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A Volatile Week

I had arthroscopic knee surgery (nothing major) this morning, so please excuse this abbreviated (and analysis-lacking) Bulletin. I am hoping to edit and improve it tomorrow.

Wild volatility returned to the U.S. equity market. On the back of today's surge, the Dow and S&P500 ended the week with gains of just under 1%. The Morgan Stanley Consumer index added 1%, while the Morgan Stanley Cyclical index was about unchanged. The Transports and Utilities, however, ended the week 2% in the red. The broader market was about unchanged, with the small cap Russell 2000 flat and the S&P400 Mid-Cap index down about 1%. The technology sector was strong. The NASDAQ100 gained 3%, returning the index to break-even for the year. The Morgan Stanley High tech index added 2% and The Street.com Internet index 1%. The Semiconductors surged 7% this week, while the NASDAQ Telecom index was about unchanged. The Biotechs missed the rally, dropping 3% for the week. The Securities Broker/Dealer index was unchanged, while the Banks added about 1%. With Bullion pummeled for $18.30, the HUI Gold index dropped 3%.

Credit market performance was mixed. For the week, two-year Treasury yields were unchanged at 1.61%. Five-year yields declined four basis points to 2.85%, while the 10-year Treasury note saw its yield rise one basis point to 3.94%. Interestingly, the long-bond performed poorly, with yields jumping eight basis points to 4.88% (inflation worries?). Benchmark mortgage-backs appeared to under-perform (yields generally up three basis points), while agency debt continues to perform quite well (implied agency yields down three basis points). The spread on Fannie's 5 3/8 2011 note narrowed 2 basis points to a very narrow 33 basis points. The 10-year dollar swap spread narrowed 2.5 to 42, with agency and dollar swap spreads narrowing to levels not seen since pre-Russia/LTCM September 1997. However, corporate spreads began to widen this week. Ford and GM saw their debt spreads (to Treasuries) widen five or six basis points. Junk bonds were pounded yesterday, with speculative grade spread indices widening almost 20 basis points. While generally unimpressive, today's rally put the dollar slightly in the plus column for the week. Declining less than 1%, commodities gave back a portion of their recent strong gains.

February 11 - Bloomberg: "Cotton prices soared the exchange-imposed limit on speculation that China has increased purchases of the fiber. China, the world's biggest consumer of cotton, has bought at least 300,000 bales of cotton from U.S. shippers, traders said. The sale couldn't be confirmed. 'China is buying anything that isn't nailed down.'"

The corporate bond market continues to enjoy extraordinary liquidity. Crown Cork & Seal's $2.12 billion (raised from $1.75 billion) issuance was the largest junk bond financing in three years (according to Bloomberg). American Electric Power raised $2 billion, CIT raised its bond issuance 33% to $1 billion, and PHH, a division of Cendant, sold $1 billion of bonds. It is worth noting, however, that Mandalay Resorts postponed their $300 million offering, while Citgo has delayed its offering until next week.

California sold $900 million of general obligation this week at historically wide spreads. The state sold seven year tax-exempt bonds at a yield of 3.71% (6.66% tax equivalent), a 48 basis point premium to top-rate muni issuers. This was about 30 basis points more than state of New York yields and up from the 25 basis point premium California paid back in October.

Broad money supply (M3) expanded $16.9 billion last week, with three-week gains of $87.2 billion. Currency increased $1.2 billion, while Demand and Checkable deposits jumped $11.8 billion. Curiously, narrow money (M1 - Currency, Travelers Checks, Demand and Checkable Deposits) is up almost $47 billion in three weeks. Savings Deposits declined $3.4 billion and Small Denominated Deposits decreased $1.5 billion. Retail Money Fund deposits declined $3.9 billion, and Institutional Money Fund deposits declined $6.6 billion. Large Denominated deposits increased $11.3 billion and Repurchase Agreements jumped $8.5 billion. Official Foreign Holdings of U.S. debt securities increased $4.5 billion last week to $870 billion, and is up $60 billion (30% annualized) over 13 weeks. Bank Total Assets expanded $74.1 billion last week (seasonally-adjusted), with five-week gains of $113.5 billion (17% annualized). Securities holdings jumped $35.7 billion for the week. Loans and Leases increased $9.8 billion. Real Estate loans were up $18.8 billion, while Commercial and Industrial (C&I) loans declined $5.1 billion. For the first five weeks of the New Year, Real Estate loans are up $42.8 billion (22% annualized growth rate!), while C&I loans have declined $2.5 billion. Issuance of asset-backed securities was a slow $3.4 billion, with performance said to be diverging notably between top-tier issuers and the faltering subprime sector.

