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August 19, 1988
The bond market is up this morning, and loan discounts will drop accordingly. 10.5s will probably stay in a range of par to three discount until the markets see how the economy responds to four months of Fed tightening. It will take some very scary numbers to force the Fed to tighten again in the next month, and numbers showing economic weakness can produce temporary but sizable drops in rates.
July Industrial Production rose .8%, Capacity Utilization rose .4% to 83.5%, and the Trade Deficit widened to $12.5 billion: if the bond market didn't crash on those numbers, it's not going to any time soon. The impact of higher rates showed up in a 5.4% drop in July Housing Permits. The bias in rates is still up, and you should probably lock clients before the consumer price release on Tuesday. Take advantage of these little rallies.
We had new examples this week of the potential danger in COF indexes: Silverado's failure, new testimony about FSLIC, and more S&L "mergers" in Texas. Tbills are the same as always: the terms of payment are the same, the Treasury still issues them in big volume, and the Treasury still borrows more cheaply than anybody else in the world after inflation. COF indexes are not the same as they were in the early 80's, and comparison charts can be misleading.
The credit problems of S&Ls are so deep (pushing $75 billion, larger maybe than the third world debt problem) that S&L costs of funds can move upward fast and a lot. Notice that the first thing that Silverado did after announcing insolvency was to raise the rates it would pay for deposits by half a percent. Yesterday, Federal regulators announced the "merger" of 12 broke Texas S&Ls. The new "capital" for the $3.1 billion group is $45 million in cash and a $500 million note from broke FSLIC (and FSLIC will still be responsible for future losses). This wreck of an S&L will continue to bid up the costs of deposits.
Note also that S&Ls used to take lots of long term deposits; since 1979, their new deposits have been mostly short term. Those nice charts showing COF under Tbills in the early 80's don't bear much relevance to today.
My concerns may be misplaced, but I believe that the deterioration of S&L credit can cause a bad surprise for COF ARM borrowers. Beware of your representations.
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