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The Unraveling

Total Annual Corporate Borrowing
Total Annual Mortgage Borrowing
Implied Yield
Productivity gains

Extraordinary uncertainty as to the direction of the economy, inflation, and market interest rates seemed to begin to wear on the equity market this week. For the week, the Dow declined 1% and the S&P500 lost 2%. The Morgan Stanley Consumer index added 1%, the Transports gained fractionally, and the Morgan Stanley Cyclical index and Utilities were largely unchanged. The broader market was in retreat, with the small-cap Russell 2000 declining 1% and the S&P400 Mid-Cap index dipping 2%. The technology sector came under selling pressure, with the NASDAQ100 and Morgan Stanley High Tech indices hit for 5%, the Semiconductors 3%, the NASDAQ Telecommunications index 5%, and The Street.com Internet index 9%. The Biotech index dropped 4%. Financial stocks were also under pressure, with Bank stocks dropping 3% and the Securities Broker/Dealer index declining 2%. Gold prices rose again this week, with an almost $2 increase in the price of bullion and 9% surge in the HUI Gold index. The dollar index gained better than 1%.

Today's stronger than expected retail sales report and bounce in the University of Michigan consumer confidence were enough to push a vulnerable credit market over the edge. Importantly, the mortgage-back and agency markets significantly under performed today, with Fannie May benchmark mortgage-back yields surging 21 basis points and the implied yield on the June agency futures contract jumping 22 basis points. In the worst back-to-back sessions since October 1998, these yields jumped 32 and 35 basis points, respectively. The Treasury market had a rough week as well, with 2-year yields increasing 18 basis points and the 5-year jumping 24 basis points. The key 10-year Treasury yield surged 22 basis points to 5.49%, the highest yield since early December. The implied yield on 10-year Treasury futures jumped 28 basis points in two days. Long-bond yields rose 18 basis points this week to 5.85%. "Spreads reversed abruptly yesterday, with the 10-year dollar swap spread widening 5 basis points to 82 in two sessions."With the Street saturated from a flood of recent corporate debt issuance, this week's market sell-off was particularly painful.

No doubt about it, reckless money and credit excess has been running unabated. This protracted period of "reliquefication" has now worked its "magic" throughout the credit market, with even some risky credits again given access to market borrowings. Bloomberg tracks the amount of syndicated bank loan "securities released for public display…" Last week's list of 121 issuers with a total of almost $74 billion of syndicated loans is by far the largest I have seen. From MarketNews International (www.marketnews.com) "Over $7.0 billion of new rated U.S. corporate bonds poured into the capital markets in the last week of April, compared to the roughly $12.0 billion sold in the three weeks prior, Moody's Investors Service said Tuesday in a statement. The market's second wind helped boost monthly totals for April to a respectable $19.8 billion… in the first three months of this year, average monthly domestic issuance was around $38.0 billion. Still, last month's sales figures easily surpassed the $13.8 billion monthly issuance average of last year, so new bond sales continue to be above-trend. Three-month totals for domestic issuance were up by almost 172% year-to-year at the end of last month, making April the 4th consecutive month that year-to-year issuance has exceeded 75 percent."

Last week, the junk bond market enjoyed one of its strongest performances in a year, with AMG reporting that almost $500 million flowed into junk bond funds. Moody's reported April junk issuance of $6.6 billion, up from last year's monthly average issuance of about $2.8 billion. May is off with a bang, with WorldCom coming to market this week with almost $12 billion of new bonds, an issuance record by a U.S. corporation. The company is to use $6 billion of the proceeds to pay down commercial paper, understandably anxious to avoid the liquidity crunch faced by Xerox and Lucent. Verizon Communications issued a $3 billion zero-coupon convertible bond (the largest convert this year and #5 on the all-time list), although the deal was apparently not well received. Have the hedge funds reached their fill of convertibles? Year-to-date, convertible bond issuance of $38 billion is running 25% above last year's very strong pace. For comparison, a total of $41 billion of converts were brought to market during all of 1999.

Yesterday, Moody's reported that $71 billion of asset-backed securities were issued during the first-quarter, up 74% year over year. This deluge surpassed the previous quarterly issuance record of $62 billion set during last year's second quarter. At $20 billion, home equity-backed security volume jumped 55%. Credit card-backed issuance increased to $19 billion, 19% above the previous record. There were $18 billion of vehicle-backed securities brought to market, up 80% from last year. Analysts now expect $70 billion of vehicle-backed issuance this year.

