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Tuesday April 27, 2010

For the week, the S&P500 dropped 2.5% (up 6.4% y-t-d), and the Dow fell 1.7% (up 5.6%). The Banks were hit for 3.8% (up 30.5%). With Goldman Sachs down $22.20, the Broker/Dealers fell 3.2% this week (up 4.3%). The Morgan Stanley Cyclicals dropped 3.2% (up 12.8%), and the Transports declined 1.7% (up 13.9%). The Morgan Stanley Consumer index declined 2.3% (up 6.5%), while the Utilities were little changed (down 2.2%). The S&P 400 Mid-Caps dropped 3.1% (up 13.3%), and the small cap Russell 2000 sank 3.4% (up 14.8%). The Nasdaq100 declined 2.7% (up 7.5%), and the Morgan Stanley High Tech index fell 3.9% (up 3.6%). The Semiconductors sank 6.1% (up 4.5%). The InteractiveWeek Internet index declined 2.0% (up 8.1%). The Biotechs added 0.3%, increasing 2010 gains to 27.2%. With bullion up almost $22, the HUI gold index jumped 4.9% (up 7.9%).

One-month Treasury bill rates ended the week at 13 bps and three-month bills closed at 15 bps. Two-year government yields sank 14 bps to 0.88%. Five-year T-note yields fell 20 bps to 2.36%. Ten-year yields sank 15 bps to 3.66%. Long bond yields dropped 14 bps to 4.52%. Benchmark Fannie MBS yields dropped 10 bps to 4.39%. The spread between 10-year Treasury and benchmark MBS yields widened 5 bps to 73 bps. Agency 10-yr debt spreads were little changed at 37 bps. The implied yield on December 2010 eurodollar futures declined 2 bps to 0.82%. The 10-year dollar swap spread was little changed at near zero. The 30-year swap spread declined 5 to negative 23.5. Corporate bond spreads were mostly wider. An index of investment grade bond spreads widened one to 89 bps, and an index of junk spreads widened 14 bps to 492 bps.

It was another strong week for debt sales. Investment grade issuers included NBC Universal $4.0bn, New York Life $750 million, US Bank $500 million, BB&T $500 million, Tyco $500 million, and Advanced Auto Parts $300 million.

Junk issuers included Reynolds Group $1.0bn, Levi Strauss $525 million, AK Steel $400 million, Amkor Technologies $345 million, American Seafoods $275 million, Patriot Coal $250 million, Lennar $250 million, American Renal Holdings $250 million, Penson Worldwide $200 million, Southern States Co-op $130 million, and ASG Consolidated $125 million.

Convert issues included Lennar $250 million.

International dollar debt sales included KMG Finance $1.5bn, Hana Bank $500 million, Columbus International $640 million, KFW $500 million, Marfrig Overseas $500 million, and Yanlord Land $300 million.

U.K. 10-year gilt yields dropped 19 bps to 3.85%, and German bund yields declined 5 bps to 3.01%. Greek bond yields traded above 11.25% this week, before closing up 35 bps for the week to 8.95%. The German DAX equities index fell 2.0% (up 3.0% y-t-d). Japanese 10-year "JGB" yields declined 3 bps to 1.28%. The Nikkei 225 gained 1.0% (up 4.8%). Emerging markets were mostly weaker. For the week, Brazil's Bovespa equities index dropped 2.8% (down 1.5%), and Mexico's Bolsa sank 3.4% (up 1.8%). Russia's RTS equities index sank 3.3% (up 8.9%). India's Sensex equities index dipped 0.8% (up 0.5%). China's Shanghai Exchange was hit for 3.8%, increasing 2010 losses to 12.4%. Brazil's benchmark dollar bond yields jumped 9 bps to a 3-wk high 4.90%, while Mexico's benchmark bond yields dipped one basis point to 4.82%.

