Outstanding Contraction!: Commercial Paper Outstanding July 16 2009

The Commercial Paper (CP) market is essentially a private debt market used by corporations as a cheaper means of funding typical recurring operations than drawing on a line of bank credit.

Commercial paper, as financial instrument, is by no means a recent innovation and, in fact, you can read about how the CP market was affected by the many historic financial shocks experienced by the U.S. (read Panic on Wall Street: A History of America’s Financial Disasters or this account)

Although the Federal Reserve was able to artificially bring CP rates down significantly since the shocking 615 basis point spread blowout (A2/P2 spread) of late 2008, they have apparently not been successful in preventing an overall contraction in the CP market.

The Federal Reserve calculates and published the total amount of CP outstanding every week and as of the latest published period, commercial paper outstanding is contracting at the fastest rate on record, registering a whopping 37.33% decline year-over-year.

Another important insight, at $1.097 trillion the total CP market is now 13.75% smaller than the $1.272 trillion seen at the bottom of the last contraction in late 2003.

The CP market that expanded wildly throughout 2004, 2005, 2006 and most of 2007 is now no more, replaced instead by one smaller and contracting faster than at any other time in this century.

Philadelphia Feeling: Federal Reserve Bank of Philadelphia Business Outlook Survey October 2008

Today, the Federal Reserve Bank of Philadelphia released the results of their Business Outlook Survey for October showing a dramatic resumption of deterioration of the regions manufacturing sector with the current activity index indicating substantial contraction at -37.5.

The survey of the Philadelphia regions manufacturing sector has been a pretty solid leading indicator of the overall strength or weakness and recession experienced by general economy.

As you can see by the following chart (click for larger version), during the past three post-recession expansion periods, the “current” diffusion index (more on diffusion indices later) generally vacillated between 0 and 35 while the “future” index left the period of contraction at an elevated level and eventually joining the “current” index.

Finally, as the economy pushes closer to contraction, both indices decline dramatically with a breach of -20 by the “current” index generally indicating that recession is upon us.


As you can see from recent results, -20 had been breached significantly now twice by the “current” index which now stands at -37.5 while the “future” index stands at -4.2.

The latest results also currently display a significantly less significant parallel to the stagflationary eras of the 70s and early 80s.

The following chart shows the latest results of the “current new orders” “current prices paid” and “future employment” components (click for larger versions).

Notice that that current orders, future employment and current prices paid are all now trending down.

The following chart (click for larger) shows these measures during the last stagflationary era seen between 1976 – 1980. Notice the clear divergence of rising prices and falling growth.

Mid-Cycle Meltdown?: Jobless Claims October 16 2008

Today, the Department of Labor released their latest read of Joblessness showing seasonally adjusted “initial” unemployment claims decreased 16,000 to 461,000 from last week’s revised 477,000 claims while “continued” claims jumped 40,000 resulting in an “insured” unemployment rate of 2.8%.

It’s very important to understand that today’s report continues to reflect employment weakness that is strongly consistent with past recessionary episodes and that this signal is now so strong and sustained that a contraction in the economy is fundamentally certain.

Historically, unemployment claims both “initial” and “continued” (ongoing claims) are a good leading indicator of the unemployment rate and inevitably the overall state of the economy.

I have added a chart to the lineup which shows “population adjusted” continued claims (ratio of unemployment claims to the non-institutional population) and the unemployment rate since 1967.

Adjusting for the general increase in population tames the continued claims spike down a bit but as you can see, the pattern is still indicating that recession has arrived.

The following chart (click for larger version) shows “initial” and “continued” claims, averaged monthly, overlaid with U.S. recessions since 1967 and from 2000.

NOTE: The charts below plot a “monthly” average NOT a 4 week moving average so the latest monthly results should be considered preliminary until the complete monthly results are settled by the fourth week of each following month.

As you can see, acceleration to claims generally precedes recessions.


Also, acceleration and deceleration of unemployment claims has generally preceded comparable movements to the unemployment rate by 3 – 8 months (click for larger version).


In the above charts you can see, especially for the last three post-recession periods, that there has generally been a steep decline in unemployment claims and the unemployment rate followed by a “flattening” period of employment and subsequently followed by even further declines to unemployment as growth accelerated.

This flattening period demarks the “mid-cycle slowdown” where for various reasons growth has generally slowed but then resumed with even stronger growth.

So, looking at the post-“dot com” recession period we can see the telltale signs of a potential “mid-cycle” slowdown and if we were to simply reflect on the history of employment as an indicator of the health and potential outlook for the wider economy, it would not be irrational to conclude that times may be brighter in the very near future.

But, adding a little more data I think shows that we may in fact be experiencing a period of economic growth unlike the past several post-recession periods.

Look at the following chart (click for larger version) showing “initial” and “continued” unemployment claims, the ratio of non-farm payrolls to non-institutional population and single family building permits since 1967.

One notable feature of the post-“dot com” recession era that is, unlike other recent post-recession eras, job growth has been very weak, not succeeding to reach trend growth as had minimally accomplished in the past.

Another feature is that housing was apparently buffeted by the response to the last recession, preventing it from fully correcting thus postponing the full and far more severe downturn to today.