On the mortgage bubble front, Countrywide reported April mortgage lending data this week. The company funded a record $10.2 billion of new loans during the month (not bad for one company!), an increase of 130% from last April. Refinanced mortgages totaled $5.9 billion (58% of total volume), versus $940 million a year ago. Mortgages for home purchases were up 24% to $4.3 billion. Home equity loan fundings increased 16% to $394 million. Average daily application volume of $675 billion was down slightly from last month's peak, but remains almost double year ago levels. The pipeline of mortgages in the process of funding ended the month at a record $18.6 billion, double what it was one year ago.

Weekly data from the Mortgage Bankers Association confirm that the mortgage-lending boom remains very much alive. Last week's total mortgage applications dollar volume was up 71% year over year, with purchase applications up 3% and refinancing applications 451% above year ago levels. Although the refinancing boom is tempering somewhat, it obviously remains at exceedingly strong levels. Going through the data it is worth noting that the average purchase application was for a mortgage of $168,400, and $171,300 for refinancing. Much more interesting, however, is that the average fixed mortgage was for $156,600, while the averaged adjustable-rate mortgage was more than double the amount at $323,500. It would certainly appear that these borrowers are choosing adjustable mortgages out of necessity, with extreme housing inflation in California and other key markets (and upper-end locations throughout the country!) having forced households to accept considerable interest-rate risk to afford their homes. Add this to the long list of factors (including unprecedented amounts of short-term debt outstanding, an over leveraged financial sector, enormous derivative positions, over borrowed household and business sectors, the GSE bubble, etc.) that together create acute systemic risk to higher interest-rates. While most focus on the risks associated with an economic downturn, there remains considerable systemic risk as well to a stronger than expected economy and/or a negative surprise on the inflation front. With continued egregious credit excess, there remains great uncertainly as to how things will develop in the short and intermediate term. For now, aggressive Federal Reserve accommodation and unprecedented credit availability fuel perpetuation of an historic real estate boom through much of the country.

This week USAToday ran a story, "Home Prices Rising Rapidly - Home prices across the USA are shooting through the roof, fueled by high demand and low borrowing costs. The owner of the typical American house valued at $133,000 is earning $708 a month by just sitting back and watching the market lift values, according to a new estimate by DataQuick Information Systems…" With the newfound recognition of the risks involved in the stock market, the accepted financial "wisdom" that real estate is a "can't lose proposition" becomes only more deeply entrenched. From the Los Angeles Times: "Apartment rents in the Southland surged to record highs in the first quarter, with the typical two-bedroom unit leasing for nearly $1,400 a month in Los Angeles and Orange counties… Throughout the five-county region, average rents for all apartments at larger complexes increased by 9% or more from a year ago, as the scarcity of new buildings, rising home prices and sustained job growth pushed up rents at more than double the rate of inflation. The biggest increase was in Los Angeles County, where renters paid an average of $1,187 during the January-March period. That was a 13% jump from a year earlier and made Los Angeles County the priciest apartment market in the region, according to the quarterly report by RealFacts… Average rents rose by 10% to $1,175 in Orange County and by about 9% each in the remaining counties…Analysts say landlords have been able to bump up rents as average home prices have climbed sharply."

Yesterday, the California Association of Realtors (CAR) reported that April median home sales prices throughout the state were up almost 10% from last year to $250,760 (average CA homeowner enjoyed almost $23,000 of 12-month gains!). The CAR breaks the data into 18 regions, with all posting year over year increases. Thirteen regions experienced double-digit price gains. Five regions, Central Valley (20%), High Desert (28%), Northern Wine Country (27%), Sacramento (23%), and Santa Clara (23%), have experienced better than 20% price appreciation over the past twelve months. Interestingly, Santa Clara posted a new record median price of $598,600. April Condo prices were up 15% from last year. For the entire state, sales volumes were down 5%, with the inventory of unsold home at 4.3 months (versus last year's 4 months).

Certainly not unrelated to the credit and real estate bubble, the consumer-spending boom survives as well. Surprising analysts, today's 0.8% (expectations of 0.1%) increase in retail sales was the strongest performance since January. Yesterday's reports on April same-store sales came in on average up about 4%, more than double March's 1.7%. Certainly benefiting from inflating prescription prices, the drug store category enjoyed comps up 9.3%. Industry leader Wal-Mart saw total sales increase 13.9% from a year ago to surpass $16 billion. Bank of Tokyo-Mitsubishi has revised higher its expectations for May same store sales to the 3 to 4% range.

