The stock market enjoyed its third week of gains. For the week, the Dow, S&P500, Transports, and Morgan Stanley Cyclical indices all gained about 2%. The Utilities surged 8%, while the Morgan Stanley Consumer index added 1%. The broader market generally outperformed the major indices, with the small cap Russell 2000 gaining almost 3%. The S&P400 Mid-Cap index rose about 1%. The technology rally continues, with the NASDAQ100 gaining 4% for the week. The Morgan Stanley High Tech, The Street.com and NASDAQ Telecommunications indices jumped 7%. The Semiconductors surged 9%. Month-to-date, the NASDAQ100 and NASDAQ Telecom indices have gained 20%, the Morgan Stanley High Tech index 21%, the Semiconductors 23%, and The Street.com Internet index 26%. The Biotechs actually dropped 1% this week. Financial stocks gained also, with the Securities Broker/Dealer index gaining 3% and the Banks 2%. With bullion up 60 cents, the HUI Gold index had a small gain.

The stock market rally didn't really keep Treasury market on edge. For the week, 2-year Treasury yields declined 10 basis points to 1.94%. The five-year saw its yield drop six basis points to 3.03, and the ten-year one basis point to 4.09%. The long bond yield rose two basis points to 5.08%. After recent weakness, the mortgage-back and agency markets performed better. Benchmark Fannie Mae mortgage-back yields generally declined 10 basis points, while the implied yield on agency futures dropped 8 basis points. The spread on Fannie Mae's 5 3/8% 2011 note narrowed 9 to 59, while the benchmark 10-year dollar swap spread narrowed 3 to 60. The December 3-month Eurodollar yield dropped 10 basis points to 1.65%. The dollar suffered a small decline for the week.

Ford debt was downgraded to triple-B by S&P today, although Ford bond spreads did narrow slightly this week. Ford's 10-year bond yield ended the week at 9.45%. Household International hastily raised $900 million, but that did not stop the spread on its bonds from widening about 30 basis points this week to 600 over Treasuries. At one point Thursday (just prior to raising capital), the price of Household International Credit default swaps surpassed 1000 basis points, before subsiding to about 700 basis points this afternoon.

Broad money supply (M3) increased $22 billion last week. Currency added $1.9 billion and Demand Deposits jumped $17 billion. Savings Deposits rose $15.4 billion. Retail Money Fund assets declined $4.8 billion and Institutional Money Fund assets declined $14.9 billion. During the past four weeks, Institutional Money Fund assets have declined $53.6 billion, while Retail Money Fund assets have dropped $4.0 billion. Commercial paper borrowings increased $3.6 billion last week, with Financial Sector borrowings up $6.4 billion (to $1.2 trillion) and Non-financial down $2.9 billion (to $160 billion). Volatile total Bank Credit declined $30.7 billion, after gaining $30 billion the previous week. Securities holdings dropped $44 billion, while Loans and Leases added $13.3 billion (Commercial and Industrial up $4 billion, "Other Loans" up $5.9 billion). Total Bank Assets actually expanded $6.6 billion, with "Cash Assets" up $16.2 billion, "Interbank Loans" up $16.9 billion, and "other assets" up $4.7 billion.

October 24 - Business Wire - "Standard & Poor's Ratings Services today placed its 'A-1' commercial paper ratings on Black Forest Funding Corp., Bavaria Universal Funding Corp., Bavaria TRR Corp., and Maximillian Capital Corp. on CreditWatch with negative implications… The CreditWatch placements follow the Oct. 24, 2002, placement of Bayerische Hypo- und Vereinsbank AG's ratings on CreditWatch with negative implications. Bayerische Hypo- und Vereinsbank provides liquidity and credit support for the commercial paper issued by Black Forest Funding, Bavaria Universal Funding, Bavaria TRR, and Maximillian Capital."

