Are Things Really This Good?

Equities all over the globe have recovered nicely. It is almost as if the August credit crunch never happened. But are things really that good?

Inter bank rates in the US, UK and other countries, some as remote as Russia, are just now spiking or have remained elevated.

Borrowing Costs Soar; Banks Seek Loans Amid Squeeze (Update1): “The cost of borrowing pounds, dollars, and euros rose as banks sought funding over the quarter- end amid a credit squeeze that shows no signs of abating.

The London interbank offered rate that banks charge each other for overnight loans in pounds rose 20 basis points to 6 percent today, according to the British Bankers' Association. The corresponding rate for dollars rose 21 basis points to 5.30 percent, and the euro rate climbed 6 basis points to 4.23 percent.”

Some of the riskiest borrowers are left with no alternative but to head straight for the punitive discount window.

“Northern Rock borrowed a further 5 billion pounds ($10 billion) from the Bank of England, bringing the total it owes to the central bank near to 8 billion pounds, the FT said. Northern Rock fell as much as 5.4 percent today, while the value of U.K. home loan providers Bradford & Bingley Plc and Alliance & Leicester Plc, which also raise financing in money markets, declined.”

Russian Liquidity Trouble Starts To Boil: ““There could be some defaults. The Russian rouble bond market is not working.”

Overnight lending rates in Russia climbed to 10 per cent, the highest since mid-2005, even after the central bank on Wednesday pumped an additional $2.56bn into the banking system via two one-day repo auctions. Traders and bankers said the spike came as companies and banks prepared to make a monthly round of tax payments and primed their accounts to meet central bank requirements in time for end of third quarter financial reports.”

While the credit crunch may have kicked off in the US and spread to Europe, believing it has stopped there is over simplifying the matter. This is a GLOBAL credit bubble.

Canadian Commercial Paper Investors Seek Extension (Update3): “Banks and investors seeking to restructure about C$35 billion ($35 billion) of Canadian asset- backed commercial paper said they need more time to come to an agreement.

“I'm going to damn well do everything I can to have a solution before year-end,” Purdy Crawford, a Toronto-based lawyer who chairs the investor committee, said today on a conference call. “What we're trying to do is avoid a meltdown, which would not be in the interest of any of the investors.””

That is pretty serious indeed. Some of the very real and practical consequences of a credit crunch are revealed in my post the other day A Big Deal when essential supplies such as food and drilling equipment almost didn’t make it to remote mines in Canada’s north.

“The market for Canadian commercial paper has been roiled after Coventree Inc. and other non-bank funds failed to roll over most of their maturing debt in mid-August because investors feared possible ties to subprime mortgages. Banks refused to provide back up financing, effectively shutting the market, prompting 10 banks and money managers to propose conversions into longer-term debt by mid-October.”

Things aren’t getting any better either. In fact one could argue that the opposite as authorities increase their interventions.

“In an effort to ease the credit crunch, the Bank of Canada made C$985 million in one-day securities purchases today, the first such move in six weeks.”

U.S. Commercial Paper Drop Slows After Fed Cuts Rates (Update5): “The decline in the U.S. commercial paper market slowed last week, after the Federal Reserve cut interest rates to shore up confidence in the credit markets.

Debt maturing in 270 days or less fell by $13.6 billion in the period ended yesterday to a seasonally adjusted $1.86 trillion, including a $17.3 billion decline in asset-backed commercial paper, according to the Federal Reserve in Washington.

The amount outstanding has fallen by $368.1 billion, or 17 percent, over seven straight weeks to the lowest since August 2006 as some issuers were shut out of the market. The decline is smaller than the previous week's drop of $48.1 billion, a sign that the credit crunch in short-term debt markets may be subsiding following the Fed's half-percentage-point reduction in its benchmark rate on Sept. 18.”

The commercial paper market is not deteriorating as fast as it was in August, but it IS deteriorating… and not just a little bit.

Greenspan Says Risk of U.S. Recession Has Increased (Update3): “Former Federal Reserve Chairman Alan Greenspan said the odds on the first U.S. recession in six years have increased as falling house prices threaten consumer spending.

