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Lies, Damn Lies, and 'Analysis'

Balance Sheet of Household Sector
Financial Sector Debt Outstanding

Wow, that was one week of wild volatility, interesting divergences, and major crosscurrents. For the week, the NASDAQ Telecommunications index dropped 5%, while the small cap Russell 2000 gained 4%. The Dow and S&P500 declined about 1%. Economically sensitive issues generally outperformed, with the Transports adding 3% and the Morgan Stanley Cyclical index gaining 2%. The Morgan Stanley Consumer index increased 1%, while the Utilities were largely unchanged. The broader market was quite impressive, with the S&P400 Mid-Cap's 2% gain not quite keeping up with the small caps. The tech wreck and telecom debt disaster continued this week, with the NASDAQ100 declining 2%. The Morgan Stanley High Tech index dipped 3%, while the Semiconductors and The Street.com Internet index lost 2%. The Biotechs generally added about 2%. With Wall Street analysis under the spotlight, the AMEX Securities Broker/Dealer index was hit for 3%. The bank stocks held their own, ending a particularly wild week about unchanged. With bullion up $1.90, the HUI Gold index added about 3%.

The Credit market enjoyed the unsettled stock markets and sinking oil prices. For the week, two-year Treasury yields declined 11 basis points to 3.35%. Two-year yields have dropped 35 basis points over the past two weeks. Five-year yields dropped 10 basis points to 4.50%, and 10-year yields declined 5 basis points to 5.16%. The long-bond saw its yield drop 2 basis points to 5.65%. Implied yields on December eurodollars dropped 17 basis points (50 basis points in two weeks!). Benchmark mortgage-back and implied agency yields declined 5 basis points. The benchmark 10-year dollar swap spread widened 3.5 to 66.5. The spread on the Fannie Mae 5 3/8 2011 note narrowed 1 to 67. The dollar index was unchanged for the week.

"A gradual improvement in the U.S. economy is expected to produce another record year for existing-home sales, according to the National Association of Realtors (NAR)… Even with sales easing off the big numbers at the beginning of the year, we expect existing-home sales to rise 0.3 percent this year to a total of 5.31 million, edging-out the record of 5.30 million in 2001… NAR forecasts the national median existing-home price for 2002 to be $155,300, an increase of 5.1 percent over last year. The typical new home price is expected to be $184,700 this year, up 6.1 percent from 2001, in part due to higher lumber prices."

This week from Countrywide Credit: "Average daily loan applications remained robust at $851 million, an increase of 16 percent over March of last year. Countrywide's pipeline of loans in process was up 17 percent over the prior year at $21 billion. Application and pipeline trends continue to indicate strong fundings in the near future. Total mortgage loan fundings of $15.2 billion in March represented the third highest funding month in the Company's history. Purchase fundings reached a new record of $6.7 billion, a 15 percent increase over the prior month and a 63 percent increase over March last year…"

Total loan fundings were up 9% from February and 59% y-o-y. March home equity loan fundings were up 11% m-o-m and 106% y-o-y. Subprime fundings were up 19% m-o-m and 54% y-o-y. Countrywide now has a mortgage servicing portfolio of $355 billion, up from last year's $296 billion. The portfolio delinquency rate of 4.43% is down from February's 4.76%, but remains above March 2000's 4.32%.

MGIC reported a strong quarter, with insurance in force growing at a rate of almost 15%. "New insurance written in the first quarter was $23.6 billion, compared to $16.7 billion in the first quarter of 2001." Interestingly, 49% of new insurance written was for refinanced mortgages. The number of loans delinquent rose slightly to 3.48% (from 3.46% at year-end), and remain up significantly from the 2.67% delinquent at March 31, 2001. The company had "primary insurance in force" of $190.6 billion, up 16% y-o-y. First quarter losses of $59.7 billion were double year ago losses for the quarter.

Statistics are a strange beast. The following was extracted from Freddie Mac's response (from a few weeks back) to the WSJ's questioning the soundness of the company's rapid growth: "The Journal's contentions are baseless. Here are the facts…Our growth has been rapid, but not in relation to the overall growth of the residential mortgage market. In fact, during the past 5 years, Freddie Mac's total mortgage portfolio has grown only 3 percent faster than the growth in mortgage debt outstanding." To read these two seemingly straightforward sentences, one would be left with the impression that Freddie Mac put to rest any claim of excessive growth, while these "facts" would clearly prove those of us that claim absolutely reckless excess as nut balls. The only problem, however, is the facts are that over the past five years Freddie Mac's total assets have increased 255% to $617 billion, the company's retained mortgage portfolio has expanded 259% to $494 billion, and its "total book of business" (retained mortgages and guaranteed mortgage-backs held in the marketplace) has increased almost 90% to $1.14 trillion. That Freddie Mac management can present such alarming growth numbers in such benign terms is only further evidence that we live in an age of artful obfuscation, and that we must be especially circumspect in how we view statistics.

