UNEDITED!

It feels like a period of heightened uncertainty and instability is developing. Despite increased volatility, the Dow and S&P500 ended the week little changed. The Transports were slightly positive, which the Utilities were marginally negative. The Morgan Stanley Cyclical index was up a bit, while the Morgan Stanley Consumer index was down a bit. The broader market was weaker than the major averages, with the Russell 2000 small cap index declining 1%. The S&P400 Mid-cap index posted a small decline. Technology stocks were generally weaker. The NASDAQ100 and Morgan Stanley High Tech indices lost about 1%. The Semiconductors fell 2%. The Street.com Internet Index and the NASDAQ Telecommunications index both declined 1%. The Biotechs were hit for a 1.5% loss. Financial stocks were notably weak. The highflying Broker/Dealers were down 3%, and the Banks lost 2%. Although Gold gained $6.50, the HUI index was only slightly positive.

Sir Greenspan and bearish fundamentals forced the bond market into a reality check. For the week, two-year Treasury yields jumped 11 basis points to 3.43%, the highest level since April 2002. Five-year Treasury yields shot 17 basis points higher to 3.86%. Ten-year Treasury yields rose 18 basis points, to 4.27%, its worst weekly performance in nine months. Long-bond yields surged 18 basis points to 4.65%. The spread between 2 and 30-year government yields widened 6 basis points to 122. Benchmark Fannie Mae MBS yields gained only 12 basis points. The spread (to 10-year Treasuries) on Fannie's 4 5/8% 2014 note narrowed 4 basis points to 35, and the spread on Freddie's 5% 2014 note narrowed 5 basis points to 32. The 10-year dollar swap spread increased 0.5 to 38.5. Corporate bonds generally performed well, with junk bond spread narrowing for the fifth straight week. The implied yield on 3-month March Eurodollars rose 1.75 basis points to 2.9925%.

This week's investment grade issuers included Citigroup $2.0 billion, Alltel $1.4 billion, JPMorgan Chase $1.25 billion, Capital One $1.3 billion, Fifth Third Bank $800 million, Sempra Energy $560 million, Enterprise Products $500 million, FPL Energy $465 million, Temple-Island $340 million, Dow Jones $225 million, and Kimco $100 million.

Junk bond funds saw outflows of $107.25 million (ending 3 weeks of inflows). Junk issuers included Sanmina-Sci $400 million, and Bear Creek $245 million.

Convert issuers included Sybase $400 million, Blackrock $250 million, Lions Gate $150 million and SFBC International $140 million.

Foreign dollar debt issuers included Telefonos de Mexico $1.75 billion, America Movil $1.0 billion, Chuo Mitsui Trust $850 million, and Nordic Investment Bank $400 million,

February 18 - Bloomberg (Todd Prince): "Emerging market stock funds received $1.26 billion in the seven days ending Feb. 16, according to EmergingPortfolio.com. Emerging market stock funds got $1.33 billion in the week ending Feb. 9, the most in at least five years..."

Japanese 10-year JGB yields rose 1.5 basis points to 1.415%. Emerging market debt generally performed well in the face of the backup in Treasury yields. Brazilian benchmark dollar bond yields actually declined 3 basis points to 7.76%. However, Mexican govt. yields ended the week up 15 basis points to 5.15%. Russian 10-year dollar Eurobond yields rose 5 basis points to 5.91%.

February 16 - Bloomberg (Lukanyo Mnyanda): "The yield on the South African five-year bond dropped to a record low after the release of a report showing economic growth slowed in the fourth quarter. The R153 note, due in August 2010, gained 0.60 to 124.34, pushing the yield down by 13 basis points or 1.7 percent to 7.54%..."

February 14 - Bloomberg (Todd Prince): "Emerging market stock funds had their largest inflow of money in at least five years as investors shifted out of the U.S. to tap share price gains in nations such as Turkey and Poland, according to EmergingPortfolio.com. The funds attracted a net $1.33 billion in the week to Feb. 9, the Boston-based research company said in a statement today. That was the most since it began compiling weekly data in 2000. Investors are pursuing higher returns in emerging markets as the U.S. dollar declines and interest rates in the world's largest economy rise. They have added $1.8 billion into emerging market funds this year, pulling $1.6 billion from U.S. equity funds in the same period, according to EmergingPortfolio.com."

Freddie Mac posted 30-year fixed mortgage rates increased 5 basis points this week to 5.62%. Fifteen-year fixed mortgage rates rose 4 basis points to 5.14%. One-year adjustable mortgage rates increased 4 basis points to 4.11%. The Mortgage Bankers Association Purchase applications declined 4.8% the past week. Purchase applications were about unchanged from one year ago, with dollar volume up 10%. Refi applications jumped 4.1% to the highest level since mid-April. The average new Purchase mortgage was down slightly to $237,400. The average ARM jumped to $330,400. ARMs declined to 30.7% of total applications.

Broad money supply (M3) declined $25 billion to $9.478 Trillion (week of February 7). M3 is up $574 billion, or 6.4%, over the past year. For the week, Currency dipped $1.0 billion. Demand & Checkable Deposits dropped $28.5 billion, while Savings Deposits rose $25.5 billion. Small Denominated Deposits added $2.2 billion, while Retail Money Fund deposits declined $2.2 billion. Institutional Money Fund deposits fell $10.2 billion. Large Denominated Deposits gained $2.4 billion. Repurchase Agreements added $1.7 billion, while Eurodollar deposits dropped $14.8 billion.

