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Weak Links

Federal Home Loan Bank Assets

Market action was choppy, but the bulls sustained their rally. For the week, the Dow added less than 1%, while the S&P500 gained almost 2%. The Utilities, Morgan Stanley Cyclical and Morgan Stanley Consumer indices all added about 1%, while the Transports declined 1%. The broader market was strong, with the small cap Russell 2000 and the S&P400 Mid-cap indices up 2%. The technology rally resumed, with the NASDAQ100 gaining 5% and the Morgan Stanley High Tech index increasing 4%. The Semiconductors jumped 7%, The Street.com Internet index 5%, and the NASDAQ Telecommunications index 6%. The Biotechs were up about 1%. The financial sector also caught fire, with the Securities Broker/Dealer index up 6% and the Bank up 3%. Gold was volatile but resilient, as bullion dropped about 80 cents for the week. The HUI Gold index added less than 1%.

The Credit market remains extraordinarily unsettled. Ten-year Treasury yields surged an unusual 22 basis points yesterday, after collapsing 18 basis points last Thursday. The mortgage and interest rate derivative players have their work cut out for them, and perhaps they are now feeling the Fed may have a few inflationary tricks up their sleeve. For the week, 10-year Treasury yields jumped 20 basis points to 4.02%. Two-year Treasury yields increased 3 basis points to 1.87%, while the five-year yield jumped 16 basis points to 3.02%. The long-bond saw its yield rise 12 basis points to 4.91%. Benchmark Fannie mortgage-back yields jumped 16 basis points, while the implied yield on agency futures rose 17 basis points. The spread to Treasuries for Fannie's 5 3/8 2011 note widened 3 to 48, while the 10-year dollar swap spread increased 1.5 to 49. The three-month December Eurodollar saw its yield rise 3.5 basis points to 1.41%. The news of troubled Household's acquisition by a strong foreign banking institution provided needed good news for the vulnerable corporate bond, Credit default swap, and asset-backed securities marketplaces.

This week from Larry Kudlow: "The Fed lowered the target interest rate to 1.25% this week, which was fine in itself. But the action was made sweeter by the announcement that accompanied it: The Federal Reserve 'continues to believe that an accommodative stance of monetary policy, coupled with still-robust underlying growth in productivity, is providing important ongoing support to economic activity.' The crucial reference to productivity suggests that the old Alan Greenspan is back. In the late 1990s, the Fed chairman consistently - and correctly - argued that rapid productivity gains were increasing the economy's potential to grow. Therefore, the Fed could afford to be more generous with the cash without being concerned about inflation…Why Greenspan departed from this script in 2000 is one of the great mysteries of monetary history. For about 18 months, into the middle of 2001, the estimable Fed chairman worried that too-high stock prices and too-strong growth were reviving inflation. So, rather than keeping the economy's money-pump primed, he deflated the money supply, all while ignoring clear recessionary signals…And over at the Federal Reserve, the recent decision to link productivity with monetary policy strongly suggests that Dallas Fed president Robert McTeer is being groomed to succeed Greenspan…" What? And you've got to be kidding…

November 11 Bloomberg: "Asia-Pacific-based insurers face an increased threat of collapse next year amid tumbling equity markets and lower fee income, Standard and Poor's Rating Services said. 'The sector is challenging, unsettled and rife with competition,' Ian Thompson, head of Standard & Poor's Asia-Pacific Ratings Group, said in an e-mailed statement. At the bottom end of the rating scale, we are seeing a number of players fighting to survive.'"

November 14 - Bloomberg: "National Century Financial Enterprises Inc., which faces lawsuits over mismanagement of cash reserves, sold $725 million of bonds to two money-market investment programs, said a managing director at Moody's…The bonds, whose credit ratings were cut to junk status three weeks ago, were pooled with other securities to create so-called asset-backed commercial paper. Investors in asset-backed debt are repaid by dedicated revenue streams such as payments on credit cards, loans and customer bills. One program holds $500 million of National Century's debt, said Sam Pilcer, a managing director in charge of commercial paper ratings for Moody's…The program is guaranteed by a 'highly-rated bank' so investors won't suffer losses on the commercial paper, Pilcer said. He declined to name the programs and the bank. The other commercial paper program sold $225 million of National Century's debt two weeks ago."