If one steps back a bit and thinks about this objectively, isn't it just silly and at the same time absolutely frightening that so many have put so much faith in the capabilities of Federal Reserve? Unimaginable amounts of money have been invested in the markets, unprecedented borrowings from home mortgages to junk bonds have been accumulated, massive resources have been expended by businesses large and small, state and local governments throughout the country have borrowed freely, and untold scores of speculators from home and abroad have placed massive bets. With effortless adjustments to short-term interest rates, so the thinking goes, central bankers have both the skill and capacity to orchestrate positive and enduring effects to financial markets, while stimulating just the right amount of additional demand to perpetuate a non-inflationary U.S. economic boom. With the Fed able and more than willing to ward off any financial difficulty or economic slowdown, the only thing to fear of boom is fear itself. Isn't life a dream…

For much too long, the Fed and the bullish contingent have chosen to ignore unprecedented money, credit and speculative excess, as well as the resulting perilous financial and economic distortions. As the bullish thinking has had it, technology-induced productivity gains and rising profits were the magic elixir that made everything just fine. "Don't worry, be happy" was for some time the prevailing attitude. Complacency was hip, and doing actual analysis was very much out of fashion. Times, however, they are a changin'. And while few will admit it, we are now in the midst of witnessing The Unraveling of The New Economy Illusion. The bottom line is that the U.S. economy is extraordinarily imbalanced, with volatile and unpredictable business conditions and wildly diverging pricing pressures impacting various industries and sectors. One very low short-term interest rate and the resulting extreme monetary expansion will not bring the system back to normalcy or stability. You can count on it.

Summer blackouts have begun in earnest in California. Ominously, they arrive with the first heat wave in early May, with what will certainly be a summer of discontent to follow. As the situation turns desperate, the latest plan calls for rate increases of as much as 40% for residential customers, with industrial users absorbing price hikes up to 60%. Despite the seriousness of the matter, state officials nonetheless have their work cut out convincing California citizens this crisis in not contrived by the energy operators. Economists, Wall Street analysts, and pundits were all too eager to disregard the significance of it taking only a matter of months to saddle the state's two powerful utilities with $14 billion of debt and virtual insolvency. It must today be increasingly difficult to ignore the fact that the unfolding cancerous energy crisis has the clear potential to bankrupt the State of California. Being very much the aorta at the heart of the Great Credit Bubble - with dueling runaway real estate and technology bubbles - the Golden State today epitomizes bubble economy precariousness. In fact, the state now has all the quite disconcerting makings for one history's great reckless booms turned painful busts. For the life of me, I cannot comprehend why there was not some response from the Fed as this historic bubble took hold. But hopefully, a lesson will be learned, and going forward the Federal Reserve's number one priority will be to cautiously and assiduously protect the soundness and stability of the U.S. economy and financial system.

From Dion Nissenbaum's article in the San Jose Mercury News: "California will soon hit another energy crisis milestone: It will burn through the last of its $6.6 billion budget surplus in its costly four-month scramble to keep the power flowing. What began as a short-term proposal to siphon $500 million from the surplus to avert blackouts has become a multibillion-dollar juggernaut that has lawmakers drawing up contingency plans to shave billions from the state budget. When the budget surplus has been drained, Gov. Gray Davis plans to tap other programs -- from anti-tobacco campaigns to highway construction -- to keep buying energy this summer. State leaders are struggling to wrap up a bond plan that would restore the borrowed money and insist no programs will be pared because of the energy crisis. But with the price of electricity climbing toward $100 million a day, some lawmakers are growing increasingly concerned that the bond revenue could come too late to avoid some cuts. Davis estimates the state will spend more than $18 billion on power in the next 12 months."

Surging energy costs aren't the only problem. Estimates now have revenues through June of next year significantly below forecasts made just a few months ago in January. From Bloomberg: "California, which already faces a budget pinch over power purchases this year, might take in $3.4 billion less revenue than it expected through mid-2002, the state's legislative analyst said. 'Our reduced revenue projections would cause the budget to fall significantly out of balance' in the new fiscal year beginning July 1 without spending cuts, Elizabeth Hill, California's legislative analyst, wrote in a letter to lawmakers today… A slowing economy and a stock market decline that will cut into capital gains tax receipts are among the reasons California will realize $3.4 billion less through June 30, 2002, than Governor Gray Davis estimated in January, Hill said." Projections from only a few months ago of a combined $8 billion surplus for this year and next have recently been revised to a $7.5 billion deficit (Federal government take notice!). The state has authorized the issuance of $13.4 billion of bonds to finance energy purchases, although state statue stipulates a 90-day waiting period. It is estimated that the California general fund will have absorbed $9 billion of energy expenditures by August.

