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The Meaning of Stage II

For the week, the Dow added 0.3% (down 2.8% y-t-d), and the S&P500 increased 0.5% (down 4.8%). The Transports gained 0.3%, increasing y-t-d gains to 12.0%. The Morgan Stanley Cyclical index declined 1.6% (down 1.8%), and the Utilities fell 0.8% (down 5.5%). The Morgan Stanley Consumer index dipped 0.4% (down 5.3%). The small cap Russell 2000 added 0.1% (down 5.8%), and the S&P400 Mid-Caps gained 1.1% (down 1.7%). The NASDAQ100 rose 1.0% (down 8.0%), and the Morgan Stanley High Tech index jumped 2.0% (down 7.1%). The Semiconductors surged 3.7% (down 4.1%), the Street.com Internet Index declined 0.7% (down 6.1%), and the NASDAQ Telecommunications index jumped 3.1% (down 4.6%). The Biotechs declined 1.5% (down 4.4%). Financials rallied. The Broker/Dealers jumped 6.4% (down 15.7%), and the Banks rallied 3.0% (down 5.1%). With Bullion down $30.80, the HUI gold index was smacked for 9.9% (up 0.4%).

One-month Treasury bill rates fell 8 bps this past week to 0.78%, and 3-month yields declined one basis point to 1.36%. Two-year government yields surged 28 bps to a three-month high 2.42%. Five-year T-note yields jumped 28 bps to 3.18%, and ten-year yields increased 16 bps to 3.87%. Long-bond yields added 10 bps to 4.59%. The 2yr/10yr spread ended the week at 145 bps. The implied yield on 3-month December '08 Eurodollars surged 22.5 bps to 3.14% (high since 1/3). Benchmark Fannie MBS yields rose 7 bps to 5.54%. The spread between benchmark MBS and 10-year Treasuries narrowed 10 to 167 bps. The spread on Fannie's 5% 2017 note narrowed 3 to 55 bps and the spread on Freddie's 5% 2017 note narrowed 2 to 54 bps. The 10-year dollar swap spread declined 1.75 to 64.75. Corporate bond spreads were mostly narrower. An index of investment grade bond spreads narrowed 5 to a 3-month low 100 bps. An index of junk bond spreads narrowed 9 to 617 bps.

Investment grade issuance included Merrill Lynch $9.55bn, Citigroup $6.0bn, Goldman Sachs $4.0bn, Bank of America $4.0bn, Wachovia $3.5bn, JPMorgan Chase $2.5bn, Xerox $1.4bn, Great River $400 million, and Textron $300 million.

Junk issuers included Firekeepers Development $340 million, CCS Inc. $300 million, and Inergy $200 million.

Convert issuance this week included Airtran Holding $65 million.

International dollar bond issuance included KFW $3.0bn, Export Development Canada $1.0bn, International Finance Corp $1.0bn, Canadian National Railways, and Nine Dragons $300 million.

April 25 - Bloomberg (Theresa Barraclough and Yumi Teso): "Japanese government bonds tumbled, causing the biggest jump in five-year yields in nine years, after inflation accelerated, stocks climbed and the dollar rallied against the yen. Ten-year bond futures plunged as much as 1.8%, forcing the Tokyo Stock Exchange to order a 15-minute halt in trading for the first time since September 2002... 'The market is in a bit of a panicked state,' said Masahiro Sato, joint general manager of the treasury division at Mizuho Trust & Banking Co... 'I can't say how far Japanese bond yields will rise, because they've already broken through my forecast levels and the selling pressure could snowball from here.'"

German 10-year bund yields rose 4 bps to 4.18%, as the DAX equities index added 0.8% (down 14.5% y-t-d). Japanese 10-year "JGB" yields surged 21.5bps to 1.60%. The Nikkei 225 rallied 2.9% (down 9.4% y-t-d and 19.6% y-o-y). Emerging debt markets came under pressure, while equities were mixed. Brazil's benchmark dollar bond yields jumped 13 bps to 6.26%. Brazil's Bovespa equities index gained 1.0% (up 2.0% y-t-d). The Mexican Bolsa declined 2.5% (up 5.0% y-t-d). Mexico's 10-year $ yields rose 12 bps to 4.96%. Russia's RTS equities index fell 2.1% (down 7.0% y-t-d). India's Sensex equities index jumped 3.9%, reducing y-t-d losses to 15.6%. China's Shanghai Exchange rallied 15.0%, cutting 2008 losses to 32.4%.

Freddie Mac 30-year fixed mortgage rates were unchanged again at 5.88% (down 28bps y-o-y). Fifteen-year fixed rates declined 2 bps to 5.40% (down 47bps y-o-y). One-year adjustable rates dropped 8 bps to 5.10% (down 33bps y-o-y).

Bank Credit dropped $36.5bn to $9.404 TN (week of 4/16). Bank Credit has expanded $191bn y-t-d, or 6.7% annualized. Bank Credit posted a 39-week surge of $761bn (11.7% annualized) and a 52-week rise of $954bn, or 11.3%. For the week, Securities Credit sank $45.5bn (3-wk drop of $74bn). Loans & Leases increased $9.0bn to $6.875 TN (39-wk gain of $550bn). C&I loans jumped $11.6bn, with one-year growth of 22.4%. Real Estate loans declined $2.7bn. Consumer loans gained $4.3bn, while Securities loans fell $6.1bn. Other loans added $1.8bn. Examining the liability side, Deposits jumped $43.1bn, while "Borrowings" fell $21.5bn and "Net Due to Foreign" dropped $31.7bn.