Freddie Mac 30-year fixed mortgage rates dipped one basis point last week to 5.06% (up 28bps y-o-y). Fifteen-year fixed rates were unchanged at 4.39% (down 9bps y-o-y). One-year ARMs increased 3 bps to 4.25% (down 52bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates down one basis point to 5.82% (down 58bps y-o-y).

Federal Reserve Credit dipped $1.5bn last week to $2.317 TN. Fed Credit was up $96.8bn y-t-d (13.3% annualized) and $229bn, or 11.0%, from a year ago. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 4/28) rose $4.9bn to a record $3.061 TN. "Custody holdings" have increased $105.8bn y-t-d (11% annualized), with a one-year rise of $410bn, or 15.5%.

M2 (narrow) "money" supply was down $16.1bn to $8.450 TN (week of 4/19). Narrow "money" has declined $62.1bn y-t-d. Over the past year, M2 grew 1.5%. For the week, Currency added $0.9bn, and Demand & Checkable Deposits increased $4.3bn. Savings Deposits fell $13.2bn, and Small Denominated Deposits declined $3.4bn. Retail Money Fund fell $4.7bn.

Total Money Market Fund assets (from Invest Co Inst) declined $5.8bn to $2.872 TN. In the first 17 weeks of the year, money fund assets have dropped $421bn, with a one-year decline of $926bn, or 24.4%.

Total Commercial Paper outstanding jumped $32.9bn last week to $1.109 TN. CP has declined $61.4bn, or 16% annualized, year-to-date, and was down $314bn from a year ago (22%).

International reserve assets (excluding gold) - as tallied by Bloomberg's Alex Tanzi - were up $1.260 TN y-o-y, or 18.9%, to a record $7.925 TN.

Global Credit Market Watch:

April 27 - Bloomberg (Abigail Moses and Kate Haywood): "Credit-default swaps on European sovereign debt surged to records after Standard & Poor's cut its ratings on Greece to junk and downgraded Portugal. Contracts tied to Greek government bonds climbed 111 bps to 821... Portugal rose 54 bps to 365."

April 28 - Financial Times: "Greece will need financial assistance amounting to between €100-120bn over the next three years, German parliamentarians claimed on Wednesday after meeting Dominique Strauss-Kahn, managing director of the International Monetary Fund, and Jean-Claude Trichet, president of the European Central Bank. They said that the euro 45bn currently proposed as a rescue package of loans from the IMF and other members of the eurozone was only enough for the first year of support."

April 28 - Bloomberg (John Glover): "Holders of Greek bonds may lose as much as 200 billion euros ($265bn) should the government default, according to Standard & Poor's. The ratings firm yesterday cut Greece three steps to BB+, or below investment grade, and said bondholders may recover only 30% to 50% of their investments if the nation fails to make debt payments... The downgrade to junk status led investors to dump Greece's bonds, driving yields on two-year notes above 25%... from 4.6% a month ago..."

April 28 - Bloomberg (Niklas Magnusson): "Greek banks... may face further declines after Standard & Poor's cut their credit ratings to junk on concern over Greece's funding crisis. National Bank of Greece SA, the largest Greek lender, fell 10% in Athens trading before the cut was announced yesterday, bringing the slide this year to 45%...

April 28 - Financial Times (Chris Giles): "The crisis in Greece serves as a warning to other countries not to lose control of their fiscal positions and the confidence of markets. But advanced countries have now stretched their public budgets so far that investors, economists and international organisations are getting worried. Returning to form, the International Monetary Fund warned this month that reducing budget deficits, 'should precede the normalization of monetary policy' in many economies and that they 'need to make more progress in developing and communicating credible medium term fiscal adjustment strategies'. Willem Buiter, chief economist of Citi, uses rather blunter language. 'Today's 'best of breed' may be the same dog that yesterday was fit only for the World's Ugliest Dog Contest - an indicator of just how far the fiscal conditions in most advanced industrial countries have deteriorated,' he says. The problem is simple. Huge budget deficits resulting from the financial crisis have put public debt on an unsustainable trajectory and doubts are growing that the political will exists for the nasty medicine to be swallowed."