As we have highlighted repeatedly, total mortgage debt has exploded during the past five years. After expanding $921.6 billion, or 23%, for the five-year period 1991 to 1996, total mortgage debt jumped $2.78 trillion, or 57%, over the following five years. No reasonable analysis could hold that such enormous Credit growth is consistent with stable prices and, as we have witnessed, housing prices have inflated tremendously over the past five years. It is simply beyond credibility that Freddie Mac, Fannie Mae or others make contentions that growth has been anything but extreme. The only way these institutions that dominate the industry can present their individual growth as reasonable is to compare it to the growth of the market - a market that they dominate. Such presentation is disingenuous and a misrepresentation.

I appreciate that "discretion is the better part of valor," and would even be tempted to incorporate this wisdom into my persona in the future. Sometimes it's better to just look the other way - pretend you don't hear. But one can only be pushed so far, and the current environment dictates that we remain in the mode of analytical pit bulls. When the hot game was the Internet/technology and telecommunications debt Bubbles, we were all subject to appalling "analysis" and unrelenting disinformation. That Bubble has burst, and the involved Wall Street analysts are today justly under fire. Meanwhile, the hot game has rotated over to the expansive consumer debt sector and, amazingly, the nonsense propaganda and disinformation somehow continues right where it left off with the tech Bubble.

In last week's Barron's, Gene Epstein stated, "The economic recovery that began the first quarter of this year shows every appearance of being just the first leg in a long period of expansion." This follows his recent forecast that corporate profits were about to surge because of economic recovery and "productivity." These bold conjectures were presented without solid analytical support, but that is his prerogative. But he does leave us to presume that the previous protracted boom was either without significant maladjustments or that these maladjustments were rapidly and painlessly rectified during last year's shallow downturn. Similarly, apparently there are no structural issues behind dismal corporate profits, leaving us poised to enjoy the magic of cyclical recovery.

If this were merely a case of Mr. Epstein feeling compelled to rouse the crowd and climb daringly out on a rotting analytical limb, we'd be content to sit back and enjoy the entertainment. But Mr. Epstein is not satisfied with showboating, as he continues to espouse specious reasoning that would give some of Joe Battipaglia's old technology propaganda a run for its money. I realize I should have just turned the other cheek as I have in the past, but this time he crossed the line. For whatever reason, Mr. Epstein can't leave well enough alone, as he throws insults at us "credit-kvetchers." Considering all the crap that's going on, I suggest he pick his fights elsewhere; that is unless he is ready for an analytical brawl he cannot win. We've seen and been through too much to have much patience for lightweight badgering. There are those of that take our work and the soundness of the financial system very seriously, and we continue to be very troubled by runaway Credit and financial excess - excess that places the public directly in considerable harms way. Moreover, we are far enough into this process to have witnessed the costs of previous Credit excess; we have already seen many innocent victims lose their financial security.

The public is in the midst of a conspicuous borrowing and spending binge of historic dimensions, and to claim otherwise is poor analysis. Mr. Epstein knows enough to recognize this and should appreciate the consequences. Why not focus his efforts on this issue and perhaps direct criticism on those perpetrating gross lending excess, rather than throwing nonsense at those of us that have and continue to attempt to inform and educate a public that is generally unprepared and defenseless to the underlying fragility of a much-vaunted prosperity? Perhaps Mr. Epstein can provide us one historical example of an economy that has borrowed and consumed its way to prosperity.

In his March 18th piece, Much (Misplaced) Ado About Consumer Debt, Mr. Epstein states, "For the consumer sector as a whole, there is nothing especially worrisome about the growth of credit or the cost of debt-servicing. As I'll soon explain, there's even good evidence to believe that today's consumers borrow at about the same rate as their parents did decades ago." Now we've truly heard everything. As I said, he gives up nothing to the "Bat-Man." These statements are so preposterous that I am left with a sense that he made them only to incite us who know much better. It is certainly suspicious that Mr. Epstein does not even present the actual household debt numbers. I will, and they're especially worrisome. During the past five years, total household debt increased 51% to $7.72 trillion. There is nothing in history remotely similar to the $2.6 trillion of consumer debt added over this period, the resulting current account deficits, or the unprecedented accumulation of foreign liabilities, and to suggest this is somehow consistent with the way our parents borrowed decades ago is coming too close to gross misrepresentation.

