several inflation gauges at or near multi-year highs, the Fed is playing a dangerous game.

"Put simply: Talking the talk on inflation is one thing. Walking the walk is another. By keeping real interest rates deeply in negative territory, and failing to follow the lead of several foreign central banks, which ARE raising rates, the Fed could weaken the dollar further and “accommodate” these high commodity prices. That, in turn, could ultimately result in an even-worse inflation problem down the road."

May new home sales slip 2.5%

The Fed isn't the only area of focus out there right now. Investors are also paying attention to the latest housing news. On that front, we just got fresh data on the new home business in May. It showed:

* Sales dipped 2.5% to a seasonally adjusted annual rate of 512,000 in May from 525,000 in April (previously reported as 526,000). That was exactly in line with the average forecast of economists. Sales plunged 40.3% from 857,000 in May 2007.

* Regionally, sales fell 7.9% in the Northeast and 11.6% in the West. They inched up by 0.4% in the South and climbed 5.1% in the Midwest.

* The inventory of new homes for sale continued to fall. It dropped 1.7% to 453,000 from 461,000 in April (previously reported as 456,000). Supply is also down 16.9% from a year earlier. The "months supply at current sales pace" indicator of inventory rose to 10.9 months from 10.7 in April (previously reported as 10.6). The cycle high was 11.4 months in March.

* The median price of a new home dropped 5.1% to $231,000 from $243,500 in April (previously reported as $246,100). Prices were off 5.7% from $245,000 a year earlier.

Economists were looking for weak housing numbers, and that's exactly what they got. New home sales slumped and home prices fell, providing further evidence the spring selling season has been a disappointment. The industry is battling tighter lending standards, slumping consumer confidence, rising unemployment, and more recently, higher fixed mortgage rates.

There continues to be one bright spot in a sea of gloom, however: The raw supply of homes for sale is falling. Builders have slashed housing starts aggressively, helping pare the inventory of homes for sale to 453,000 units from a peak of 572,000 in July 2006. That's still about 125,000 units above the long-term, historical average. But you have to start somewhere, right?

Slumping mortgage activity, more "dialing for dollars" at Barclays, and other assorted bits

Good Wednesday morning -- and Happy Fed Day! It's still a few hours until the big event so I figured I'd cover a few of the things grabbing my attention in the meantime ...

* Mortgage application activity continues to decline. The purchase loan index compiled by the Mortgage Bankers Association slumped 7.4% to 333.4 in the week of June 20. That level is the weakest going all the way back to February 2003. The overall index (including refinances AND purchases) dropped to 461.3, the lowest since December 2001. Slumping home prices, falling consumer confidence, tighter lending standards, and the weakening economy are the key challenges facing the housing and mortgage markets.

* The "dialing for dollars" process continues. The fourth-biggest bank in the U.K., Barclays Plc, announced that it will be selling $8.9 billion of new shares to shore up its capital base. The usual suspects are buying: The Qatar Investment Authority, Temasek Holdings (of Singapore), China Development Bank, etc. Someday, at some price, the banks will find a bottom. But just about every billionaire investor, sovereign wealth fund, hedge fund, and so on that has tried to call one so far has ended up with egg on his face.

* The central bank in Norway followed India's central bank this week by implementing a surprise rate increase. Norway raised rates by 25 basis points to 5.75%. The Reserve Bank of India raised the repurchase rate in that country by 50 basis points to 8.5%.

* Lots of commentary this morning on the housing rescue bills winding their way through Congress. Here's the New York Times' take, and here's some more from the Washington Post.

Tuesday, June 24, 2008

Food for thought on the big picture and inflation ahead of the Fed

Everyone is paying close attention to this week's Federal Reserve policy meeting. The majority of the commentary I've read has been focused on the minutiae -- whether the Fed will "talk tough" and/or imply that it's ready to implement one or two quarter-point rate hikes later this year.

But what about the big picture? Is the Fed truly ready to “fight inflation?" Would one or two minor rate increases make a difference? Well, consider this ...

The nominal federal funds rate is currently 2%. But the Consumer Price Index is rising at a 4.2% year-over-year rate. That means REAL, inflation-adjusted interest rates are NEGATIVE 2.2%. Money isn’t just cheap. It isn’t just free. It’s BETTER than free. In fact, rates haven’t been this deep into negative territory since 1980!

That’s not all. Since the beginning of 1980, the real funds rate has averaged POSITIVE 2.4%. Just to get real interest rates back to "normal" (and assuming the inflation rate remains constant), the Fed would have to hike the nominal funds rate all the way up to 6.6%!

Forget the debate over the language in the Fed's post-meeting statement, or whether the Fed will push through a 25-basis point hike or two later this year. Instead, think about this: The Fed would have to more than TRIPLE the nominal funds rate to get the real funds rate back in line with its historical mean.

Now we all know that's just not going to happen. In fact, I doubt the Fed will hike at all tomorrow. But as the chart above makes painfully clear, the Fed has kept the real funds rates in negative territory for a considerable portion of the past few years. The last time the Fed did the same thing was a period stretching from the mid-1970s through 1980. What was the result? Stagflation. Food for thought the next time you wonder why oil prices are at $136+, food prices are going through the roof, and overall inflation is on the rise.

April Case-Shiller data: 15.3% YOY drop in prices

I hate to sound like a broken record. But the latest S&P/Case-Shiller figures show that home prices are still falling. In April ...

* Prices fell 1.36% from March in 20 major U.S. metropolitan areas. That was actually an improvement from the 2.17% decline in March. However, the year-over-year decline in prices came to 15.3%, worse than the 14.3% drop in March. That's the largest decline so far for the monthly index, which was first published in 2001.