I think there is enough evidence to suggest that our potential “mid-cycle” slowdown, having been traded for a less severe downturn in the aftermath of the “dot-com” recession, may now be turning into a mid-cycle meltdown.

Video of The Day - Severe Recession Train “Has Left the Station”

Professor Nouriel Roubini provides, in great detail, his take on the failed bailout bill as well as discussing the current state of the economic crisis and alternative measures that may help to begin to heal the banking system and the wider economy.

Click the following link for the complete audio.

S&P/Case-Shiller: July 2008

Today’s release of the S&P/Case-Shiller home price indices for July continues to reflect the extraordinary weakness seen in the nation’s housing markets with now ALL of the 20 metro areas tracked reporting year-over-year declines and ALL metro areas showing substantial declines from their respective peaks.

Further, there has been a notable re-acceleration of the price slide with the 10 city index dropping 1.09% just since last month.

Also, it’s important to keep in mind that today’s release was compiled using home sales data primarily from June and July, well in advance of the historic levels of financial collapse seen in August and September.

In all likelihood, today’s report sits on the threshold of a new and even more momentous wave of home price declines as the continued economic crisis and dramatically accelerating unemployment work to both crush consumer sentiment and force panicked mortgage lenders to continue to tighten their lending standards.

As the housing decline goes “Up-Prime” a larger and much more damaging population of homeowners will face historic levels of financial stress the outcome of which is, at the moment, very hard to calculate.

The 10 city composite index declined a record 17.49% as compared to July 2007 far surpassing the all prior year-over-year decline records firmly placing the current decline in uncharted territory in terms of relative intensity.

Topping the list of peak decliners were Phoenix -34.44%, Las Vegas -34.34%, Miami -33.48%, San Diego -31.21%, Los Angeles -29.71%, San Francisco -28.16%, Detroit -26.64%, Tampa -26.47%, Washington -22.14%, Minneapolis -16.18%, Cleveland -11.45%, Chicago -11.27%, Boston -10.89% and New York -10.61%.

Additionally, both of the broad composite indices showed significant declines slumping -21.14% for the 10 city national index and 19.51% for the 20 city national index on a peak comparison basis.

To better visualize the results use the PaperEconomy S&P/Case-Shiller/Futures Charting Tool as well as the PaperEconomy Home Value Calculator and be sure to read the Tutorial in order to best understand how best to utilize the tool.

The following chart (click for larger version) shows the percent change to single family home prices given by the Case-Shiller Indices as compared to each metros respective price peak set between 2005 and 2007.

The following chart (click for larger version) shows the percent change to single family home prices given by the Case-Shiller Indices as on a year-over-year basis.

Additionally, in order to add some historical context to the perspective, I updated my “then and now” CSI charts that compare our current circumstances to the data seen during 90s housing decline.

To create the following annual charts I simply aligned the CSI data from the last month of positive year-over-year gains for both the current decline and the 90s housing bust and plotted the data with side-by-side columns (click for larger version).

What’s most interesting about this particular comparison is that it highlights both how young the current housing decline is and clearly shows that the latest bust has surpassed the prior bust in terms of intensity.

Looking at the actual index values normalized and compared from the respective peaks, you can see that we are still likely less than half of the way through the portion of the decline in which will be seen fairly significant annual declines (click the following chart for larger version).

The “peak” chart compares the percentage change, comparing monthly CSI values to the peak value seen just prior to the first declining month all the way through the downturn and the full recovery of home prices.


In this way, this chart captures ALL months of the downturn from the peak to trough to peak again.

As you can see the last downturn lasted 97 months (over 8 years) peak to peak including roughly 43 months of annual price declines during the heart of the downturn.

Notice that peak declines have been FAR more significant to date and, keeping in mind that our current run-up was many times more magnificent than the 80s-90s run-up, it is not inconceivable that current decline will run deeper and last longer.

Question of The Day?

Bears… Do you feel vindicated?

Have Any stories to share?

The Almost Daily 2¢ - Epic Irony

By now most of you have likely already either perused the mega-bailout bill or some summarizations of its features so I won’t dwell endlessly on each individual feature but rather draw your attention to a few points of interest in the bigger, more ironic picture.

First, the “Purpose” of the proposed bill (soon to be law) sets out goals that, aside from being couched in foolish election-season populist language, declares an intention that is both pious and purposefully deceitful.

The purposes of this Act are—

(A) protects home values, college funds, retirement accounts, and life savings;
(B) preserves homeownership and promotes jobs and economic growth;
(C) maximizes overall returns to the taxpayers of the United States; and
(D) provides public accountability for the exercise of such authority.

The elites clearly take us for fools … perhaps rightly so, though I have to imagine that there is at least a small contingent among us who can see the irony, albeit subtle, in the notion of the largest taxpayer funded financial crisis bailout in human history “maximizing returns to the taxpayer”, “promoting job growth” and “preserving homeownership”.

Further irony, how about that 11th hour phone call to Warren Buffett by Congressional negotiators in desperate need of a confidence boost and reassurance that bailing out Wall Street is the right thing to do… a truly epic embarrassment.