In response to models incorporated into his analysis (constructed by Jason Benderly), Epstein stated, "Over the 56 years since 1946, consumer borrowing habits don't appear to have changed at all." Geez, I can't even believe I have allowed myself to respond to such nonsense. But I did go back to 1946 data and crunched some numbers. I see that, as a percentage of National Income, total personal sector liabilities were 31%, non-farm mortgages outstanding were 13%, and consumer Credit was 5% back in 1946. Have borrowing habits led to any meaningful changes since then? Well, at the end of 2001, total personal sector liabilities had increased to 133% of National Income, non-farm mortgages 70%, and consumer Credit 21%. Other noteworthy comparisons have non-farm corporate liabilities at 44% in 1946 versus 101% at the end of 2001, total mortgage debt 23% versus 93%, security Credit 3% versus 10%, state and local government debt 7% versus 17%, and total Credit market debt 192% versus 359%. Personal savings was 9% compared to about 2% today.

Consistent with the mortgage sector, Credit Bubble apologists must be creative to concoct "statistics" to support their case. And like Freddie Mac, Mr. Epstein conveniently uses them to obfuscate reality. Mr. Epstein states, "The real measure of the debt burden is…debt payments to disposable income." But the problem is that this analysis, in particular, will provide flawed results in today's environment. For one, Credit Bubble excesses have significantly distorted both the numerator and denominator in this ratio. Disposable income has been inflated, while consequences of previous Credit and speculative excess have forced the Fed to cut rates to 40-year lows - artificially reducing the numerator. This ratio is only valid if one believes that continued rapid growth in personal income and current 40-year low interest rates are sustainable. But they are clearly an anomaly.

To make the above analysis even sillier, this "debt burden" excluded mortgage debt. Today, in the age of rapid-fire mortgage refinancings, ultra-easy home equity loans, and huge real estate transaction capital gains, the non-mortgage consumer debt number by itself is not very valuable. To use this number in calculations demonstrating household debt load is disingenuous. In fact, the most alarming aspect of last year's consumer borrowing data was that record mortgage borrowing and enormous equity extraction saw no reduction in other consumer debt. Non-mortgage consumer debt actually rose strongly. Recognizing that many have been using cheap and tax-deductible mortgage finance to reduce higher-cost Credit card and revolving debt, this only provides further evidence of the extreme nature of the ongoing consumer-borrowing binge.

But the apologist Epstein wants us to believe that gross mortgage Credit excesses are benign as well. "And as most of us know, mortgages are better viewed as a form of forced saving that generally enhances household wealth." This is another example of where he paints the current atypical environment as normal, and also where he really starts to bury himself. We are in the midst of unprecedented mortgage Credit excess, and to associate "forced savings" with what is in reality unprecedented borrowings is a misrepresentation. In a traditional environment where households were reducing outstanding principle and building equity, we could state such a process is part of saving and household wealth creation. But this Bubble involves the exact opposite processes: massive mortgage Credit excess has set in motion self-feeding real estate inflation, borrowing excess, and over-consumption. This has nothing to do with saving or the creation of economic wealth. Apparently to support his contention that "forced savings" is enhancing "household wealth," Epstein states, "by the end of last year, net equity in owner-occupied homes stood at $6.6 trillion, up from $4.8 trillion as recently as early 1998." But since we know that household mortgage debt has increased by $1.4 trillion (32%) in the three years since 1998, it should be clear that this extraordinary 37% gain in "net equity" is a direct consequence of Credit inflation. It is, at best, flawed logic to associate inflated home values with savings or as evidence that consumer borrowings have not been excessive. Sound analysis would state the exact opposite.

Clearly enjoying himself, Mr. Epstein (swinging back and forth) becomes only more determined to play precariously out on the limb of flawed analysis. He dismisses what he calls the "let's-throw-in-the-kitchen-sink-and-really-worry method" that includes all nonfinancial sector and divides it by GDP - "the trend has been flat since the buildup of the 1980s, not to mention the fact that the cost of servicing this debt is about one-third lower…" We would argue that this very high ratio is in itself quite worrying, but does not do justice to the extreme nature of the Credit Bubble. The endemic nature of this ongoing terminal stage of Credit excess has significantly inflated calculated GDP. As we have tried to address previously, an increasing portion of this monetary Bubble economy's "output" is intangible and directly Credit-induced. This "output" may today help debt ratios, but it won't be of much value in the future servicing the economy's unmanageable debt load when the Bubble bursts.

