Inflation Peaks/Real-gdp Peaks/Interest Rates Peak

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Re: Inflation Peaks/Real-gdp Peaks/Interest Rates Peak

BIS, S&P Disagree Over Severity of Credit Market Rout (Update1)

By Steve Rothwell
Sept. 3 (Bloomberg) -- The market fallout from the subprime mortgage slump is less severe than in 1998 after Russia's default and the collapse of Long-Term Capital Management LP, the Bank for International Settlements said.
The assessment from the BIS, which monitors financial markets for central banks and regulates lenders, contrasts with analysis from Standard & Poor's, which last week said the outlook for securities firms is worse than in 1998.
``Some investors began to draw parallels with the autumn of 1998, when the collapse of LTCM had triggered fears of instability in the banking system as a whole,'' the BIS in Basel, Switzerland, said in a report published today. ``However, the recent rise in U.S. 10-year swap spreads was less sharp than at the time of the LTCM crisis.''
Investors are demanding a yield premium over 10-year Treasury notes of 70 basis points to swap floating interest-rate payments for fixed, up from 54 basis points in May. The premium, which increases as the perception of risk deteriorates, had more than doubled in 1998 to 97 basis points.
Bank stocks dropped as much 17 percent this year, half the 35 percent decline in 1998, according to the Standard & Poor's Banks Index.
Declines in stock markets ``largely reflected investors' anticipation of losses related to speculation in the subprime market and other credit products, as well as expected declines in bank profits due to lower M&A-generated fees,'' the BIS said. ``Despite such losses, the overall decline amongst U.S. banks had not by late August been as severe as in 1998.''
http://www.bloomberg.com/apps/news?p...orporate_bonds

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Re: Inflation Peaks/Real-gdp Peaks/Interest Rates Peak

http://www.minyanville.com/articles/.../index/a/13898

the genesis of the asset-backed commercial conduits was regulatory capital arbitrage. Through the conduits’ convoluted structures, banks were able to "lend" huge amounts off-balance sheet and collect fees on no-capital-required lines of credit. No one - and I mean no one - ever expected these conduits to move from off-balance sheet back on-balance sheet and I don't think the market yet understands the earnings, capital and liquidity impact of this migration. If you figure you need anywhere from 6-8% capital per dollar of loans, then a move of $1.0 trln from off-balance sheet to on requires $60-80 bln in additional equity capital. I don't know about you, but I don't see this kind of free capital sitting around.

Second, I don't think people appreciate the significance of the change in Fed policy that took place on Friday involving the brokerage affiliates of several money center banks. In the asset-backed commercial paper market, maturing commercial paper is normally either rolled over or replaced by loans from standby liquidity banks when it can't be rolled over. With Friday’s change, it would appear that investors now have the ability to "put" unmatured commercial paper back to the bank affiliated brokers - who in turn will pass it along through the Discount window to the Fed.

In doing this, I believe the Fed has established a very dangerous precedent. If investors can now put unmatured CP to the banks (instead of waiting for the standby liquidity banks to fund at maturity), it may not be long before investors pressure the bank-affiliated brokers to accept MTNs and who knows what else further out the curve.

Third, the last consumer led recession was around 1990. Since then, the SEC has placed enormous pressure on the banks to minimize their loan loss reserves. The SEC hates earnings management and the loan loss provision has historically been a key way for banks to "save for a rainy day." I don't think the market yet appreciates the fact that banks are currently provisioned for the top of the market. (And, in fact, up until recently, most major banks reported net provision reductions over the last several quarters.) As credit continues to deteriorate, the earnings/capital hits will be enormous as provisions need to reflect higher and higher delinquency and loss rates. And, experience suggests, that when the banking regulators finally do begin to act (as they did in New England during the late 1980’s), the pendulum will push banks to over-reserve at what will ultimately be the bottom of the credit cycle.

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Re: Inflation Peaks/Real-gdp Peaks/Interest Rates Peak

Legislators are lobbying for an increase in government participation in the mortgage sector in an attempt to help distressed borrowers stay in their homes. Three proposals have recently emerged. The first is an increase in the limits on MBS portfolios for Fannie Mae and Freddie Mac. As of May 2006, the Office of Federal Housing Enterprise Oversight (OFHEO) capped Fannie Mae’s portfolio to $727.2 billion. Freddie Mac’s current portfolio, approximately $720 billion, is limited to an annual 2% growth rate under an agreement with OFHEO. 1 An increase in the ceiling or permitted limits of MBS securities held by the government-sponsored entities (GSEs) would help provide liquidity to the secondary market for "agency MBS."2 A second proposal advocates greater flexibility by the Federal Housing Administration (FHA) to potentially provide distressed borrowers with more refinancing opportunities. This proposal seeks to raise FHA’s current loan limit to $417,000 from $362,790, which would increase the number of FHA-eligible loans in the subprime secondary market. A third proposal aims to eliminate the 3% down payment required under FHA’s underwriting guidelines.3

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Re: Inflation Peaks/Real-gdp Peaks/Interest Rates Peak

Commercial Paper
Part of the problem is that a lot of mortgage paper has been going into so-called “conduits”, which are off-balance sheet entities run by banks and relying on commercial paper for financing. The paper they issue is so-called asset-backed commercial paper (ABCP) and has been about half the commercial paper market. ABCP is now being treated as toxic waste and is essentially unsaleable. The Fed has suspended the regulations limiting bank lending to their brokerage affiliates, so that they can borrow at the discount window and re-lend the money to their affiliates in a bid to break up this logjam. Conduits are essentially the same kind of deal that got Enron into trouble, and have already brought down a couple of German banks.

http://alamedalearning.com/reality/2007/09/

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Re: Inflation Peaks/Real-gdp Peaks/Interest Rates Peak

2/26/07
Suckers Rally
If gold doesn't fall, then there's a new paradigm

5/08/07
Dollar strengthening;
Gold softening;
Stocks have flattened

5/18/07
Gold has bottomed
Both short-term & long-term monetary flows (MVt) have bottomed. Inflation is due for a big pick-up!