October 25 - Dow Jones (David Feldheim) :"Activity in the asset-backed commercial paper market - a lifesaver for many corporations shut out of other debt markets - is starting to slow as well. Access to the asset-backed commercial paper market (ABCP) has cushioned the blow for some issuers that recently lost their top tier P-1 short-term credit rating, which effectively shut them out of the unsecured commercial paper… The slowdown makes sense to William Cunningham, credit strategist at JP Morgan Chase, who sees the trend as a reflection of the precipitous drop in new corporate debt issuance in general that has been underway for the last two years. Not since the credit crunch of 1990-1991 - when there was an outright decline in corporate indebtedness - has there been such a marked slowing in debt creation, said Cunningham."

Yesterday, the White House Office of Management and Budget reported a fiscal year deficit of $159 billion (a swing of $286 billion from last year's surplus!), the first deficit since 1997 and the largest since 1995. Year-over year, spending jumped 7.9% to $2.012 trillion, while revenue dropped 6.9% to $1.853 trillion (the steepest revenue drop since 1946, according to Bloomberg). Individual tax receipts declined 13.7% to $994.3 billion. Corporate tax receipts declined 2% to $148 billion. Interestingly, (again from Bloomberg), the four consecutive years of surplus (1998-2001) were "the longest since 1927-1930." It will be quite some time before we see another surplus, with the question being how large and how quickly the deficits balloon. In the "largest increase in defense spending since President Reagan," President Bush this week signed an appropriation bill with a 10% y-o-y increase in defense spending to $355 billion. Wednesday, New York mayor Michael Bloomberg stated that New York City could run a billion dollar deficit this year, with next year's deficit surging to as much as $5 billion to $6 billion.

October 22 - Bloomberg: "Kansas' pension plan for retired government workers will need a larger contribution from the state, the Lawrence Journal-World reported… the Kansas Public Employees Retirement System owes a projected $11.74 billion to future retirees but only has assets to cover $9.7 billion of the cost, the newspaper reported."

October 24 - American Banker: "A slowdown in the auto industry is starting to show up in the loan portfolios of a few Midwestern banks. In recent weeks the banks have reported that loans to car-parts manufacturers accounted for higher nonperforming assets and credit costs in the third quarter." The article quoted a bank CEO: "Despite the fact that auto sales have been strong, manufacturers have been pressuring suppliers on price."

Last week's bankruptcy filings of 28,653 were about unchanged year-over-year. The ABC News/Money Magazine index of consumer confidence dropped four points to negative 23, the lowest reading since January 1994. The index is down 24 points from its positive reading in mid-April. The State of the Economy component sank six points to negative 48, also a low since January 1994. Ominously, the Personal Finances component has dropped 10 points in four weeks to six, the lowest reading since 1995.

The Personal Finances index did not drop below 30 during year-2000, and only dipped below 20 during the final three weeks of 2001. Today's Durable Goods report was dismal. New Durable Orders declined 5.9%, the largest decline since last November's 5.9% (but which followed October 2001's 9.2% surge), while Unfilled Durable Orders dropped to the lowest levels since October 1996. "Non-defense Capital Goods" orders sank 6.6%. The University of Michigan's report on October consumer confidence was also quite weak. The reading of 80.6 is down from September's 86.1 (May's reading was 96.9), and is even below last October's 82.7. The Mortgage Bankers Association weekly refi index dropped 18% to the lowest level in more than one month (up 22% y-t-d). The Purchase index, however, increased 6% to the highest level in a month (up 37% y-t-d).

October 21 - Dow Jones (Mike Esterl): "While some parts of Argentina's ravaged economy are showing tentative signs of life, the formerly high-flying mortgage business remains completely dead, the head of the country's largest mortgage bank said Friday. 'There's no mortgage market at the moment,' said Miguel Kiguel, chairman of Banco Hipotecaria SA, which is spending its time these days trying to restructure its hefty debts. Mortgages were the fastest-growing credit business in the Argentine financial sector between 1994 and 2000, with mortgage loans jumping to $19 billion from $8 billion. But the only credit that banks are extending right now in the default-riddled country are 7- and 14-day loans…"