But to be candid, if he would have only stopped right there, I would have bit my lip and walked away. But the overconfident dare devil Epstein (now way out on the limb doing one arm loopty-loops) saves his zinger for his parting shot at us Credit analysts: "So then you cheat. You throw in the debt owed by dealers in debt, banks and all other financial institutions, the assets of which are actually the debt owed by the nonfinancial sector to begin with. Then you call this double-counted debt figure 'total debt.' Recall that classic telegram: 'Start worrying (stop) Letter to follow.'" Those are fighting words.

The reason this is such a potent zinger and fascinating issue: there is definitely double-counting involved anytime one analyzes financial borrowings, and there is, regrettably, no way around this fact in the tangled web on financial sector assets and liabilities. Mr. Epstein knows this, and uses it skillfully but disingenuously (similarly to Larry Kudlow screaming "Philips Curve" at anyone questioning his New Economy propaganda - or the old, "Do you still beat your wife?" trick). But this quantification issue in no way justifies open disregard for the explosion of financial sector liabilities. Actually, it is precisely here that Epstein, along with the economic consensus, makes the critical mistake that will keep economic historians bemused for decades to come. For at least forty years there has been this notion that the financial sector is merely the "middleman" (intermediary), taking money from savers and lending it to borrowers. Since the assets and liabilities of these "intermediaries" offset, they are irrelevant to national wealth and can be ignored. As the thinking goes, it is necessary only to follow the amount of non-financial debt.

But it is the expansion of financial sector liabilities that creates the money and Credit that drives the entire system. To disregard financial sector expansion is to miss the vitally important analysis, especially today. What happens when financial sector liabilities (contemporary money and Credit) actually become THE Bubble? What happens when this Credit Bubble is the true source for inflated asset-prices, over spending, maladjusted GDP expansion, and unsustainable personal income growth? What happens when an historic financial Bubble is what keeps debt service to income ratios looking reasonable, while clearly unreasonable debt growth runs out of control? Are we to ignore the explosion of GSE debt, mortgage-back securities, asset-backed securities, and the related proliferation of interest rate swaps and derivatives? Do we disregard "structured finance" and it consequences because this would be double-counting? How about all the hedge funds, Wall Street financial leverage, and "special purpose vehicles" that has been the source of insatiable demand for securities? Double-counting? How does conventional doctrine deal with unsustainable financial sector borrowing and speculating as the key factors in system wide Credit availability? It cheats and ignores it. This is why you will not see reference to "financial fragility" in conventional analysis: the financial sector is not even considered.

The little secret is that, while the assets and liabilities of the financial sector do offset, the affects don't. And they don't by a lot. Expanding financial sector liabilities (money and Credit) inflate the value of household sector assets (home prices, stock values, amount of deposits, etc.). At the same time, the explosion of financial sector assets (ultra-easy Credit availability) leads to lower market interest rates, thus reducing the burden of household sector liabilities. This is a powerful combo. It is the enormous expansion of financial sector borrowings that is the major factor in inflating household sector perceived wealth (simultaneously inflating real and financial asset market values, with the nominal value of liabilities increasingly much less rapidly), while a seductively manageable "debt burden" seemingly defies the laws of finance. Fed data has household sector (including non-profit organizations) net worth increasing from $24.9 trillion at the end of 1994 to $40.3 trillion at the end of 2002. This amazing $15.5 trillion (62%, or about 150% of current GDP) increase in seven years was possible because asset values increased $19 billion while household liabilities increased $3.5 billion. There is little mystery why the household sector feels so wealthy, or why it continues to borrow and spend seemingly without a care in the world.

It is truly amazing to witness one of history's great financial misconceptions right in front of our eyes. It's the explosion of financial sector liabilities that transforms a savingless society into a bastion of unending liquidity, asset inflation, and spending. It is the expansion of the financial sector and the consequent Bubble in total financial claims that explains what confounds so many. And to think that the key to this great analytical puzzle is quickly dismissed as "double-counting," and that Mr. Epstein would accuse the few of us that focus on financial sector expansion as cheating… We'll wait patiently for his brittle little branch to snap and the smug and misinformed Mr. Epstein to fall right on his noggin. The only satisfaction we'll take is that we expect such an event will knock some sense into an individual that is clearly capable of much better than we have seen of late. Mr. Epstein, "It's Wildness Lies in Wait."