* The 10-city index has a longer history. It declined 16.4% in April, compared with 15.3% in March. That's the worst reading since S&P started tracking in the late 1980s.

* Also worth noting: The price declines are broadening out. Prices fell from year-ago levels in every single one of the 20 metropolitan areas the group tracks. The biggest declines were found in Las Vegas (-26.8%), Miami (-26.7%), Phoenix (-25%), and California (-22.2% in San Francisco, -22.4% in San Diego, and -23.1% in Los Angeles). Charlotte had been the lone holdout, but it slipped slightly into the red in April (-0.1%).

Monday, June 23, 2008

WSJ: Bank investors done flushing money down the toilet

You gotta love this excerpt from the Wall Street Journal this morning ...

"Once bitten, twice shy.

"As banks rack up billions of dollars in losses from bad loans and blundered investments, large investors are becoming skittish about pumping more money into them.

"In the past several weeks, bank executives have encountered unexpected resistance from investors, who have expressed reluctance to participate in the capital-raising transactions sweeping through the industry, according to people familiar with the situation. Already bruised by big losses and fearing that bank shares haven't yet hit bottom, some of these investors are choosing to tighten their purse strings.

"The window for capital-raising is closing," says Brad Evans, a portfolio manager for Heartland Advisors Inc., a money-management firm in Milwaukee that invests in small, regional banks. "Investing in a bank right now means investing in a large portfolio of loans that are essentially a black box."

"The change in sentiment could have sweeping implications for financial institutions that are trying to shore up their balance sheets by issuing stock and other securities to their investors. Some may be forced to lure investors with sweeter terms, further raising the costs of doing these deals."

Everyone wants to be a bottom-fishing hero. But the "smart money" that has been playing that game has proven to be anything BUT smart.

Friday, June 20, 2008

S&P puts GM, Ford, Chrysler on credit watch negative

Ouch, that's going to leave a mark -- Standard and Poor's just put its ratings for General Motors, Ford and Chrysler on CreditWatch with negative implications. S&P is also putting its ratings on their finance units (GMAC, Ford Motor Credt and DaimlerChrysler Financial Services Americas) on watch negative. The reason? You guessed it -- plunging demand for SUVs and pickups due to surging energy prices. The Detroit Free Press had a story earlier this week about how June is shaping up to be an extremely nasty month.

All about oil and the financials -- and some thoughts on the "surprising" crisis in the banking industry

Sorry for the lack of posts the past couple of days. I had to travel to handle some family issues. But it looks like the big story on the last day I posted is still the big story today -- oil.

Yesterday, oil prices tanked by more than $5 after China raised the domestic price of refined products (gasoline, diesel, etc.). Why would that matter? The idea is that if more consumers have to pay the "real" price of energy (China, Malaysia, Venezuela, and other countries subsidize or cap the price of energy products for their citizens), energy use will fall and so will energy prices. Today, oil prices have come bouncing right back (+$3.50 or so as I write) amid reports that Israel is contemplating an attack on Iran's nuclear facilities. That kind of volatility really gets the market's blood pumping.

The other big news of the week? Many companies in the financial sector continues to plumb new depths. Almost every day, we hear about fresh losses, more capital raisings, and more regulatory trouble. The regional banks have been the latest firms to take their lumps, as covered in the New York Times yesterday. An excerpt:

"For the banks’ shareholders, the numbers tell a sad story: Wednesday’s decline brought the loss for the S.& P. bank index to 39.3 percent so far this year. Fifth Third’s odd name almost seems like a bad joke. Fifth Third has lost two-thirds of its value this year. Shares of two other banks based in Ohio, the National City Corporation, of Cleveland, and Huntington Bancshares, of Columbus, have suffered similar declines.

"Banks based in the Southeast are hurting, too. The Regions Financial Corporation, the biggest bank in Alabama, has lost half its value. Standard & Poor’s predicted this week that Regions would cut its dividend to conserve its capital in the face of rising losses on real estate loans. The share price of SunTrust Banks, which operates across the Southeast, has fallen almost 41 percent.

"Small and midsize lenders are in far less danger than they were during the 1980s and early 1990s, when about 1,600 federally insured institutions failed during a savings and loan crisis. But the breadth and depth of the current troubles have caught bank executives by surprise. Federal regulators are particularly concerned about the exposure of smaller banks to the commercial real estate market, which has softened in some parts of the country.

"But another worry is that raising money will become increasingly costly for banks that need capital. In a report issued this week, analysts at Goldman Sachs said banks might need as much as $65 billion on top of the $120 billion they have already raised."

I especially like the part about bank executives being caught by "surprise." How could so many of these guys NOT see this coming? How could they NOT realize the housing and mortgage markets were swept up in a gigantic bubble, one that would result in one of the worst downturns in decades ... and the biggest threat to the financial system since the S&L crisis? Plenty of observers, myself included, began warning about the dire risks of just such an outcome years ago, and turned up the "heat" on those warnings within the past 12 months.

Yet regulators and bankers continue to be surprised at virtually every step of the way. Remember it was only about a year ago that officials were giving speeches about how the problem was "contained" to subprime mortgages. I'll never forget this March 28, 2007 excerpt from Mr. Bernanke's testimony before Congress:

"Although the turmoil in the subprime mortgage market has created severe financial problems for many individuals and families, the implications of these developments for the housing market as a whole are less clear. The ongoing tightening of lending standards, although an appropriate market response, will reduce somewhat the effective demand for housing, and foreclosed properties will add to the inventories of unsold homes. At this juncture, however, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained. In particular, mortgages to prime borrowers and fixed-rate mortgages to all classes of borrowers continue to perform well, with low rates of delinquency."