M2 (narrow) "money" supply declined $15bn to $7.665 TN (week of 4/14). Narrow "money" has expanded $203bn y-t-d, or 9.4% annualized, with a y-o-y rise of $466bn, or 6.5%. For the week, Currency declined $0.8bn, and Demand & Checkable Deposits dipped $1.7bn. Savings Deposits dropped $10.1bn, and Small Denominated Deposits decreased $1.5bn. Retail Money Fund declined $1.1bn.

Total Money Market Fund assets (from Invest Co Inst) were little changed last week at $3.484 TN, posting a y-t-d gain of $370bn, or 38.7% annualized. Money Fund assets have posted a 39-week rise of $900bn (46.4% annualized) and a one-year increase of $1.049 TN (43.1%).

Asset-Backed Securities (ABS) issuance was stable at about $4.0bn. Year-to-date total US ABS issuance of $61bn (tallied by JPMorgan's Christopher Flanagan) is running 25% of the comparable level from 2007. Home Equity ABS issuance of $303 million compares with 2007's $136bn. Year-to-date CDO issuance of $11.7bn compares to the year ago $138bn.

Total Commercial Paper dropped $21.9bn to $1.785 TN. CP has declined $439bn over the past 37 weeks. Asset-backed CP fell $10.8bn (37-wk drop of $428bn) to $767bn. Over the past year, total CP has contracted $261bn, or 12.8%, with ABCP down $321bn, or 29.5%.

Fed Foreign Holdings of Treasury, Agency Debt last week (ended 4/23) rose another $12.7bn to a record $2.253 TN. "Custody holdings" were up $197bn y-t-d, or 29.2% annualized, and $335bn year-over-year (17.5%). Federal Reserve Credit expanded $1.2bn to $868bn. Fed Credit has contracted $5.1bn y-t-d, while having increased $18.4bn y-o-y (2.2%).

International reserve assets (excluding gold) - as accumulated by Bloomberg's Alex Tanzi - were up $1.422 TN y-o-y, or 27%, to a record $6.669 TN.

Global Credit Market Dislocation Watch:

April 25 - Bloomberg (Bryan Keogh and Gabrielle Coppola): "Citigroup Inc. and Merrill Lynch & Co. led $43.3 billion of U.S. corporate bond sales, the busiest week on record, as financial companies sold debt at the highest yields since May 2001."

April 22 - Bloomberg (Esteban Duarte): "The European Central Bank said it increased lending to banks in Europe last week to the highest in more than three months. The ECB loaned 499.52 billion euros ($795 billion) through monetary operations compared with 424.99 billion euros a week earlier... It said 204.5 billion euros were lent in the main refinancing operation and 295 billion euros in longer-term auctions."

April 22 - Financial Times (Chris Giles and Peter Thal Larsen): "The Bank of England yesterday made an almost unlimited offer to acquire UK banks' mortgage-backed securities for up to three years in return for Treasury bills. Mervyn King, governor, said the plan would 'take the liquidity issue off the table in a decisive way'. The plan is designed to support banks' liquidity rather than their solvency. The facility will be open for six months and the Bank of England expects to swap £50bn ($100bn) of assets in the first couple of months. This figure could rise sharply as commercial banks rush to offload loans on to the central bank for a period of at least one year, renewable for a further two years. It is a radical action... US Federal Reserve officials will consider a similar long-term liquidity scheme if it eases UK financial strains. The European Central Bank had no comment."

April 21 - Bloomberg (Jennifer Ryan and Brian Swint): "The Bank of England offered to swap government bonds for mortgage securities to kick-start bank lending, with Governor Mervyn King pledging to meet demand even if it exceeds an estimate of 50 billion pounds ($100 billion.) 'There is no arbitrary limit on this so it could well go higher,' King told reporters... He said the plan aims to restore confidence to the banking system and the most important aspect of the scheme is that 'everyone needs to know this is there for them to access as needed... The measures, backed by Prime Minister Gordon Brown's government, mimic a similar swap of $200 billion of securities by the U.S. Federal Reserve last month... 'We will make sure there is enough liquidity in the economy to make sure people can buy their own houses,' Brown said... 'We can get markets working again in a way that we can ensure that jobs.'"

April 23 - Financial Times (Ben White and Francesco Guerrera): "Big US financial groups have raised more than $28bn in the capital markets in recent days, suggesting that many investors believe the sector is poised for a strong comeback. Merrill Lynch raised $7bn in its first senior unsecured debt sale in six months yesterday and Goldman Sachs sold $1.5bn in 10-year notes. CIT, the commercial finance group, sold $1.5bn in common and convertible preferred stock yesterday, 50% more than it had planned. These sales followed a preferred share offering from Citigroup on Monday that raised $6bn and a preferred sale by JPMorgan Chase last week that raised about $6bn. Merrill raised $2.5bn in a preferred share sale on Monday. Lehman Brothers also raised $4bn this month in a preferred share offering... 'We are witnessing a tsunami of fund raisings,' one senior fund manager said..."

April 25 - Financial Times (David Oakley): "Bond issuance has jumped sharply this month amid improved investor sentiment stemming from central bank interventions and hopes that banks have revealed most of their writedowns and credit losses. Issuance this month has hit $300bn globally in the four main currencies - dollar, euro, yen and sterling - a 25 percent increase compared with March, according to Thomson Financial. In the whole of April last year, issuance was $440bn."