Elsewhere, in this most fascinating environment, Bill Gross rattled the cages again this week with interesting comments. Hopefully, I will paraphrase correctly when I state that his main point was that corporate America has utilized the swaps market significantly over the past ten years. The aggressive swapping of long-term debt to short-term has thus made U.S. corporate profits, hence the stock market and the U.S. economy, much more sensitive to the Fed funds rate. This will force the Greenspan Fed to hold short rates lower than would normally be the case, which will over time tend to lead to increased inflation and higher longer-term market rates. Mr. Gross' comments, as always, are insightful and well-worth pondering carefully.

For too long, the Federal Reserve and the marketplace have held firmly to the notion that, with rate cuts basically costless, the Fed should err on the side of aggressive accommodation. With such a sanguine view, there has been no need to analyze the true source of recurring financial distress, not when quick and extreme Fed response to any potential financial or economic risk has been possible and viewed as appropriate. As accommodating as the Fed has been to the markets, the markets have been equally accommodating to the Fed. We are relieved to see the dangerous misconception of costless Fed accommodation under a bit of review, and appreciate that Mr. Gross is now laying out some of the inevitable costs associated with the Fed's extreme rate stance. We have no disagreement that corporate earnings are a problem or that the Fed is held hostage to loose money. Structural profit issues and the Fed's consequent accommodation have impelled corporate America to shift borrowing costs to the front part of the yield curve (only compounding structural profit weakness and financial fragility by adding an additional layer of interest rate vulnerability). Yet isn't this exactly what the Fed has been encouraging them to do? Throw some cheap money their way to help them through a rough patch. Then, as the thinking goes, when the economy improves and profits recover, corporate America will then gladly call their friendly derivatives trader, reverse their swaps, and everyone lives happily ever after.

But the harsh reality is that faltering corporate profits and the bursting of the technology Bubble are not cyclical "rough patches" that will be successfully navigated by extending extreme Fed accommodation. These are, instead, only symptoms of the severe and endemic structural impairments that are the consequence of runaway Credit and speculative excess. It has been a classic case of throwing "good" money after bad, with inappropriate response to the inevitable collapse of the technology and telecom debt Bubbles throwing gas on the Credit Bubble. As we have argued throughout, this has always been a case of the Fed fighting the consequences of Credit and speculative excess by inciting only more egregious Credit and speculative excess. It's a losing battle.

The intractable dilemma today is not corporate debt woes, but an only more dysfunctional Credit system and resulting dysfunctional monetary processes. Furthermore, and consistent with irony that the Great Credit Bubble rose from the ashes of an impaired U.S. banking system in the early 1990s, we think the critical aspects of this Bubble will not be found with the sector (today it's the corporate debt arena) under the administered Fed I.V. The major systemic risk lies, instead, unexposed with an acutely fragile financial sector, Bubble economy, and a leveraged speculating community having all become hopeless addicts to the drug of Fed and GSE-induced Credit excess. We are in 100% agreement that the swaps market is a critical issue, but we'll part company that the analytical focus is best directed at the nonfinancial sector and corporate earnings, or that this sector's profits are the key transmission mechanism of short-term interest rates to the stock market and economy.

The Office of the Comptroller of the Currency (Treasury Department) places year-end US commercial bank notional interest rate derivative positions at $38.3 trillion. This is up from the $13.4 trillion outstanding at the end of 1996. For comparison, notional foreign exchange contracts ended 2001 at $5.7 trillion, below the $6.2 trillion outstanding at the end of 1996. Commercial banks have about $25 trillion of interest rate swap contracts, a rather intimidating sum when compared to the $3.3 trillion outstanding (12/1993) going into the Fed's previous problematic tightening cycle. The Federal Reserve estimates daily interest-rate swap turnover last year at $82 billion, up from $31 billion during 1998, and $14 billion during 1995. Outstanding swaps positions jumped almost 50% to $14.3 billion during 1998 (Fed and GSE "reliquefication"), and it certainly makes sense that the swaps market is playing an instrumental role in the recent exchange of corporate bonds for their commercial paper borrowings.