Divergences, not surprisingly, are increasingly evidence in the economic landscape as well. The manufacturing sector continues to show signs of life. This morning provided a stronger-than-expected 0.7% increase in Industrial Production (strongest gain in six months) and a slight uptick in Capacity Utilization. Earlier in the week, Retail Sales Less Autos were reported stronger-than-expected (although weak auto sales saw an overall disappointing retail sales report). Retail Sales were up 4.6% y-o-y, with Retail Sales Less Autos up 5.8% y-o-y. Sales growth was led by Building Materials up 6.6% y-o-y, Health Stores up 5% y-o-y, Gasoline Stations up 19.3% y-o-y, General Merchandise up 5.3% y-o-y, and Eating and Drinking up 8% y-o-y. But while the number of dollars expended remains relatively strong, the mood is grim. Today's University of Michigan Consumer Confidence report had the Future Situation component sinking four points to 68.8, the weakest reading since September 1993. This index is down 12 points in two months.

Yesterday the Labor Department reported that Import Prices jumped 1.5% during January, the strongest gain since last April. There have been only two stronger monthly readings during the past 10 years (a 1.6% rise in April 2002, and 1.9% in February 2000). Year-over-year import prices were up 5.5%, the highest level since August 2000. It is worth noting that y-o-y import prices were slightly negative as recently as September. Y-o-y by category, Food & Beverage prices were up 5.3%, Industrial Supplies 26.8% (fuels and lubricants up 12.5% for the month and 66% y-o-y), and Autos and Parts up 0.5%. Capital Goods prices were down only 2.1% y-o-y, although prices have declined only slightly during the past three months. Consumer Goods Ex Autos saw prices down 0.5% y-o-y, although prices have increased marginally over the past two months.

February 11 - Bloomberg: "The California Public Employees' Retirement System, the largest U.S. public pension fund, is considering selling credit enhancement to municipal bond issuers to earn as much as $17.5 million a year. Calpers' investment committee is considering whether the pension fund should begin selling letters of credit or liquidity facilities to state and local bond issuers as a way to generate income. Under the proposal, the fund would back up to $5 billion on bonds, about 5 percent of the fund's $133.8 billion in assets… 'The program will provide support for California municipalities and others across the nation while adding value to our investment portfolio.' Calpers would join a number of states that already run bond insurance programs…"

February 11- Financial Times (Jenny Wiggins): "'Bond insurers risk taking losses in their structured finance portfolios due to ongoing weakness in the credit markets,' Moody's Investors Service has warned. Many bond insurers are heavily exposed to the structured finance markets, having accumulated $210bn of exposure to the collateralised debt obligation (CDO) and credit default swap (CDS) markets by the third quarter of 2002. To date, Financial Security Assurance is the only bond insurer to have recorded a material loss on CDOs and significantly increased its loss reserves. It has the largest CDO/CDS exposure in the industry, accounting for 35 per cent. Other insurers with substantial exposure include MBIA, Ambac Financial, ACE Guaranty and XL Capital Assurance."

Things are turning desperate at subprime auto lender AmeriCredit. Now fighting for survival, the company is sharply reducing lending, shuttering 60% of its branch offices, and firing 1,000 employees. But retrenchment rarely proves a viable option in the game of subprime. Any reduction of Credit availability - and consequent slowdown in lending growth - finds current "earnings" overwhelmed by ballooning Credit losses. Yet, we have been amazed that the enterprising Credit insurers have continued to provide Credit enhancements necessary for the company to sell its securitizations. But the well is clearly running dry, and there will be a high price to pay. We will now watch the performance of the company's securitizations and how quickly loss "triggers" hits the company and its various Credit insurers. This looks to be one more blow to an increasingly punch-drunk asset-backed securities market, as well as a significant escalation of the bursting of the consumer debt Bubble. AmeriCredit ended 2002 with managed receivables of $16.2 billion (up 60% in 18 months!). At $1.533 billion, AmeriCredit is #16 on MBIA's "Top 25 Structured Finance Servicer Exposures."

