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April 18, 2008
Psychology on the Street changed completely this week, to economic optimism and concern for inflation, and assumption that the Fed is done with rate cuts or will be shortly. Low-fee, fixed mortgages are 6.375%, jumping with all interest rates, long and short. The Fed-forecasting 2-year T-note has soared from 1.70% to 2.24%.
This week, “credit” appeared only in sentences including this clause: “The worst is over.” The worst probably is over for write-downs of the abysmal “structured securities” of the 2001-2007 era. However, euphoria at that prospect masks these things: the financial system is still too busted to function properly, credit is extremely scarce and expensive, the system is terribly vulnerable to recession-cycle credit loss ahead, and inflation here, there, and everywhere is forcing global economic slowdown.
The loopy reply from the stock market: Business is great! Earnings are down but are headed up! Global trade will fix everything!
Let the data talk. The opening line in the Fed’s April beige book: “Reports from the twelve Federal Reserve Districts indicate that economic conditions have weakened....” In the Fed’s lexicon, a slow economy is “mixed,” one turning sour is “soft,” and one in trouble has weakened. The Fed does not use the term lightly.
Retail sales were .1% positive because of higher gasoline prices (ick); industrial production upticked a .3% hair, capacity in use hanging at 80% stall-speed. New claims for unemployment insurance are also at an edge, about 375,000 weekly; extended claims rising near 3 million signal recession. CPI was okay: overall .3%, core .2%.
The Street’s party rests on good results at IBM, Google, and Caterpillar, and coulda-been-worse financials: Merrill wrote down only $6.6 billion, Citi only $16 billion. Only.
Give the financials this: despite the huge write-downs consuming most of the new capital raised by the two firms, their losses net of write-down were $1.96 billion and $5.11 billion, respectively, which means their current operations are making good money. In time they will re-capitalize themselves. In time for the economy?
The commentariat this week, even informed non-spinners, has announced “relaxing” of the Crunch, “normalization” beginning. They are partly correct, but not the part that matters to the economy. The Bear Stearns lesson is sinking in: no large institution will be allowed to fail, here or in Europe or anywhere. Central banks will not allow it. So, big money fearful of that event has stopped its panicked buying of Treasurys (even gold), begun to unload, and up rates have gone.
Nevermind that they were worried about the wrong thing. The Crunch is still full-on: the spread between retail mortgages and the 10-year Treasury is still 2.50%, at least .80% out of line. Fixed-rates in the mid-sixes intercept housing recovery, eliminate the benefit of payment-reducing refis to crimped household budgets, and makes ARM-escape impossible. The Jumbo market is still completely broken, and the new mini-Jumbos are a high-priced joke. Issuance of securitized credit of all kinds is at standstill.
In the broad credit markets, Libor is the global mark for all short-term borrowing. The WSJ this week discovered the Libor-setting British Bankers’ Association had for months conspired to understate the wildly high true cost: three-month dollar Libor is 2.91% today (really) versus 90-day T-bills at 1.43%, five times a normal .3% spread.
The Treasury/Libor spread (called the “TED” spread for ancient reasons, Treasury/Eurodollar) has always been considered a default-risk measure: ultra-safe Treasurys versus unsecured bank-to-bank loans. We know now that no one need fear a major institutional failure, and so the heart of the Crunch is coming clear: Libor is high-cost because loans are scarce. Same for mortgages. Pure supply/demand.
How can loans be scarce with the Fed hosing loans into banks? Because system captial is impaired. There isn’t enough capital to support current loans outstanding, let alone new ones. How the economy makes it through a slow, grinding recapitalization without adequate credit... that’s the question. That part of the worst is not over at all.
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