November 13 - Bloomberg: "National Century Financial Enterprises Inc., which is facing lawsuits over mismanagement of cash reserves, sold almost $50 million of bonds to three money-market investment programs, analysts at Fitch Ratings said. The bonds were then pooled with other securities to create so-called asset-backed commercial paper…'There's $40 million of exposure in one program and less than $10 million in the other two,' said Deborah Seife, who rates asset-backed commercial paper at Fitch. She declined to name the affected programs. Many unrated or low-rated companies find the asset-backed market an easier place to raise money by promising lenders revenue from bills due from customers as collateral. There is about $710 billion of asset-backed commercial paper outstanding, representing about 52 percent of the total market…In the asset-backed commercial-paper program that holds $40 million of National Century debt, a swap counterparty rated F1+ covers any losses on the underlying assets, Seife said."

November 14 - Dow Jones: "Janus Capital Management LLC, the mutual-fund company owned by Stilwell Financial Inc. (SV), purchased $85 million of investment-grade commercial paper from its Institutional Janus Money Market Fund, according to a regulatory filing Thursday. Janus made the purchase Oct. 31 because the credit rating of the commercial paper was downgraded below the level that Janus management believed was prudent for the fund to own the investment, Stilwell said in its third-quarter report filed with the Securities and Exchange Commission. Janus funded the transaction with $41 million from its credit line and a $44 million short-term borrowing arrangement, the filing said."

Yesterday from the Bureau of Economic Analysis: "The 2001 economic slowdown was mild by historical standards because of strong growth in real GDP for private services- producing industries that helped to offset sharp declines in real GDP for private goods-producing industries, according to a report released by the Bureau of Economic Analysis (BEA) of the U.S. Department of Commerce. In 2001, real GDP for private services-producing industries increased 1.7 percent, while private goods-producing industries dropped 4.2 percent, primarily reflecting a 6.0-percent drop in manufacturing. Real GDP grew 0.3 percent in 2001, though growth rates varied widely among industries. Growth was led by such large private services-producing industries as communications (12.3 percent); retail trade (4.6 percent); finance, insurance, and real estate (FIRE) (2.8 percent); and services (0.9 percent). Declines, particularly in the manufacturing industries, were steep. Durable-goods manufacturing decreased 5.2 percent, and nondurable-goods manufacturing decreased 7.1 percent." It is today helpful to think in terms of the "quality of GDP" similar to the important issue of the "quality of earnings." Furthermore, as analysts, whether it is a company or economy, we focus first on the balance sheet (and contingent liabilities) then to the "earnings" statement. The poor quality of corporate "earnings" is playing a key role in the ongoing corporate debt collapse, as the deficient quality of GDP "growth" will going forward for non-corporate debt.

November 14 - Bloomberg: "New Jersey plans to remove the head of its pension management division after state funds lost more than $6 billion last quarter and $20 billion over the last three years, people familiar with the matter said. The top manager in the Division of Investment…would cease overseeing $56 billion in pension funds and move to a new government job until he takes early retirement on June 30, the people said. Lawyers were negotiating an agreement, which would be reached as early as today, the people said…'Many other state pension funds have had losses because they have similar investment strategies as New Jersey's,' said Parry Young, an author of a Standard & Poor's analysis titled 'Public Pension Funds Under Stress.' Some states 'are re-evaluating how they invest as well,' Young said. New Jersey pension funds lost $20 billion, or 24 percent, during the past three years."