It is our contention that the explosion of interest rate swaps and other derivatives has played an instrumental role in fostering endemic interest rate speculation. This has manifested into the unprecedented U.S. financial sector growth experienced during this cycle. In the grand scheme of things, we would expect that the amount of interest-rate speculation in the non-financial sector is a minor compared to that existing in the financial sector and hedge fund community, and if we are wrong on this things are only worse than we thought. Again, it has been this momentous expansion of financial sector liabilities that is behind the general explosion of money and credit. From a macro perspective, the key monetary transmission has not been through corporate profits, to the stock market, and then to the economy. Rather, it has been through unsustainable financial sector expansion, the resulting insatiable speculative demand for securities, and the consequent extreme Credit availability throughout both the financial sphere and real economy. The driving force has been extreme financial market liquidity, which increasingly emanates from the mortgage sector.

It is worth noting that during the four-year period beginning in 1998 - the ongoing terminal stage of the Credit Bubble - non-financial corporate borrowings increased $1.6 trillion (47%). Over this same period, household sector borrowings increased about $2.2 trillion (39%). Importantly, however, these striking numbers are dwarfed by financial sector borrowings. Over the past four years, U.S. financial sector Credit market borrowings have surged $3.9 trillion, or 72%. Fully 81% of this growth is explained by three sectors: The GSEs increased borrowings $1.1 trillion (112%); Federal-related mortgage-back pools $1.0 trillion (55%); and asset-backed securities pools $1.0 trillion (96%). Over this four-year period, we also know that financial sector commercial paper borrowings increased $448 billion (59%) to $1.21 trillion, while outstanding repurchase agreements increased $627 billion (54%) to $1.79 trillion. Meanwhile, non-financial commercial paper borrowings increased $24 billion (12%) to $225 billion. It is within the realm of the GSEs, mortgage finance, asset-backed securities, and the repo market that we suspect one can locate the key epicenter for interest rate swaps, speculation, and Fed trepidation. It is this murky world that provides the powerful but alarmingly tenuous transmission mechanism of financial excess to the real economy.

We can only hope that Bill Gross is proved correct, and that the risk going forward is related to the corporate sector having gone overboard with its swapping of long-term debt for short. We can sleep at night with continued bleak corporate profits, a bit more inflation risk, and a steeper-than-normal yield curve. But is this pinpointing the key area of excess, or recognizing only the most obvious symptom of a Credit system run amuck? We fear the latter. If we are correct that the greater issue lies within the financial sphere, the nature of systemic risk going forward changes profoundly.

Let's assume, as we believe is true, that the financial sector has been using swaps, commercial paper borrowings, the repo market, and other instruments as vital aspects of their aggressive expansion and speculations - one massive "financial arbitrage" of borrowing short and lending long. We know the GSEs are huge derivative players. It is, furthermore, the unrelenting expansion of financial sector liabilities (the Credit Bubble) that is the true liquidity lifeline for the stock market, real estate, and economic Bubbles. And let's also consider that playing this Fed and GSE-"managed" financial Bubble has been the critical factor in the ongoing recycling of the global flood of "Bubble Dollars" right back to the U.S. financial sector. With this view, non-financial sector interest rate speculations are but a sideshow.

The financial sector and acute financial fragility then become the critical issues lying fully hidden in the tall grass. The financial sector can create its own liquidity, but only through continued aggressive expansion. The key vulnerabilities today remain financial sector liquidity, Credit availability, and the domestic currency. Not coincidently, these were the critical issues in respective Credit Bubbles that went bust throughout SE Asia, Russia, Argentina, etc. And as we have witnessed first hand, these kinds of Bubbles are precariously seductive, as they remain hidden as long as additional Credit excess is forthcoming and speculative juices are maintained. But such Bubbles are doomed; it's only a matter of time.

What keeps us awake at night is the knowledge that the financial sector - and particularly mortgage finance - must continue its rapid expansion to sustain liquid and levitated asset markets, while it takes boom-time spending levels to stabilize the maladjusted U.S. Bubble economy. This precarious condition is masked only by unrelenting rampant financial Credit expansion. It is this circumstance and the necessity of feeding the voracious financial sector appetite that has the Fed locked into gross over-accommodation. To cap it all off, Credit Bubble-induced corporate debt woes have only seductively guided everyone merrily into the granddaddy of all Bubbles in the U.S. mortgage sector. This monster will require incredible continued nourishment. If we are correct, the critical issue going forward will be to recognize that we are in the midst of the terminal stage of Credit and speculative excess within the financial sector and mortgage Bubbles. The problem lies with the unpredictable and often chaotic nature of such dysfunctional processes, and the generally short time horizon between climactic excess and the run for the evaporating liquidity of a bursting Bubble. When will the sophisticated money sneak quietly toward the exits?

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