“The danger of recession has obviously risen,” said Greenspan, who will meet U.K. Prime Minister Gordon Brown in London this weekend, in an interview on BBC Radio 4 today. Greenspan said the chance of recession was “less than 50-50,” repeating a comment made Sept. 23.”

Really? Less than 50/50. What kind of economic shit storm is required for the odds to be higher than 50/50? The simultaneous collapse of a global credit and asset price bubble isn’t enough to get the odds over 50/50?

U.S. August Personal Spending Rises Greater-Than-Forecast 0.6%: “Consumer spending in the U.S. rose more than forecast in August, a sign the fallout from a weaker job market and collapse in subprime lending had yet to reach the biggest part of the economy.

The 0.6 percent rise in spending was the biggest in four months and followed a 0.4 percent increase in July, the Commerce Department said today in Washington. The Federal Reserve's preferred measure of inflation cooled.”

Numbers like this don’t point to a recession… but then again, what if they’re just lagging? I mean look at yesterday’s new home sales numbers. Calculated Risk cleanly presents all the data and to say its scary is an understatement.

Now What?

Europe is broadly higher. S&P futures are higher as a continuation of yesterday. Today is a light news day.

European Retail Sales Weaken, Bloomberg PMI Shows (Update1): “European retail sales growth slowed in September, led by the sharpest drop in Italy since June 2005, the Bloomberg purchasing managers index showed.

A gauge measuring retail sales slipped to a seasonally adjusted 50.5 from 51 in August. The index is based on a survey of more than 1,000 executives compiled for Bloomberg LP by NTC Economics Ltd. A reading above 50 indicates expansion.”

There are signs of consumer fatigue even outside the US.

“European consumers are more reluctant to increase spending after rising credit costs worldwide and turmoil on financial markets clouded the outlook for economic expansion. In Italy, the government said this week that economic growth will be weaker than expected this year and next.”

On the other hand, Asia is still in party mode.

South Korean Consumers Most Confident in Five Years (Update3): “South Korean consumers became the most optimistic in five years in the third quarter, indicating shoppers may step up spending and spur economic growth.

The consumer sentiment index increased to 112 from 108 in the second quarter, the Bank of Korea said in a report released in Seoul today. A reading higher than 100 indicates optimists outnumber pessimists.”

Banks Borrow 3.9 Billion Euros at ECB's Penalty Rate (Update3): “The European Central Bank lent the most money at its penalty rate in almost three years, suggesting at least one bank is still being shut out of credit markets.

The ECB loaned 3.9 billion euros ($5.5 billion) at its marginal rate of 5 percent yesterday, the most since October 2004, the Frankfurt-based central bank said in a daily borrowing-requirement statement today. It didn't provide details of which bank or banks asked for the money.”

No-one knows where the bodies are buried. Although things have calmed down some banks are still reluctant to lend to each other.

“The overnight rate for euros fell 18 basis points to 4.17 percent, the BBA said today, while the corresponding rate for pounds climbed 14 basis points to 5.8 percent. The three-month rate for pounds dropped 1 basis point to 6.31 percent.”

Bear Stearns May Draw Investment From Buffett, Banks (Update1): “Bear Stearns Cos. may be close to selling a stake to Warren Buffett or a financial institution as the beleaguered securities firm struggles to revive earnings and its stock price.”

Traders took that rumor and ran with it yesterday. However, these talks may signal that Bear Stearns needs cash quite badly after taking some serious mortgage related losses. I know a little about Buffett. He does not like complicated financial alchemy, going so far as to call certain derivatives ‘financial weapons of mass destruction’. I’m not yet convinced that Buffett would make this kind of purchase. I could see him snap up regional banks, insurance companies and maybe even a brokerage, but for some reason this Bear Stearns rumor doesn’t fit.

The rumor that a Chinese bank might be interested in a 30% stake… now that, that is far more likely.

KKR Banks Selling $10 Billion of First Data Loans (Update2): “Banks financing Kohlberg Kravis Roberts & Co.'s acquisition of First Data Corp. plan to sell as much $10 billion of loans today, double the amount targeted last week, said a banker involved in the deal.