November 13 - Salem, Oregon, Statesman Journal: "The stock market swoon has caused a $9.72 billion shortfall at the state pension system, much higher than earlier estimates, the system's actuary reported Tuesday. Whittling away that funding gap will require Oregon governments to shell out nearly 40 percent more for employee pensions next year, barring other policy changes. The dismal news came from actuary Mark Johnson's annual review of Public Employees Retirement System accounts (PERS)…Nearly all the increase in PERS' shortfall can be traced to the stock market slide of 2000 and 2001, Johnson said. He stressed that Oregon's plight is not unique. "Every pension system in the country is experiencing almost the same situation," he said. But the rising employer costs and mushrooming shortfall don't reflect the pummeling that stocks have taken so far in 2002. And the rate increases of nearly 40 percent don't reflect some of the 2000 and 2001 market losses that PERS is deferring, via a process called 'smoothing.'"

November 14 Bloomberg: "New York Mayor Michael Bloomberg said he would seek a 25 percent increase in the city's property tax and reduce the workforce by 8,000 during the next 19 months to help close budget gaps."

November 11 Associated Press: "Eighteen months ago, the city's economic engine was chugging along so mightily that a record $3 billion surplus allowed City Hall to cut taxes, hire thousands of people and plan two new baseball stadiums costing $800 million each. Today, New York City is looking at its worst fiscal crisis since it went to the brink of bankruptcy in the 1970s. The city faces a projected $6 billion deficit next year, thousands of layoffs and big tax increases. The thought of new ballparks has become the most anachronistic of pipe dreams."

November 14 Dow Jones (Stan Rosenberg): "At some point, sick people have to swallow bitter medicine. It's no different in New York, where the city has been diagnosed with looming fiscal insufficiency... Fitch Ratings' Vice Chairman Claire Cohen also felt that strong medicine was the right approach. 'What they're facing is big,' Cohen said. 'The easier measures and reserves have kind of been tapped out, and the income tax has collapsed,' given the loss of capital gains from Wall Street, she said. Cohen also used the New York City situation to warn other cities and states facing budget difficulties that it's time for them, too, to face up to the cure. Speaking of larger municipal governments, generally, and citing a $6 billion hole in Texas' next budget biennium, as well as a New York State deficit that's estimated anywhere between $5 billion and $10 billion, Cohen told Dow Jones Newswires: 'Whether it's New York City or the states that we rate, we'll be watching the '04 budgets real closely. The time has come to start figuring out what to do because there's nothing to indicate that revenues will come back in amounts sufficient to solve their problems.'"

November 14 - Associated Press (Alexa Bluth): "California faces a more than $20 billion budget deficit for the second straight year, according to projections released Thursday by Legislative Analyst Elizabeth Hill. Lawmakers will be forced over the next 19 months to fill in a $21.1 billion deficit - one quarter of the state's total operating budget - and could face $12 to $16 billion deficits for at least six more years, said Hill, the Legislature's nonpartisan economic adviser. 'There is no easy way out of this predicament,' Hill said. Gov. Gray Davis signed a $98.9 billion budget Sept. 5 - a record 67 days late - that used a combination of cuts, borrowing and increases to the state's revenues, including the suspension of a tax break that allows businesses to write off losses, to fill a $23.6 billion gap. But many, including Hill, predicted continuing deficits and said that Davis and lawmakers have exhausted easier, one-time fiscal fixes such as tapping into future funds from a nationwide tobacco settlement. Now, slumping revenues, a plunge in exports and the dismal performance of the stock market have translated to a $6.1 billion deficit in the current year that will grow - if not addressed - to $21.1 billion in the new fiscal year that begins July 1…Plus, Davis' current-year budget is out of balance partly because federal funds and savings built into the current spending plan never materialized."