Bank Credit expanded $12.6 billion for the week of February 9 to a record $6.915 Trillion. Bank Credit is up a noteworthy $170.5 billion during the first 6 weeks of the year (up 8.0% over the past year). For the week, Securities holdings jumped $17.3 billion, while Loans & Leases slipped $4.7 billion. Commercial & Industrial (C&I) loans dipped $0.2 billion. Real Estate loans rose $7.5 billion. Real Estate loans are up $324 billion, or 14.4%, over the past 52 weeks. For the week, consumer loans increased $0.7 billion, while Securities loans added $0.6 billion. Other loans dropped $13.2 billion, reversing much of last week's large gain. Elsewhere, Total Commercial Paper jumped $9.4 billion to $1.433 Trillion (up 8.9% over 52 weeks), expanding at a 10.1% rate y-t-d. Financial CP increased $6.3 billion to $1.290 Trillion. Non-financial CP rose $3.0 billion to $143.5 billion. Non-financial Commercial Paper is up 21.6% from one year ago.

Fed Foreign Holdings of Treasury, Agency Debt rose $2.0 billion to $1.342 Trillion for the week ended February 16. "Custody" holdings are up $6.5 billion, or 3.6% annualized, year-to-date. Federal Reserve Credit rose $7.1 billion for the week to $783.7 billion.

ABS issuance rose to a strong $18.0 billion (from JPMorgan). Year-to-date issuance of $87.6 billion is running 52% ahead of comparable 2004. At $52.2 billion, Home equity ABS issuance is running 43% above year ago levels.

Currency Watch:

The dollar index ended the weak down about 1%. The Norwegian krone gained 2%, the South African rand 1.9%, the Swiss franc 1.3%, and the Iceland krona 1.25%. On the downside, the Romanian leu sank 2.5%, the Uruguay peso dropped 1.4%, and the Thai baht declined .60%.

Commodities Watch:

February 16 - Bloomberg (Mark Shenk): "World oil demand will rise to 83.78 million barrels a day, according to an OPEC report. Chinese oil use will climb by 500,000 barrels a day, to 7 million a day, because of economic growth of 8 percent... 'The market is very jittery and for good reasons,' Boone Pickens...said in an interview... 'Worldwide production is 83 million barrels a day and it's never going any higher than that.'"

February 17 - Bloomberg (Jennifer Itzenson and Claudia Carpenter): "Copper in New York surged to the highest price in almost 16 years on speculation that manufacturers in China are increasing purchases as the dollar falls. Copper, priced in dollars, rose 39 percent last year as demand surged in China, the U.S. and Japan, the top three users of the metal. Global demand has exceeded production from mines and scrap yards, eroding inventories monitored by the London Metal Exchange by 82 percent in the past year. 'The Chinese have to buy because they need it,' said David Threlkeld, president of Resolved Inc., a copper-trading company... 'China needs to buy and they're starting to come in the market. What happened last year, they essentially bought one year's consumption in three months. Now I think they're coming back again.'"

March Crude Oil jumped $1.19 week to $48.35. The Goldman Sachs Commodities index rose 1.7%, increasing its year-to-date gain to an impressive 7.6%. The CRB index jumped 1.6%, increasing 2005 gains to 2.4%.

China Watch:

February 18 - Bloomberg (Jianguo Jiang): "China's economy is expected to grow at least 9 percent this year, the Economic Information Daily said... Industrial production will probably increase about 15 percent, Tang was reported to have said."

February 17 - Bloomberg (Philip Lagerkranser): "China's money supply growth in December stayed within the government's target after banks were ordered to limit lending to industries including steel, autos and real estate. M2, which includes cash and all deposits, expanded 14.1 percent from a year earlier to a record 25.8 trillion yuan ($3.1 trillion) after growing 14.6 percent in December..."

February 16 - Bloomberg (Yanping Li): "China's retail sales during the week-long lunar new year holiday rose 16 percent from a year earlier, the official Xinhua news agency reported... with restaurants registering an increase of more than 20 percent over last year's holiday... China's retail sales rose 13.3 percent...in 2004..."

February 17 - Bloomberg (Yanping Li Parra-Bernal): "China's retail sales may rise about 10 percent this year, China Central Television reported, citing Vice Commerce Minister Zhang Zhigang. Sales of production materials are expected to grow 12 percent from 2004, Zhang was quoted as saying."

February 17 - Bloomberg (Yanping Li Parra-Bernal): "China plans to safeguard the country's growing foreign reserves by curbing risk and improving investment returns, according to Guo Shuqing, head of the State Administration of Foreign Exchange. A 'strict risk-control mechanism' will be established, Guo told officials of the foreign exchange regulator... China 'aims for better returns on the basis of ensuring the safety and liquidity of its foreign reserves,' Guo said... The country's foreign reserves stood at about $610 billion at the end of 2004, the highest in the world after Japan's $824 billion."

February 16 - Bloomberg (Loretta Ng): "PetroChina Co., the nation's biggest oil company, plans to spend 27.2 billion yuan ($3.3 billion) expanding the country's largest petrochemical project to meet China's demand for fuels and raw materials to make plastics..."

February 15 - UPI: "An official from the Shanghai Paper Trade Association said China's consumption of wood pulp for toilet tissue was worrisome, China Daily reported... Wood pulp used to produce various kinds of paper has become China's third largest import after petroleum and steel... The country consumed 8.2 million tons of wood pulp in 2004, of which slightly more than 6 million tons were imported. 'While I am happy to see many young people adopt paper tissue for its convenience, a sign reflecting our social development and helping improve our industry to some extent, I am beginning to worry about our large wood consumption,' Wang said."

Asia Inflationary Boom Watch:

February 15 - Bloomberg (Kartik Goyal): "Indian exports rose 33 percent in January, boosted by shipments of textiles, gems and jewelry to the U.S., the country's biggest market overseas. Exports were $6.7 billion last month... Imports rose 40 percent to $9.58 billion, boosted by higher oil costs. The trade deficit widened to $2.8 billion from $1.78 billion a year earlier."