As for all those "bottom fishers/value destroyin ... er ... creating" funds that keep buying into every new bank/broker/insurance company sale of common and preferred shares, warrants, bonds, and so on? The Times sums it up this way:

"So far the vast majority of investors who bought into financial companies in the hope that the industry was out of the woods have lost, and lost big."

Tuesday, June 17, 2008

Producer price figures show wholesale inflation is up, up and away

In addition to housing figures, we got some data on wholesale inflation this morning. The verdict: Inflation keeps on climbing ...

* The headline PPI jumped 1.4% in May. That was seven times the 0.2% increase in April and hotter than the 1% gain that was expected. Worse, wholesale inflation is rising at a 7.2% year-over-year rate. That's up from 6.5% a month earlier and just shy of the 7.4% cycle high set in January.

* The "core" PPI rose 0.2%, in line with the 0.2% forecast and down slightly from the 0.4% rise in April. I am sick and tired of hearing everyone talk about figures that exclude food and energy, but the market pays attention to these numbers, so I have to as well. The core PPI was up 3% from a year ago, tying May's figure, which in turn was the highest going all the way back to December 1991 (3.1%).

* At the intermediate stage of production, prices were up 2.9%. Crude goods prices jumped 6.7%. "Core" inflation at the intermediate level was +2%, the single-biggest monthly gain going all the way back to January 1980 (+2.3%). "Core" crude goods inflation was +5%. The year-over-year figures look much worse. Inflation is running at 12.6% for intermediate goods and 41.5% for crude goods. Those are the worst readings since December 1980 and March 2003, respectively.

I'm going to keep my commentary short and not-so-sweet. Anyone who claims inflation is "well-contained" needs to have his or her head examined. These figures stink, through and through. The Fed has to normalize interest rates, and soon.

Housing starts dip in May; Construction activity slowest since 1991

May housing starts and permitting data was just released. Here's what the numbers looked like ...

* Overall housing starts came in at a seasonally adjusted annual rate of 975,000 million last month, down 3.3% from 1.008 million in April (previously reported as 1.032 million). Starts were down 32.1% from 1.436 million in May 2007 and slightly below forecasts for a reading of 980,000.

* Building permit issuance fell 1.3% to 969,000 units from 982,000 in April. That's also down 36.3% from the year-earlier reading of 1.522 million and slightly above forecasts for a number of 960,000.

* Breaking it down by property type, single-family starts dipped 1% to 674,000. Multifamily starts dropped 8% to 301,000. Single-family permitting activity dropped 4% to 623,000, while multifamily permitting gained 3.9% to 346,000.

* Regionally, starts surged 61.5% in the Northeast. But they dipped 4.4% in the South, slumped 10.3% in the West, and dropped 25% in the Midwest. Permits rose 30.6% in the Northeast and 4.1% in the West, but slipped 7.6% in the Midwest and 8.6% in the South.

The construction slump continued into May. Overall starts haven't been this weak since March 1991 (921,000). More telling: Excluding one month (January 1991 -- 604,000), single-family construction hasn't been this slow going all the way back to August 1982 (654,000).

Builders are cutting back sharply for several reasons: They're trying to reduce the overhang of inventory on their books. They're facing a much-lower level of housing demand. And they're being forced to compete for buyers with distressed sellers and lenders who are loaded down with foreclosures. Construction activity will remain muted until more inventory is worked off and the demand for housing starts rebounding. That's going to take some time, with a noticeable improvement not likely until later in 2009.

Monday, June 16, 2008

NAHB index dips further in June

The National Association of Home Builders just released its latest batch of housing market data. What did the June numbers show?

* The group's overall index slipped to 18 this month from 19 in May. Economists were expecting no change. The June number ties the cycle low set back in December.

* The sub-index measuring current home sales was unchanged at 17 (a cycle low). The sub-index measuring expectations about future sales was also unchanged at 28 (The low to date? November's reading of 24). Meanwhile, the sub-index measuring prospective buyer traffic slumped 1 point to 17 (December's reading of 13 was the low so far for this downturn).

* Regionally, the index fell 6 points to 12 in the Northeast and 4 points to 16 in the West. Activity was unchanged in the South, but up 5 points to 17 in the Midwest.

June was another uninspiring month for the housing industry, according to the latest figures from the National Association of Home Builders. An index that measures current home sales tied its cycle low from December, while another index measuring traffic of potential buyers remained stuck in the mid.

The causes for the ongoing malaise are well-known by now: Higher mortgage rates, elevated inventory levels, a lack of home buyer confidence, and tighter lending standards. Home buyers are lurking out there. But they're only targeting properties that offer them maximum bang for their buck. Specifically, they're focusing on deeply discounted bank repossessions, aggressively priced existing homes, and new homes sold with the proper balance of price cuts and incentives. Properties that aren't priced right are just languishing on the market.

Monday morning roundup

It's easy to stay in touch on the road, technology being what it is these days. But I still feel a bit discombobulated when I'm away from my desk for several days. So forgive me if this post meanders a bit -- there's a lot of stuff that I feel like commenting on ...

First, the newly-hawkish Federal Reserve may be having second thoughts, according to Robert Novak at the Washington Post. From a column that's up on the Post's website today ...

"Bernanke, according to sources, disagrees more with the European position than is reflected by his public statements. In his June 3 speech, he said that the jump in oil prices could simultaneously slow already low economic growth while raising inflationary dangers -- recalling the "stagflation" of 30 years ago. Privately, Bernanke is said to be much more concerned about low growth.

"According to these reports, Bernanke feels that oil at $125 a barrel and $4-a-gallon gasoline threaten contraction more than inflation, despite the daunting prices. The depressing impact on the oil-driven American economy is especially menacing in his view. Bernanke knows that he faces difficult choices that his lionized predecessor never had to confront. Indeed, the traditional tools of the central bank may be inadequate to the task.

