Monday’s Minutia

Merrill chief Stan O’Neal is leaving the firm, at the request of the board according to the NYT, though the WSJ says he’s stepping down. The $7.9b write-down in Q3 was a factor, but the Times says the real problem was approaching Wachovia for merger talks without consulting with the board first.

 

Oil traded over $93 last night as Mexico temporarily stopped production at some locations due to bad weather. The WSJ today has a story featuring analysts who don’t think it can top $100 because traders will want to lock in gains.

 

Chrysler workers approved a new contract by a very narrow margin on Saturday. 56% of UAW members and 51% of contract workers voted for the pact. Ford is still negotiating its deal.

 

Bloomberg says “reluctant Bernanke” would rather not raise rates, but may cave to pressure from the market. The article assumes that silence equals no change, and sees a lot of “no comment” in speeches, but when we reviewed the speeches and other Fed output, we got different results. For us, the tipping point was the Beige Book, which reveals considerable deterioration in October in every sector except tourism. The Fed research staff is known internally as the second most important member of the FOMC after the chairman, even without a vote.

 

This is a very heavy data weak, starting slowly on Tuesday with the Case-Shiller 20-city composite house price index, then heating up Wednesday with ADP employment, the Chicago PMI the advance Q3 GDP report, the employment cost index, construction spending and of course the FOMC rate decision. The week culminates with Friday’s October employment report.

Friday Fish Wrap

Crude oil is trading at $91.68 at 5:30AM, up on fears that Iran will cut production in retaliation for new sanctions imposed by the US government. It was trading over $92 last night. High oil prices represent one of the most significant threats to growth this winter, especially if it ever gets cold enough to turn on the heat in the Northeast. Part of oil’s strength is also dollar weakness, as the greenback fell to a new low against the euro on expectations for fed rate cuts.

Countrywide reports before the bell this morning. Estimates are all over the map, as analysts struggle to pin down the extent of losses on exotic prime mortgage loans. A trader at RBC says bonds were intentionally mispriced to boost earnings, says the WSJ, adding to the woes in the financial sector. In contrast, Microsoft yesterday posted earnings that were well above expectations, lifting the entire tech sector. 

The “mother of all tax reforms” proposed by House Ways and Means Chairman Rangel adds up to an increase of about $1 trillion over ten years, making it the biggest tax hike ever, according to critics and appears to have very little support even among fellow Democrats. Hillary Clinton was the only member of Congress to comment – through a spokesman – who said she shares Rangel’s goal of a more progressive tax system.

Today’s economic calendar limited to the final October U Mich sentiment, which is expected to be unchanged from the preliminary 82.0.

 In our local market, most everyone has heard about the demise of Diablo Funding Group.  Another example of the perils of correspondent lending in today’s environment.  Margin calls, loan buybacks, and falling volume (lower revenues) all add up to the inability to keep their doors open.  What is most disturbing are the stories of originators not receiving commissions owed and this in turn causes them to fall behind on their obligations! A vicious spiral that is indicative of our industry as a whole. 

Another shocker this week was the announcement by B of A that they are exiting the wholesale lending market and closing down their wholesale lending division at year end.  As of November 25th, they will cease taking any new applications through the wholesale business channel and will wind down by year end.  This is NOT a good time to be a mortgage broker and as far as doing business with a mortgage broker it is “buyer beware”.  There are too many stories and too many instances of transactions that got to the end and failed to close due to the inability of the lender to fund the transaction.  Wholesale lending sources are drying up and those that remain are tightening up on guidelines.  The safe haven for the consumer is a moretgage lender backed by or part of a bank where they do not have to rely on lines of credit to fund their transactions.

Thank you and have a great weekend!

Thursday’s Update

New orders for durable goods fell 1.7% in September after falling 5.3% in August. (August was revised from -4.9%.) Orders were expected to rise 1.5%. Orders ex-transportation rose 0.3%, about half of the 0.7% consensus forecast. Durable orders are down 8.4% year-on-year, while orders ex-transportation are down 1.2% year-on-year.

New Orders for Durable Goods, Yr/Yr%

Capital goods orders were down 1.3% thanks to a 38.7% drop in defense capital goods. Non-defense cap goods orders were up 4.4%, thanks to a partial rebound in aircraft orders after a big drop in August. Non-defense cap goods are down 12.0% year-on-year headline and 5.6% ex-aircraft.

There were declines in vehicle orders, computer orders, electrical equipment orders and orders for fabricated metals. Primary metal and machinery orders were up.

Durable shipments fell 2.0%, about the same as in August, but non-defense cap goods shipments rose.