February 17 - Bloomberg (Amit Prakash): "Singapore's economy grew at an annual 7.9 percent pace in the fourth quarter, triple the government's earlier estimate, as pharmaceutical companies raised production."

February 14 - Bloomberg (Anuchit Nguyen): "Thailand's new vehicle sales in January rose 18 percent from a year earlier on new models and low loan rates, Toyota Motor (Thailand) Ltd. said."

February 15 - Bloomberg (Soraya Permatasari): "Auto sales in Indonesia rose 50 percent in January from the same month last year, according to figures released by PT Toyota-Astra Motor... Total auto sales in the country rose to 45,481 units last month from 30,356 a year earlier..."

February 16 - Bloomberg (Yoolim Lee): "Indonesian President Susilo Bambang Yudhoyono said the government aims to boost growth to an average annual pace of 6.6 percent over the next five years, driven by exports, consumer spending and investment in infrastructure. The $208 billion economy will expand 5.5 percent this year, the fastest pace in nine years..."

February 17 - Bloomberg (Jason Folkmanis): "Vietnamese exports to the U.S. rose 15 percent in 2004, as shipments of furniture, oil, cashews and coffee made up for quotas on apparel exports."

Global Reflation Watch:

February 15 - Bloomberg (Tim Kelly): "Japan's current account surplus expanded 28 percent in December as imports fell faster than exports. The surplus grew to 1.78 trillion yen ($16.9 billion) from 1.39 trillion yen in November... From a year earlier, the surplus widened 35 percent to 1.61 trillion yen."

February 15 - Bloomberg (Rainer Buergin and James Hertling): "European Central Bank council member Christian Noyer said interest rates in the dozen-nation euro economy are 'accommodative' and 'a more neutral stance' will be required eventually. Accommodative monetary policies around the world will have to be adjusted, even if it is at a moderate pace, in order to avoid the risk of inflationary pressures building up,' Noyer, who is also the governor of the Bank of France, told the International Herald Tribune in an interview published today. The bank confirmed his comments."

February 15 - Bloomberg (Chris Malpass): "European Central Bank council member Arnout Wellink is worried about rising house prices in some of the 12 countries that share the euro and in the U.S., Financial Times Deutschland said, citing an interview. 'The impact of asset prices like house or share prices on economic activity is much greater today than used to be the case,' the German newspaper cited Wellink as saying. 'The rise in real estate prices in some euro countries, but also in the U.S., causes me concern,' he told the paper."

February 14 - Bloomberg (Susanna Ray): "European airlines' passenger traffic rose 9.6 percent in January, continuing last year's growth on higher demand for flights to Asia. Traffic on Asian routes climbed 13 percent from a year earlier, according to preliminary figures posted on the Brussels-based Association of European Airlines' Web site. European traffic surged 12 percent. Demand across the North Atlantic rose 0.1 percent."

February 16 - Bloomberg (Sam Fleming): "U.K. wages grew at the fastest pace in almost three years during the last three months of 2004, adding to concerns about inflation in Europe's second-biggest economy. Average earnings excluding bonuses gained an annual 4.5 percent in the three months ended December..."

February 16 - Bloomberg (Monika Rozlal): "Polish workers in the mining and energy industry will seek pay increases that exceed the inflation rate after accelerating economic growth has boosted companies' profits, the Rzeczpospolita newspaper reported. KGHM Polska Miedz SA, Europe's No. 2 copper maker has agreed to raise salaries by 7 percent, while workers at PKN Orlen SA, the country's No. 1 oil company, are demanding 10 percent more pay... Miners at Jastrzebska Spolka Weglowa SA are seeking an 8.5 percent increase and unions at Kompania Weglowa SA, the country's top coal mining company, have called for salary increases of as much as 15 percent..."

February 16 - Bloomberg (Vladimir Todres): "Russia's foreign trade surplus rose 48 percent last year, as the country pumped more oil and sold it at higher prices, enabling exports to outpace imports for the second consecutive year. The surplus totaled $88.4 billion, compared with $59.9 billion in 2003..."

February 16 - Bloomberg (Tracy Withers): "New Zealand's economy is expanding faster than expected, buoyed by domestic spending, Finance Minister Michael Cullen said. 'Strength in the economy has remained greater for longer,' Cullen said during an appearance before the parliament's finance & expenditure committee... 'The economy is operating close to capacity, fed by domestic demand.' Central bank Governor Alan Bollard raised interest rates six times last year to a four-year-high of 6.5 percent..."

February 16 - Bloomberg (Tracy Withers): "Workers at New Zealand manufacturing companies want a 7 percent wage increase to reflect rising earnings by the industry, according to the Engineering, Printing and Manufacturing Union. 'The economy is doing well and company profits are up,' Andrew Little, national secretary of the union, said... 'Companies can afford to pay above the usual cost-of-living increase.'"

Latin America Reflation Watch:

February 16 - Bloomberg (Thomas Black): "Mexico's economy expanded in the fourth quarter at the fastest pace in more than four years, buoyed by a surge in consumer spending. Latin America's largest economy grew 4.9 percent from a year earlier after expanding 4.4 percent in the third quarter..."

February 17 - Bloomberg (Guillermo Parra-Bernal): "Brazil's retail sales rose 9.3 percent last year, the fastest pace since at least 2001, led by spending on vehicles and home appliances financed with loans. In December, retail, supermarket and grocery store sales, as measured by units sold, rose 11.4 percent ..."

February 16 - Bloomberg (Alex Emery): "Peru's economy grew at the fastest pace in 33 months in December as copper, fishmeal and natural gas output expanded. Gross domestic product expanded 9.1 percent in November from a year earlier..."