"There is no question that the low-key Bernanke is calling the shots at the Fed. Lack of control by him was suggested June 5 when Jeffrey Lacker, president of the Richmond Fed, and Charles Plosser, chief of the Philadelphia Fed, in separate speeches took issue with the March bailout of Bear Stearns. But regional bank presidents play a minor role in setting monetary policy, and the other Federal Reserve governors go along with their chairman."

Second, the Saudis are pledging to raise oil output by another 200,000 barrels per day, beginning next month. That move would increase supply by just 0.2%. After briefly pulling back on the news, oil futures are spiking again (up by about $4). Why? I think it's this renewed "no tightening" talk. The Group of Eight nations also failed to call for a stronger dollar over the weekend. Both factors are causing the dollar to lose steam (it's down about 1.24 cents against the euro as I write).

Third, we continue to get economic data that underscores the stagflationary economic backdrop. The Empire Manufacturing Index, for instance, came in at -8.7 for June. That was down from -3.2 in May and below expectations for a reading of -2. The key "growth" subindex -- new orders -- fell to -5.5 from -0.5. But one "inflation" subindex (measuring prices paid) remained elevated (66.3 vs. 69.6 a month earlier), while another (measuring prices received) jumped to 26.7 from 15.2. That's the highest since January 2006 (27.4) and just below the all-time high (27.7 in January 2005).

Fourth, the list of executive casualties stemming from the credit crisis continues to lengthen. American International Group replaced its CEO Martin Sullivan with Robert Willumstad. AIG is the world's biggest insurer, and it has been losing billions of dollars in recent quarters as a result of the souring credit markets.

Fifth, real interest rates are deeply negative, and have been for the greater part of the past few years, if you use the federal funds rate and the year-over-year change in the CPI as your benchmarks. In fact, real rates are running at -2.2% (2% nominal FF rate - the 4.2% YOY change in CPI in May; See chart above). Bloomberg picks up the torch this morning, reporting that real 10-year Treasury Note rates have also been negative for the longest stretch of time since 1980. An excerpt:

"The bear market for U.S. government bonds that began three months ago is just getting started.

"For the longest period since 1980, U.S. inflation has been higher than what investors earn on 10-year notes, a sign that yields have further to rise. Treasuries paid 2.88 percentage points more than the consumer price index the past two decades, according to data compiled by Bloomberg. Investors who buy $10 million of the securities would lose $1.4 million over the next year if the relationship returns to normal.

"The math doesn't pencil real well,'' said Thomas Atteberry, a partner at Los Angeles-based First Pacific Advisors, who recommended selling 10-year notes when yields fell to a five-year low in March. He co-manages the $2 billion New Income Fund, which beat 96 percent of its peers in the past five years, according to data compiled by Bloomberg.

"The combination of rising commodity prices, Federal Reserve Chairman Ben S. Bernanke's renewed focus on inflation and his success in reviving capital markets after the collapse of subprime mortgages has turned Treasuries into a quagmire. Investors who bought notes due February 2018 on March 17, just after the Fed helped arrange the bailout of Bear Stearns Cos., have lost 6.2 percent, according to Bloomberg data."

Thursday, June 12, 2008

How 'bout those bonds

I'm checking in briefly again in between engagements and once again, my focus has to be the interest rate picture. Yields continue to zoom higher amid stronger-than-expected economic data and hawkish talk from Federal Reserve officials. This is exactly the kind of market move I've been expecting and talking about for some time. Some more details on the bond market action from Bloomberg:

"Treasuries fell, pushing the yield on the benchmark 10-year note to the highest level this year, after a larger-than-expected gain in retail sales bolstered the case for the Federal Reserve to boost interest rates.

The yield on the 10-year note has climbed 90 basis points since March 17, when the Fed backed JPMorgan Chase & Co.'s bailout of Bear Stearns Cos., a sign to traders that the seizure in credit markets caused by the subprime mortgage collapse was ending. Losses in Treasuries accelerated after policy makers signaled they would stop cutting interest rates and Fed Chairman Ben S. Bernanke said June 3 that "we are attentive to the implications of changes in the value of the for inflation and inflation expectations.''

"The story right now is purely an inflation story,'' said David Glocke, who manages $75 billion of Treasuries at Vanguard Group Inc. in Valley Forge, Pennsylvania. "The key issue is the market's response to increased focus by the Fed on the inflation picture.''

Ten-year note yields increased 14 basis points to 4.21 percent at 2:42 p.m. in New York, according to bond broker BGCantor Market Data. They touched 4.22 percent, the highest since Dec. 27. The 3.875 percent security due May 2018 declined 1 3/32, or $9.38 per $1,000 face amount, to 97 9/32. A basis point is 0.01 percentage point."

Monday, June 09, 2008

On the road, limited posting

Just as an FYI, I'm in New York City for business this week. So my postings will probably be shorter and not as frequent. I'll also be doing my best not to pass out mid-post from the heat (it's been 95+ the past couple of days here)!

The big story of the day in housing is clearly the surprise gain in April pending sales. But I expect the gains to be relatively short-lived for a few reasons ...

* Buyer confidence remains weak. People are afraid house prices will continue to fall, and rightfully so. That lack of confidence in the ability of their homes to hold their value is sidelining many potential buyers. The latest Conference Board figures from May showed only 2.1% of those surveyed said they plan to purchase a home in the next six months, the lowest level since October 1982.