U.S. homes sales data remains exceptionally strong. New homes, for the second consecutive month and for only the second time, sold at an annualized rate surpassing one million units (1.02m). September's average price of $218,100 is up 7.3% y-o-y. This year is on pace to surpass last year's record 908,000 new homes sold by about 5%. It is worth noting that new homes sold at an annualized rate of about 600,000 units during the first five years of the nineties, surpassing 700,000 units for the first time during 1997, 800,000 during 1998, and 900,000 for the first time last year. Existing home sales were reported at an annualized rate of 5.4 million units, up from August's 5.28 million and the year ago 5.01 million. Midwest sales surged 8.9% (and were up 2.3% in the South), while they declined in the Northeast (1.6%) and West (3.5%). Average prices have now suffered three straight months of moderate price declines after June's spike. Year-over-year, median prices are up 7.9% to $159,000, while average (mean) prices are up 9.7% to $203,200. Average Annualized Transaction Value (avg. prices multiplied by annualized sales volumes) for September was up 18.3% y-o-y.

While maintaining a brave face, California real estate players must be feeling a bit uneasy these days. Granted, one of history's great real estate Bubbles appears to have some life left, yet there are signs… September's 2.9% median price decline can be dismissed as "seasonal" and year-over-year price gains of 17.3% to $323,310 remain impressive. But last month's sharp sales declines are a troubling sign. Statewide single-family sales were down 12.3% from August, while condo sales declined 15.3%. In fact, single-family sales were only 3.9% above depressed levels from September 2001. Interestingly, sales declines from August were down 25% or more in key upper-end markets in Monterey County, Santa Cruz County, Santa Barbara and Ventura County. Anecdotal accounts have sales activity slowing further this month. Recalling an infamous 1929 comment from one of America's great economist, Bloomberg quoted Merrill's chief economist Richard Berner: "Housing is on a high plateau." But to make this a "permanent plateau" will require uninterrupted enormous Credit creation, forever at expanding rates.

As it generates much of its revenues from rating new securities issues, Moody's has become an interesting business to monitor. Revenues were up 30% for the quarter, with EPS up 37%. "Total Ratings Revenue" jumped 22%, with "Structured Finance" up 37% to $91.6 million, "Financial Institutions and Sovereign" up 27% ($38.5m), and "Public Finance" up 34% ($20.6m). At the same time, "Corporate Finance" ratings revenues dropped 4% to $50.2 million. Looking at ratings revenues compared to two years ago, "Structured Finance" is up 90%, "Corporate" 16.7%, "Financial Institutions…" 36.5%, and "Public" 73.1%. As a percentage of total ratings revenues, over the past two years "Structured Finance" has jumped from 37% to 46%, while "Corporate" has dropped from 33% to 25%. Sign of the times…

October 24 - American Banker: "The price tag is in for a decade of lobbying by some of the largest financial services companies… Fourteen diversified financial companies, Freddie Mac, and four trade groups made the (top 100 political contributor) list… These entities donated $164.2 million to political candidates during the pasts 14 year, including $53 million from what are now Citigroup Inc., J.P. Morgan Chase & Company, Bank of America Corp. and MBNA Corp… Much of that money was given when Congress was debating what became the Gramm-Leach-Bliley Act of 1999, which removed the Depression-era barriers that separated banking, securities and insurance."

Freddie Mac reported strong earnings Wednesday. For the quarter, total assets increased $37.9 billion, or at an annualized growth rate of 23.5%. This was the strongest growth since 2001's fourth quarter, and quite a reversal from the third quarter's decline in total assets of about $2 billion. Freddie's back! Interestingly, "Investments" jumped almost $12 billion during the quarter to $80.4 billion. "Derivative Assets" jumped to $7.7 billion from $3.3 billion. "Real Estate Owned" continues to grow, ending the quarter at $575 million, up from the year ago $376 million. Freddie has been working diligently on the liability side of its balance sheet, with long-term debt ("Due after one year") up almost $110 billion to $396 billion y-o-y. Freddie's short-term debt has actually declined over the past year by $22 billion to $222 billion. During the past four quarters, Freddie's "Total Book of Business" (mortgages held and mortgage-backs insured) is up $154 billion or 14%. Fannie and Freddie's combined book of business increased $392 billion over the past 12 months, a 15% growth rate, to surpass $3 trillion. Over the past 36 months their combined book of business has surged $967 billion, or 47%. I think it is fair to say we have become numb to truly extraordinary numbers.