Bottom line: There’s no denying it now, capital spending was hurt by the credit crisis in August and September. Not only did orders fall enough to reverse the improving trend of the spring, but, like the slowdown in employment and the recession in housing, the weakening trend in durable orders was evident well before the credit markets locked up over the summer (see chart). Weak capital spending is one of the red flags the FOMC is on the lookout for. As a result, the unexpected decline in September’s orders will be on the list of concerns supporting another rate cut next week.

Tuesday Trivia

Did the Fed endorse M-LEC, the still under-construction Master-Liquidity Enhancement Trust? That’s what Bloomberg says, citing an official who asked to remain anonymous. The Fed’s silence since the Treasury-orchestrated plan was announced has been interpreted as criticism, this official said, but “the proposal looks reasonably well designed and has the potential to contribute – rather than impair – improvements in these markets and the process of price discovery.” Other Fed officials refused to comment specifically on the Treasury’s plan. The WSJ stopped short of calling it an endorsement, saying instead that the Fed’s silence “does not reflect opposition.”

Charles Rangell, Chairman of the House Ways and Means Committee, has proposed cutting the corporate tax rate from 35% to 30-31%. The cut would be funded by closing existing corporate exemptions, including a tax break for manufacturers designed to prevent jobs from going overseas. The plan is not expected to fly with this Congress, but the WSJ says it may “set the stage for” future discussion or a broader overhaul by the incoming president in 2009.

The WSJ reports an increase in bankruptcy filings of about 45% in the first three quarters of this year, with an increasing number of people opting to file Chapter 13, which blocks foreclosure as long as mortgage payments are made on time.

Barney Frank has proposed an overhaul to the way mortgages are offered, securitized and supervised, according to the WSJ. The plan prohibits brokers from steering borrowers to more expensive mortgages for bigger commissions. It would eliminate prepayment penalties on subprimes and reduce them on prime loans. The bill includes assignee liability – which extends some liability in cases of loan fraud to mortgage bond holders – but only if they do not follow due diligence laid out in the bill.

Chicago Fed President Charles Evans gave his first speech last night. In it, he said he would base policy on the economy’s structure, on where the funds rate stands against a neutral funds rate and “uncertainties.” The last is an endorsement of a risk-management approach to monetary policy advocated by Alan Greenspan and Ben Bernanke.

No US data today.

Friday Fish Wrap

Delinquencies on new mortgages are falling, according to data from First American Loan Performance, a sign that tighter lending standards are working. Delinquencies are expected to continue to rise on loans made between 2003 and 2006, however.

 

Yesterday, crude closed at $88.47, and it traded over $90 last night. The WSJ spotlights an increasing number of analysts calling this latest rise a bubble. If it’s not, the US economy could be in real trouble.

 

The IMF declared the dollar still too strong, according to the Financial Times, and named the yuan and euro as two currencies it would like to see the dollar depreciate further against.

 

The mood darkened in the fixed-income universe yesterday as another decline in ABCP outstanding was reported along with a passel of poor bank earnings, a spike in unemployment claims and a plunge in the ABX indices, all reminiscent of August’s troubled times. Treasuries rallied further overnight so that the10-yr is now under 4.5% at 4.48%. The last close under 4.5% was on September 17, the day before the Fed cut rates by 50bp. Bloomberg’s new fed funds implied probability function {FFIP <GO>} puts the odds of a rate cut at the end of this month at 61.6%, up from 38.1% a week ago.

                                          

There are no US releases scheduled today. Bernanke and Poole speak at a St Louis Fed event.

Thursday Stuff

Yesterday, bond yields plunged in reaction to a series of reports suggesting weaker US economic growth: Housing starts fell in September; the IMF slashed its 2008 US GDP forecast to 1.9%; S&P downgraded $23.4 billion of 2007 vintage RMBS paper and the Fed’s Beige Book showed slower economic activity in September and October.

Today, the WSJ says the super-SIV bailout plan is meeting resistance from 1. investors wary of SIVs in the first place even more wary of a giant one and 2. potential backers reluctant to participate in what they see as a bailout of Citibank. Of course, there’s also the fact that the bailout is only for bank-backed SIVs. Jamie Dimon, President of J.P. Morgan, was quoted in the paper yesterday saying the SIV bailout was never intended to be for everyone.  Partial data in the Fed’s commercial paper release showed a drop in yields and tighter spreads in the past week, suggesting most investors reacted positively to the news of the Treasury’s bailout plan. The outstandings will be released today, as will the maturity distribution. The week before last, ABCP outstanding was down again, and the amount of commercial paper maturing in a week or less rose again, to $464.5bn. The pressure is on.