February 16 - Bloomberg (Alex Kennedy): "Venezuela's economy grew a fifth quarter in the October-December period as record high oil prices fueled increased spending by the world's fifth-largest crude exporter. Gross domestic product grew 11.2 percent in the fourth quarter from the same year-ago period, the central bank said in a statement. The economy grew a record 17 percent last year..."

February 14 - Bloomberg (Alex Kennedy): "Venezuela boosted government spending by almost half in December on bigger outlays for social programs such as food and medical care, paid for by surging revenue from record oil prices. President Hugo Chavez's government raised spending 47 percent in the month from a year ago..."

Dollar Consternation Watch:

February 17 - Bloomberg (Khoo Hsu Chuang): "Malaysian central bank Governor Zeti Akhtar Aziz comments on global imbalances caused by the U.S. current and fiscal account deficits and calls for adjustments to the ringgit peg. 'The current discussion on how to address existing global imbalances appears skewed toward pressure for a realignment of exchange rates.' 'Exchange rates are only a small part of the solution.' 'Competitiveness requires more than just adjustments to exchange rates. It requires fundamental structural changes in the countries concerned. The appreciation of regional currencies is not likely to eliminate these imbalances.' 'In fact, excessive focus on the exchange rates as corrective mechanisms for these imbalances has led to speculative inflows into Asian economies.' 'This has required policy makers to intervene to avoid a sharp appreciation of their currencies, thus accumulating large reserve holdings.' Clearly, exchange rates offer only a partial solution and excessive focus could be counter productive. It risks sharp movements which at the extreme could be highly destabilizing to the global currency, capital and commodity markets.' 'The long-term solution would be for the U.S. to increase its savings and moderate its import demand, and for the rest of the world to increase its demand and exports.' 'Such a transformation will eventually occur, though not overnight. With rising income levels in regional economies, there is potential for an intrinsic source of demand within the region.' 'The rebalancing of demand across the world will eventually reduce the prevailing imbalances.'"

February 17 - Bloomberg (John Brinsley): "The yen may rise as much as 10 percent to 95 a dollar this year and the government shouldn't try to halt the advance, Japan's former currency policy chief Eisuke Sakakibara said. A 2.4 percent slide in Japan's currency this year 'is over,' and it will gain past 100 to the dollar in the next few months as investors realize the U.S. Federal Reserve will stop raising interest rates, Sakakibara said... 'Breaking 100 is just a natural market move, which authorities should let happen,' Sakakibara said. A level of '95 yen for the Japanese economy at this moment is not disastrous. If it goes beyond 90, and goes to 80 or 70, I would recommend intervening,' or selling the currency."

California Bubble Watch:

February 16 - San Francisco Chronicle (Kelly Zito): "The unrelenting Bay Area real estate market kicked off 2005 in high gear, as home prices in January soared 20 percent from a year ago and sales reached the highest level for the month since 1989. Though the start of the year is typically the slowest time in the real estate market, abnormally strong demand, relatively short supply of properties and an influx of international buyers pushed the median price for a single-family home in the nine counties to $556,000, just below the record of $560,000 set in November but a whopping 20 percent more than the year-ago price of $463,000. It was the strongest year-over-year appreciation rate in four years..."

Bubble Economy Watch:

February 14 - Bloomberg (David M. Levitt): "Rents for some office space in midtown Manhattan rose 5 to 10 percent in the last year, reversing four years of flat or falling prices, Crain's New York Business reported. The increases came at opposite ends of the bulk office market: spaces of 250,000 square feet or more in some of the largest skyscrapers, and 10,000 square feet or less in prestige buildings... The trend raised landlords' hopes for a broader rent pickup later this year, the weekly newspaper said."

Financial Bubble Watch:

February 17 - American Banker (Damian Paletta): "The thrift industry had record earnings last year thanks to brisk mortgage originations... Net income rose 2% to $13.96 billion. Thrifts originated $689.1 billion of mortgages... Their assets rose 19.6% to $1.31 Trillion."

Mortgage Finance Bubble Watch:

February 16 - CNN/Money: "Upper-end real estate is red hot, with listings as high as $75 million for a 25,000-square-foot Hamptons mansion that includes its own golf course, and much stronger sales of eight-figure homes, according to a published report. USA Today reports that the number of homes selling for $10 million or more increased to 28 in 2004, up from 18 in that price range in 2003."

February 16 - South Florida Business Journal: "More than 3,000 homes changed hands in each of the three South Florida counties in the fourth quarter, at prices ranging from 27 percent to 34 percent higher than the same period the year before. The most homes moved in Fort Lauderdale. The 3,115 single-family, existing homes that sold in the fourth quarter were down 15 percent from the 3,656 homes that sold in the area for the same period the year before, though. But the homes fetched higher prices - 27 percent higher. The median sales price in Fort Lauderdale in the fourth quarter was $299,900, up from $237,000 in the fourth quarter the year before... Prices also increased faster in West Palm Beach-Boca Raton. The median sales price in the most recent period was $339,100, up 34 percent from $253,000 for the fourth quarter 2003."

Highlights from The Bond Market Association's February Research Quarterly:

"Total bond issuance declined in 2004, to $5.48 trillion, compared to $6.81 trillion in the previous year, as economic growth continued and interest rates, especially at the short end of the yield curve, moved up."

Gross issuance of Treasury coupon securities totaled $853.3 billion in 2004, a 14 percent increase over the $745.2 billion raised in the previous year... Net cash raised from both bills and coupons totaled $363.9 billion for the year... TIPS have become increasing popular as a new asset class and amid some heightened concern about inflation. In the past year, Treasury has demonstrated its commitment to this growing sector through the expansion of its product offerings. Treasury issued $63 billion... Daily trading volume of Treasury securities by primary dealers averaged $497.9 billion I 2004, up 14.8 percent...