April 30 - Bloomberg (Peter Woodifield and Rodney Jefferson): "Mounting government debt may weigh on stocks and bonds in the U.S., the U.K. and other parts of Europe for as long as a decade and result in a 'dull' outlook for some markets, according to two Edinburgh fund managers. Almost $1 trillion was wiped off the value of stocks on April 27 on concern that debt will spur defaults and derail the global economy... 'It is going to change relative returns for the next 10 years,' Gerald Smith, deputy chief investment officer of Baillie Gifford & Co., said in an interview at his office in the Scottish capital"

April 28 - Bloomberg (Emma Ross-Thomas): "Spain had its credit rating cut one step by Standard & Poor's to AA, putting it on a par with Slovenia, as contagion from Greece's debt crisis spreads through the euro region. S&P said...its outlook on Spain is negative, indicating possible further downgrade..."

April 30 - Bloomberg (Katrina Nicholas): "Volatility indexes show Europe's fiscal crisis is jolting markets in Asia's largest economies, with gauges in China and India jumping as much as in the U.K."

April 30 - Bloomberg (Louisa Fahy): "Ireland could skip 'a couple' of monthly bond auctions amid concerns that the mounting fiscal crisis in Greece will spread to other euro-area nations, the head of funding at the country's debt agency said."

Global Government Finance Bubble Watch:

April 27 - Bloomberg (Christopher Palmeri and Michael M. Marois): "Hawaii Governor Linda Lingle said citizens must act to stop the increase in government-pension benefits or risk letting the expanding liabilities hinder future economic growth. 'Until the public rises up and says, 'Enough is enough, you have to stop this spending,' it won't stop, and our quality of life will degrade,' Lingle, 56, said...

Currency Watch:

April 30 - Bloomberg (Klaus Wille and Matthias Wabl): "Swiss officials are making decisions their peers in Greece or Portugal envy: Canceling bond sales as a budget surplus reduces the nation's borrowing needs... Switzerland called off bond sales in November and December, saying it didn't need additional funds to finance the budget."

The dollar index rose 0.6% this week to 81.88 (up 5.2% y-t-d). For the week on the upside, the New Zealand dollar increased 1.4%, the Brazilian real 1.0%, the South African rand 0.4%, and the Japanese yen 0.1%. For the week on the downside, the Canadian dollar declined 1.9%, the Swedish krona 1.2%, the Mexican peso 1.1%, the euro 0.7%, the British pound 0.7%, the Swiss franc 0.4%, and the Australian dollar 0.4%.

Commodities Watch:

The CRB index declined 0.5% (down 2.0% y-t-d). The Goldman Sachs Commodities Index (GSCI) added 0.2% (up 4.8% y-t-d). Spot Gold jumped 1.9% to $1,179 (up 7.5% y-t-d). Silver rose 2.5% to $18.68 (up 10.9% y-t-d). June Crude gained 99 cents to $86.11 (up 8.5% y-t-d). June Gasoline increased 1.5% (up 17% y-t-d), while June Natural Gas sank 9.3% (down 29% y-t-d). July Copper dropped 5.0 (unchanged y-t-d). May Wheat slipped 0.3% (down 9% y-t-d), while May Corn gained 3.8% (down 12% y-t-d).

China Bubble Watch:

April 28 - Bloomberg: "China is 'less and less likely 'to raise interest rates this quarter after Greece's debt-rating downgrade highlighted the fragility of the global recovery, Bank of America-Merrill Lynch said... 'What happened in Greece and other European countries could convince Chinese policymakers that it's still too early to hike rates," Hong Kong-based economist Lu Ting said."

Japan Watch:

April 30 - Bloomberg (Mayumi Otsuma): "The Bank of Japan pledged to help lenders provide credit after reports showed the economic recovery isn't yet strong enough to overcome deflation. Governor Masaaki Shirakawa said the bank will explore steps similar to those undertaken in 1998-1999, when it increased credit to lenders to funnel cash to companies amid a credit squeeze.