Japan’s former top currency official Eisuke Sakakibara, known as Mr. Yen, said last night that he feared the dollar may plunge in 2008 if the US economy slows too much, necessitating aggressive intervention from central bankers.

Kansas City Fed President Thomas Hoenig says he is “optimistic but alert” about the economy. Recent speeches and the breakdown of discount rate votes in August and September reveal resistance to rate cuts from a core group of Federal Reserve presidents. We’ll have more details in this week’s weekly commentary.

Two German’s governor’s of the European Central Bank are now on record favoring further rate hikes in the EU despite the credit crunch there. 3-mo euro LIBOR rates have fallen from 4.78% to 4.65% in the past week or so, but remain well above the 4.25% rate before the August/September credit crisis.

Today in the US, jobless claims are expected to rise from 308k to 312k, leading indicators are expected to partially rebound by 0.3% in September after falling 0.6% in August. Also, the Philly Fed index is expected to slip from 10.9 to 7.0.

Wednesday’s Wash

Retail sales were still strong, but softer, housing may “remain subdued” for months to come and factory output was hurt by the housing slowdown. So said the Beige Book survey of anecdotal reports conducted by the Fed for the October meeting.

 

Growth was reported unchanged in seven districts and slower in five (Cleveland, Dallas, Kansas City, Richmond and San Francisco). Stronger exports offset domestic weakness for some firms, but the Fed said the weak dollar is pushing import costs higher. On a related note, the Fed says companies are having mixed results when they attempt to pass higher costs to consumers.

 

The outlook for manufacturing was mixed, which is consistent with other recent factory reports. Housing related manufacturers have been hit directly by the problems in that sector, but other manufactures are not reporting much of a slowdown in orders.

 

Most districts continue to report tight labor market conditions in selected industries, so that while wage growth was generally subdued, (indeed, wage pressures “softened”) there were sharply higher increases in select industries. The Fed is likely to be concerned about these hotspots when setting policy, however, as long as there is not an aggregate labor shortage.

 

There was a ”higher than usual degree of uncertainty” about the economic outlook, which may in turn affect investment spending.

 

Delinquencies are rising and credit quality is deteriorating at district banks, while mortgage lending of all types slowed. Business lending rose, but credit standards were tightened, especially for commercial real estate.

 

Bottom line: The Beige Book paints a picture of slowing activity and growing uncertainty in almost all facets of the economy. It supports an October rate cut, but the Fed will not act on the Beige Book alone unless it is backed up by economic data.

Tuesday Trivia

Last night in New York, Ben Bernanke sounded confident the Fed has done enough to stabilize the financial markets, so that it is now safe to guide policy based on the economic and inflation data. As to that, he said strong income growth is propping up the economy in the face of the “considerable drag” from the housing downturn, a downturn the Fed now expects to continue into the first half of 2008. This is a significant change. Every time Bernanke has offered an opinion on housing in the past, it has been to say that the worst is already over. He has never admitted to more than the possibility of another month or two of weakness. Bernanke made no mention of collapsing Treasury tax receipts, a sign that income growth might not be as strong as it was.

 

Bernanke said there are “quite tentative” signs of a cooling labor market, another departure, this time in the other direction. The minutes from September 18 acknowledged a slowdown in hiring stretching back for months before the credit markets locked up in August. He is likely watching unemployment claims as well as payrolls.

 

As to the future direction of policy, “it remains to early to tell the extent to which household and business spending will be affected by the weakness in housing and the tightness of credit conditions,” he said, suggesting it’s too early to tell if further rate cuts will be required to avert an excessive slow down. At the same time, the FOMC is “prepared to reverse the policy easing if inflation pressures proved stronger than expected.”

 

Asked about the inflationary implications of the weak dollar, Bernanke explained that “all else being equal” some inflation comes through import prices when the dollar depreciates, but in the Fed’s experience, the impact is small. In other words, for now, all decisions about the direction of rates will be decided by the direction of domestic economic data.

 

As tempting as it is to think that Bernanke is regressing to his old ways now that the immediate threat of a dysfunctional credit market is gone, that is not true. Gone is the old Chairman, who repeatedly painted himself and the Fed into corners by stressing the threat of inflation despite clear evidence of a slowing economy. This Bernanke clearly wants to leave all options open.  

 

Oil traded at $88 in Europe after closing at a record yesterday in New York. This is one place where dollar weakness is being felt in a big way. After all, oil is still under 60 euros a barrel.

                                                                                                                                     

Foreign investors sold a record net $69.3bn in US assets in August in reaction to the credit crunch. They sold $163bn including short term assets like asset-backed commercial paper. Japanese holdings of US Treasuries dropped by almost $25bn, as banks there started to reduce US exposure as they come to grips with their subprime exposure.