Six underwriters led by Credit Suisse Group, Citigroup Inc., Deutsche Bank AG and Goldman Sachs Group Inc. will sell as much as $8 billion of the debt at a discount of 4 percent of the face value. A further $2 billion will be sold at a 3 percent cut, said the banker, who declined to be identified because details of the sale are private.

“It's a significant event on the road back to normality,” said John Pattullo, who manages about $2 billion of mainly high- yield bonds and loans at Henderson Global Investors in London. “It shows that investors at least will accept a market clearing price and that wasn't the case a month ago.””

Some deals are starting find nibblers at discounted rates while others are still being abandoned:

Sallie Mae Says Investor Group Won't Complete Buyout (Update3): “SLM Corp. said a group led by J.C. Flowers & Co. won't complete the $25.3 billion purchase of the largest U.S. student loan company. The group said it's open to negotiation.

The group doesn't expect to complete the $60-a-share acquisition, Reston, Virginia-based SLM, known as Sallie Mae, said today in a statement. Under an agreement announced in April, SLM was to be sold for $60 a share to an entity 50.2 percent- owned by Flowers, with JPMorgan Chase & Co. and Bank of America Corp. each holding 24.9 percent.”

This morning Sallie Mae rejected an offer from Flowers to renegotiate the deal.

Dollar Falls to Record Low Against Euro Before Home Sales: “The dollar fell to an all-time low against the euro on speculation a government report will show a drop in U.S. home sales, bolstering the case for lower U.S. interest rates.

The currency headed for its biggest quarterly slump versus the euro and yen since December 2004 as the yield advantage on 10-year Treasuries over similar-maturity European debt narrowed to the least in almost three years. The dollar has weakened against 15 of the 16 most-active currencies since June 30, falling 4 percent versus the euro.”

The slow slide into the Abyss continues…

U.S. Economy Grew at a 3.8% Rate in Second Quarter (Update1): “The U.S. economy grew in the second quarter at the fastest pace in more than a year before last month's credit-market turmoil heightened concern the expansion might be cut short.

Gross domestic product rose at a revised 3.8 percent annual rate from April though June, propelled by a surge in exports, figures from the Commerce Department showed in Washington. The economy advanced at a 0.6 percent rate in the first quarter.”

While impressive, this is old data and not something to get excited about.

“More recent reports have shown residential construction slumped to a 12-year low in August and manufacturing cooled, suggesting last quarter's growth rate will be the strongest of the year. Concern over the damage a worsening housing recession may wreak prompted Federal Reserve policy makers last week to cut interest rates more than most economists forecast.”

A closer look at the data also reveals the ‘growth’ to be very concentrated and probably a consequence of the declining dollar more than anything else.

“Today's GDP revision mainly reflected a smaller narrowing of the trade deficit than previously estimated. Still, the smaller gap added 1.3 percentage points to growth, the most since 1996. Other categories were little changed.”

More important is determining the health of the consumer.

“In today's report, consumer spending, which accounts for about 70 percent of the economy, rose at a 1.4 percent pace, the same as previously estimated and the smallest gain in a year.”

The overall result is still a rapidly weakening economy.

“The economy will grow 2 percent this year, the least since 2002, according to this month's survey. Economists had projected a 2.5 percent expansion at the start of the year.”

A Big Deal

So it probably was a ploy to look tough…

GM, UAW Reach Contract Agreement, Ending 2-Day Strike (Update6): “-- General Motors Corp. reached an historic contract agreement with the United Auto Workers, ending a two-day strike and taking $50 billion of future health-care obligations off GM's books.

The four-year accord may transform the competitive landscape for the U.S. auto industry, allowing the Detroit automaker to operate with a cost structure closer to that of its Japanese rivals. Should the deal be approved by GM workers, Ford Motor Co. and Chrysler LLC will seek similar cost-cutting UAW contracts. GM rose 6.8 percent in early trading.”

Since this is a ‘pattern’ settlement, Ford and Chrysler will get similar deals. The deal does look very good for the ‘big three’ and is going to be a tough thing for UAW members to swallow. Ultimately it is a win-win in the sense that this settlement increases the probability of survival and reform for everybody involved; GM, Ford, Chrylser and the UAW.