* The broad economy is struggling and joblessness is rising. The economy grew just 0.9% in the first quarter and 0.6% in the fourth. That’s not very impressive. Moreover, the economy shed 49,000 jobs in May – the fifth decline in a row – and the unemployment rate soared to 5.5% from 5%, the biggest one-month gain since February 1986.

* Rising interest rates are another threat – The Fed is caught between a rock and a barrel of oil. It has slashed interest rates deeply into negative territory (nominal funds rate of 2% vs. a 3.9% YOY rate of CPI inflation in April). That has helped drive the dollar much lower and commodities through the roof – including a $10+ surge in oil prices on Friday alone. Consumers are now expecting an inflation rate of 5.2% over the next year, according to the most recent University of Michigan confidence survey. That’s the highest since February 1982.

So I believe the Fed really can’t afford to cut short-term rates any longer. That means no further breaks will be forthcoming for HELOC and ARM holders. Meanwhile, long-term rates have been RISING along with inflation fears. Freddie Mac’s average 30-year fixed rate is up to 6.09% (week of June 5th) from a low of 5.48% in mid-January (week of January 24th). This is starting to drive mortgage demand lower, and that suggests the May and June numbers will look worse than the April ones.

If you want a bit more on this topic, you can check out my interview with Canada's BNN from this afternoon.

Friday, June 06, 2008

Crude up $11+ freaking dollars ...

That just beats it all. Biggest two-day rally in the history of the futures market. Heating oil limit up -- limit up -- in June ... ahead of a weekend where New York City's high temperature is supposed to be 93 degrees. If I weren't staring at this stuff on my quote screen, I wouldn't believe it.

I hope Ben Bernanke is happy about what his Federal Reserve's policies have led to. I really do. The response to the tech bust was to slash rates deep into negative territory. That created a housing bubble. The response to the popping of the housing bubble was to slash rates deep into negative territory again. Now, we have a tanking dollar and an oil/commodities bubble. Yet somehow, the Fed is shocked ... SHOCKED ... that it's happening. I'd be laughing if I didn't have to spend $41 every time I fill up my gas-sipping Toyota Corolla.

Construction loans the next source of pain for banks

The Wall Street Journal touched upon a theme I've mentioned before: Many banks are overexposed to construction and development loans. This risk was highlighted by the regulators as far back as two years ago. But nobody on Wall Street was worried then. That sure has changed. Look for more bank failures to result from overdependence on real estate lending:

"Federal regulators warned Thursday that banking-industry turmoil would continue as financial institutions come to terms with piles of bad loans they made to finance the construction of homes and condominiums.

"Until now, most of the damage to banks from the housing crisis has come from homeowners defaulting on their mortgages. But amid a dismal spring sales season for new homes, loans to home and condo builders are looking increasingly shaky. Banks have begun to dump them at what will likely be steep discounts, setting the stage for billions of dollars in fresh losses.

"As long as the housing market is on a downward path, as long as those prices continue to fall, I think there's a risk that the losses could continue to mount on a variety of loans," Federal Reserve Vice Chairman Donald Kohn told the Senate Banking Committee Thursday.

"At the same hearing, Federal Deposit Insurance Corp. Chairman Sheila Bair said banks that aren't diversified, or those with high exposures to residential construction and development, are of particular concern. "That's where we are really seeing the delinquencies spike," she said."

Employment stinks ... dollar falls ... crude soars

What a crazy early market we have going on. I am just stunned by some of the things going on.

For starters, the May employment report wasn't pretty. The U.S. economy lost 49,000 jobs in May, the fifth month in a row of declines and worse than April's downwardly revised drop of 28,000. Job cuts were widespread -- in construction (-34,000), manufacturing (-26,000), trade and transport (-41,000), and temporary help (-30,000). The only decent hiring was in education and health care (+54,000)

While average hourly earnings rose 0.3% on the month, better than the 0.1% increase that was expected, the unemployment rate was a gigantic shocker. It soared to 5.5% from 5% in April, the biggest month-over-month rise since February 1986 and much higher than the 5.1% reading that was expected.

But the REAL story isn't the economic data, it's the oil market. Crude oil futures ramped higher by about $5.50 yesterday. And this morning, they're surging even more -- $6.62 a barrel at last count. You can blame the falling dollar. Its drop against the euro yesterday was the trigger for the first leg of the oil rally, and its further decline this morning in the wake of the disappointing jobs data has helped turbocharge crude.

Thursday, June 05, 2008

Fitch lowering the ratings boom on the mortgage insurers

Fitch Ratings just took the axe to the ratings on several mortgage insurers and their related debt securities. Why? Here's an excerpt from the company's release this afternoon (emphasis added in bold):

"Today's announcement follows previous rating actions taken by Fitch within the MI industry on Feb. 25, 2008. Based on further review of the U.S mortgage market and its impact on the financial and insured portfolio performance of the MI industry, Fitch has grown considerably more pessimistic on the outlook for the sector. This relates greatly to Fitch's view that 2007 will likely prove to be one of the worst underwriting years in the modern history of the U.S. mortgage industry, and recognition that 2007 was a year of rapid growth for a number of key mortgage insurers. Fitch notes that 2007 vintage mortgages are turning delinquent at a significantly faster pace than the 2006 or 2005 vintage years; an early indication in support of Fitch's growing concerns with exposures underwritten in that year.

"The current trouble being experienced in the U.S. mortgage markets has spilled over from subprime into other mortgage products, such as adjustable-rate, negative amortizing, reduced documentation, and second-lien mortgages. The major factors driving the deterioration in mortgage performance indicators has been the poor underwriting process demonstrated by many mortgage lenders the past few years, combined with the continued and accelerating national home price decline which has eliminated the option to sell or refinance a home to avoid foreclosure for many borrowers. Adding to the strain seems to be an increasing willingness for borrowers to 'walk away' from mortgage debt when estimated home values are below their current mortgage balances. This is appearing quite apparent for 2007 mortgages as these borrowers have born the full brunt of home price declines. Fraud has also played a key role.