Broad money supply increased $5.2 billion last week. Demand Deposits declined $16.5 billion, while Savings Deposits jumped $21.7 billion. Retail Money Fund assets declined $3.1 billion. Institutional Money Fund assets increased $2.0 billion. Repurchase Agreements added $3.8 billion. In the commercial paper market, borrowings increased $12.4 billion last week, with financial sector CP borrowings up $13.1 billion. Bank Credit jumped another $47 billion last week, with Securities Holdings up $31 billion. Loans and Leases jumped $16 billion, with "other" real estate loans up $13.9 billion. Total bank assets are up about $83 billion over the past three weeks. And in another monetary development to monitor closely, the Investment Company Institute reported that money market fund assets surged $85 billion this week to $2.24 Trillion, with two-week gains of $129 billion.

Today, Fannie Mae reported a record $95.1 billion of "Total Business Volume" (mortgage purchases) for the month of October ($1.14 Trillion annualized pace!). Fannie's Total Book of Business (mortgages held plus mortgage-backs outstanding in the marketplace) expanded at a 21% annualized rate during the month to $1.77 Trillion (up $206 billion, or 16%, y-t-d). Outstanding mortgage-back securities (MBS) expanded at a 39.6% rate during the month to surpass $1 Trillion. So far this year, Fannie's outstanding MBS have increased $159 billion, or at a 22.7% rate (after increasing 21.5% during 2001). It has been a truly incredible MBS issuance boom, and we should not now be the least bit surprised by acute indigestion problems suffered in the Credit and derivatives markets.

We see that the Federal Home Loan Bank System (FHLB) expanded assets by $39 billion during the third-quarter to $761 billion, the largest growth since the $40 billion increase during the pre-Y2K fourth quarter of 1999. The FHLB's record asset growth of $45.6 billion was set during the (infamous) fourth-quarter of 1998. Since the beginning of 1997 (23 quarters), FHLB assets have surged $469 billion, an increase of 161%. Total "Big Three GSE" (FHLB, Fannie, Freddie) assets jumped $88 billion during the third quarter, the largest increase since the third quarter of 1999. "Big Three" third-quarter annualized growth of 16% compares to the second quarter's 6.6% and the first quarter's 8.1%. Total "Big Three" assets have expanded an historic $1.46 Trillion over 23 quarters to $2.28 Trillion, an increase of 179%.

The FHLB's just completed third-quarter annualized growth rate of 22% compares to 11%, 3%, and 3% for the preceding three quarters. For the three months ended September 30, "Advances" to member institutions expanded at a 17% annualized rate to $490 billion. "Fed Funds Sold" grew at a 48% rate to almost $54 billion, while total securities holdings increased at an 8% annualized rate to $132 billion. Mortgage loans held expanded at a 92% annualized growth rate to $47 billion, and Deposit assets at a 77% rate to $26.9 billion. So far this year, Mortgage loans have increased at a 94% rate, Securities 20%, Fed Funds sold 15%, and Deposits 52%.

On the liability side, we see that short-term FHLB "Discount Notes" are basically unchanged since year-end at $140 billion, while "Bonds" are up $46 billion to $528 billion. There is, however, a liability line item that gives us pause. We see that "Derivative Liability" almost doubled during the quarter to $17.3 billion (up from $7.8 billion at year end). This compares to the "Derivatives Asset" that has increased about $1.1 billion to $3.8 billion. The company's explanation: "The $9.5 billion or 120.9 percent increase in derivative liabilities from December 31, 2001 to September 30, 2002, is the result of interest rate changes and the small growth in derivative volumes." Well, that's one heck of a ballooning liability - about one-half Total "Capital" of $36 billion - and a pretty feeble "explanation."

Even Fannie Mae, with all the questions (some legitimate) regarding its hedging operations, ended the third quarter with a "Derivatives in Loss Position" liability of $7.8 billion. This was, however, offset by "Derivatives in Gain Position" asset of $3.1 billion. And while Fannie is forced to mark its derivative loss to market (calculate/estimate a gain or loss based on current market conditions), at least it enjoys unrealized gains on its $760 billion mortgage portfolio. Looking at the FHLB balance sheet, we are puzzled by the scope of interest rate hedging that would lead to a $17 billion liability (loss?). The vast majority of assets comprise "Advances" to member institutions and short-term Fed funds sold. On the liability side, we see the preponderance of long-term borrowings. We don't get it…but they do admit to "intermediating" in derivatives for their member banks.