April 23 - Financial Times (Gillian Tett and Michael Mackenzie): "As the Bank of England announced the details of its new swap facility yesterday, global policymakers were handed some good news: the three-month sterling Libor, or London Interbank Offered Rate, fell back slightly... However, any sense of euphoria was tempered... behind the scenes, a much bigger worry is haunting Libor: that, at the same time as institutions such as the Bank of England are trying to pull this rate lower, the credibility of Libor as a measure is declining. This is threatening to inject a new element of volatility and investor distrust into the financial arena of the type that banks, policymakers and investors can ill-afford to see. Indeed, traders say this crisis of confidence has left some investors doubly wary of taking on large positions in derivatives markets and made banks more reluctant to lend money to each other. 'Since Libor is such a critical rate and now filled with uncertainty as to where it should be, it's only logical that all sorts of positions have been exited until the fair level is determined,' says David Ader, strategist at RBS Greenwich Capital..."

April 23 - Bloomberg (Christine Richard): "Ambac Financial Group Inc., the world's second-largest bond insurer, posted a wider loss than analysts estimated after being crippled by writedowns for guarantees on subprime-mortgage securities. The first-quarter net loss was $1.66 billion... Ambac, which was stripped of one of its three AAA ratings this year, was 'severely impacted' by the plunging value of mortgage- related guarantees, interim Chief Executive Officer Michael Callen said... Ambac's new business slumped 87%..."

April 24 - Bloomberg (Shannon D. Harrington): "The cost to protect against the risk that Ambac Financial Group Inc. and MBIA Inc. won't make good on their guarantees and debt payments rose to a record on concern the companies may not be able to raise enough capital to keep their AAA ratings. Credit-default swap sellers today are demanding $1.25 million upfront and $500,000 a year to protect $10 million of debt guaranteed by Ambac's insurance unit for five years, according to CMA Datavision."

April 24 - Bloomberg (Neil Unmack): "BlackRock Inc., the biggest publicly traded asset manager in the U.S., Invesco Ltd. and Bear Stearns Cos. have pushed the amount of defaulted collateralized debt obligations to $180 billion, Wachovia Corp. analysts said. Downgrades to mortgage bonds and other assets triggered events of default on 165 CDOs, an increase from 99 of the deals worth $116 billion in February... An event of default forces a CDO manager to either liquidate or divert money to repay senior creditors at the expense of other investors."

April 23 - Bloomberg (Caroline Salas): "The looming wave of bankruptcies is unlikely to be kind to bondholders. And they have only themselves to blame. Rather than receiving the historical average recovery of 42 cents on the dollar in a default, owners of a third of high- yield, high-risk bonds rated B+ or lower may get no more than 10 cents, according to...Fitch... About 22% are likely to get 11 cents to 30 cents. Bond investors... may pay the price for allowing themselves to be Subordinated by junk-rated companies that borrowed a record $2.2 trillion of bank loans in the past three years."

April 22 - Financial Times (Paul J Davies): "The banks involved in the $20bn financing for the buy-out of Chrysler, the US carmaker, at the height of the private equity boom are renewing a push to offload the debt by slashing prices. Goldman Sachs and Citigroup have already sold chunks of the roughly $12bn in secured loans granted to the Cerberus-backed private equity buy-out, which acquired Chrysler from its fromer parent Daimler - among the biggest of the jumbo deals struck in the run-up to the credit crunch. Goldman broke ranks first to sell $500m worth of the loans at 63 cents in the dollar and Citigroup swiftly followed with a chunk of Chrysler debt set to be included in a $12bn portfolio of risky, leveraged loans being sold... Citi was offered prices of 63-65 cents for the Chrysler debt, according to people involved."

April 25 - Bloomberg (Michael B. Marois and Jeremy R. Cooke): "More than $9 billion of auction- rate bonds sold by student-loan agencies in states from Pennsylvania to Utah have trapped investors in debt that's not paying interest."

April 25 - Bloomberg (Laura Cochrane): "Australia's non-bank mortgage lenders, which rely on the nation's now dormant securitization markets for funding, won't be able to sell mortgage-backed bonds for at least two years, according to FirstMac Ltd.

Currency Watch:

April 25 - Bloomberg (Emma O'Brien): "Russia's central bank bought about $20 billion in April as it sought to curb the appreciation of the ruble, deputy Chairman Alexei Ulyukayev said... Bank Rossii's actions were aimed at 'holding back' the ruble..."

The dollar index rallied 1.1%, ending the week at 72.79. For the week on the upside, the South African rand increased 2.2%, the Mexican peso 0.7%, and the British pound 0.3%. On the downside, the Swiss franc declined 2.5%, the Norwegian krone 2.4%, the Danish krone 1.8%, the Euro 1.8%, the Swedish krona 1.5%, the New Zealand dollar 1.5%, and the Japanese yen 1.1%.

Commodities Watch:

April 24 - Bloomberg (Jae Hur): "Rice prices in Chicago advanced above $25 per 100 pounds for the first time on speculation more countries may introduce export curbs, reducing supplies needed to combat shortages and cool inflation. Brazil may restrict exports of rice to build domestic inventories amid tightening international supplies."

April 23 - Financial Times (Carola Hoyos, Ed Crooks and Javier Blas): "Expectations rose yesterday that soaring food prices will provoke a rethink of support for biofuels in Europe and the US, as the price of oil hit a new high of almost $120 a barrel. Biofuels produced from crops such as corn and soya provide a small but fast-growing share of road-fuel supplies, and had been expected to make an important contribution to meeting growing demand. But yesterday Gordon Brown, the UK prime minister, said the country could push for a change in a European Union target to increase the proportion of biofuel to 10% of road fuels by 2020."

April 21 - Financial Times (Carola Hoyos): "Saudi Arabia, the world's biggest oil producer, has put on hold any plans to further increase long-term production capacity from its vast oil fields, its most powerful policymakers have said. In a series of statements, including one by the king himself, the kingdom has warned consumers it does not believe there is a need for further expansion, an assumption disputed by the world's biggest developed countries."