Asia Bubble Watch:

April 29 - Bloomberg (Shamim Adam and Sophie Leung): "Asia's economic recovery that's outpacing the rest of the world is attracting capital inflows that may cause the region to overheat and lead to the formation of asset bubbles, the International Monetary Fund said. Expectations of Asian exchange-rate appreciation may be boosting carry trade flows, where investors borrow cheaply in one currency and use the funds to invest in others... The World Bank predicts as much as $800 billion in global capital flows this year, compared with about an annualized $450 billion to developing economies in the second half of 2009..."

April 29 - Bloomberg (Suttinee Yuvejwattana): "Thailand's central bank raised its economic growth forecast as exports rebound, even as prolonged political protests threaten the country's recovery... Gross domestic product may expand 4.3% to 5.8% in 2010..."

Latin America Bubble Watch:

April 27 - Bloomberg (Alexander Ragir): "Brazil's economy will grow 6.4% to 7% this year as the country's output gets 'close to overheating,' said Octavio de Barros, chief economist at Banco Bradesco SA."

April 29 - Bloomberg (Iuri Dantas): "Brazilian outstanding bank lending expanded 16.8% in March from the same month a year earlier, the central bank said."

April 30 - Bloomberg (Adriana Brasileiro): "Adriana Pires, a human resources manager in Rio de Janeiro, had a pleasant surprise when she prepared her income taxes: the 8,000 reais ($4,575) she paid for breast implants and liposuction are tax-deductible. As Brazilians race to meet today's filing deadline, the federal government for this year for the first time will allow taxpayers to deduct the cost of boob jobs, tummy tucks and any other type of cosmetic surgery. The measure, retroactive to procedures performed since 2004, may spur the 3 billion reais plastic surgery market, the world's second-largest after the U.S...."

April 27 - Bloomberg (Ye Xie and Camila Fontana): "Brazilian policy makers are poised to raise borrowing costs at the fastest pace since President Luiz Inacio Lula da Silva took office in 2003 after central bank chief Henrique Meirelles pledged 'vigorous action' on inflation... The biggest two-day surge in six months on yields of the overnight interest rate futures contract due in July reflects expectations that Meirelles will raise the benchmark Selic rate 2.25 percentage points to 11% by the June policy meeting..."

Unbalanced Global Economy Watch:

April 29 - Bloomberg (Simone Meier): "European confidence in the economic outlook improved to the highest in more than two years... amid signs the euro-area recovery is strengthening even as Greece's fiscal crisis spreads across the region."

April 29 - Bloomberg (Patrick Donahue and Frances Robinson): "German unemployment fell at the fastest pace in more than two years in April as Europe's largest economy shrugged off the coldest winter in 14 years and a worsening fiscal crisis in the euro region's periphery... The jobless rate fell to 7.8% from 8%."

April 30 - Bloomberg (Emma Ross-Thomas): "Spain's unemployment rate rose above 20% for the first time in more than a decade, undermining Prime Minister Jose Luis Rodriguez Zapatero's fight to cut the euro region's third-largest budget deficit."

U.S. Bubble Economy Watch:

April 29 - Bloomberg (Jody Shenn): "Decisions by homeowners to walk away from mortgages they can afford are accounting for more defaults, according to Morgan Stanley. About 12% of all mortgage defaults in February were 'strategic,' up from about 4% in the middle of 2007... analysts led by Vishwanath Tirupattur wrote..."

April 29 - Bloomberg (Brian Faler): "Since the U.S. recession began in December 2007, Congress has extended the duration of weekly unemployment benefits for the jobless three times. Now, the lawmakers may have reached their limit. They are quietly drawing the line at 99 weeks of aid, a mark that hundreds of thousands of Americans have already reached. In coming months, the number of those who will receive their final government check is projected to top 1 million."

April 28 - Bloomberg (Jeff Green): "U.S. manufacturers will fill fewer than 30% of 2 million lost factory jobs as the economy recovers over the next six years, according to an estimate from an industry trade group. Most of the hiring will come in 2011 and 2012, David Huether, chief economist for the National Association of Manufacturers, said..."