The difficulty now lies in determining how much of this good news will be offset by the continued weakening of the US economy. After all, a car purchase is one of the easier things to postpone for a year or two. Especially the more expensive, gas guzzling SUV and truck types that are the bread and butter of all three…

Speaking of durable goods:

U.S. August Durable Goods Orders Fall 4.9%; Ex-Transport Down: “Orders for U.S.-made durable goods fell in August by the most in seven months, raising concern business investment will soften.

Demand for products meant to last several years fell a greater-than-forecast 4.9 percent after a revised 6.1 percent gain the prior month, the Commerce Department said today in Washington. Excluding transportation equipment such as airplanes, orders declined 1.8 percent after a 3.4 percent gain.”

While bad, this data series is notoriously nasty and therefore requires a good number of data points before we can start to make arguments about trends…

“The drop in demand followed the biggest jump in almost a year, testament to the data's inherent volatility, economists said. Still, with housing in long-term decline and access to credit more costly and difficult, industrial demand may cool even as exports climb and inventories remain lean.”

Carlyle Capital Assets Fall 24% Amid Debt Selloff (Update1): “Carlyle Capital Corp., the publicly traded credit fund backed by private-equity firm Carlyle Group, fell 24 percent in August as it sold assets and global debt prices declined.

Carlyle Capital's net assets dropped to $642.1 million from $843.5 million at the end of July, according to a monthly financial statement obtained by Bloomberg News. The decline wiped out 61 percent of the $327.8 million in capital that the Guernsey, U.K.-based fund raised in the previous two months.”

OUCH. The problem now is determining what the economic effects will over the coming months and years of these funds being bailed out by their sponsors because those will SUCK UP A LOT OF USEFULL CAPITAL. While Carlyle is a private equity group banks are facing the same problems with their own funds, conduits and SIVs. You may go to the bank for a mortgage, line of credit or business operating line of credit… any credit really, and find the bank less than enthusiastic about lending to you because they would rather allocate their capital to save their asses first over making new loans… Can you say CREDIT CRUNCH?

Subprime Panic Freezes $40 Billion of Canadian Commercial Paper: “On Baffin Island in the Arctic Circle, Baffinland Iron Mines Corp. almost missed its window to ship provisions to workers before winter arrives. The delay came not from the weather, but from a sudden freeze in the market for short-term debt 2,000 miles south in Toronto.

Baffinland ran short of funds to pay for food, fuel and drilling equipment after investing in commercial paper that borrowers couldn't repay. Without the money, the company had to arrange an emergency line of credit before shipping lanes froze over.”

Those are some of the very real and practical consequences of a CREDIT CRUNCH.

“Investors fled Canada's asset-backed commercial paper, paralyzing the C$40 billion market for debt that carried the highest credit ratings, after losses from home loans to people with poor credit histories roiled global credit markets.

AMBAC, FGIC, May Need More Capital If Subprime Losses Worsen: “Bond insurers, including those owned by AMBAC Financial Group Inc. and FGIC Corp., may need to raise capital to maintain their top credit ratings if losses worsen on subprime mortgage securities, Moody's Investors Service said.

Under what Moody's called its most stressful scenario, losses on securities backed by subprime mortgages could reach 14 percent, causing AMBAC, FGIC, Security Capital Assurance Ltd. and CIFG Assurance North America Inc. to fall short of the capital needed to keep their Aaa ratings. The most likely source of losses would be from guarantees on collateralized debt obligations, which may be backed by subprime mortgage securities. The stress test is higher than Moody's expected loss rate of 10 percent under which the guarantors experience no material losses.”

Things are about to get far worse for the ‘bond insurers’. Considering they based their insurance pricing schemes on flawed and faulty models there is no way that reserves are adequate. That much at least is obvious.

“MBIA Inc.'s bond insurance unit would remain adequately capitalized, despite its exposure to CDOs backed by subprime mortgage-backed securities, Moody's said.”

Well, I’m just going to throw out the fact that Moody’s sucked at building and using appropriate models for its ratings of these slippery little derivatives…

The Housing Abyss

Flip flop.

GM, UAW Resumption of Talks May Signal Short Strike (Update3): “The United Auto Workers' return to bargaining with General Motors Corp. within hours of calling the first national strike against the automaker in 37 years may signal the union's desire for a quick end to the walkout.