April 21 - Financial Times (Javier Blas and Joanna Chung): "Speculators such as hedge funds or pension funds are not responsible for pushing agricultural commodities' prices, including wheat and rice... The US Commodity Futures Trading Commission is meeting farmers and traders tomorrow to discuss the jump in agriculture commodities' prices amid criticism from US politicians and farming associations that speculators are behind the increase. It will say prices have been driven by robust demand, weather-related supply disruptions, the lowest inventories in 30 years, government trade restrictions and the impact of the weakening US dollar, officials said."

Gold dropped 3.4% to $886 and Silver 5.5% to $16.96. May Copper added 0.5%. May Crude rose $2.68 to a record $118.84. May Gasoline gained 2.0% to a record (up 23% y-t-d), and May Natural Gas rose 4.2% (up 47% y-t-d). July Wheat sank 8.0%. The CRB index dipped 0.4% (up 16.5% y-t-d). The Goldman Sachs Commodities Index (GSCI) rose 0.9% (up 22.1% y-t-d and 55.9% y-o-y).

China Watch:

April 21 - Bloomberg (Mark Shenk): "Traffic jams in Beijing and humming air conditioners in Dubai are replacing U.S. highways and suburbs as the driver of global oil prices. China, India, Russia and the Middle East for the first time will consume more crude oil than the U.S., burning 20.67 million barrels a day this year, an increase of 4.4%, according to the International Energy Agency... U.S. demand will contract 2% to 20.38 million barrels daily... Economic growth of more than 8% in China and India, coupled with increasing car ownership among the countries' combined populations of 2.45 billion people, will more than compensate for falling U.S. demand... 'Does the U.S. matter anymore?' said Mike Wittner, head of oil research at Societe Generale SA... 'Has the U.S. mattered for the last few years? It is debatable. As far as the oil market is concerned, demand growth is going to be continued to be driven by China and the Middle East.'"

Japan Watch:

April 25 - Bloomberg (Mayumi Otsuma): "Japan's consumer prices rose at the fastest pace in a decade in March as companies passed on higher costs of gasoline and food to protect profits. Core prices, which exclude fresh fruit, fish and vegetables, climbed 1.2% from a year earlier..."

April 23 - Financial Times (David Pilling and Kathrin Hille): "Japanese export growth slowed to its lowest rate in three years... Export growth for Taiwan and Thailand also slowed under the influence of the weakening dollar and US economy. The 2.3% year-on-year rise in Japanese exports in March, coupled with an oil and commodity-led 11.1 per cent jump in the country's import bill, sent its trade surplus down 30% to Y1,100bn ($10.6bn)..."

India Watch:

April 25 - Bloomberg (Pratik Parija): "India, the world's second-biggest wheat consumer, increased purchases of the grain from farmers to bolster state reserves that may be used to tame food prices. The government bought 10.4 million metric tons so far this season, 3.6 million tons more than the quantity procured in the year-ago period... The government will create a strategic reserve of 5 million tons of rice and wheat to bolster food security..."

Asia Watch:

April 25 - The Wall Street Journal (Nguyen Pham Muoi and Stephen Wright): "Vietnam's inflation rate was the highest in more than a decade in April, despite a raft of government steps to damp rising prices, which threaten to undermine the increase in living standards brought about by the country's free-market economic reforms. The consumer price index is estimated to have risen 21.4% from a year earlier in April..."

April 23 - Associated Press: "Singapore's inflation hit a 26-year high in March as food and oil costs continued to surge... The consumer price index...rose 6.7% from a year earlier after rising 6.5% in February..."

Latin America Watch:

April 22 - Bloomberg (Thomas Black and Jens Erik Gould): "Mexican President Felipe Calderon said his $50 billion public spending plan is already bolstering economic activity in the country. Spending on highways, ports and energy has helped Mexico's first-quarter growth, including industrial production, Calderon said."

Unbalanced Global Economy Watch:

April 22 - Bloomberg (Luzi Ann Javier): "Myrna Lacdao used to eat two meals a day. Now she eats one and gives the rest to her two grandchildren. Lacdao, 53, shares a 70-square-foot shack in Manila's San Roque shantytown with her husband, two adult children and grandchildren. After the price of rice rose 41% in the past year, only the youngsters get three meals a day. 'I just take coffee in the morning and then have lunch at noon,' said Lacdao, who makes pillow cases for sale to neighbors, contributing to the family's monthly income of 9,000 pesos ($215). 'That's my first and last meal of the day.'"

April 25 - Bloomberg (Christian Vits): "Money-supply growth in the euro region slowed for a second month in March... M3 money supply...rose 10.3% from a year earlier after gaining 11.3% in February... The ECB has cited 'vigorous' M3 growth, which reached a 28- year high of 12.4% in November, as one of the upside risks to the inflation outlook..."

April 24 - The Wall Street Journal (Laurence Norman): "The outlook for the U.K. housing market darkened on news that mortgage approvals last month fell by nearly half from a year earlier to their lowest level in 11 years. Mortgage approvals for house purchases fell to 35,417 in March, down 18% from February and 46% from a year earlier..."

April 23 - Bloomberg (Neil Unmack): "London's office market faces 'imminent stress' as the fallout from the global credit crisis weakens demand for space in the city's financial district, Moody's...said. Conditions in the City of London deteriorated faster than any other European market last year... Banks and securities firms may cut as many as 40,000 jobs in London in the coming months, according to forecasts... About 7.3 million square feet of office space is due to be completed in London this year with a further 8.3 million square feet available by 2010..."