Yesterday Freddie Mac reported 30-year mortgage rates at a record low 5.94%. One-year adjustable rate mortgages were had a 4.09%. The Mortgage Bankers Association's weekly index had purchase applications dropping about 10% to the lowest level since early April. Refi applications were down slightly, although remain quite elevated. Bankruptcy filings jumped to 33,525, an increase of 2,000 from last week and up 9% y-o-y. This was also only slightly below the 52-week high for filings.

November 14 - American Banker: "With demand for residential mortgage loans soaring, bankers are tightening underwriting standards, appraisals are becoming more conservative, and the expectation of ever-higher home prices is fading. According to the Federal Reserve Board's periodic poll of senior loan officers, 10% tightened standards on residential mortgage loans in the past three months - the largest share of surveyed domestic banks in a decade. But twice as many told the Fed that they expect average home prices in their markets to decline over the next twelve months."

The National Association of Realtors' quarterly home price report was released yesterday. Nationally, the median home price of $161,800 was up 7.2% y-o-y. During the past year prices have inflated 10.7% in the Northeast ($166,200), 8.6% in the West ($214,800), 8.4% in the South ($151,600), and 5.1% in the Midwest ($140,700). By leading metropolitan area, Monmouth NJ was up 26%, Sacramento 24.6%, Providence 24.1%, Nassau/Suffolk NY 23.9%, San Diego 21.5%, New York/New Jersey/Connecticut 19.4%, Los Angeles 17.6%, Newark NJ 17.2%, and Washington DC 17%. Also posting double-digit y-o-y gains were the likes of Miami, Milwaukee, Baltimore, New Haven, San Bernardino, Ft. Lauderdale, Boston, Tucson, Honolulu, Philadelphia, San Francisco, Minneapolis, Madison, and Jacksonville.

From Chairman Greenspan's November 13th testimony before the Joint Economic Committee, U.S. Congress:

Jim Saxton, chairman Joint Economic Committee: "Can you expand on the temporary nature, or as opposed to the permanent nature, of this downturn that we're experiencing in the fourth quarter of the year?"

Chairman Alan Greenspan: "Mr. Chairman, as I point out in my written testimony, our best judgment is that we're going through a soft patch. That is not something which is the precursor of far more significant weakening. The reason for it, as best we can judge, is a combination of the after effects and still marginally important issues of the decline in stock prices, but increasingly to the fallout from corporate governance malfeasance problems and, of course, more recently and perhaps most importantly, currently the geopolitical risks surrounding the negotiations with Iraq.

The economy as such is not evidently significantly out of balance. That is, we do not have excess inventories. We do not have, as best we can judge, a debilitating large overhang of capital stock from over-building of plant and equipment. We don't have the usual internal weaknesses that presage an economy going down in a cumulative manner. But we do have is a very large degree of uncertainty, both as a consequence of corporate governance and as a consequence of geopolitical risks. And they are creating some significant hesitation mainly in the business sector, but presumably at least in part amongst consumers, as well.

Our judgment is when this uncertainty is lifted, when this risk premium essentially is restored to normal, as it will, that a number of the activities which are basically built in to the type of market economy that we have will take force and begin to increase the rate of growth. And while I, obviously, cannot speak for other forecasters around the country, you're quite right that the general consensus is for a gradual pickup in the rate of growth next year. But that, I suspect, pretty much rests on the presumption that that overhang of uncertainty is lifted."