Even further still, Senator John Kerry inadvertently hit on a great point of irony too when he suggested that ”[Voters] don’t want a bailout of Wall Street and neither do we. What we are talking about is not losing 3 million jobs in a matter of weeks.”

Yet, we have been watching unemployment simply skyrocket for eight straight months now and it will continue to skyrocket precisely for the reason that those being bailed out don’t feel even the slightest twinge of remorse about throwing workers overboard in order to maximize shareholder value.

All the more reason a taxpayer-funded bailout of private institutions is a clear perversion of our economic system.

Yet the most significant irony of all might be what happens in November.

I generally steer clear of direct political statements preferring instead to simply spur along some form of action whatever it may be and so today I ask just one thing.

Keep all of these foolish dealings fresh in your mind when you enter the voting booth … don’t vote for the incumbent and if you can’t get yourself to pull the lever for a party you oppose, simply leave the space blank.

The only way to get some balance back in the system is for tainted elitist and lazy career politicians to be sent packing.

Video of The Day - Roubini on The Bailout

Professor Nouriel Roubini joins Bloomberg to discuss why he feels the bailout is a failure.

Roubini further elaborates on his opposition in his latest blog post, calling the package a disgrace and a "rip-off".

The Almost Daily 2¢ - Goin’ Up-Prime!

I’ve been arguing for the better part of two years that although the traditional media and apparently general consensus has focused on subprime and other “toxic” mortgage products as the source for the credit tumult, the historic deterioration would by no means be limited to these “bleeding edge” products.

To be certain, I’m not arguing that prime borrowers will default with the same rates as their sub-prime or near-prime brethren but rather that each mortgage product will inevitably experience respective historic levels of defaults.

Before this massive housing and general economic contraction is complete, I expect to see new records set for prime defaults, be they prime-Jumbo ARM loans, prime-Jumbo fixed rate loans, prime-conforming ARM loans or prime-conforming fixed rate loans… we will see historic defaults across the entire spectrum of mortgage products.

Until recently, most of my reasoning was based on a cursory study of the other periods with higher than “normal” mortgage defaults.

Although there is significant debate about the true drivers of mortgage default, most individuals in default cite unemployment as the cause while other key instigators are: risky or insufficient household financial planning (high consumer debt and low/no savings), low-equity stake and housing depreciation, and simply general recession.

The key point to consider though is that while all of these factors have contributed to creating environments of high mortgage default in the past, our current circumstances make these past periods look like walks in the park.

So, if borrowers from past periods, many of whom would likely be considered “prime” borrowers today (fully documented income, large down-payment, fixed-rate loans, etc. etc.), experienced bouts of higher mortgage defaults, what are the chances that our current cohort of “prime” borrowers will not perform the same?

In an effort to prove out this conjecture, I will track, with a quarterly recurring post, the operating performance of one of today’s most celebrated “conservative” mortgage portfolio lenders, Hudson City Bancorp (NASDAQ:HCBK), to see how their borrowers perform over the course of this economic downturn.

Hudson City is now fully recognized as the “poster child” for safe prime-only mortgage lending, stringent underwriting standards and a CEO, Ronald Hermance, who’s frequent media appearances usually come with heaping portions of high praise and accolades.

It’s important to understand that although Hudson City’s average borrower has a reasonable LTV of 61.5%, they are still seeing a precipitous increase in loan defaults.

In fact, currently the average LTV of their non-performing loans (defaulted loans) is 69% so “prime” borrowers with 31% equity at the time of origination are now defaulting in steadily increasing numbers.

The following chart plots Hudson City Bancorp’s Non-Performing Loan Ratio (defaulted loans to total loan portfolio) since Q1 2004.

Notice that defaults have been on the rise since Q2 2006 while in Q2 2007 things really started to heat up.


But how does the growth in defaults of the Hudson City Bancorp “prime” portfolio stack up compared to other well know default rates?

The Following charts compare the Hudson City default rate to that of Fannie Mae and the MBAA foreclosure rate.

The top chart compares the normalized default rates since Q1 2004 while the lower two compare the same data since Q1 2007 in order to get a sense of the respective growth over these periods.

It’s important to keep in mind that although Hudson City is not experiencing the same ratio of defaults (Fannie Mae and the general MBAA rates are worse) the growth of prime defaults is comparable and, since Q1 2007, has even been substantially higher.



The key instigators in this growth of default is likely home price depreciation and unemployment both working together to bear down on “prime” homeowners as is shown by the following charts plotting the year-over-year percent change to the New York area S&P/Case-Shiller home price index against the Hudson City default ratio as well as the unemployment in New York and New Jersey since 2004.


I will continue to update this data in coming quarters in order to see how slumping home values and rising unemployment affect the performance of “prime” borrowers.

Video(s) of The Day - Barney Frank's Junk Assets

Barney Frank joins Charlie Rose to discuss his view of the causes of our current economic crisis and details of the massive Wall Street bailout.

Frank explains that if only the government buys and holds the junk financial assets (mortgage, HELOC, credit card, auto, and education debt securities) the credit markets would flow again and the government would inevitably turn a profit.

Sure good one!