April 24 - Bloomberg (Simone Meier and Sandrine Rastello): "Business confidence in Germany and France, which account for about half the euro-region economy, slumped in April as record oil and food prices stoked inflation... the lowest since January 2006."

April 21 - Bloomberg (Joshua Gallu): "Swiss producer and import price inflation... unexpectedly accelerated in March to the fastest pace in almost 19 years on higher energy costs. Prices for factory and farm goods as well as imports rose 3.9% from a year earlier after gaining 3.6% in February..."

April 24 - Bloomberg (Ben Sills): "Producer prices in Spain accelerated in March to the fastest pace in 12 years as more expensive oil and other commodities increased cost pressures for manufacturers. The price of goods leaving Spain's factories, farms and mines rose 6.9%..."

April 25 - Bloomberg (Ben Sills): "The unemployment rate in Spain, once an engine of European job creation, jumped the most in 15 years in the first quarter to a three-year high as the building market contracted. The jobless rate rose to 9.6% from 8.6% in the fourth quarter..."

April 25 - Bloomberg (Robin Wigglesworth and Niklas Magnusson): "Swedish household credit growth slowed to 10.9% in March as higher interest rates limited demand for mortgages."

April 21 - Bloomberg (Alex Nicholson): "Russian retail sales growth slowed last month. Sales rose an annual 16.5% in March, compared with a revised 17.7% in February..."

April 23 - Bloomberg (Jacob Greber): "Australia's inflation rate accelerated to more than 4% for the first time in seven years, driving the nation's currency to the highest against the dollar since 1984... The consumer price index rose 4.2% in the first quarter from a year earlier..."

April 24 - Bloomberg (Nasreen Seria): "South African inflation accelerated to an annual 10.1% in March, the highest in more than five years, adding to pressure on the central bank to raise interest rates. The CPIX inflation rate, which excludes mortgage costs, rose from 9.4% in February..."

Bursting Bubble Economy Watch:

April 23 - Financial Times (Joanna Chung, Krishna Guha and Daniel Pimlott): "Risky loans made to borrowers with poor credit at the height of a housing boom may have helped to kick off the credit crisis, but residential mortgages were not the only type of lending where standards fell. While residential property experienced the most dramatic deterioration in the quality of loans issued, contributing to a sharp rise in defaults rates on mortgage repayments, attention is increasingly turning to other kinds of loans as the economic slowdown puts borrowers under greater stress. 'We definitely saw a loosening of underwriting in a broad category of instruments over time which we are watching and monitoring,' said John Dugan...Comptroller of the Currency... 'We're seeing declining credit in a broad range of asset classes.' Defaults on other forms of consumer loans such as home equity loans, credit cards, auto loans and commercial real estate are now beginning to shift higher... So far the 20 largest banks that the Office of the Comptroller of the Currency regulates have raised in excess of $80bn in capital since October to help deal with mounting losses..."

April 23 - Financial Times (Daniel Pimlott, Krishna Guha, Joanna Chung and Ben White): "US bank failures could rise above 'historical norms' as a weakening economy puts pressure on badly underwritten loans, particularly in commercial real estate, according to a bank regulator. In an interview with the Financial Times, John Dugan, who oversees about 1,700 national banks as comptroller of the currency, said the growing problems for lenders follow a period of almost four years in which no institution regulated by his agency had failed. 'We're going to have some more bank failures that will come back more to historical norms and may go above that with time. That is a natural consequence of the economy going from historically exceptionally benign credit conditions to something that is more normal to something you would get in a downturn.'"

April 24 - New York Times (Barnaby J. Feder): "Call it the Lasik indicator. As the economic downturn forces consumers to cut back on discretionary spending, laser vision-correction surgeries have been falling — as they did during the last recession. Although more than 800,000 Americans got Lasik surgery in 2007, a slight increase from 2006, the numbers started slumping along with the economy in the second half of last year. And industry analysts are now seeing a Lasik recession. 'We're forecasting a 17% drop for 2008,' said David Harmon, president of Market Scope, an eye surgery market research house... Doctors and analysts said a wide range of elective medical procedures, including breast implants and skin treatments like Botox injections, are also being affected."

April 24 - The Wall Street Journal (Jeffrey McCracken and Janet Adamy): "When you serve 1.1 million eggs a week, even a tiny price increase can pinch. So when egg prices tripled for casual-dining restaurant chains Bakers Square and the Village Inn over the past two years, the result was especially painful. Pricier eggs and other foods added $9 million in annual costs. This month, the chains' owner, Denver-based Vicorp Restaurants Inc., filed for bankruptcy-court protection. Vicorp won't be the last. The $558 billion restaurant industry is hitting rough times, squeezed by many of the same woes hitting other sectors of the economy: tightfisted consumers, scarce credit and surging commodity prices. Adding to the pressure is a big jump in the minimum wage starting this summer, which will boost wages by 12% in some states."

April 24 - Bloomberg (Brian Kladko): "Students in the U.S. have lost access to more than $6.7 billion a year in education loans after private lenders fled the market, spurring schools including Pennsylvania State University and Northeastern University to turn to the Education Department's Direct Loan Program. Dozens of lenders, led by College Loan Corp. and CIT Group Inc., stopped making federally guaranteed loans because the U.S. cut subsidies and investors hurt by the subprime-mortgage crisis shunned bonds backed by student loans."