Not surprisingly, chairman Greenspan does not address unfolding Credit market problems as THE critical issue for financial markets and the U.S and global economies. Mr. Greenspan and most economists retain great faith in the U.S. economy's inherent growth bias. Repeatedly, he and others have trumpeted the economy's "resilience," and we have regularly rebutted that the leading forces at work were an abnormal monetary/service sector economy stoked by unhealthy and unsustainable Credit and speculative excess. It is the monetary regime of "contemporary finance" that has been amazingly resilient. We see only further evidence that this "regime" is unstable and increasingly vulnerable.

With our view of escalating Credit problems, we see little possibility for anything other than brief respites from the "uncertainty overhang." With liquidity abundant, these respites will feed intermittent stock market rallies and an attendant boost in confidence (and spending). The true ongoing problem, however, is anything but investor psychology, and no amount of positive thinking will rectify gross structural impairment. As analysts, we think in terms of the created edifice of fragile debts structures and financial and economic Bubble distortions. Unlike Dr. Greenspan, we view the U.S. economy as grossly imbalanced. Looking through the eyes of a traditional business cycle economist, he sees little cyclical inventory overhang in the industrial sector. Yet, Greenspan remains blind to deep structural maladjustments in the New Age "Service Sector" economy. The acutely fragile financial system impaired by many years of gross speculative and Credit excess - and the residual irreparable damage done to the real economy - that will keep "risk premiums" extraordinarily high going forward. The problem is not "uncertainty," but bad debt. The great system "overhang" is found in leveraged speculations.

Watching the unfolding financial and economic crisis develop for several years now, the manner of its eventual resolution is becoming somewhat more visible. The degree of leveraged speculation in the U.S. Credit system increased the possibility for a systemic (LTCM-style) unwinding/dislocation and liquidity crisis. The Fed and GSEs, however, mastered the art of maintaining over-liquefied markets, keeping the leveraged players keen to stay in what became basically the only game in town. What speculator would not want to stick around for the greatest central bank rate cuts in history with multiple "buyers of first and last resort"?

After watching the SE Asian dominos collapse in the 1996/97, we saw the possibility for The Weak Link being similar "hot money" speculative flight out of dollar financial assets. After viewing the mechanism of leveraged speculating community distress transferred to LTCM and the U.S. Credit market after the pummeling in Russia, he saw the possibility of post-U.S. stock market Bubble hedge fund losses being The Weak Link causing a domino liquidity crisis in the U.S. Credit system and global markets. Greenspan assured this did not transpire. Instead, the outcome has been (blow-off) Credit and speculative excess beyond our imaginations. Mastering market liquefication and fostering continued excess, the Fed and GSEs assured unmanageable systemic Credit losses. And that's where we are today.

As I wrote, unfolding developments are becoming somewhat clearer. A Weak Link is found with the Credit insurers and Credit derivatives. In "text-book" speculative blow-off fashion, the Credit insurers became major players in guaranteeing against losses throughout the Bubbling asset-backed securities marketplace (and collateralized debt obligations) at the late stage of an historic Credit Bubble (the high price to be paid for prolonging this dangerous Credit cycle). For the Credit insurers, it was most unfortunate timing. We now find out they are on the hook for myriad of the weakest Credits imaginable, including (apparently fraudulent) loans to truck driving schools, National Century asset-backs, subprime Credit cards, and lord knows what to surface later.

The immediate problem is that the marginal borrower is being denied Credit - the very same weak Credits that have played such a crucial role in sustaining boom-time spending (the "resilient" economy). Think of it this way: if the increasingly risk averse market had not shied away from extending new Credits to National Century, then the Credit losses associated with their specious securities (and other health care Credits) would have remained hidden. But instead we have billions (?) of losses now to recognize, with some being shouldered by the Credit insurers. Many healthcare providers will suffer from faltering Credit availability. Importantly, we expect ABS and "structured finance" losses will now be a significant issue for the Credit insurers. And when confidence wanes for these key insurers, we've got a catalyst for financial dislocation. Remember, these thinly capitalized companies' insurance buttress truly enormous quantities of securities. In this regard, it does not take a deranged imagination to see a potential train wreck developing in muni finance; faltering finances, mushrooming underfunded pension liabilities, and huge borrowing needs for as far as the eye can see. And with the Credit insurers playing such a critical role throughout municipal finance, we think it is now fair to identify this area as a Weak Link for future systemic dislocation.