"It appears the MIs' underwriting processes were ineffective in identifying and protecting against these risks, as the industry aggressively courted new business throughout 2007. As a result, these companies' insured portfolios are now heavily concentrated with 2007 vintage mortgage loans, many of which are very high loan-to-value (greater than 95%) and/or were underwritten to borrowers who provided limited or no documentation.

"The deterioration in the U.S. mortgage market has led to continued sharp increases in delinquencies for all the MI companies, particularly for loans originated in the 2005-2007 vintage years. With reduced options to refinance or cure troubled credits, Fitch believes a greater percentage of these delinquent borrowers will end up in foreclosure in the years ahead which will translate into higher claims and losses over this time period."

There goes the AAA ... and how about that oil/dollar relationship?

Standard & Poor's finally pulled the plug on the AAA ratings of MBIA and Ambac Financial. Both had their insurance financial strength ratings lowered to AA from AAA. From the S&P statement:

"The rating actions on the companies reflect our belief that these entities will face diminished public finance and structured finance new business flow and declining financial flexibility."

Meanwhile, how about that monster $5+ move in oil! Did any economic fundamentals change? Nope. But the dollar tanked against the euro on Trichet's hawkish comments. Is there anyone out there who can seriously argue that the falling dollar hasn't had an impact on oil and commodities prices? And shouldn't it be obvious how to put the knife in the heart of commodity inflation once and for all? Raise interest rates and defend the dollar.

MBA: Delinquency and foreclosure rates surge to new highs in Q1 2008

The Mortgage Bankers Association just released its data on mortgage delinquencies and foreclosures for the first quarter of 2008. Here's what the numbers showed:

* The overall mortgage delinquency rate jumped to 6.35% from 5.82% in Q4 2007 and 4.84% a year earlier. This is the worst seasonally adjusted late payment rate since 1979.

* The subprime DQ rate jumped again -- to 18.79% from 17.31% in Q4 2007 and 13.77% a year earlier. But it's NOT just subprime loans that are souring. The prime delinquency rate rose to 3.71% from 3.24% in Q4 2007 and 2.58% a year earlier.

* The worst deterioration was evident in adjustable rate loans. Prime ARM DQ rates are all the way up to 6.78%, while subprime ARM DQs hit 22.07%. Meanwhile, the DQ rate on FHA loans improved -- to 12.72% from 13.05% a quarter earlier.

* The foreclosure figures were plug ugly. The percentage of mortgages entering the foreclosure process climbed to 0.99% from 0.83% in Q4 2007 from 0.58% a year earlier. The percentage of mortgages in any stage of foreclosure jumped to 2.47% from 2.04% in Q4 2007 and 1.28% a year earlier.

These are the worst readings on record. And the awful performance of subprime ARMs jumps right off the page at you. A whopping 17.09% of these loans were in some stage of foreclosure, up from 13.43% in Q4 2007 and 6.46% a year earlier.

The dismal mortgage performance figures released today are hardly unexpected. But they are shocking nonetheless. Delinquency and foreclosure rates were up across the board, hitting levels we haven't seen in almost three decades.

The boomtime expansion of reckless mortgage lending continues to take a heavy toll on subprime borrowers. Foreclosure rates in that subsector of the market have more than tripled since 2005. But this isn't just a "subprime problem." Falling home prices, the cooling economy, and the strain on household budgets from things like rising food and fuel prices are driving delinquencies higher in the prime market as well.

What about the future? Until home prices stabilize, we're going to be dealing with elevated foreclosure rates. Government assistance programs and loan modifications can help keep some folks in their homes. But when you're upside down on your loan, and something bad happens (job loss, divorce, you name it), your options are limited. And let's be frank: Too many people bought too much house with too many easy money mortgages in recent years. For many of these people, foreclosure will prove unavoidable.

ECB to raise rates?

Wow -- European Central Bank president Jean-Claude Trichet just threw a hand grenade into the bond pits, saying ...

"We had a number of us thinking that, all taken into account, that we had a case for increasing rates ... It's not excluded that after having carefully examined the situation that we could decide to move our rates for a small amount at our next meeting in order to secure the solid anchoring of inflation expectations."

In other words, the ECB is openly talking about a rate HIKE at its next meeting in July. European bond prices dropped in response, and U.S. Treasuries fell in sympathy. Long bond futures were recently down 25/32 and 10-year yields were up 4 basis points to 4.02%.

Wednesday, June 04, 2008

Bernanke jawboning on inflation ... again

Fed Chairman Ben Bernanke is speaking at Harvard University today. His remarks on the similarities and differences between 1975 and now were just released. It looks like he is -- once again -- ratcheting up his anti-inflation rhetoric. The most important passage, as far as I'm concerned, is the following one ...

"For a central banker, a particularly critical difference between then and now is what has happened to inflation and inflation expectations. The overall inflation rate has averaged about 3-1/2 percent over the past four quarters, significantly higher than we would like but much less than the double-digit rates that inflation reached in the mid-1970s and then again in 1980. Moreover, the increase in inflation has been milder this time--on the order of 1 percentage point over the past year as compared with the 6 percentage point jump that followed the 1973 oil price shock. From the perspective of monetary policy, just as important as the behavior of actual inflation is what households and businesses expect to happen to inflation in the future, particularly over the longer term. If people expect an increase in inflation to be temporary and do not build it into their longer-term plans for setting wages and prices, then the inflation created by a shock to oil prices will tend to fade relatively quickly. Some indicators of longer-term inflation expectations have risen in recent months, which is a significant concern for the Federal Reserve. We will need to monitor that situation closely."