 

Industrial production rose 0.1% in August, as expected, while capacity utilization fell a tenth to 82.1%. August production was revised from +0.2% to unchanged.

Monday Minutia

On Friday, Bloomberg News broke the story that a consortium of banks, working with the Treasury Department, was trying to organize a fund to pool mortgage assets from bank-backed structured investment vehicles, or SIVs. This morning, the papers are abuzz about the plan, which Bloomberg News says is a done deal. Citi, Bank of America, JP Morgan Chase and “others” have agreed to set up an $80bn fund to help revive the asset-backed commercial paper market. An announcement could come today, according to the latest update of the article. The fund will buy assets from SIVs. It’s hoped other banks will join in financing the fund, so that SIVs can avoid selling their $320bn in assets at fire sale prices. The fund, called the Master Liquidity Enhancement Conduit, or MLEC, will buy assets rated AAA or AA by Moody’s or S&P. (It will have to move fast; downgrades are coming.)

 

The WSJ says some critics think the Treasury went too far initiating the process that led to the creation of the MLEC, because Treasury is helping risk-takers avoid the consequences of their risky behavior, though the fact that the Treasury took no active part in financing the deal should shield it from this line of criticism. Others worry that pooling risky assets may not make them any easier to finance, while others worry that pooling assets is a bad precedent that may encourage banks to take excessive risk in the future.

 

Bloomberg warns that Treasury issuance could swell 50% as the budget deficit expands this year. The problem is Treasury receipts, which have begun to suffer significantly from the loss of income and capital gains on home sales as a result of the housing slump. (See Jim Vogel’s Charts of the Week in The Weekly Report.) Of course, it goes without saying that normally a collapse in Treasury revenue goes hand-in-hand with a slowdown in the broad economy.

 

Today, the Empire Manufacturing survey (New York Fed) is expected to have slowed from 14.1 to 13.0 in October. Bernanke speaks tonight at the Economic Club of New York, a venue that Greenspan used more than once to spill the beans on Fed policy. Given Bernanke’s ongoing efforts to differentiate himself from his former boss, will he opt to talk about something else tonight?

Friday Fish Wrap

The employment report is once again the indicator of the month, as it is seen as the primary determinant of Fed policy. The consensus for the change in nonfarm payrolls is +100k and most economists expect August’s -4k to be revised up into positive territory. The June, July and August numbers all included declines in local government employment, an unusual circumstance that was not confirmed in the sum of the state employment changes reported by BLS.  BLS warns not to sum the state employment changes, but they do tend to track the national figures fairly well. Unfortunately, when they diverge, as they did over the summer, it’s not a given that one or the other series will be the one to come back into line, however. Sometimes the sum of the states is wrong, sometimes the national figure is wrong and it’s a tossup which it is. Bloomberg says homebuilders are liquidating assets at panic prices in “a desperate bid for survival.” The drop in new home prices is putting pressure on the existing home market, too, which may mean an acceleration in price declines over the next few months.     The unemployment rate rose in July from 4.5% to 4.6%. Taken to two decimal places, there have been small increases for months, but it’s unlikely we’ll see an increase big enough today to round up to 4.7%.   Yesterday, the Fed reported an increase of $4.5bn in commercial paper outstanding, the first increase in eight weeks. Asset-backed CP was down again, by $6.1bn, however, and nonfinancial was down by $4.0bn. The rise in financial cp is a sign that the CP market is healing, but in part it is healing because so many SIVs and conduits have been forced out of the market. The final month-end tally in September was a $54.5bn decline in CP, with non-financial down $6.1bn, financial up $3.7bn and asset-backed down $54.6bn. In August and September combined, CP outstanding fell by $314.1bn.As to where the funding came from for all the assets formerly funded in the CP market, we suspect the huge increase in home loan advances in Q3 likely accounts for much of it. Jim Vogel has written quite a bit about $110bn in FHLB growth in August and $53bn in growth in September, compared to typical growth of $10-20bn in a quarter. Many conduits and SIVs were set up by banks and the banks have likely been using FHLB advances to keep them going.   The WSJ reports that there is a criminal investigation of Bear Stearns two collapsed hedge funds, and that Countrywide’s option grants are being examined. The FDIC’s chairman has asked loan services to convert adjustable subprime loans to fixed-rate loans, apparently unaware that the problem for most adjustable rate borrowers is that they could not afford to make fixed rate payments in the first place. Most mortgage holders would be thrilled to convert loans before they go into foreclosure, but apparently only 1% of the loans in the foreclosure process have been successfully renegotiated.