Capital Markets Update

by Louis S. Barnes Friday June 10, 2011

Financial markets stayed in tight ranges all week — not at all calm, just waiting for more falling footwear.

Whistling noises from above: Greece is going to default, and soon, and its creditors are going to pretend that it hasn’t, but the default will trigger obligations under credit-default swaps, the contagion vector to banks, followed by other Club Meds wanting the same non-default default.

Perfesser Bernanke’s speech on Tuesday snipped the suspenders holding optimists’ pants: the economy has slowed but will do better in six months (uh-huh), no new stimulus coming. Trying to pull pants up while texting SELL! can produce accidental Weiners, even if perps have seen the Bernanke movie before.

OPEC refused to increase production, impoverished members enjoying high prices (Iran, Venezuela), Saudis understanding the damage to customers. The no-shortage story that speculators are responsible for $100/bbl no longer holds crude.

China is the great, global-economic black box. It is widely rumored to be in a slowdown, perhaps deeper than intended to hold down inflation, real estate bubble blowing at last, but nobody trusts official statistics, and all other observations are blind-men-with-elephant. China itself likely does not know what is happening to it. To the degree that the People’s Bank of China does, it ain’t talking — not straight, anyway. Best free-space blog is www.mpettis.com, which emphasizes how little anyone knows.

In perfect contrast, we in the US all but drown in good data. Withal, two problems: our leadership either refuses to read the obvious, or cannot agree what to do about it. This week the Fed released the mother of all data, at www.federalreserve.gov quarterly Z-1, which accounts for the flow and landing place of every dollar in the economy.

Through Q1’11, consumer credit continued to fall (ex-student loans) as it has since 2008. Total bank loans and leases have stopped declining for the moment, but are off 10% from the 2008 peak in a series that had not declined significantly since data began in 1950. Part of the current credit shortage is off-bank, in the collapse of “asset-backed securities.” Some ABS were the super-toxic mortgages for which Fannie is blamed (was $2.2 trillion, written down to $1.2 trillion… oops), but the rest, another $2 trillion has also collapsed to half the 2007 outstanding, mostly by payoff and little new issuance.

Second mortgages continue their slow slide, now $925 billion, down from $1.1 trillion in 2008. However, as CoreLogic reports that 40% of these loans are underwater, the presence of all $925 billion on financial-system balance sheets is an absurd fiction.

Another one: this week, Fed Vice Chair Janet Yellen spoke on housing. Refreshing, at first — the first top Fed official to devote a speech to the subject this year. Yellen is a “dove,” a believer in Fed intervention, a Democrat, and her speech began by describing over-tight credit as a principal cause of housing non-recovery. The second half of the speech advocates new regulations to tighten credit more. Germans have a wonderful word for Yellen’s thinking: Wolkenkuckcuksheim. (“Cloud-cuckoo-land”)

News headlines elsewhere trumpet the “$943 billion gain in household net worth.” And I have a bridge to sell to you. The two lines accounting for asset increase are stock values up in the quarter, and pension fund assets — stocks again. Maybe stocks stay up, maybe not. Overall household liabilities declined by foreclosure, but no decline for households not foreclosed, and a mixed blessing for those who were.

Two things matter to households: the money they have, and the equity in their homes, net of mortgages or free and clear. Z-1 money — deposits, money-markets — crept upward by about $100 billion. Aggregate values of homes clunked down another $339 billion. In 90 days. The next 90 will decline about the same. The national total value of US homes is now a little less than in 2003, a little more than in 2002. Down $6.6 trillion since 2007.

In the perverse world of mortgages and bonds, falling footwear means lower rates. If you qualify. And not enough lower to intercept the footwear, just following.