Long-term debt issuance by federal agencies totaled $896.7 billion in 2004, down 29.3 percent from the $1.27 trillion issued in 2003.

Total short- and long-term municipal issuance in 2004 of $418.5 billion was the third highest ever, but less than the record $452.6 billion set in 2003.

New corporate bond issuance volume declined to $711.0 billion in 2004, a 7.0 percent decrease from the $764.6 billion issued during 2003... Credit spread tightening continued in full force through the end of 2004. The Merrill Lynch Investment Grade Corporate Market Index...had option adjusted spreads to Treasuries narrowing by 18 basis points, to 83 basis points by year end, and the High Yield Corporate Master index narrowing by over 100 basis points, to around 300 basis points. With both the high-yield and investment-grade spreads the tightest since 1998...

Total convertible bond issuance totaled $32.6 billion in 2004, a 55.2 percent decline from $72.7 billion issued in 2003.

New issue activity of non-convertible investment-grade bonds totaled $602.8 billion in 2004, a 6.4 percent increase... Financial services industry sector issuance continued to grow. Commercial banks issued $172.1 billion investment-grade bonds for the year, a 21.2 percent increase... Similarly, the investment banking sector increased issuance volume 23.0 percent, to $110.8 billion in 2004. High-yield non-convertible debt issuance declined during 2004, to $108.2 billion, a 12.2 percent decline from the totals in 2003... The average daily corporate trading volume by primary dealers in bonds with maturities of greater than on year increased 1.6 percent in the fourth quarter, to $21.5 billion...

Issuance of asset-backed securities (ABS) totaled $896.6 billion in 2004, breaking the previous annual issuance record of $585.1 billion set in 2003. Issuance in the ABS market has increased every year since 1985, when the asset class was first introduced. Since 1997, new issue activity has increased almost 400 percent and has nearly doubled since 2002. Most ABS pay a floating-rate coupon, which appeals to investors who may be concerned with the fixed-income market in a period of rising interest rates. Tremendous growth in the market reflects the level of consumer borrowing in the last several years... Home equity loans (HEL) comprise the largest ABS sector, accounting for nearly 50 percent of total issuance in 2004 and 40 percent in 2003...

Issuance in the HEL sector increased 80.8 percent in 2004, to $421.4 billion, compared to the $233.1 billion issued in 2003. Fourth-quarter to fourth-quarter issuance nearly doubled, totaling $102.7 billion in 2004... Yield spreads to Treasuries of 3-year home equity ABS ended the year about 10 basis points lower from the end of the third quarter. Issuance in the auto loan sector decreased to $68.4 billion in 2004, down 13.5 percent... New issue activity in the credit card sector totaled $51.2 billion in 2004, down 22.7 percent from the $66.2 billion issued in 2003... The student loan sector capped off a very active year with $44.7 billion in issuance, up 12.0 percent from the $39.9 billion issued in 2003."

Mortgage-related securities issuance, which includes agency and non-agency pass-throughs and CMOs, decreased 42.6 percent in 2004, to $1.76 trillion... Issuance of agency MBS decreased to $1.02 trillion in 2004, down 52.2 percent... All three agencies - Fannie Mae, Freddie Mac and Ginnie Mae - decreased issuance... Private-label MBS continued to be the bright spot in the mortgage-related market, totaling $387.4 billion in 2004, up 12.4 percent...

The average daily volume of total outstanding repurchase (repo) and reverse repo agreement contracts totaled $4.95 trillion in 2004, a 22.4 percent increase from the $4.04 trillion outstanding in 2003. Daily outstanding repo agreements averaged $2.87 trillion this year, a 21.8 percent increase... The data represent financing activities of the primary dealer reporting to the Federal Reserve Bank of New York and include repo and reverse repo agreements involving U.S. government, federal agency, agency mortgage-backed and corporate securities... In excess of $348.5 trillion in repo trades were submitted by (The Government Securities Division of the Fixed Income Clearing Corporation) participants in 2004, with an average daily volume of approximately $1.4 trillion.

The outstanding volume of money market instruments, including commercial paper, large time deposits and bankers' acceptances totaled $2.87 trillion at the end of 2004, an increase of 4.7 percent from the total in September 2004.

It Has Everything to do with 'Finance,' Mr. Chairman

I found Chairman Greenspan's testimony this week, Wednesday before the Senate Banking Committee and Thursday before the House Committee on Financial Services, absolutely captivating. In particular, the in depth discussions of the loo ming Social Security and Medicare shortfalls (ballooning contingent government liabilities), the GSEs, and the Current Account deficit get very close to the core of some of the most vexing issues of contemporary finance and economics. Below I have included numerous excerpts from the two Q&A sessions. The hearings offered much to contemplate and debate.

I will begin with the decisive general issue of Monetary Disorder:

A comment from Senator Paul Sarbanes: "...I recall four years ago you (Greenspan) came before us...and you told us...this was when we were projecting over a 10-year period a $5.6 trillion surplus in the federal budget, a $5.6 trillion surplus projected over 10 years. Now we're projecting a $3.7 trillion deficit. That's a turnaround, a rather staggering turnaround, of $9.3 trillion dollars, almost $10 trillion."

How is it possible to effectively debate and craft legislation to deal with mushrooming government contingent liabilities when budget forecasts have been so wildly off the mark? And while Mr. Greenspan once again asserts that the Fed has "maintained a stable monetary system" (see his response to Rep. Paul below), this is rather preposterous. The reality of the situation is an environment fraught with historic Monetary Disorder, with radically distorted government revenues at both the state and federal level one of many manifestations. Credit inflation and attendant excess fostered Bubbling government receipts, all too similar to the current strain that is artificially swelling the coffers of corporate America.