April 28 - Bloomberg (Rebecca Christie): "The financial crisis and recession cost U.S. households an average of about $100,000 in lost wealth and income, according to a study by former Treasury Department economist Phillip Swagel. From September 2008 through the end of 2009, households' stock holdings fell $66,000 and real estate dropped $30,000, according to... the Pew Economic Policy Group."

Real Estate Watch:

April 28 - Bloomberg (Dan Levy and Daniel Taub): "The U.S. housing market won't recover for three to five years as mounting foreclosures hold down prices, according to mortgage-bond pioneer Lewis Ranieri. 'There's another big leg down and the question is how long does it stay,' Ranieri...said... 'You can't have much of a rally when you've got this big overhang.' Home foreclosures probably will reach a record this year with more than 1 million properties seized by banks, according to data seller RealtyTrac Inc."

Central Bank Watch:

April 29 - Bloomberg (Andre Soliani and Iuri Dantas): "Brazil's central bank became the first in Latin America to increase borrowing costs in more than a year...In a unanimous vote yesterday, the bank board raised the Selic rate to 9.5% from a record 8.75%."

Fiscal Watch:

April 28 - Bloomberg (William Selway): "The agency financing construction of the new San Francisco-Oakland Bay Bridge may sell as much as $4 billion of bonds this year to take advantage of federal debt subsidies before they're scaled back or expire."

Muni Watch:

April 28 - Financial Times (Nicole Bullock): "Council meetings in Harrisburg, the capital of Pennsylvania, have weighed issues ranging from snow removal and rubbish collection to a rise in dog fighting, but a meeting this week was particularly unusual. In a sign of the tough times, officials called in experts to discuss the pros and cons of going bankrupt. 'There is no good option,' Dan Miller, Harrisburg city controller, told the city's administration committee. Mr Miller and some members of the committee advocated exploring bankruptcy as way to get out from under its debts... Bankruptcy has never been used widely by municipal authorities, so they have few guidelines. But with cities, towns and counties across the US hard hit by the recession, local officials, investors and analysts are questioning whether bankruptcy could become more common. The debate stretches from city halls to Wall Street, and the Securities Industry and Financial Markets Association (Sifma) will have its own public airing on the topic at a conference on Thursday in Manhattan."

Speculation Watch:'

April 30 - Bloomberg (Garfield Reynolds and Khalid Qayum): "Emerging-market bond funds have had their three best weeks on record this month, taking in more than $5 billion... EPFR Global said."

April 29 - Bloomberg (Kristen Haunss): "BlackRock Inc., the world's largest asset manager, and Blackstone Group LP's GSO Capital Partners LP are forming mutual funds to invest in loans... The firms have joined Goldman Sachs Group Inc. in announcing funds investing in leveraged loans pegged to short- term interest rates. Investors poured more than $2.5 billion into bank-loan mutual funds in March and the first three weeks of April, more than triple the amount for March and April last year, according to Lipper..."

April 30 - Bloomberg (Ben Moshinsky): "High-frequency trading faces a European Union clampdown, as regulators investigate whether traders could use the practice to manipulate financial markets. The European Commission, the EU's executive arm, said it's summoning hedge funds and banks for fact-finding talks on the practice, as it considers stricter rules on market abuse due before the end of the year."


Tuesday April 27, 2010

My secular bearish view is premised on the Serial Bubble Thesis: the current backdrop is the product of more than two decades of ever-expanding Bubbles and increasingly expansive government reflationary measures. Post-Wall Street/mortgage finance Bubble reflation is fomenting the current Bubble, which I have coined the "global government finance Bubble." It's a Bubble built on the most fragile underpinnings.

This week I found myself pondering parallels between two historic Bubbles.