Central Banker Watch:

April 23 - Financial Times (Chris Giles): "With its new special liquidity scheme, the Bank of England...became the country's largest and grandest pawnbroker. Just as the pawnbrokers' shops in Dickensian London offered temporary relief to the profligate or unfortunate, so the Bank's new facility will do the same for 21st century British banks. A pawnbroker offers to swap precious but hard-to-sell heirlooms for temporary cash at a discounted price and the Bank is doing the same for the banks' illiquid asset-backed securities... For the next six months it will exchange Treasury bills for a wide variety of high-quality triple-A rated asset backed securities, including credit card debt but excluding securities based on US home loans."

April 21 - Bloomberg (Simone Meier): "Germany's Bundesbank said the European Central Bank must raise interest rates if it becomes clear that price stability is at risk. Inflation pressures 'have considerably increased over the past months and the price climate has significantly worsened,' the...Bundesbank said... 'If there are upward risks to inflation in the medium term, the central bank needs to react with an interest-rate increase in order to guarantee price stability.'"

April 24 - The Wall Street Journal (Paul Hannon and Joel Sherwood): "The Bank of Norway raised its main interest rate by a quarter point to 5.5%, while Sweden's central bank kept its key interest rate steady and acknowledged that inflation would be higher than previously forecast this year and next. The moves illustrate the different approaches central banks around the world are taking in response to the global credit crunch, a slowing U.S. economy and rising food and energy prices."

MBS/ABS/CDO/CP/Money Funds and Derivatives Watch:

April 23 - Financial Times (Paul J Davies): "The problems in processing credit derivatives are still dogging the industry in spite of a concerted effort since 2005 to end sloppy practices which prevent some trades from being confirmed. According to a new survey, sharp rises in trading volumes in the over the-counter derivatives markets since last summer - as investors rushed to make bets on the impact of the credit crunch - led to corresponding spikes in unconfirmed trades, data...by Markit Group show. The report shows that average outstanding confirmations more than doubled from about 6,000 per dealer bank to more than 13,000 between June and August last year as average monthly trading volumes rose from just under 20,000 to more than 25,000 per dealer."

April 22 - Financial Times (Gillian Tett): "Last Christmas, Gerald Corrigan, the former president of the New York Federal Reserve, hunkered down with some unusual reading material. While many people might spend their holidays watching cheesy films, Mr Corrigan studied a clutch of financial prospectuses - cover to cover. 'I read the offering documents for two retail mortgage-backed securities, two collateralised debt obligations and two CDO squared [derivative CDOs],' Mr Corrigan recalled... 'What I found there was that the content of these things is better than I thought but the presentation is challenging, to put it mildly. What we need is not more disclosure but better disclosure. That is the issue.' Four months later Mr Corrigan is turning these words into action. In recent days the formidable former regulator has assembled a team of senior Wall Street financiers to study the credit turmoil and propose remedies. One key part of such reforms, Mr Corrigan says, will be an effort to overhaul the way that complex mortgage-securities are sold to investors - and traded."

Mortgage Finance Bubble Watch:

April 24 - Bloomberg (Mark Pittman): "Standard & Poor's raised its projection for losses on U.S. subprime residential mortgage- backed securities issued in 2007 to 23% from 17.3% amid a worsening housing market. Transactions from last year will have cumulative losses ranging from 21% to 25%, S&P said..."

Real Estate Bubble Watch:

April 22 - Florida Association of Realtors: "A total of 9,142 existing single-family homes changed hands in March, a 10% increase over the previous month when 8,310 homes sold. Existing condo sales statewide rose 13.7%... The median price for both housing types increased slightly as well during the one-month period. The median price of an existing single-family home reached $205,600 in March, compared with $198,900 the previous month. The median price of an existing condo rose to $176,600 in March from $175,600 in February."

GSE Watch:

April 24 - Bloomberg (Jody Shenn): "The Federal Home Loan Bank of Chicago, the money-losing cooperative owned by U.S. banks and insurers, plans to stop buying home loans from members to diversify its $84 billion asset portfolio. The bank will end loan acquisitions through its Mortgage Partnership Finance program on July 31... The announcement follows the collapse this month of the Chicago bank's efforts to merge with its Dallas counterpart."

Fiscal Watch:

April 22 - Bloomberg (Michael Quint): "New York Governor David Paterson asked state agency heads to limit hiring to 'absolutely essential' positions and present plans for spending reductions of 3.35% by May 16... The cuts are part of the $121.7 billion budget plan that closed a $4.6 billion gap. The state has about 200,000 employees."

California Watch:

April 22 - Los Angeles Times (Peter Viles): "The number of California homes lost to foreclosure in the first quarter surged 327% from year-ago levels -- reaching an average of more than 500 foreclosures per day -- DataQuick said in a report warning that the widening foreclosure problem could 'spread beyond the current categories of dicey mortgages, and into mainstream home loans.'"

April 23 - Dataquick: "The number of California homes going into foreclosure jumped last quarter to its highest level in more than 15 years, as the market continued to works its way through declining home values and a pool of at-risk mortgages that were originated in 2005 and 2006... Lending institutions sent homeowners 113,676 default notices during the January-to-March period. That was up by 39.4% from 81,550 the previous quarter, and up 143.1%... from first-quarter 2007... 'The main factor behind this foreclosure surge remains the decline in home values. Additionally, a lot of the 'loans-gone-wild' activity happened in late 2005 and 2006 and that's working its way through the system...' Most of the loans that went into default last quarter were originated between August 2005 and October 2006. The median age was 23 months, up from 16 months a year earlier... There are 7.9 million houses and condos in the state..."

Speculator Watch:

April 21 - Bloomberg (Katherine Burton): "Hedge funds attracted $16.5 billion of new cash in the first quarter, the smallest net inflows since the end of 2005... The drop in deposits followed a record 2007, when investors pumped $194 billion into the loosely regulated investment pools, according to...Hedge Fund Research Inc. Industry assets rose 0.4% in the quarter to $1.88 trillion, the smallest increase in four years."