Bernanke notes that we don't have evidence of a wage-price spiral like we did in the 1970s. But clearly, he is expressing more concern about inflation now than we were hearing several weeks ago.

Treasuries aren't getting the warm and fuzzies from Ben's comments. Bond futures took a late day tumble, and were recently down 1 3/32 in price. Ten-year yields are up by about 9 basis points. Also notice how oil and the dollar are reacting: Crude is falling and the dollar is rallying a bit.

I've been saying for a while that if Fed policymakers really want to do something about rising commodity prices, they should start by looking in the mirror and recognizing that they are part of the problem. Their negative real interest policy has been a key contributor to the recent run up in prices. Note my chart above, which graphs the nominal funds rate against crude oil futures prices. Maybe Bernanke's recent comments signal that they are starting to "get it." One can only hope.

More AAA bond insurer drama

It's been a while since we revisited the ongoing saga of MBIA and Ambac Financial. They are, of course, the bond insurers who got into a heap of trouble by expanding from the municipal bond insurance business into the business of insuring all kinds of structured finance products. Today, Moody's Investors Service said these ... er ... "AAA"-rated companies could lose those vaunted top-notch ratings. Per Bloomberg:

"The Aaa insurance ratings of MBIA Inc. and Ambac Financial Corp., are again under threat by Moody's Investors Service after the two largest bond insurers reported deepening losses from the mortgage-market slump.

"MBIA Insurance Corp.'s insurance financial strength rating may fall to the Aa range, although a drop to the A category is possible, Moody's said in a statement today. Ambac Assurance Corp.'s ranking would probably be lowered to Aa, Moody's said in a separate statement.

"Moody's analyst Jack Dorer placed the ratings on review last month after losses on home-equity loans and collateralized debt obligations in the first quarter increased concerns that the companies didn't have enough supporting capital to justify a Aaa ranking. The prospect of downgrades earlier this year for Armonk, New York-based MBIA and Ambac roiled world capital markets on concern that their guarantees for more than $1 trillion of debt may be worthless.

"The companies' credit profile may not be worthy of Aaa because of their diminished ``new business prospects and financial flexibility,'' Moody's said. The companies also have the potential for higher losses within their insurance portfolio, Dorer said. "

Mortgage activity plunges, inflation pressures remain high, and the job market stabilizes

Lots of ground to cover in another exciting market day. Here's what I'm watching:

* Higher rates = Lower mortgage demand. The Mortgage Bankers Association's application index tanked to its lowest level in six years in the week of May 30. The index hit 502.3, down 15.3% on the week to the lowest since April 2002. Purchases fell 5.4% while refis plunged 25.7%. The average rate on a 30-year fixed loan climbed to 6.17% from 5.96%, its highest level since the week of March 7.

* The Institute for Supply Management's service sector index dipped a bit in May -- to 51.7 from 52 in April. But that was a bit better than the 51 reading that was expected. New orders perked up to the highest level since December, but employment dipped slightly. Also noteworthy: The "prices paid" subindex climbed to 77 from 72.1 a month earlier. That's the highest since September 2005 (right around the time Hurricanes Katrina and Rita struck).

* ADP Employer Services actually had some mildly encouraging news on the job front. The company said U.S. companies added 40,000 jobs in May. Economists were expecting a 30,000-worker loss. The "official" employment report doesn't come out until Friday (the consensus estimate: -60k), but if ADP is right, we could catch an upside surprise.

The dollar and bonds have been all over the map -- up a bit, down a bit, etc. One reason why the bonds probably aren't selling off even harder (given the decent fundamental data on the economy) is all the renewed credit concerns, particularly those centered on Lehman Brothers.

Tuesday, June 03, 2008

Bernanke talking a bit tough

Federal Reserve Chairman Ben Bernanke is speaking via satellite to the International Monetary Conference in Barcelona, Spain. A lot of his comments just recap what we already know. But I would say the comments on inflation look a bit hawkish. Moreover, the Fed seems to be indicating that it is paying more attention to the dollar ... and that could be significant.

Anyway, here are a few potentially import comments (with my emphasis added in bold):

On inflation:

"Unfortunately, the prices of a number of commodities, most notably oil, have continued upward recently, even as expectations of future policy rates and the foreign exchange value of the dollar have remained generally stable in the past few months. The possibility that commodity prices will continue to rise is an important risk to the inflation forecast. Another significant upside risk to inflation is that high headline inflation, if sustained, might lead the public to expect higher long-term inflation rates, an expectation that could ultimately become self-confirming."

And on the dollar:

"In collaboration with our colleagues at the Treasury, we continue to carefully monitor developments in foreign exchange markets. The challenges that our economy has faced over the past year or so have generated some downward pressures on the foreign exchange value of the dollar, which have contributed to the unwelcome rise in import prices and consumer price inflation. We are attentive to the implications of changes in the value of the dollar for inflation and inflation expectations and will continue to formulate policy to guard against risks to both parts of our dual mandate, including the risk of an erosion in longer-term inflation expectations."

By the way, notice the qualifier "for now" in this excerpt below. This tells me that the Fed is not going to hike immediately, but that it is giving itself the wiggle room to start hiking at any time. My read anyway ...

"For now, policy seems well positioned to promote moderate growth and price stability over time. We will, of course, be watching the evolving situation closely and are prepared to act as needed to meet our dual mandate."

After earlier being up, long bond futures are now trading down about 9/32 to the day's lows. Crude oil is down $1.30 and gold is off by about $12. The dollar index is on its daily high.

Is Lehman passing the hat around ... again?