These wild distortions in the flow of finance through both the "financial sphere" and "economic sphere" create a serious dilemma for decisions makers and market participants throughout. This is the case for our politicians, businesspersons, bankers, consumers, and market professionals. How is it, these days, possible for prospective California home buyers to make sound decisions? How about the manufacturing executive faced with spiraling health care costs here at home? How about corporate CFOs generally? Why not continue to repurchase stock and pay fat dividends, while passing on uncertain investment in new capital assets? And what about bond and equity investors? Is it rational to focus on valuation, or simply "benchmark" and play the Bubble with the crowd?

I particularly sympathize with our legislators in Washington, today faced with the formidable task of grasping the nature of the looming Social Security (government contingent liability) Bust. Mr. Greenspan's testimony will certainly add to the unavoidable complexity of the debate. And I can only hope that the issue of "national savings" takes center stage.

Representative Tom Price: "My question relates to our savings rate as a nation and my understanding that the household savings rate is low as it relates to our history as a nation and also as it relates to other industrialized nations. And so I would ask you what your thoughts are on anything that we might do in terms of policy that would positively and significantly affect our savings rate as a nation."

Mr. Greenspan: "That's one of the most difficult problems government has had Congressman, in trying to address this particular question. And the reason is that it's not just a question as we tend to create vehicles to save, such as 401(k)s or IRAs or the like. Because what we really have to do is to get people to consume less of their income because that's what savings is. If you don't consume less of your income and you're building up a 401(k), it's essentially saying that you just drew the funds from other forms of savings and you did not increase your aggregate amount of savings. So the issue really gets down to the question of how do you increase income relative to consumption, and that is not very easy for government to address per se. What we can do is find measures which will augment the growth rate in the economy, create incentives for growth and the like. But unless you impose some things such as a consumption tax, which economists have argued for, which I suspect has very little support in the Congress, it's difficult to see how you come to grips directly with that issue."

These valuable insights are, regrettably, not indicative of the general tenor of Mr. Greenspan's testimony. They do, however, offer a good starting point for discussion. When households borrow against inflating home equity to fund their 401(k)s, there is a resulting increase (inflation) in both system Credit and financial market liquidity. This Credit expansion would augment available "finance," although this would have absolutely nothing to do with the concept of traditional "savings." Contemporary finance is certainly not constrained by the amount of available "savings" when it comes to creating additional Credit. And as we have witnessed, mortgage debt and securities leveraging have the potential for unchecked expansion. Such a Credit Bubble creates an incredible amount of self-reinforcing "finance"/liquidity. And the longer the Bubble inflates, the greater the deviation of "finance"/liquidity from actual underlying "savings."

The Mortgage Finance Bubble, in particular, incites household sector over-consumption - the antithesis of "savings" both from a micro homeowner level and the macro economy perspective. The massive U.S. Current Account Deficit is representative of the disastrous state of the U.S. economy's true "national savings" - having manifested from the financial sector's ballooning and household sector's unprecedented borrowing and spending binge.

From Mr. Greenspan: "[W]we're going to need to build the capital stock, plant and equipment because that is the only way we're going to significantly increase the rate of productivity growth which will be necessary to supply the real goods and services that the individuals who are retired..."; "[I]f we are going to do that, we have to have a significant increase in national savings..." "What the test in this context of our individual financial systems should be up against is do they or do they not create savings to create the capital assets? Or put it another way: Are they fully funded or not?"

I agree with the Chairman - that "we're going to need to build the capital stock, plant and equipment... to supply the real goods and services" to our future retirees - while adding that our foreign trading partners will at some point balk at trading goods and resources for endless dollar IOUs. This gets to the essence of true savings - the economy's direction of resources to capital investment and tradable goods and services at the expense of current consumption. But this is altogether a separate issue from whether individual accounts are "fully funded or not."

As an example, think of manufacturing Company A that has been investing soundly in added productive capacity in part to fund future liabilities associated with its employee defined benefit pension plans. And perhaps costs have increased and the actuaries say that the plan is today marginally "under funded." Compare this to Company B that buys back stock and invests little in its business, while funding employee defined contribution plans that (chasing performance) acquire casino and restaurant stocks, along with "jumbo" mortgage-backed securities. Company B's plan would today surely be "fully funded." With respect to future prospect for the economy as a whole, we would be ok with a lot of Company As. We would, however, be propagating eventual financial and economic crisis with a preponderance of Company Bs. It is important to separate the issue of sufficient sound investment for the economy from the current verity of pension plans' financial statements (assets covering liabilities).

Mr. Greenspan: "The major issue of personal accounts is essentially economic." "Our problem with respect to retirement has got nothing to do with finance; it's got to do with real assets, real physical resources, and goods and services that people consume."

This is where I take strong exception with our Fed Chairman, and I believe this is among the most important economic issues of our time. I am not convinced that the problems associated with social security and ballooning government contingent liabilities are "essentially economic." Furthermore, I believe wholeheartedly that the essence of our economy's failings have Everything to do with Finance.

It is central to my (expanding on the work of the great Hyman Minsky) "Wall Street Financial Arbitrage Capitalism Paradigm" thesis that the current financial apparatus has evolved to the point of being incapable of nurturing "national savings" and sound investment in productive capacity. Instead, the design and nature of the system has emerged to lend excessively to the asset markets and securities speculators, creating "finance"/liquidity in destabilizing excess. Massive markets in "structured products" and derivatives are the financial tail that wags the economic dog. While currently masked by runaway asset and liquidity inflation, we face an abhorrent predicament that has developed over decades and has been fully nurtured by the Greenspan Fed. The system is geared up to finance real estate and securities, in the process creating the ABS and MBS for playing speculative spread returns.