“It shows that the union leadership does in fact want to reach an agreement,” said Jules Crystal, a labor lawyer at Bryan Cave LLP in Chicago, who has negotiated more than 260 contracts with the UAW and other unions for auto-parts suppliers. “In many cases, the union would walk out in a huff and say, "Call us when you're ready to talk.””

Looks like all this is part of the ploy. Perhaps the deal will be so hard to swallow for UAW members that the union has to put on this great act of fighting tooth and nail.

S&P/Case-Shiller Home Price Index Falls 3.9% in July (Update2): “Home prices in 20 U.S. metropolitan areas fell the most on record in July, indicating the threat to consumer spending was rising even before credit markets seized up in August, a private survey showed today.

Values dropped 3.9 percent in the 12 months through July, steeper than the 3.4 percent decrease in June, according to the S&P/Case-Shiller home-price index. The index declined in January for the first time since the group started the measure in 2001, and has receded every month since then.”

Prices are ACCELERATING to the downside with no bottom even in sight. Next we should start seriously seeing the consequences of these falling house prices in other economic indicators.

“A glut of homes on the market adds to pressure for sellers to lower prices. The inventory of single-family existing homes on the market represented a 9.2-months' supply in July, the most since October 1991, the Realtors group said on Aug. 27.”

Inventory levels are now at levels only seen in the DEPTHS of RECESSIONS. Prices have no choice but to COLLAPSE to market clearing levels. Where that may be is anybody’s guess…

U.S. Retailers' Sales Fell 1% Last Week, ICSC Says (Update1): “U.S. retail sales fell 1 percent last week from the previous seven days, the second consecutive decline, and September sales may rise less than previously estimated, according to a report by an industry group.”

Expect these numbers to get far worse. With a declining dollar gasoline prices are about to become a major problem…

“Higher gasoline prices and the worst U.S. housing slump in 16 years have slowed consumer spending. Lowe's Cos., the second- largest U.S. home-improvement retailer, said yesterday that earnings this year may miss its previous forecast. Target Corp., the second-biggest U.S. discount chain, lowered September sales projections yesterday after customer visits declined.”

U.S. August Existing Home Sales Fall to Five-Year Low (Update1): “Sales of previously owned U.S. homes fell in August to a five-year low, extending a slump that threatens to stall economic growth.

Purchases declined 4.3 percent, less than forecast, to an annual rate of 5.5 million, the National Association of Realtors said in Washington. Sales dropped 13 percent compared with a year earlier and median home prices rose 0.2 percent to $224,500.

Sales are likely to keep falling after borrowing costs rose and mortgages became more difficult to get last month. The number of properties on the market rose to a record in August. Lower home values and slower job growth may hurt consumer confidence and spending, economists said.”

Lennar Reports Biggest Loss in Its 53-Year History (Update3): “Lennar Corp., the largest U.S. homebuilder, reported the biggest quarterly loss in its 53-year history after $848 million of costs to write down the value of real estate. The shares fell as much as 6.5 percent.

The third-quarter net loss was $513.9 million, or $3.25 a share, exceeding the most pessimistic estimates from analysts and suggesting the worst housing market in 16 years shows no signs of stabilizing. Revenue at Miami-based Lennar fell 44 percent to $2.34 billion, the lowest in more than three years.”

Into the abyss housing will go… from boom to bust. Like it always has and always will. Did you really think this time was different? Its called an economic CYCLE for a reason.

The 11th Hour

It is the 11th hour in so many ways…

General Motors Faces Auto Union Strike Deadline Today (Update6): “The United Auto Workers, in pay talks with General Motors Corp., set a strike deadline for 11 a.m. New York time today, the 10th day since its current contract with the largest U.S. automaker was originally due to expire.

“General Motors has failed to recognize and appreciate what our membership has contributed during the past four years,'' UAW President Ron Gettelfinger said in a statement. “In this current round of bargaining, we did everything possible to negotiate a new contract.””

Negotiations are still ongoing right into the deadline. It is likely that a compromise will be reached and the UAW is just acting tough. This way, when the results are announced they can say they fought hard right to the end. Both the UAW and GM know that the future of the company is at stake here. For real this time.