Countrywide Credit saw quarterly EPS jump 53%. "Loan fundings advanced to $64 billion, up 90 percent over the $34 billion produced during last year's August quarter… The servicing portfolio reached $406 billion, an increase of 29%..." Total assets expanded at a 32% annualized rate to $45.2 billion (up 28% y-o-y). "Investments in other financial instruments" increased from $3.4 billion at 12/31/01 to $9.9 billion (up $1 billion during the quarter). Over the same period, bank deposit liabilities increased from $675.5 million to $3.1 billion, while repurchase agreements increased from $9.5 billion to $11.4 billion.

Additional signs of heightened stress this week from the mortgage insurance sector. Credit insurer Radian reported quarterly earnings up 16% y-o-y. "Primary mortgage insurance-in-force was $109.4 billion at September 30, 2002, compared to… $106.8 billion one year ago." With business growth stalled, it is not surprising to see a marked deterioration in Credit quality ratios. The primary ratio of "loans in default" rose from 3.48% to 3.83% during the quarter, and is up from the year ago 3.05%. The performance of "non-prime" loans was quite troubling. "Alternative A" loans in default rose 105 basis points to 5.51%, and are up from the year ago 3.37%. The "A Minus and below" loan defaults surged from 6.35% to 11.88%. In an unmistakable sign of deteriorating business conditions, "Direct Claims Paid" jumped 69% to $41.2 million (2002 Q3 vs. 2001 Q3), after increasing only 3% the previous year (2001 Q3 vs. 2000 Q3).

Reading through a report from a prominent Wall Street analyst of financial institutions, I was struck by the following: "Yes, the Journal's housing bubble stories are gripping, but check out the table below. Where's the beef, people?" Well, the analyst's table detailed delinquencies and charge-offs from Fannie Mae, Washington Mutual, Golden West, Greenpoint, and MGIC. Considering the fact that we are in the midst of unprecedented mortgage Credit creation, one would surely not expect Credit problems to be a significant issue today. His analysis is analogous to an investment banker stating in 1999 that there is no telecom debt Bubble because few companies were defaulting back then. Just give it time… The key in identifying a Bubble, of course, is in protracted Credit excess. The losses come when Credit excess inevitably subsides, with asset inflation reversing course and Credit losses quickly emerging on the scene. It is then worth noting that year-over-year asset growth has been 12% at Fannie, 17% at Washington Mutual, 13% at Golden West, and 13% at Greenpoint. During the just completed quarter, Golden West expanded assets at a 20.5% annualized rate and Greenpoint at 49.3%. For more egregious examples, one can look at New Century's 85% annualized asset growth (53% y-o-y) during the quarter or American Home Mortgage's 257% (230% y-o-y).

It is likely that we will see total mortgage Credit growth surpass $800 this year, with a growth rate in the neighborhood of 12%. Mortgage debt growth of $800 billion would surpass 2001's record expansion by 13% and 2000's by 41%. The mortgage finance Bubble appears more like the tech Bubble by the month - when you thought it couldn't get any more outrageous the market thumbs its nose and goes into speculative blow-off mode. Well, this year's $800 billion would put 5-year total mortgage debt growth at almost $2.5 trillion, or about 48%. Even during the late eighties real estate lending excess, total annual mortgage Credit growth averaged (1987 to 1989) "only" about $300 billion. It is an amazing phenomenon of protracted bull markets (especially contemporary ones buttressed by uncontrolled fiat money, runaway Credit systems and endemic speculation) that they invariably end with a wild terminal phase of gross speculative excess. After witnessing a "once in a lifetime" spectacular NASDAQ/stock market blow-off, we are now afforded the unfortunate opportunity of viewing a development of similar historic proportions today throughout mortgage finance.