Having the government increase borrowings to fund individual retirement accounts has the potential to prolong the Credit Bubble and create additional marketplace liquidity - nourishing The Dysfunctional Finance Beast and its asset Bubbles, over-consumption, misdirected investment, and Bubble economies. Mr. Greenspan stated that "pay-as-you-go creates no savings; it merely transfers from taxpayers in any particular period to beneficiaries." Well, that is true and not a preferred arrangement. But do we really want to create and direct only greater liquidity - "throw another big bone" - to the same "financial sphere" that financed the technology Bubble, the telecom debt debacle, the Bond Bubble, the GSE Bubble, The Mortgage Finance Bubble, The Great California Housing Bubble, the Leveraged Speculating Bubble, unprecedented consumption and massive Current Account Deficits?

From Mr. Greenspan: "So that the question really is, if it doesn't affect national savings, it should not affect the supply and demand for funds." Well, the supply and demand for "funds" is not the critical issue. Rather, the source and quantity of the finance; how "finance"/liquidity is directed; and the attendant allocation of real resources. And he says to "have capital investment, you need to have savings." This is another misconception. There is today unparalleled global liquidity excess that provides abundant cheap finance from China and India to Eastern Europe and Latin America. Here at home, there is clearly sufficient liquidity to fund virtually any subprime mortgage borrower, all securities speculators, millions of new homes and condos, reckless real estate speculation, and virtually any M&A project. The issue is certainly not a dearth of Credit, liquidity or "savings," but a system that promotes consumption, myriad excesses and endemic financial speculation at the expense of capital investment.

On a related matter, it is amazing to witness the transformation of Mr. Greenspan to a GSE growth antagonist. Where was our Fed Chairman from 1997 to 2003 when GSE assets ballooned from $1.1 Trillion to $2.8 Trillion? Still, he does at least seem to grasp the issues rather clearly these days - "they have, granted by the marketplace, a significant subsidy which enables them to sell debentures significantly..." "The problem basically is that left to their own devices, the GSEs have a subsidy granted not by law but by the marketplace, which therefore gives them unlimited access to capital below the normal competitive rates, and that therefore, given no limits on what they can put in their portfolios, they can, by merely their initiative, create an ever-larger increase in portfolio, which, given the low levels of capital, means they have to engage in very significant dynamic hedging to hedge interest rate risks. If you get large enough in that type of context and something goes wrong, then we have a very serious problem." "because these institutions, if they continue to grow, continue to have the low capital that they have, continue to engage in the dynamic hedging of their portfolios, which they need to do for interest rate risk aversion, they potentially create ever growing potential systemic risk down the road..."

Interestingly, the leading markets and derivatives proponent these days links marketplace distortions and derivatives exposure to potential systemic fragility. Well, well... I am at the same time frustrated and fascinated by the belated recognition that a "significant subsidy" "granted by the marketplace" affords the opportunity for "unlimited access to capital" with growth "given no limits." "If you get large enough in that type of context" and "have to engage in very significant dynamic hedging...they potentially create ever growing potential systemic risk." And while Mr. Greenspan was describing GSE-related systemic risks, I contend that precisely these dynamics are even more applicable in the context of ballooning U.S. financial assets and liabilities.

This evening I assume that Mr. Greenspan will also at some point belatedly testify that a marketplace imperfection (the dollar's status as "world's reserve currency, and resulting highly-liquid markets for dollars, U.S. securities, and dollar derivative protection) granted the U.S. government and financial sector unlimited access to "capital" that fostered massive U.S. current account deficits and attendant foreign-sourced liabilities. And that the explosion of foreign dollar holdings, currency risk aversion, and dynamic hedging of international dollar exposure created an ever growing system risk. Why not have these discussions right now?

Senator Debbie Stabenow: "Turning to a different subject in terms of our debt, and this actually goes back to my concerns on manufacturing. But it relates indirectly to manufacturing, when we look at our dependency on inflows of foreign capital to finance economic activity. And then I would argue on the other hand our difficulty in enforcing trade agreements against those who own so much of our foreign debt, I think this is going to be making it more and more difficult for us. I would - I'd welcome your thoughts on that. But when we look at the fact that -- and I have just a small chart, but in the last four years, foreign holdings of U.S. Treasury debt has gone from basically a trillion to $1.85 trillion. And about half of that's owned by China and Japan. And I think people would be shocked to know who else owns our foreign debt as we're talking about financing private accounts through Social Security or other privatization efforts or anything else that we're doing for that matter -- the war, anything else -- that South Korea, Taiwan, Germany, Hong Kong, OPEC, Switzerland; we have a lot of foreign entities that hold our debt, portions of our debt right now.

And I'm wondering at what point, particularly when we're looking at $2 trillion or we're hearing now 20 years down the road, two decades, potentially $5 trillion in new debt added, if in fact privatization in some part goes into effect of Social Security, at what point do you believe that we should be concerned that our foreign financing of our national debt is becoming too great?"

Mr. Greenspan: "Well, Senator, we have a difficult problem that people find U.S. Treasury securities the safest in the world. And it's not as though we're forcing them to go buy our securities, nor do I believe we have any legal mechanism to prevent them from buying them in the open market, which is what they do. So I'm not sure how to address this issue because I'm not sure what we can do about it."

Representative Walter Jones: "This is my question: If Japan owns over $700 billion of U.S. debt, mainland China and Hong Kong together hold over $250 billion of U.S. debt, Mr. Chairman, the question is, if this deficit continues to rise, and it looks like we're not going to do what needs to be done to hold it from rising, what would be the impact on U.S. financial markets if Japan or China were to stop buying U.S. Treasury bonds? It might be a hypothetical, but I would appreciate if you'd give us your opinion."