May 24, 2006 - Washington Post (Kathleen Day): "Fannie Mae engaged in 'extensive financial fraud' over six years by doctoring earnings so executives could collect hundreds of millions of dollars in bonuses, federal officials said... in a report that portrayed a company determined to play by its own rules... The result was a company whose managers engaged in one questionable maneuver after another, including two transactions with investment banking firm Goldman Sachs Group Inc. that improperly pushed $107 million of Fannie Mae earnings into future years. The aim, OFHEO said, was always the same: To shape the company's books, not in response to accepted accounting rules but in a way that made it appear that the company had reached earnings targets, thus triggering the maximum possible payout for executives... The settlement closes regulators' civil probe into Fannie Mae's accounting scandal, the result of the company's misstating earnings by about $10.6 billion from 1998 through 2004.

The great crisis of 2008's die had been cast back in 2006. With the scope of the accounting fraud having finally awoken Congress, Fannie and Freddie asset growth had been effectively reigned in. Momentously for the marketplace, intense regulator scrutiny would ensure that the GSEs no longer retained the capacity to provide the leveraged players (and others) their coveted "backstop bid" - a powerful mechanisms that had underpinned an increasingly speculative marketplace through a series of crises and bouts of illiquidity. Yet, throughout 2006 marketplace liquidity remained abundant, confidence ran very high, and fundamentals appeared sound. Certainly, no one was in the mood to contemplate that a historic Bubble had turned acutely susceptible to the next serious bout of market tumult.

The GSEs had for years acted as steadfast financiers for the mortgage marketplace. They provided the linchpin for the entire system of mortgage risk intermediation; their activities were instrumental to market pricing distortions and the unleashing of the historic Wall Street/mortgage finance Bubble. By 2006, dynamics fundamental to the mortgage market had changed - and yet the market didn't care. Home prices were rising rapidly, and mortgage Credit was on its way it way to another stunning year of growth ($1.4 TN). Post-tech Bubble reflation was in overdrive. And with total mortgage Credit having almost doubled in just six years, the Wall Street/mortgage finance Bubble was inebriated by "terminal phase" excess.

Interestingly, the overheated mortgage market didn't need the GSEs in 2006. Instead, the key dynamic was an over-liquefied and speculative marketplace feverishly chasing yield. Short-term interest-rates were too low, and "private-label" mortgages were all the rage. Collateralized debt obligation (CDO) issuance was said to have surpassed $1.0 TN, with rapid growth in the fancy new "synthetic CDO." A wall of finance was flowing into (and out of) the mortgage arena that was gladly borrowed by millions with visions of making some easy money of their own. With finance flowing so loosely, the last thing anyone worried about was the mispricing of finance or the ramifications from GSE fraud.

Actually, I have my own theory on how malfeasance at the GSEs actually contributed to late-cycle "terminal phase" mortgage excess. Fed funds began 2006 at only 4.25%, a ridiculously low rate considering the scope of mortgage Credit growth and asset price inflation. I believe Chairman Greenspan was keenly aware of GSE-related fragility and this was an important factor in the decision to maintain loose monetary policy. He was content to see monetary policy entice homebuyers into adjustable-rate mortgages - thus transferring interest-rate risk from the GSEs and financial sector to the household sector.

Loose monetary policy was also instrumental in spurring rapid growth in higher-yielding asset-backed securities and derivatives more generally. This dynamic reduced system dependency to GSE Credit, while also seemingly shifting mortgage and interest-rate risk away from the GSEs and the banking system. I believe policymakers appreciated that there were problematic mortgage excesses; they just mistakenly envisaged overriding systemic benefits from low rates and the rapid expansion in securitized mortgage Credit. Perhaps it was with the best of intentions. But the end result was a policy-induced absolute mess in the pricing and distribution of finance throughout the entire system.

From my analytical perspective, the system has found its way into another "terminal phase" of excess - this time emanating from the Global Government Finance Bubble. Intoxicated yet again by the effects of loose "money," the bulls see inflating markets confirming sound system underpinnings. I, in contrast, see another policy-induced absolute mess in the pricing and distribution of finance throughout the entire system. As always, calling the timing of a Bubble's demise is a perilous proposition. But I can sure see the makings of acute systemic fragilities.