Weekly bankruptcy filings jumped to 32,223, up 9% to the highest level since early November. Last week's filings were up 14% y-o-y, on top of a high base created by 2001's 19% surge and 2002's 5.7% increase. In blow-off week #34 of The Great Mortgage Finance Bubble, the Mortgage Bankers Association Refi application index declined 2.7% from the previous week, while remaining up 156% from the year ago level. The Purchase application index declined 11.4% to the weakest reading since March, although it was up 4.5% y-o-y. A one-year adjustable-rate mortgage could be had last week at 3.61%, down from the year ago 5.10%. National Mortgage News this week estimated fourth-quarter 2002 mortgage originations at a stunning $1 Trillion. Wow…

Highlights from Countrywide Financial's January production report: "Loan fundings reached $33.7 billion, up 127 percent from last year's $14.8 billion. This marks the third highest funding month in the Company's history… Average Daily applications remained strong at $2.0 billion, up 111 percent from January 2002… The month end mortgage pipeline closed at $48.2 billion, up 110% over last year's… The servicing portfolio reached a record $469 billion… Total assets at Countrywide Bank now stand at $6.5 billion…" Y-o-y, January Purchase Fundings were up 61%, Non-purchase (refi) Fundings 159%, Home Equity Fundings 47%, and Subprime Fundings 50%.

Fannie Mae reported that January "Total business volume rose to a record high of $121.1 billion. Fannie's retained mortgage portfolio jumped $19.8 billion, or 34.6% annualized, during January to $810.6 billion. Over two months, Fannie's retained portfolio has surged $49.9 billion, or 39% annualized. To put this Credit creation into perspective, Federal Reserve Total Assets have expanded $14.3 billion over the past two months to $697 billion, and have increased $62.4 billion (9.8%) during the past twelve months. Fannie's total Book of Business (retained mortgage portfolio plus mortgage-backs sold into the marketplace) is up $78.7 billion, or 27% annualized, over two months to $1.859 Trillion. Fannie's Book of Business is up $278 billion, or almost 18%, over the past twelve months.

February 12, 2003: "Median existing-home prices are increasing at strong rates in most metropolitan areas and typically are increasing well above historic norms, according to the latest quarterly survey by National Association of Realtors… The association's fourth-quarter metro area home price report, covering changes in 120 metropolitan statistical areas, shows 39 areas with double-digit annual increases in median existing-home prices and only 10 areas posting generally small price declines… David Lereah, NAR's chief economist, said inventory shortfalls continue to squeeze home prices in many areas. 'There was an average 4.7-month supply of homes on the market during the fourth quarter, well below the 6.0-month level considered to be a generally balanced market between buyers and sellers. The tight supply of available homes has persisted for several years now. The result is that home prices in the fourth quarter rose almost three times faster than historic norms."

Wednesday the National Association of Realtors reported median prices for fourth-quarter existing home sales. And despite increasingly vocal propaganda arguing otherwise, data are rather conclusive that we remain in the midst of an historic national Mortgage Finance Bubble. Accordingly, inflationary manifestations are rather conspicuous from coast to coast. Fourth quarter prices were up 8.8% y-o-y, with gains of 12.9% in the Northeast, 8.9% in the Midwest, 7.7% in the South, and 10.8% in the West. The California housing Bubble saw the top two along with the eighth lending price gainers by metro area, with Sacramento up 26.7% y-o-y, San Diego up 26.6%, and Orange County gaining 20.4%. Median prices were up 24.6% in Providence, RI , 23.6% in Nassau/Suffolk, NY, 22.1% in Monmouth/Ocean, NJ, 20.9% in Melbourne, FL, 20.8% in Ft. Lauderdale, FL, and 20.2% in "NY/NJ/CT." Other notable gains included the "Los Angeles Area" up 19.8%, Milwaukee, WI 19.7%, Chicago 15.7%, Baltimore 14.2%, Washington DC 14.1%, Philadelphia 12.6%, San Francisco 11.3%, Boston 10.2%, and Minneapolis 10.2%.