Dollar Falls to Record Low Against Euro as U.S. Growth Falters: “The dollar fell to a record low against the euro and declined versus the yen on speculation economic reports will show U.S. growth is losing momentum, adding to pressure on the Federal Reserve to cut interest rates again.”

Housing and Consumer Confidence reports will be out this week. With each report it becomes more and more difficult to justify holding anything dollar related other than commodities.

Fed's Rate Reduction May Give Little Relief to U.S. Homeowners: “Americans may be disappointed that the Federal Reserve's interest rate cut won't translate into lower monthly mortgage payments and a revival of the housing market.

“Mortgage rates won't stimulate demand,” said Scott Anderson, senior economist at Wells Fargo & Co. in Minneapolis. “The Fed may be a little impotent here because what caused this housing crash was overpriced housing, not mortgages.”

Duh. Sometimes it just takes a really really long time for the obvious to sink in. The housing crash was caused by OVERPRICED HOUSING, NOT MORTGAGES. In my post The Bond Vigilantes Are Back I argue that its going to be far more complicated. The rate cuts are actually causing mortgage prices to RISE.

“Investors concerned about inflation following the Fed's half-point interest rate cut have driven up the yield of 10-year Treasury notes by 23 basis points, or 0.23 of a percentage point, to 4.7 percent. The increase has dashed hopes that lower home-loan costs might entice more Americans to overcome their fear of falling prices and buy homes.”

The Fed had a simple choice: INFLATE or DO NOTHING. Had the Fed done nothing the housing market and therefore the economy as a whole would have CORRECTED by falling into a MANAGEABLE and DESERVED recession. Instead the Fed chose to cut rates and add liquidity. In other words: INFLATE the entire system. The ultimate results will still be a recession. Only now the recession may have been postponed, possibly for years, and when it does hit it will be neither MANAGEABLE nor MILD.

Brown May Hurt Investors to Damp Northern Rock Anger (Update1): “Prime Minister Gordon Brown's government, which insured the deposits of Northern Rock Plc customers to stop a run on the bank, seems willing to sacrifice its investors and executives to lawmakers looking for someone to blame.

While Chancellor of the Exchequer Alistair Darling guaranteed U.K. savers with accounts at the bank will lose no money, his backing doesn't extend to new accounts. That makes it difficult for the Newcastle-based mortgage lender to remain independent; its shares fell by a third since Darling's decision on Sept. 17.”

Grinding blindly through the mess… all the while just ensuring that the next mess will be much bigger.

Banks Reduce Backlog of Unsold Debt to $370 Billion (Update2): “Banks reduced the backlog of unsold corporate debt by 2 percent in the past two weeks to $370 billion as investor demand for leveraged loans and bonds improved, Bank of America Corp. analysts said.”

Pimping a 2% reduction in the debt backlog of $370 billion as ‘progress’ smacks of desperation. This is hardly a sign that the debt markets are moving again. There must be good deals in this massive pile somewhere and they will get done.

KKR, Goldman Walk Away From $8 Billion Harman Buyout (Update3): “Kohlberg Kravis Roberts & Co. and Goldman Sachs Group Inc. abandoned their $8 billion takeover of Harman International Industries Inc., maker of Infinity and JBL audio equipment, citing a decline in the firm's performance.”

Another EXPENSIVE cancellation for everybody. The breakup fees is $225 million and investors got dinged for $27.25 as Harman plummeted to $85.

Suddenly a Good Bear Is Hard to Find as Stocks Rise on Fed Ease: “The Federal Reserve has driven most stock market bears into hibernation.

From UBS AG to Deutsche Bank AG and Citigroup Inc., Wall Street strategists are the most bullish they've been since 2000 after the U.S. housing slump erased $5.6 trillion from global equity markets and prompted the Fed to cut interest rates.”

Let me emphasize: Wall Street strategists are the MOST BULLISH they’ve been since 2000. Scrolling through the last few months of headlines this just sounds INSANE. But the market can stay irrational far longer than you can stay solvent. It really is the 11th hour. We are either in 1998 or 2000 again.