Today from Bloomberg: "Three companies advised by Alliance Capital Management Holding LP own $50 million of bonds sold by National Century Financial Enterprises Inc., the target of lawsuits alleging financial mismanagement, people familiar with the situation said. The companies -- ASAP Funding Ltd., MPF Ltd. and MPF Two Ltd. -- sold short-term debt and used the health-care financing company's bonds as collateral, the people said…Money-market mutual funds, considered among the safest investments, might also lose as a result. ASAP Funding, MPF and MPF Two pooled National Century's debt with other securities and created so-called asset-backed commercial paper, the people said…Radian Group Inc., a seller of financial guarantee insurance, is one company that insures ASAP Funding…"

Earlier this week from Bloomberg: "National Century Financial Enterprises Inc.'s use of cash reserve may close the $1.2 trillion asset-backed bond market as a funding option for companies without publicly traded shares and credit ratings, investors said…'It pretty scary' for as much as a quarter of the market is made up of bonds backed by 'off the run' assets such as health-care receivables, said…an analyst…" A managing director at Moody's averred: "The market overall will be looking much harder at smaller, thinly capitalized originators or services, especially if they're unrated or below investment grade."

From the Asset Securitization Report: "The implications of this are frightening, one source argued. If NCFE is found to have violated contracts with these healthcare providers, the contracts may be ruled invalid, and the providers would have a strong case in court."

"Frightening," indeed. Credit issues have now made their way to the "Heart of the Matter" - the asset-backed securities market and the expansive money-market fund arena. The marketplace even appears to taking a more cautious approach to behemoth money market borrowers Fannie Mae, Freddie Mac, and GE. We also believe this development is the impetus for the Fed's 50 basis point rate cut.

It is also worth noting the $1.44 billion loss reported this week by Credit Suisse, a major player in asset-backs (National Century's investment banker!) and U.S. "structured finance" generally. But they are only one of an expanding number of troubled foreign financial institutions operating in U.S. financial markets. It is today important to appreciate that the big international financial conglomerates became major U.S. Credit Bubble operators. They are now beginning to suffer the consequences. It is our view that it was these and other leveraged speculators that played the instrumental role in what was the painless recycling of increasingly massive U.S. current account deficits ("Bubble Dollars") back to the U.S. Credit system. Evidence of their key role is found by scanning the list of borrowers in one's money market fund, while also pondering the quality of assets underpinning hundreds of "funding corps" managed by these same institutions (and held in huge quantities by the money fund complex). It is also worth noting that the recently released Shared National Credit Review of U.S. syndicated bank loans stated that 45% of these Credits were held by foreign-sourced institutions. This is a problem, and their problem is our problem. As we have written repeatedly, there is a lot of bad paper out there somewhere.

Whether it is large amount of poor Credits extended or their over-enthusiasm for the fledgling Credit default swaps, foreign players acquired enormous U.S. Credit risk as they aggressively played the Great Credit Bubble. How much of this risk lies hidden in American investment portfolios (in funding corps, special purpose vehicles and elsewhere) - and how much of this risk has been re-insured by the U.S. Credit insurers, Banks, GE and others - only time will tell. However, one way or the other, these unfolding Credit losses are quite likely a critical Weak Link. Despite this week's curious bid to acquire Household International, we would now expect that, on the margin, the reeling foreign financial conglomerates will attempt a quiet retreat from the faltering U.S. Bubble. If so, this will prove a seminal development for the Great Credit Bubble and its twin, the Bubble dollar. Again repeating previous analysis, "As goes structured finance, so goes the dollar." And if, as we expect, the dollar proves a Weak Link, Dr. Greenspan's inflationary goals become more challenging and considerably more risky.

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