We have watched Fannie, Freddie and Wall Street create unprecedented quantities of mortgage-backed securities this year. We have often pondered who the buyers might be, all the while assuming the holders were too often the leveraged players (hedge funds, Wall Street proprietary trading desks, insurance companies, etc). This view has been supported by the concomitant unprecedented expansion of the repurchase agreement ("repo") market. Fed data has outstanding repurchase agreements today at about $2.5 trillion, up an incredible $500 billion so far this year (closely paralleling mortgage Credit growth). This number surpassed $1 trillion for the first time during 1997.

There are many things we don't like about gross mortgage lending excess: burdensome consumer debt loads and economic distortions, for example. There is, as well, much to find problem with when it comes to aggressive leveraged speculation: weak debt structures, boom/bust dynamics, and acute financial fragility. That unprecedented mortgage debt is being acquired by highly leveraged interest rate speculators at this stage of the Credit and economic cycles - and that it has become absolutely endemic/the "hot game" - should be recognized as a debacle in the making. The above mentioned Wall Street research report also made reference to "permabears" and included the following comments: "But reality can sometimes intrude even on the most entertaining paranoia." Well, I guess there are these days worse labels than "permabear." But when it comes to not letting the reality of an historic mortgage finance Bubble intrude on warped perceptions, the "permabulls" demonstrate truly extraordinary determination.

We've witnessed a lot of reckless Credit and speculative excess over the years. Yet, somehow the Fed and financial sector worked diligently to avoid (postpone) learning lessons -- fight Credit problems with more Credit, bursting Bubbles with larger Bubbles. Yet, if the Fed saw no alternative than to collapse interest rates in response to the collapsing NASDAQ Bubble, shouldn't they at least have moved to restrain the over aggressive mortgage finance sector? After all, it doesn't take rocket science to recognize that speculative impulses had become imbedded in the marketplace, that the speculating "infrastructure" was firmly in place on Wall Street, and that the methods of creating unlimited finance for purposes of leveraged speculation had been mastered throughout the financial system. To protect financial stability, the Fed should have warded off mounting lending and speculative excesses. Instead they nurtured and supported.

Well, it's pretty obvious that the old "borrow short and lend long" game is back like never before - textbook "speculative blow-off." It's gone to unprecedented extremes with a new wrinkle that has worked like magic thus far: the "repo" market has become the source of unlimited, extraordinarily cheap finance, while limitless quantities of mortgage paper have become the speculative instrument of choice. Throwing gas on a flame…

I am simply at a loss when it comes to the runaway excesses now being perpetrated by the mortgage real estate investment trusts (REITs). With all the distortions and fragilities in the U.S. Credit system, we can now Throw in a REIT Bubble. The numbers are shocking, adding one more dimension to the GSE/leveraged speculation dilemma. For the third quarter, Thornburg Mortgage expanded assets at an annualized rate of 51% to $10.1 billion. Total assets are up 90% year-over-year. Thornburg ended September with $8.3 billion of repurchase agreement borrowings. Redwood Trust saw its assets grow at a 215% annualized rate to $5.7 billion, and up 150% y-o-y. For Impac Mortgage Holdings, it enjoyed a 104% annualized growth rate to $5.4 billion during the quarter (assets up 125% y-o-y). Annaly Mortgage expanded assets at a 16% annualized rate to $11.6 billion, with assets up 78% y-o-y. Annaly ended the quarter with repurchase agreement liabilities of $9.8 billion. A few of the more aggressive REIT players have yet to report. But the second quarter saw Apex Mortgage Capital expand assets at annualized rate of 144% to $3.5 billion, with assets up five-fold during the previous 12 months. Assets at MFA Mortgage Investments grew at a rate of 105% during the quarter to $3.5 billion, up almost 300% y-o-y.