Back in April, the CEO of Lehman Brothers declared that the "worst is behind us" as far as the credit crisis is concerned. In fact, Richard Fuld was just one of many financial executives and government officials who repeated that mantra. Now, according to the Wall Street Journal, Lehman is going to be forced to raise even more capital on top of the $6 billion it already rounded up since February. An excerpt:

"Lehman Brothers Holdings Inc., set to report its first quarterly loss since going public, is considering raising billions of dollars in fresh capital to help shore up its balance sheet, according to people familiar with the matter.

"The exact amount of the capital hike isn't known, but analysts and Wall Street executives estimate it is likely to be $3 billion to $4 billion. They said Lehman would probably announce the capital raising in conjunction with its quarterly results, due the week of June 16. The amount of new capital under consideration suggests Lehman's quarterly loss could be larger than the $300 million or so that some analysts have been expecting.

"On Monday, shares in the 158-year-old firm fell $2.98, or 8%, to $33.83 on the New York Stock Exchange after negative comments from two Wall Street analysts. The shares are down almost 50% this year compared with year-to-date drops of about 20% for rivals Goldman Sachs Group Inc. and Morgan Stanley. The new capital would likely be raised by issuing common shares, diluting current shareholders, people familiar with the matter said."

How did Lehman screw up? According to the Journal:

"During the second quarter, Lehman was stung by hedges used to offset losses in real estate and other securities, according to people familiar with the matter. The firm bet that indexes tracking markets such as real-estate securities and leveraged loans would fall. If that happened, it would book profits that would make up some of its losses from holding these securities and loans.

"However, in an unexpected twist, some of the indexes rose, even as the assets they were supposed to hedge against continued to lose value or stayed relatively flat. Lehman's losses from both write-downs on assets and ineffective hedges will likely top $2 billion, people familiar with the matter said. Lehman will also realize additional losses related to its decision to reduce its work force, according to a person familiar with the matter."

The bottom line: No one knows how deep this rabbit hole goes. And that's not a comforting thought.

Monday, June 02, 2008

S&P lowers the boom on banks, brokers

Standard & Poor's just took the ratings and outlook axes to several leading banks and brokers. From the firm's release (here is Bloomberg's take as well):

"At the conclusion of its review of global universal and investment banks, Standard & Poor's Ratings Services lowered its ratings on Lehman Brothers Inc., Merrill Lynch & Co. Inc., and Morgan Stanley. Standard & Poor's also revised its outlooks on Bank of America Corp. and JPMorgan Chase & Co. to negative. In addition, Standard & Poor's affirmed its ratings on Citigroup Inc., removed the ratings from CreditWatch negative, and assigned a negative outlook. We also placed the ratings on Wachovia Corp. on CreditWatch negative. The outlooks on the large financial institutions sector in the U.S. are now predominantly negative.

"The negative actions reflect prospects of continued weakness in the investment banking business and the potential for more write-offs, though not of the magnitude of those of the past few quarters," explained Standard & Poor's credit analyst Tanya Azarchs. "They also reflect a reassessment of the vulnerabilities of the wholesale and less diversified model of funding for the specialized investment banks." (See "S&P Completes Review Of Global Securities Industry; Ratings Lowered On Morgan Stanley, Merrill Lynch & Co. Inc., And Lehman Brothers Holdings Inc.; Outlooks Negative," published June 2, 2008, on RatingsDirect, the real-time, Web-based source for Standard & Poor's credit ratings, research, and risk analysis.) For the universal banks, the outlook revisions reflect our expectation of further sharp deterioration in U.S. residential mortgage loan portfolios and residential construction. We believe loss rates in those loan sectors are poised to exceed historical levels by a wide margin. This could depress earnings to a greater extent than is discounted in our current ratings (see "Rated U.S. Banks Likely To Weather Market Difficulties," published May 6 2008, on RatingsDirect). If these firms were to suffer bottom-line losses or prolonged periods of low and volatile earnings, we could lower the ratings. Alternatively, if the effect is relatively less severe, the ratings could remain at current levels."

Wachovia CEO gets his walking papers ... another bank fails ... and more

Lots of news to recap this morning in the finance and interest rate sector. So let's try to hit the ground running by covering the biggest headlines ...

* We just learned that the CEO of Wachovia, Ken Thompson, is "retiring at the request of the board" of directors of the fourth-largest bank. The less PC way of describing this event is that Thompson was shoved out. Why? Wachovia's losses have been rising fast. The company bled $708 million in red ink in the first quarter thanks to life insurance policy losses, credit losses, and massive writedowns.

But it goes deeper than that. Wachovia made what I consider to be one of the biggest blunders in the history of modern banking -- purchasing Golden West Financial in 2006. Golden West was the mortgage industry's biggest champion of option ARMs -- those "pick a payment" loans you've probably heard about. It had heavy California exposure at the time of the merger. I simply couldn't understand why the bank agreed to dramatically increase its mortgage exposure after the national housing market had already topped out.

* Speaking of banks, a small one based in Minnesota -- First Integrity, N.A. -- became the latest to fail this year. The bank had $54.7 million in total assets. First International Bank and Trust of North Dakota is assuming its deposits and branches, as well as roughly $35.8 million of its assets. First Integrity is the fourth FDIC-insured institution to fail this year, compared with only three in all of 2007. More such failures are coming.

* Big bank and brokerage firm accounting got you confused? You're not alone. But you have to love this Bloomberg story, which chronicles how banks are generating revenue from the declining price of their own bonds.

* Lastly, if you needed more proof that the "subprime mortgage crisis" has never really been just a subprime problem, the New York Times had a nice piece this weekend. It talks about how higher-end homeowners and borrowers are also having trouble selling their homes and paying their mortgages.

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