February 12 - Bloomberg: "Total existing-home sales, which include single-family, apartment condominium and co-operative sales, rose in 45 states and the District of Columbia in the fourth quarter of 2002 compared with the same period in 2001, the National Association of Realtors (NAR) reported today. NAR's latest report on total existing-home sales showed that nationwide, the seasonally adjusted annual rate was 6.55 million units in the fourth quarter, up 8.6 percent from the 6.03 million-unit level in the fourth quarter of 2001. In addition, fourth-quarter sales were up 5.8 percent from a pace of 6.19 million units recorded in the third quarter of 2002 and were the second-highest level on record."

February 12, 2003 - Representative Bernard Sanders: "Mr. Greenspan, I always enjoy your presentation, because frankly, I wonder what world you live in."

Alan Greenspan does appear increasingly detached from reality, while his stature in Washington is in strikingly steep decline. For a senator to call (rather disrespectfully) for the Fed Chairman's resignation on national television is in stark contrast to the idolatry of too many years past. And there is no denying that Greenspan's analysis is poor and lacking of credibility, even to those that have revered him. He is clearly overstating the current economic impact from the imminent conflict with Iraq. He is determined to disregard the severe economic maladjustments imparted over his long tenure. At the same time, he is seemingly distracted from the critical issue of the impending financial and economic quagmire. He continues to trumpet the exceptional performance of contemporary finance and the U.S. financial sector specifically, while appearing oblivious to the developing dislocations throughout "structured finance." He cannot say enough good things about the household housing/mortgage environment, but then plays cautious when it comes to its Master, the GSEs. And, remarkably, in just two days of testimony he at the same time disappointed the Administration and the "Keynesian" inflationists. Perhaps Dr. Greenspan has been rattled by the energy price spike and heightened inflationary pressures.

Greenspan Testimony to Senate Banking Committee: February 11, 2003 Q&A

New Hampshire Senator John Sununu: "I have one final question about the mortgage industry. You talked about the degree to which mortgage rates, being at historic lows, have encouraged refinancing, and refinancing activity is at a very high level right now. In the past, you've been very candid about your concerns regarding the GSEs and your thoughts regarding changing some of the current legislation that provides benefits to GSEs. Let me talk about one particular reform, which I think is topical because of the Sarbanes-Oxley bill, and that is oversight -- greater oversight or involvement of the SEC in the mortgage market and the secondary mortgage markets in particular. To what extent do you, I guess, support, or would you support SEC oversight or involvement in the GSEs, but to what extent would that affect costs of mortgages and liquidity in the mortgage markets?

Chairman Greenspan: "Without stipulating whether I would agree in any particular proposal, because without seeing the specific proposal, just basically saying that this agency should oversee this part of the economy, I don't think is enough information. But having said that, the major issue here is to what extent is the subsidy, which is implicit in the GSE debentures, even though they are not legally an obligation of the United States government, they are not backed by the full faith and credit of the United States, it's the market which presumes that they will be bailed out that effectively enables them to sell mortgages at a number of basis points below what the market would otherwise be. As a consequence of that, some of that does go through into lower mortgage interest rates, but as best we can judge, it is a very small number. So I'm not at all convinced that many of the proposals really make all that much difference to the secondary mortgage market or to the level of mortgage interest rates to the American public.

Georgia Senator Zell Miller: "This also is a question that comes from personal experience. I'm sitting here between two former governors, one's left, but from time to time -- I don't know about them, but from time to time, we get to thinking that maybe it would be better to be back in the statehouse. Except right now, it's not too good back in the statehouse. And so my question to you is, do you think the Congress should address in any way the budget shortfalls that the states are having? And if so, what would be your approach?