And then there is FBR Asset Investment Corporation, a REIT managed by Freidman Billings. "At September 30, 2002, FBR Asset Investment Corporation's portfolio of mortgage-backed Securities (MBS) totaled $5.82 billion resulting in leverage of 8.2 to 1 at the end of the third quarter." (Typical of mortgage REIT leveraging) This is up from MBS holdings of $3.83 billion at 6/30/02 (200% annualized growth) and the $1.24 billion at 12/31/01 (9-month growth rate of almost 500%). FBR had total assets of $318 million only five quarters ago. What a deal the Fed and financial sector have provided these days: Unlimited short-term borrowings to finance inflating long-term assets available in unlimited supply. It is truly the greatest money-making machine since technology stocks rose every week. My handy Bloomberg indicates a "gross yield" for shareholders of 16%. Leverage is also providing great returns for the manager, who enjoys an "incentive fee" on top of a management fee. For the quarter, this incentive fee of $4.2 million is up from the year ago $417,000. Why even bother with a hedge fund? Everyone ought to manage a mortgage REIT.

It is interesting to ponder the circumstances that will cause the REIT Bubble to burst. Certainly, rising interest rates would do it. Most of these "borrow short/lend long" vehicles do "hedge" some of their interest rate exposure, but there is no doubt that our entire financial system has become acutely vulnerable to higher rates. There is also the possibility of a dislocation in the repo market, with 9/11 demonstrating how this unusual financing market falters when players move to unwind trades. (I often find ponder how the "repo" market will function in reverse) There is also a distinct possibility that hedging programs run amuck, with high leverage leaving little room for error. In this regard, the recent implosion of the Beacon Hill funds is a stark reminder of how dangerous a game leveraging cuddly little mortgages can be in a highly unsettled financial environment. For sure, we are today in uncharted waters and the models these mortgage players are using will not function as subscribed. We are today dealing with interest rates at an extreme, mortgage Credit growth at an extreme, refinancing activity at an extreme, and an economy extremely maladjusted. I wouldn't want to rely on models today…especially highly leveraged.

But the way things are developing, it does appear increasingly likely that the negative surprise is going to spring from the Credit side. The models employed by the likes of the REITS, Fannie and Freddie, the mortgage insurers, banks and S&Ls, are significantly underestimating future Credit losses (and overstating current lending profits). The proliferation of these "profitable" lending models along with an influx of speculators has nurtured unprecedented and unsustainable Credit excess that must now be maintained to keep losses at bay. Yes, the mortgage REITs are money machines today, but are poised in harms way. The mortgage finance Bubble must run uninterrupted and interest rates must remain relatively stable. Moreover, since many of these players leverage variable rate mortgages, the REIT Bubble may have unknowingly become a meaningful factor in the California housing Bubble (now addicted to cheap, variable rate, readily available mortgage Credit). The day the market thinks twice about California mortgages, we've got a problem (although Fannie and Freddie are rushing to raise loan limits!).

Perhaps Household International has resolved its short-term financing problems. But our hunch is that the expanding CONSUMER debt problem has its sights on home equity loans. We have seen a virtual collapse in the market for securities backed by manufactured housing, and a "natural" progression of Credit problems associated with the bursting of the Consumer Bubble would find risky home equity loans the next shoe to drop. Any faltering of Credit availability in the home equity area would be a major development. And with heightened stress for key financial players such as Capital One, Ford and Sears, there is a distinct possibility that general consumer Credit availability is becoming a major issue. The specter of a faltering consumer sector then has dire ramifications for the entire ABS marketplace as well as the acutely vulnerable mortgage arena. After all, the ill-prepared mortgage insurers are already suffering mounting casualties during skirmishes with Credit problem scouts. While there is a lot riding on this stock market rally, the war will be won or lost in the Credit market. Is the mortgage marketplace today sound or fragile?