This is a developing story to follow closely. From yesterday's Los Angeles Times: "Senate Budget Committee Chairman Steve Peace (D-El Cajon) said the nearly $5-billion shortfall that Hill predicts for the 2001-02 fiscal year is optimistic. He believes revenue actually could sink as much as $20 billion. Peace said Hill appears to be projecting that revenue will begin to rebound toward the end of the year, but he predicted a continued decline as the economic downturn manifesting itself on Wall Street trickles down to Main Street. 'I think we are in for a huge problem and that assumes no impact from the energy stuff,' Peace said."

Get ready for additional downgrades in California debt ratings, in cuts with almost the shocking speed of the utilities' plunge to junk status. With California's debt rating now only superior to Louisiana (according to Bloomberg), this is indeed a rather a poignant example of "financial fragility." Yields on California 10-year general obligation bonds have jumped about 40 basis points over the past few months. For some time, financial problems have been "resolved" or "pushed under the rug." It will take quite a carpet to mask California's unfolding financial crisis.

All the same, the faithful ardently refuse to recognize the unfolding national financial and economic quagmire despite evidence that becomes more conspicuous by the week. But, then again, this Great Credit Bubble has increasingly become very much The Great Confidence Game, and the bullish contingent is absolutely determined to stand their ground. It is nonetheless critical to appreciate that we are now witnessing a crumbling of the boom-time notion of a New Paradigm right before our eyes. This foundation has always rested on two legs: Profits and Productivity. Last week's Bulletin highlighted the rapid deterioration in first-quarter earnings, with reports thus far coming in with the sharpest decline in profits since 1991. Such dismal performance is even more alarming considering the unrelenting nature of money and credit excess. We are very early in the downturn. Then this week comes the news that the other "leg" is crippled as well, with a report of the first decline in productivity in six years. While this report did not receive much attention, and there curiously remains near unanimity that this data would not stand in the way of more Fed accommodation next week, it is certainly worthy of a bit of digging below the surface. After all, the "theory" of the New Paradigm is the antithesis to Credit Bubble analysis.

Overall productivity declined 0.1% for the quarter, compared to a rise of 2.0% during the fourth quarter. Output per hour increased 2.8% year over year, compared to 3.8% during last year's first quarter. Compensation per hour jumped 6% (y-o-y), compared to 4.5% a year ago. Going back six quarters sequentially, compensation per hour has been increasing (y-o-y) at a rate of 6.0%, 5.7%, 5.1%, 4.9%, 4.5%, and 4.4%. Business sector productivity actually declined 0.4% during the first quarter, the first negative performance since the first-quarter of 1995.

Along with the Labor Department's first-quarter productivity release, "fourth-quarter and annual 2000 measures of productivity and costs also were announced today for the nonfinancial corporate sector. Output per all-employee hour rose 0.3 percent from the third to the fourth quarter of 2000, as output fell 0.7 percent and employee hours fell further, 1.0 percent. This was the smallest increase in labor productivity since the second quarter of 1997…Hourly compensation increased 7.4 percent in the fourth quarterUnit labor costs grew 7.1 percent in the fourth quarter of 2000. This was the largest increase since a 7.9 percent rise occurred in the first quarter of 1982. In the fourth quarter, unit profits declined 38.5 percent--they have fallen in 8 of the last 13 quarters. The implicit price deflator for nonfinancial corporate output rose 1.2 percent during the fourth quarter of 2000, somewhat faster than the 0.5 percent increase."

The Wall Street Journal quoted Northwestern University Economist Robert Gordon: "Forty years of history told us productivity was bound to slow down when the economy slowed." It is worth noting that productivity expanded at an annual average rate of about 1.5% for two decades prior to 1995. Since that time, productivity jumped up to a rate of 2.8%. The economic consensus, including some notable individuals at the very top echelon of the Federal Reserve System, have argued vociferously that this was proof positive of a structural shift in the (New) U.S. economy. A small minority, including Dr. Gordon and Dr. Kurt Richebacher, has all along argued that such an interpretation was misguided and little more than wishful thinking. Dr. Gordon has in the past made a quite convincing case that the vast majority of the reported productivity increases were not the result of technology-induced improvements throughout the general economy. Instead, the improved data was largely the result of the dramatic increases in the production of these actual technology products. This is a critical point with important ramifications. It wasn't that the Dell computer and the Cisco router were making the general U.S. economy more productive, as much as it was the enormous increases in output per worker from the Dells, Ciscos and the entire technology sector that was the driving force behind the sudden significant surge in reported U.S. productivity.