Chairman Greenspan: "This is a difficult question, largely because the source of the problem in many of the states, as you know, Senator, has been that with the fairly substantial surge in revenues that the states had, in many cases, and it's hard to know how many, permanent programs for expenditures were financed. And to a large extent, because the tax rate on capital gains and options and the like are --or, I should say the tax rate on capital gains in the states are pretty much equivalent to the regular income tax rates, since the adjusted gross income from the federal returns are what are used for the income tax where it is applicable for the states. And we saw a very big surge in federal revenues, but for some states, because the tax rates are relatively higher, they saw an even greater surge. So that you have to weigh the fact that some of the states overexpended and should and will and are appropriately pulling back, and others didn't. And the question is, how does one - how does the Congress or the federal government appropriately handle that without essentially treating those who were not sufficiently conservative t contain their funds from those who are less conservative? In other words, how does one make a program which is fair to everybody?

I have no objection, obviously, to having federal funds go to the states. That's - we've been doing that for decades. But I must admit, I do have some problems how one -- how would one in fairness create a program which did not essentially benefit those who are the least conservative in their programs relative to those who were. If that can be done, then I think that there are obvious arguments in favor of it.

Texas Representative Ron Paul: "I have a question relating to the speech that you gave at the economic club in New York in December. Because you introduced your speech with three paragraphs dealing with gold and the -- and monetary policy. And you made some very pertinent points about gold, indicating that from the year 1800 to 1929 the price levels were essentially stable under gold. And after we got rid of the gold restraint on the monetary authorities, prices have essentially increased by over tenfold since that time. But you also follow that by indicating that inflation, when it was out of control in 1979, monetary policy changed direction in a way, and they were able to take care of inflation, more or less conquer inflation, and that now you are more or less not concerned about inflation, that your concern, really, is about deflation. And it was interesting that you brought up the subject of gold, of course. And there's a lot of speculation as to exactly why you did this and what this means.

But my question deals with whether or not we should forget about inflation, whether or not this has been dead and buried. Federal Reserve credit for the last three months has gone up at the rate of over 28 percent. Inflation is a monetary event, so therefore we have monetary inflation. The median CPI is almost going up at twice the rate as the CPI, close to 4 percent. The Commodity Research Bureau index is going up in the last 15 months over 35 percent. Gold is up 36 percent over 18 months, or 15 months. Oil is up 60 percent. So we have a lot of inflation. And we have medical care costs skyrocketing, housing costs going up, the cost of education going up, the cost of energy going up. And to assume that we shouldn't be concerned about inflation, all we can do now is print money, I would suggest that this is what we've been doing for three years, the monetary authorities. We've ... you've lowered the discount rate 12 times, and there's still no signs of good economic growth. So when -- when will you express the concern about an inflationary recession? Because that to me seems like our greatest threat, because that has existed before, we even had a taste of it in the '70s. We called it stagflation. So I'd like you to comment on that as well as follow on your comments on just why you might have brought up the subject of gold as the New York speech.

Chairman Greenspan: "First of all, we have not lessened our concerns about inflation. Indeed, our general presumption is that we seek stable prices. And stable prices mean no inflation or deflation. The reason I raised the issue of gold is the fact that the general wisdom during the period subsequent to the 1930s is that as we moved to essentially a fiat money standard, that there was no anchor to the general price level. And, indeed, what we subsequently observed is, as you point out, a very marked increase in general price levels, indeed, around the world as moved ourselves from commodity standards, and specifically gold. I had always thought that the fiat money system was chronically and inevitably an inflation vehicle, and indeed, said so repeatedly.

I have been quite surprised, and I must say, pleased by the fact that central bankers have been able to effectively simulate many of the characteristics of the gold standard by constraining the degree of finance in a manner which effectively has brought down the general price levels. The individual price levels to which you allude are certainly correct. I might say the gold and the oil issue are clearly war related and not fundamental. But we still -- looking at the broadest measures of average inflation, and the best statistics that we have, still indicate very low inflation with no evidence of an acceleration. That does not mean, however, that we believe that inflation is somehow inconceivable anytime in the future. We will maintain a considerable vigilance on the issue of inflation, and are looking all the time for evidences of an emergence of inflation, which at this particular time we do not see. But that does not mean that we believe inflation is dead and that we need not be concerned about it. We will continue to monitor the financial system as best we can to make certain that we keep prices stable. They are stable now, and we hope to be able to continue that indefinitely into the future."

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