I'll date the beginning of the end for the Wall Street/mortgage finance Bubble on June 7, 2007. While subprime problems had been festering for months, that was the day Bear Stearns announced that two of its mortgage derivatives funds would no longer allow redemptions. From that moment on, speculative finance was on it way out of the mortgage sector. I would not be surprised if Tuesday April 27, 2010 marked an important inflection point for the Global Government Finance Bubble. The stock market was able to muddle through more than a year of mortgage market tumult before succumbing to an all-out crisis. So, marketplace complacency in the face of expanding crises in European debt markets and Wall Street risk intermediation is not all that surprising.

Greek debt contagion took a dramatic turn for the worst. Two-year Portuguese government yields jumped 104 bps Monday to 3.97% and then spiked above 5% in Tuesday's rapidly escalating market dislocation. After beginning the month at 1.58%, Portugal's two-year government yields Wednesday traded as high as 5.93%. At the worst of the week's dislocation, Portuguese Credit default protection jumped to 450 bps, after starting April at 144 bps. Ireland's two-year government yields surged as high as 4.28%, up from last Friday's 2.34%. Yields in Spain jumped above 2.3%, after ending last week at 1.70%. Italian two-year yields also jumped as much at 50 bps from Friday's level to approach 2.0%. It is certainly worth mentioning that Greek two-year yields rose above 18% Wednesday, before ending the week at 12.67% (after beginning the year at 4%).

And most will argue, perhaps even persuasively, that European debt market tumult will have little impact on our market and economic recoveries. Readers surely remember how the U.S. economic expansion was supposed to be immune to subprime woes. But fragility is inherent to Bubbles, and contagion is fundamental to Bubble risk. It is the nature of things that the weakest link tends to be the first to succumb. And as confidence falters, previous risk misperceptions are comprehended and complacency is abandoned - greed morphs to fear and the dominoes begin to tumble. I don't know how much or for how long it might take for contagion to find its way to U.S. debt markets. I am, however, confident that we face enormous structural debt issues that the markets won't disregard forever.

The Goldman fiasco does not inspire confidence. Tuesday April, 27 was not a good day for Goldman, proprietary trading, the OTC derivatives marketplace or private-sector risk intermediation. It definitely marked an inflection point for efforts to impose greater regulatory restraint upon the financial sector. The old ways may have persevered through the LTCM, Enron, GSE and mortgage fiascos, but today's intense scrutiny of Goldman Sachs will alter the manner in which Wall Street goes about its business. The near-term ramifications for our government-dominated Credit system and economy are anything but clear. There days financial conditions are loose, confidence is high, market liquidity remains overabundant, and there is little difficulty intermediating risky Credit. But there is, at the same time, Bubble fragility unrecognized in an overconfident marketplace.

Reigning in Wall Street proprietary trading desks and derivatives operations pose major additional challenges for an already challenged private-sector Credit mechanism. The Street's new realities will make it more difficult for private-sector Credit to anytime soon supplant Washington's Credit juggernaut. From my perspective, this equates to massive deficits - for bigger and longer. This means, at some point, greater market risk to a change in market perceptions and a surprising jump in yields. And I would argue that Goldman and Wall Street's problems ensure that the markets for risk intermediation - interest-rate, Credit, equities, currency, etc. - become less liquid and more vulnerable to dislocation.

Perhaps it doesn't matter all that much for now, but the dislocation that unfolded in European Credit default swap markets on Tuesday April, 27, 2010 portend serious issues for sovereign debt markets both abroad and at home. There's hope that European policymakers and the IMF can come up this weekend with a credible plan for Greek aid. I would tend to believe that the "genie is out the bottle" and that global markets are in the early stage of adjusting to new uncertainties and risk realities. Many that have planned on using derivatives markets to hedge future market risks may begin to reevaluate their approach to risk taking and management.


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