During the halcyon days of the technology boom, few would accept the profound implications of Gordon's and Richebacher's analyses: that the improved productivity data was largely cyclical and not structural. First, few would even recognize the technology bubble, and, of course, it was in no one's interest to acknowledge that as goes the tech boom, so goes the so-called "productivity miracle." We have long believed the accuracy of their work and thus are not the least bit surprised by the abrupt halt to productivity gains.

Cisco is an excellent case in point. As revenues exploded from $2.2 billion in 1995 to almost $19 billion last year, productivity gains by Cisco employees (and their suppliers) were undoubtedly quite impressive, to the point of having an impact on aggregate productivity data. And with most employees more than happy to accept minimal base compensation and a slug of stock options, labor cost per additional unit of output was minimal and declining. True economic profits were significantly overstated, with both booming profits and productivity gains unsustainable. Today, with the stock having collapsed, company revenues down 30%, and the necessity of writing off $2.2 billion of inventory, Cisco's employees will no longer play such a helpful role in U.S. productivity figures. A similar situation is shared by the assemblers of electronic components at Dell Computer and throughout the vast technology industry. With the tech bubble having burst, the days of technology manufacturers contributing outsized gains to U.S. productivity are over. And for so many companies, profits have abruptly turned into escalating losses.

Most unfortunately, the flawed logic encompassing New Economy "theories" has left an ugly legacy. The fixation on profits and productivity created tunnel vision oblivious to historic money and credit excess. This exuberant focus on new technology innovations was at the expense of appreciating the momentous ramifications from truly profound financial innovations. It certainly should have been clear that we were in the midst of an extraordinary period, with a powerful and volatile interplay of rapid technological and financial developments. Such an environment, as was the case in the late 1920's, virtually by definition is quite prone to excess - financial and economic. Monetary authority caution was in order, but precisely the opposite mindset gripped our central bankers: that financial excess could be tolerated specifically because of a fundamental shift in technology advancement - that structural profit and productivity improvements were behind a healthy boom. Big mistake.

As the Fed and others marveled at the wonders of lasers, fiber optics, and the like, financial processes were quietly but resolutely taking hold. The authorities relaxed, and the always-enterprising financial sector took full advantage. Apparently, central bankers did not appreciate that credit excess was playing a defining role in fostering the boom; that monetary forces were a key factor accommodating the surging demand driving the heady corporate profit and quarterly productivity data. The greater the credit excess, the greater demand and resulting profits, only stimulating heightened demand for additional borrowing and spending. By 1998 the U.S. credit system had succumbed to an unmitigated financial bubble of historical proportions. At that point, the Greenspan Fed chose to ignore the increasingly conspicuous money and credit bubble while hoping there was indeed such a thing as a New Economy. Besides, Greenspan's public comments certainly indicated that he was prepared to aggressively counter the bursting of a stock market bubble to insure that it did not create a Japanese-style economic downturn. This not only heartened those playing the stock market, but also gave the leveraged (credit market) speculators an enormously enticing scenario worthy of excitable anticipation and wonderful daydreams. I am left with the supposition that Greenspan recognized the likelihood of a stock market bubble, without appreciating that the principal bubble was in fact emanating out of the credit system.

During the past three years (1998 through 2000), total net U.S. non-federal (including financial) credit market borrowings increased $6.1 trillion, or $2.05 trillion annually. This compares to $8.6 trillion, or an average of less than $1.1 trillion annually during the previous eight years (1990-97). Since 1998, non-federal borrowings (excluding financial sector) averaged $1.2 trillion per year, compared to $456 billion annually over the previous eight years. Corporations (non-financial) borrowed a stunning $1.35 trillion over three years ($449 billion annually), compared to $886 billion ($111 billion annually) during the preceding eight years. Three-year financial sector borrowings surged almost $3 trillion, or almost $1 trillion annually. This compares to about $3 trillion, or $377 billion annually, between 1990 and 1997. Total mortgage borrowings increased $1.7 trillion between 1998 and year-2000 ($576 billion annually), compared to $1.7 trillion ($214 billion annually) over the preceding eight years. During the eight years ended 1997, broad money supply (M3) increased $1.343 trillion, or an average annual increase of $168 billion. During the next three years, broad money has surged a staggering $1.736 trillion, or at an annualized rate of $579 billion. So far this year, broad money has increased a staggering $299 billion. Money supply is on pace (almost 13% annualized growth) for an unprecedented expansion this year of more than $900 billion. The net year-2000 increase in household sector borrowings of $573 billion was up 70% from 1997, while net corporate (non-financial) borrowings last year of $447 billion were 68% above 1997 borrowings.