Crude Liquidity Watch:

April 21 - Bloomberg (Alex Nicholson): "Inflation in Russia, the world's largest energy producer, accelerated to its fastest pace in more than 2 1/2 years in March as food costs rose. The rate rose to 13.3% from 12.7% in February..."

April 21 - Bloomberg (Alex Nicholson): "The cost of goods leaving Russian factories and mines rose at the fastest pace in more than three years in March as energy and metal prices remained high. Producer prices in the world's biggest energy exporter increased 27.4%, compared with 26.4% in February..."

April 22 - Bloomberg (Ladane Nasseri): "Iranian President Mahmoud Ahmadinejad dismissed his economy minister, who blamed record levels of inflation on high government spending... 'Can we expect the central bank to change up to 60 billion petrodollars into local currency to meet the demands of the 2008 budget and it not lead to liquidity growth?' the state-run Mehr news agency quoted Danesh-Ja'fari as asking at the hand-over ceremony. 'Inflation is the result of this policy and one cannot run away from this reality.'"

The Meaning of Stage II

The U.S. Credit Bubble was punctured this past summer, as the Mortgage Crisis escalated from the confines of subprime to the expansive marketplace for Wall Street "private-label" ABS and MBS. Especially with the bursting of the Florida and then California housing Bubbles, literally Trillions of mortgages, sophisticated debt structures, Credit insurance, various financial guarantees, leveraged speculative positions, and bloated Wall Street balance sheets were in almost immediate peril. In a brief period of only several months the U.S. Credit system went from unmatched expansion and speculative excess to the brink of implosion.

Last week I made the case for thinking in terms of the end of the first Stage of the Financial and Economic Crisis. The epicenter of this initial upheaval was in highly leveraged positions in mortgage Credit exposure - encompassing mortgage-related securities positions (i.e. ABS and MBS); sophisticated Credit structures (i.e. CDOs, "SIVs," REITs, etc.); various derivatives exposures (i.e. subprime ABX indices, Credit default swaps, synthetic CDOs, etc.); and a broad assortment of financial guarantees and liquidity agreements (monolines, mortgage insurance, asset-backed CP, etc.). I have referred to this as the breakdown in Wall Street-Backed finance.

This collapse had reached the cusp of bringing down the entire Credit system. In stark contrast to traditional Credit crises, this one engulfed the entire system before the general economy so much succumbed to a negative quarter of GDP contraction. To stem implosion required nothing less than a Fed-orchestrated bailout of a major Wall Street firm; the opening of the discount window to the Wall Street firms; the implementation of massive liquidity facilities at home and abroad; the promotion of mortgage securities as collateral for borrowings from the Fed; assurances of enormous market intervention (mortgage purchases and guarantees) by the troubled GSEs; the imposition of significantly negative real short-term rates; and open-ended federal government stimulus and financial guarantees.

An argument could be made that, while dramatic, these measures were not world changing. I would counter that such measures gave assurances to the marketplace that the Federal Reserve (along with global central bankers) and our government policymakers were willing take any and all measures necessary to stabilize the Credit system and sustain the U.S. Bubble economy. There were no longer any bounds on government intervention.

I have referred to these policy measures as the supplanting - or underpinning - of "Wall Street-backed finance" with "federal government-backed finance." Or, perhaps somewhat less analytically ambiguous, to avoid implosion Washington had no alternative but to both explicitly and implicitly nationalize both system Credit and liquidity risk. It was desperate policymaking in the extreme; it was bold and it was historic. It reworked the rules of our Credit apparatus, and the markets have for more than a month now grappled with the ramifications of these changes. To be sure, each week of relative Credit system stability has provided various troubled players the opportunity to raise new capital, others to pare problem positions, and many to adjust various risk exposures. Importantly, the unwinding of "bearish" speculations and hedges is now playing an instrumental role in the resurgence in marketplace liquidity.

According to Bloomberg data, this week saw an all-time record $43.3bn of U.S. corporate debt issuance (compared to a y-t-d weekly average of $18bn). Issuers included Citigroup, Merrill Lynch, Bank of America, Wachovia and Goldman Sachs - and much of their issuance was in the form of new "equity capital." Investment grade bond spreads narrowed this week to the lowest level since mid-January; junk bond spreads to early-March levels; and leverage loan prices recovered this week all the way back to December levels.

Many - including seasoned strategists - are today arguing that the worst of the financial crisis is now behind us. I disagree, of course. But from an analytical perspective it is imperative to appreciate that (the bust of Wall Street-backed finance notwithstanding) we still very much operate in a unique period of Market-Based Credit. The ebb and flow of market perceptions (of greed and fear) continues to have an outsized impact on Credit Availability and Marketplace Liquidity - hence economic performance. Not many weeks ago the system was seizing up in the face of collapsing confidence and fears of systemic failure. Today, with confidence and greed regaining their "flow", Credit conditions are loosening meaningfully - which does wonders for reigniting marketplace enthusiasm (not to mention short covering). So, Stage II - the dynamics, excesses, distortions and imbalances leading to the inevitable Second Phase of Crisis - is now off and running.

Does Stage II Mean the Credit Bubble has returned? No. Does Stage II Mean the reemergence of Wall Street-backed finance? No. Does Stage II Mean the reigniting of U.S. asset inflation? Not generally. Does Stage II Mean the leveraged speculating community has been granted a new lease on life? Don't bet against it. Does Stage II Mean the U.S. Bubble Economy could take on some additional air? Perhaps. Does Stage II Mean the exacerbation of Global Credit Bubble Excesses? Most certainly. Do Global Credit Bubble dynamics impact our Credit and Economic systems? Of course - more than ever.