Monday from Dow Jones Newswires' Kristina Zurla: Quoting Leland Brendsel, Chairman and Chief Executive Officer of Freddie Mac, speaking at a Mortgage Bankers Association of America: "There's no risk of a nationwide decline in home prices, period.' Also from the article: "Jamie Gorelick, vice chair of Fannie Mae, saw a rosy outlook for housing throughout the rest of the decade. "We can deliver the best decade for housing we've ever seen,' she said. Gorelick agreed minority homeowners are going to be a key force behind the market's growth in years ahead, noting surveys show their plans to buy homes are even stronger than those of the baby boomers that drove the big housing surge of the recent past. Educating these minority and/or low-income potential homeowners is key, she said, because there are some misconceptions about that it takes to buy a home. 'We need to reach out to them and let them know the American dream is within their grasp,' Gorelick said. Too many Americans still think it's necessary to put 20% down on a house or have perfect credit, she said, and don't realize underwriting innovations have allowed homebuyers to put down 1% - or even nothing - and still purchase a home." Whatever happened to Fannie lending up to 70% loan to value? This mortgage finance Bubble is out of control on many levels.

While not necessarily a microcosm for the entire country, the "beige book" report on the Dallas Fed district certainly captures some key aspects of today's maladjusted U.S. Bubble economy. Things are turning sour and it doesn't matter if GDP is reported up 5%. It is my sense that economists' focus on GDP growth is missing important nuances of contemporary "output." Should we give the same weight to the "output" of lawyers, insurance salesmen, and mortgage brokers as we do manufacturers of products? I have extracted heavily from yesterday's report from the Fed.

"Eleventh District economic activity showed signs of contracting in September and early October. Manufacturing activity declined, and retailers reported slower than expected sales. Construction and real estate conditions remained weak, with continued softening in the market for single-family homes… Price pressures are mixed. Contacts continued to report high and rising prices for all types of insurance. Prices are up for energy products, including diesel fuel and heating oil. Crude oil prices have also increased over the past few weeks… Despite near record inventories, natural gas prices remained…25 percent higher than last year. Retailers say selling prices have dropped over the past few weeks. Home prices have also fallen in some areas. Contacts in the temporary service industry report downward pressure on wages.

Manufacturing activity declined, and weakening was widespread across the industries in the sector. Demand for paper products, which has been slowing over the past few months, accelerated its decline over the last month. Apparel producers say demand continued to be slow. Demand for construction-related products continued to soften, although public works projects helped maintain sales levels of concrete, cement, and fabricated metals. Sales of processed food products were up over the last month, however, which contacts suggest is due to consumers staying at home rather than going to restaurants. The slow improvement that had been reported in the high-tech industry over the summer has dissipated in the past few weeks.

Legal firms say activity has slowed from last quarter but remains stronger than a year ago. Litigation, bankruptcy, and commercial lending activity remained strong, but transactions activity was weak to nonexistent… Demand for transportation services is still very weak. Airlines reported that the conditions in the industry are bad and getting worse, as the airlines try to adjust capacity to meet demand. The carriers with labor union contracts reported the most difficulty, because they are unable to lower fixed costs fast enough. Leisure travel over the holidays looks promising they say, but business travel is very weak and there are no signs of a rebound. Trucking firms say demand is 30 percent below a year ago. Retail sales softened. Stores reported slower-than-expected sales growth or a decline in sales compared to a year ago. Contacts had expected to easily match and exceed last year's depressed September sales and were shocked that sales were below a year ago. Many retailers expressed serious concern that nothing had really changed to precipitate slower demand and have revised down their expectations for sales. Automobile sales have softened in recent weeks and are expected to be 10 percent to 15 percent lower than two months ago.

Mortgage refinancing continues to grow, but contacts reported a recent slowing in auto and consumer lending, particularly for credit cards… Construction and real estate conditions remained weak. Contacts say activity in the single-family market has tapered in the last six weeks, although incentives and low interest rates continued to spur sales of lower priced homes. Multifamily leasing activity deteriorated in Austin and Dallas. Office vacancy rates continue to rise and rent concessions are widespread."

Amazingly, according to the consensus view, the odds of the economy sinking into recession remain remote. The real story is the maladjusted economy, and it's not going anywhere for awhile.