If one felt compelled to isolate a "New Paradigm," it can be found (conspicuously in the abovementioned data) in what has developed into an incredibly powerful "wildcat" financial sector, driven by a New Age Credit System possessing the capability of unfettered money and credit expansion. As the New Era propaganda Unravels, it should be increasingly clear that this extraordinary boom has its roots in unprecedented credit availability and not productivity and profits. Still, and it really is truly amazing, as the great technology bubble (disguised as a New Economy) collapses, a rejuvenated historic Credit Bubble has come back stronger than ever.

I had to "scratch my head" after reading this Bloomberg story: "The U.S. economy's performance over the past two decades offers evidence of a more stable growth path, one that is less vulnerable to the boom-bust patterns of previous eras, according to a new research paper released by the Federal Reserve Bank of New York. In a paper entitled 'Recent Changes in the U.S. Business Cycle,' Simon Potter, a domestic research analyst with the bank, and University of California, Riverside, economics professor Marcelle Chauvet argue that since 1984, the U.S. economy's growth level has become significantly less volatile, and that recessions are now occurring with reduced frequency…'There have been fundamental changes in the economy since the mid-1980s. We find that there is strong evidence of a change in the economy towards stability,' paper co-author Marcelle Chauvet said…There's evidence that 'better business planning and the use of inventory controls by businesses have prevented them from making some short-term mistakes' that would in the past have contributed to volatility…" We are not so sure technology executives would today agree.

And speaking of "boom and bust patterns", while aggressive Federal Reserve accommodation throws gas on the real estate fire in Southern California and elsewhere, it is worth noting that a much different story is now unfolding in the greater San Francisco Bay Area. From the San Jose Mercury News: "Bay Area Apartment Vacancies Rising - 'This market has changed dramatically in the last 60 days,' said Killian Byrne, vice president of Vasona Management, which has 4,000 apartments in the Bay Area. His company has reduced asking rates as much as 10 percent and is offering concessions to attract new tenants. 'There's no demand anymore,' he said. 'I would have never predicted this to happen to our industry so quickly.'" Another local property manager stated that "his portfolio has a vacancy rate of 4 percent. But when the units where tenants have given notice are added, that figure rises to 10 percent." Also from the San Jose Mercury News: "Home prices fall sharply in valley - Just 682 homes closed escrow in the county in April, a 19 percent decrease from March and a steep 40 percent fall from one year ago. The number of homes for sale continued to accumulate: There are 4,208 houses on the market and 1,247 condominiums. Last year at the same time, 1,499 houses and 352 condos were available. The average home now spends 31 days on the market, compared with 18 days one year ago." And with companies abandoning office space in droves, commercial vacancy rates throughout the San Francisco Bay Area are skyrocketing. The bursting of the tech bubble has made it to the real economy in Silicon Valley.

From today's MarketNews International "Reality Check" column: "US Office Space Market Down Sharply, Brokers say - The commercial real estate market appears to have given up much of its year 2000 gains in what industry officials describe as a "jolting" slowdown in 2001…Preliminary data, some still unreleased, 'shocked' the industry and created nervousness about the second quarter and beyond, said Robert Bach, national director of market analysis at Grubb & Ellis, among the nation's larger commercial real estate firms in Chicago. 'The first quarter was a shock to the system,' Bach said. 'It was a sharp reversal of the tightening market we saw during all of 2000. The overall vacancy rate shot up.' Grubb & Ellis's preliminary figures show office vacancy rates nationwide soared to 10.37% in the first quarter from 8.86% in the fourth quarter." Wow!

Today, everything seems to move with such extraordinary speed in this precarious financial and economic bubble. Such an environment simply beckons for outsized risk premiums. A fundamental feature of bubble economies is that they need continuous enormous doses of new credit to sustain both levitated asset prices and boom-time exorbitant demand. This, as we have witnessed, is no problem at all when the bubble is being financed with marketable credit instruments, and the prices of these securities is rising. As I have stressed repeatedly, bull markets create their own liquidity. Things can turn sour abruptly, however, when prices begin to decline for the debt securities necessary to perpetuate the bubble. One of these days we may even see The Unraveling of leverage in the credit system; that will not go smoothly.

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