I've written much on the issues of Monetary Processes and Inflation Dynamics. These themes today should play crucial roles in how we analyze the many complexities of today's financial and economic landscape. Prior to the bust, the rampant expansion of Wall Street-backed finance was directly fueling U.S. asset inflation and Bubbles - housing in particular. Today, post-crash, no amount of policymaker intervention can repair broken confidence in all facets of Wall Street finance, including subprime and "exotic" mortgages, the "monoline" financial guarantee business, CDOs, "private label" MBS, auction-rate securities, and so forth. Indeed, their problems are poised to only worsen as the economy falters.

It is one thing to stem implosion and something altogether different when it comes to restoring the Wall Street Credit mechanism to the point of fostering new Bubbles. Wall Street "alchemy" is a spent force unless it melds some type of government obligation. The best policymakers can do today is place a federal government guarantee on 90% of new mortgage debt and hope this somewhat stabilizes U.S. housing.

Faltering housing markets and waning consumer confidence will place increased strain on economic performance. That's not at issue. At the same time, the finance-driven Bubble economy is unmistakably on more stable footing now compared to its perilous perch a month earlier. Recognizing the Ebb and Flow of Contemporary Market-Based Credit (and the reality that today's "flow" could easily be augmented in the short-run by the unwind of "bearish" positions), I will remain mindful of the potential for a meaningful loosening of Credit Conditions. To be sure, outside of housing and finance, the U.S. economy is still demonstrating some powerful inflationary biases and impulses. And inflationary biases spur Credit growth that spurs heightened inflationary pressures.

The Global Credit Bubble must factor into our analysis. Most conspicuously, powerful price pressures throughout global energy, food, and commodities markets are stoking growth in various sectors of our economy. Our export sector continues to boom. Less obvious, I would argue that rampant global financial excess is a contributing factor in our financial institutions' capacity to raise new "capital" from the global markets - and more generally in bolstering marketplace liquidity in the face of the collapse of Wall Street-backed finance. The global leveraged speculating community - and international liquidity flows more generally - are a major Stage II wildcard.

Otherwise intelligent financial commentators argue that today's rising energy and food prices are not a "monetary phenomenon." Instead, these price pressures are said to be due to strong demand from China and India - wealthier consumers choosing to upgrade their diets. But both the Chinese and Indian economies (and many others) are now operating with virtually unlimited Credit - a unique combination of rampant domestic Credit growth coupled with massive foreign financial flows. As I've explained ad nauseam, U.S. Current Account Deficits and dollar impairment are the root cause of scores of runaway domestic Credit systemic that comprise the Global Credit Bubble. This historic Bubble is everywhere and in everyway a monetary (Credit) phenomenon.

It is my argument that Stage II Means another year of massive U.S. Current Account Deficits. This would Mean, for one, a prolonging of the massive flow of liquidity into international central bank reserves (creating domestic Credit in the process), sovereign wealth funds, and (to a lesser extent) the hedge fund community. The consequences from a further ballooning of this Unwieldy Global Pool of Speculative Finance are not at all clear. Secondly, another year of U.S. Deficits would Mean another year of excessive liquidity flows into the already overheated economies throughout Asia, the Middle East and elsewhere. Importantly, these Monetary Processes and Inflationary Dynamics are by now well entrenched and extraordinarily powerful after years of unrelenting excess. Resulting Monetary Disorder should be expected to go to increasingly destabilizing extremes (think NASDAQ 1999 and subprime 2006!) - and indeed we're seeing evidence for as much in near $120 crude, the global food price spike and related hoarding, and wildly unstable and speculative global financial markets.

It is in this context that I believe U.S. policymakers are today unknowingly risking global financial and economic catastrophe. They are, of course, fixated on domestic concerns and are willing to do any and everything in a desperate attempt to sustain the U.S. Bubble Economy. They are oblivious to both the heightened risks associated with today's Current Account Deficits and to the various linkages of their policies to Heightened International Monetary Disorder. Stage II is fraught with great but not easily recognizable risks.

It is my view that there are significant risks associated with postponing the inevitable adjustment to the U.S. Bubble Economy. As I've attempted to explain previously, the amount of Credit necessary to sustain our uniquely maladjusted Economic Structure is unmanageable. It is unmanageable for our troubled banking system, for our troubled GSEs, and for the expansive money-fund complex - for risk intermediation generally. Stage II Means great risk to the heart of contemporary "money." The problem rests on the reality that "pre-adjustment" Credit (borrowings associated with many businesses and enterprises that will be uneconomic come the arrival of the post-Bubble backdrop) is inherently vulnerable. And as discussed above, today's U.S. Credit is extraordinarily destabilizing in its effects upon the Global Credit Bubble and Resulting Monetary Disorder.

I am at this point more convinced than ever that only a severe crisis will instigate the necessary adjustment to the distorted and imbalanced U.S. and global economies. One is then left with the disconcerting view that Stage II will lead our authorities to exhaust all policy measures in a futile attempt to sustain the unsustainable. The obvious question: how long does the lead up Crisis Stage II last? I would today guess a number of months, although I wouldn't at all be surprised if it was rather short. What will be the impetus for Crisis Stage II? A spike in interest rates, a run from U.S. Treasury and agency debt, a disorderly drop in the dollar, another bout of derivative and Credit market implosion, or acute global financial tumult should be considered leading candidates based on Stage II ramifications. Or it could easily be something completely unexpected, perhaps even war.


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