6/08/07
The rate-of-change in the proxy for real-gdp (monetary flows MVt) peaks in July. The rate change in the proxy for inflation (monetary flows MVt) peaks in July. Therefore it should be obvious: Interest rates peak in July.
Therefore: Gold will resume it's upward climb in July. Therefore: The exchange value of the dollar will resume it's decline in July.

8/30/07
And they're inflexible. And their calculations are ex-post. And GDP doesn' move at the same rates-of-change. Now they're going to get whipsawed. There's been a lot of hopping back & forth between different securities/maturities, but overall interest rates bottom in Oct. (the calculation is taken from Dr. Leland James Pritchard's formula, Ph.D, Economics, Chicago, 1933, MS, Statiistics, Syracuse). From that point, depending on how far the fed "eases" will determine the next rout.
Bernanke not talking. He's got the opportunity, and is going to take it, and will "squeeze" the rate-of-change in inflation until he "wrings" it out.
The BEA just reported that 2qtr real-gdp was 4%. This is the beginning of Sept. Real-gdp is going to fall now (maybe sharply) until Oct. Stocks should fall, rates should fall (long-term), gold should fall, & the U.S. dollar? (probably rise temporarily -- lower imports & an extension of maturities by investors). Note: the maturity distribution is probably something that works well for your modeling.
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9/09/07
An increase in the transactions velocity of money (Vt) occurs/follows with most injections of legal reserves - even when temporary additions are "washed out". The 2 week infusion of excess legal reserves ending 8/15 stalled, and will minimize, any protracted drop in real-gdp. The present and temporary decline in the rate-of-change in monetary flows (MVt) will therefore not be as steep as anticipated. The current downswing in the economy ends Oct. 07. However, expect that the 4th qtr economic rebound will still be sharp.
Opportunities: Buy gold in Oct. Buy Stocks in Oct. Sell the U.S. Dollar in Oct.

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Re: Inflation Peaks/Real-gdp Peaks/Interest Rates Peak

Fed mulls options in tackling liquidity problem
By Krishna Guha in Washington
Published: September 12 2007 20:30 | Last updated: September 12 2007 20:30


As Federal Reserve policymakers look ahead to next week’s decision on interest rates, staff at the central bank are continuing to work on other potential steps that could be taken to address liquidity problems in financial markets.

The possible steps range from the relatively orthodox – a disproportionately large cut in the discount rate at which the Fed lends directly to banks – to more unorthodox measures.


At issue is whether it would be worth the Fed dusting down some rarely used tools – or improvising new ones – to help it reach beyond the banking system and channel liquidity to where it is needed most.
Ben Bernanke, the Fed chairman, flagged up the possibility in a speech at Jackson Hole at the end of last month when he said the Fed “stands ready to take additional actions as needed to provide liquidity and promote the orderly functioning of markets”.

The obvious step would be to cut the discount rate by more than the main federal funds rate. For instance, if the Fed cut the funds rate by 25 basis points, it could cut the discount rate by 50 or even 75 basis points, reducing (or in the latter case eliminating) the effective penalty on direct borrowing.

This would both encourage greater use of the discount window facility and make it a more effective back-stop for the money markets.
The Fed has already cut the discount rate by 50 basis points to reduce the direct borrowing penalty. The aim is to make banks feel comfortable lending to non-bank financial institutions against good collateral, by letting them know they will in turn be able to raise funds from the Fed against that collateral at reasonable rates.

The discount rate is set by the Washington-based board of governors, not the full federal open market committee, so there is no reason why the Fed would have to announce any change alongside the rate decision next Tuesday. But a number of analysts expect that it will.

Some also believe the Fed might consider extending the term of its open market operations, as the European Central Bank has done.
Meanwhile, work is believed to be continuing on more unconventional policy steps that could be deployed if required in the future.
Fed officials see ensuring the effective functioning of markets as a critically important mission but one that is distinct, at least in the first instance, from their other main mission of managing the macroeconomy.
So they are keen to revisit the liquidity support tools at their disposal – tools that in many cases are rusty from lack of use over the years.

There are a number of ways in which the Fed could try to reach beyond the banks to the stressed non-bank financial sector and the distressed markets for asset-backed commercial paper and non-agency mortgage-backed securities.

One option would be to set up a facility to lend directly to non-banks against their collateral, loosely modelled on the joint lending programme put in place in 1989 at the height of the savings and loans crisis.
Another option would be to establish currency swaps with European central banks to deal with pressure on the offshore dollar money markets, similar to those put in place after the terrorist attacks of September 11 2001.

The Fed could also mimic measures used in 1999 to guard against the fear of a Y2K liquidity drought at the turn of the millennium.
These included the creation of a temporary special liquidity facility that would accept commercial paper at a discount and the sale of call options giving banks the right to tap Fed loans in the future if required at guaranteed rates.