Mr. Greenspan: "Well, we've looked into that question, and I think that we've concluded that the effect of foreign borrowing of U.S. Treasury instruments has lowered long-term interest rates a modest amount. And therefore, if they were to choose to stop buying or to sell, it would raise interest rates, but again, by a modest amount. And the reason for this is that U.S. Treasury securities, as big as they are and as important as they are, are only a fraction of the competing securities around the world, which is what this market is. It's a worldwide market, and in a sense it's a market in which interest rates in various different localities and for various different instruments are all arbitraged. So if there is a significant purchase or sale of U.S. Treasury, it's sort of laid off on all other parts of the market at the same time so that the adjustment is not particularly great.

But the issue you raised is a much deeper one. If we run into serious trouble with respect to our deficit, it's not a question of whether foreigners will buy or not buy our securities; it's whether Americans will buy or not buy our securities..."

It is simply not credible that our learned and clever Federal Reserve Chairman has garnered such critical insights with respect to the GSEs and interest-rate market dynamics, while remaining such a hopeless ignoramus when it comes to the U.S. Current Account, ballooning foreign dollar holdings, and systemic risk inherent in the mushrooming currency derivatives markets. I don't buy it. I don't buy it. I don't buy it! I hope Mr. Greenspan and others will contemplate the reality that the GSE Dilemma is a Microcosm of the U.S. Dollar Quagmire. And perhaps rising U.S. rates will for awhile lend support to our vulnerable currency. Then again, it has always been the scenario of sinking bond prices, widening spreads, and a faltering dollar that I have expected would most abruptly elevate systemic risk.

The dollar was notably unimpressive this week in spite of the jump in market yields and the marketplace's perception of a more hawkish Fed. The "reflation trade" is working well again, while U.S. markets are lagging the world. So, if U.S. bonds falter, crude spikes to $60, and the China, Asian and emerging economies surprise on the upside - I wonder if Asian central bankers will consider limiting additional dollar purchases. And, importantly, would such a development mark a momentous inflection point in the liquidity environment for global currency markets - most importantly, the market for what has been to this point unlimited liquidity available to sellers using dynamic trading strategies to hedge their dollar derivatives exposure (need to short large quantities of dollars, just call an Asian central banker!). While the timing of market dislocations and crises are great unknowables, at the end of the day it will be the dysfunctional "financial sphere" and the consequent maladjusted "economic sphere" that ensure a dollar breakdown. On many levels, it does have Everything to do with Finance.

Representative Ron Paul and Monetary Sanity:

Representative Ron Paul: "Mr. Greenspan, yesterday you were quoted as saying it was imperative that the Congress restore fiscal discipline. And of course you've made that point, I think, very often over the years. I have tried my best to vote accordingly, but sometimes I find myself in a lonely category.

I have found that we have a group here that is quite willing to vote for deficits for domestic programs. Then we have another group that's quite willing to spend for militarism abroad. Then we have another group that likes both. So if you look around for people who are willing to maybe cut in both areas, it's pretty hard to come by.

But you, in the past, in answer to some of my questions have answered that you believe that central bankers have come around to getting paper money to act in many ways just like gold, and therefore, there was less of an imperative for a gold standard. I haven't yet been convinced of that.

Take, for instance, the current account deficit. You know, under a gold standard there's a lot of self-adjustment. And we certainly wouldn't have the exchange rate distortions between the renminbi and the dollar. So I think there's a lot of shortcomings under the paper standard with the current account deficit.

Also, although the argument is made that the CPI reflects that there's little or no inflation, that if you look at the price of bonds or if you look at the cost of medicine, if you look at the cost of energy, there's a lot of price inflation out there. And also, if you look at the cost of houses, which are skyrocketing, which then is reflected into tax increases, the consumer is still suffering from a lot of price inflation that we in many ways in Washington try to deny.

But I think in an effort to discipline the Congress that the Federal Reserve would have a role to play as well, because in many ways the Federal Reserve accommodates the spending because you're capable of buying bonds, and when you buy our debt that we create, you do it with credit it out of thin air. So it is that facility of the monetary system that literally encourages or actually tells the Congress they don't need to be disciplined because there's always this fallback, that we don't have to worry, the money's out there, which would not be available, obviously, under a gold standard. But I would like to quote from a famous economist that sort of defends my position. It says -- he says, 'In almost a hysterical antagonism toward the gold standard, is one issue which unites statists of all persuasions. Government deficit spending under a gold standard is severely limited. The abandonment of the gold standard made it possible for the welfare statists to use the banking system as a means to an unlimited expansion of credit. They have created paper reserves in the form of government bonds.'

Further stating: 'In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statist antagonism toward the gold standard.' And, of course, I'm sure you recognize those words because this is your argument."

Mr. Greenspan: "I do."

Representative Ron Paul: "And I would say that isn't it time -- if we ever get concerned about our deficit spending, and we've considered a real imperative, why shouldn't we talk about serious monetary reform? Do you think that the gold standard would limit spending here in the Congress?

Mr. Greenspan: "First of all, that was written 40 years ago, and I was mistaken, in part. I expected things that didn't happen. And nonetheless, my general view towards the type of gold-standard effect remains to this day -- my forecast of what was going to happen subsequent to that period has proved, fortunately, wrong. And as I said to you in the past, we have tried to manage the Federal Reserve over the years, really since October 1979 - because remember, up to that point we were in some very serious inflationary trouble -- since then I think we have been remarkably successful, in my judgment.

And while I still think that the gold standard served us very considerably during the 19th century, and mimicking much of what the gold standard does is what we do today, I think in that context so far we have maintained a stable monetary system. And I do not think that you could claim that [the] central bank is facilitating the expansion of expenditures in this country."