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Friday, November 30, 2007

High on Rate Cut Euphoria, Again

The market is high on rate cut euphoria again. The broader equity markets have strung together an impressive winning streak this week… Time to get short again.

Three-Month Libor for Euros Soars to 6 1/2-Year High, BBA Says: “The cost of borrowing euros for three months rose to the highest since May 2001, according to the British Bankers' Association.

The London interbank offered rate, the amount banks charge each other for such loans, rose 3 basis points to 4.81 percent, its 13th straight day of gains.

That's 81 basis points more than the European Central Bank's benchmark rate, the biggest gap ever.

The overnight euro rate rose for a second day, up 9 basis points to 4.08 percent, the BBA said today.”

That does not bode well for the equity markets in longer term. Libor rates are signaling that the financial system is under severe strain DESPITE massive injections of liquidity to date. Economic growth will almost certainly drop SIGNIFICANTLY in the near future.

ECB Takes More Steps to Counter Money-Market Tensions (Update3): “The European Central Bank took additional steps to calm money markets after the cost of borrowing in euros for a month rose to a six-year high.

The ECB will extend the maturity of its regular refinancing operation settling on Dec. 19 to two weeks from one, the Frankfurt-based central bank said in an e-mailed statement today. The operation will mature on Jan. 4 instead of Dec. 28. The ECB Governing Council, meeting via teleconference yesterday, decided the extra measure was necessary to “satisfy the banking sector's liquidity needs” for the holiday period over Christmas and the end of the year.

The move comes a day after the Bank of England said it will offer commercial banks emergency funds with longer repayment terms because of the risk that money markets will “tighten” at year- end. The U.S. Federal Reserve has also pledged to provide extra cash through a series of repurchase agreements into next year. Fallout from losses on U.S. subprime mortgages has made banks reluctant to lend to each other, pushing up credit costs.”

Paulson, Banks in Talks to Stem Surge in Foreclosures (Update1): “U.S. Treasury Secretary Henry Paulson is negotiating an agreement with banks to stem a surge in foreclosures by fixing interest rates on loans to subprime borrowers, according to people familiar with a meeting he led yesterday.

The Bush administration cut its forecast for economic growth yesterday, reflecting a deepening housing recession that's roiled financial markets since August. The Commerce Department reported the same day that the median price of a new house fell 13 percent in October from a year earlier, while fewer homes were sold than economists anticipated.”

The proposal is to ‘fix’ rates for 3 years, then allow the resets to occur. This does nothing but postpone the necessary price corrections. If you couldn’t afford a reset now, you won’t be able to afford the reset rate 3 years from now. End of story.

“Bair has proposed letting borrowers with adjustable-rate subprime mortgages, who are living in their homes and unable to afford resets, get extensions on the starter rate for at least five years. They could also be offered 30-year fixed-rate loans. Reich prefers a three-year freeze.

The rout will get worse because defaults on home loans are likely to rise, analysts said. The FDIC estimates that 1.54 million nonprime mortgages valued at $331 billion will reset by the end of next year.”

Stalling won’t solve the problem.

Bernanke Says Fed to Judge Market `Turbulence' Impact (Update2): “Federal Reserve Chairman Ben S. Bernanke said “renewed turbulence” in markets may have shifted the risks between growth and inflation, cementing speculation the central bank will lower interest rates as soon as next month.”

The cuts had already been priced in prior to this speech and even prior to the speech given by Kohn. This was nothing new.

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