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By William Patalon III
Money Morning/The Map Report
Dow Jones Industrial
10 yr Treasury (Yield)
Although the subprime mortgage crisis will be with us for quite some time to come, we're finally getting an idea of just how big a reach this mess may actually have. Big global banks such as Citigroup Inc. (C) and HSBC Holdings PLC (HBC) moved asset-backed debt out of structured-investment vehicles (SIVs) and onto their corporate balance sheets – as if to finally admit these investments were problematic.
We also discovered that at least one high-profile investment bank – Goldman Sachs Group Inc. (GS) – actually positioned itself to profit from the souring subprime-debt market.
And we also see that troubled banks like Cit and UBS AG (UBS) are taking on investments from outsiders to shore up their balance sheets in an effort to start moving forward.
Subprime debt will continue to go bad, clipping the earnings at banks and investment banks alike. But at least it looks like the big sector players are moving to limit the scope of the problem by corralling it. And all three of these developments – shifting assets onto the stronger balance sheets of the parent, moving to actually profit from the downturn in subprime debt, and seeking investments from outsiders – are indicative of this.
Apparently, the obscure structured products trading group at Goldman bet against some of the riskiest mortgage-related securities and then profited to the tune of $4 billion when those securities declined. [Talk about some good-old-fashioned swashbuckling financial risk-taking … and some well-deserved bonuses]. While the gains helped compensate for the $1.5 billion in expected losses from other internal fixed-income groups, some analysts have questioned whether this might not represent a conflict of interest within the firm. How could Goldman on one hand profit from these mortgage-related losses, while on the other hand also having marketed the risky subprime-related investments to the firm's customer? [Perhaps, those "Chinese Walls" kept the various groups from talking to one another?]
While Goldman may be basking in the glory of one of those ultra-rare "grand-slam-homer" market calls, rival investment firms continue to report gloom and doom. But, as noted, even some of that helps to finally really start defining the breadth and depth of the subprime problem.
Swiss financial behemoth UBS will be writing down another $10 billion in subprime-related losses and is raising additional capital from the Government of Singapore Investment Corp Pte. Ltd (GIC) [in a move similar to the Citigroup recent infusion from Abu Dhabi Investment Authority]. Bank of America Corp. (BAC) is forecasting a "disappointing" quarter, which will include another $3.3 billion in write-downs. Washington Mutual, the biggest S&L in the country, announced a hodgepodge of cost-cutting measures that included a dividend cut, office closures, and mass layoffs. Likewise, this week Wachovia Corp. (WB), H&R Block, and Freddie Mac all proclaimed more negative repercussions stemming from expected loan losses that will be reported in the weeks to come.
The U.S. Federal Reserve was front and center last week as central bank Chairman Ben S. Bernanke and his policymaking pals met for the final time of the year and lowered the benchmark Federal Funds rate by an additional 25 basis points [a quarter of a percentage point] to 4.25%. Of course, investors were far from satisfied by the move, having hoped that the Fed would "surprise" everyone again as it had on Sept. 18 when it shaved short-term interest rates by half a percentage point.
The late-week-inflation releases [see below] confirmed that the smaller rate cut of a quarter of a point was more appropriate at this time. Almost on cue, Dr. B. attempted to regain the public's trust by announcing a joint [and confusing] liquidity-enhancement effort in conjunction with the central banks of England, Canada and Switzerland.
Most equity indexes, both at home and abroad, fell last week as investors showed their disdain for the Fed's quarter-point cut and their lack of understanding about the worldwide central banks' liquidity effort. With the dreaded "I" word creeping back into the daily chatter around the water cooler, investors took advantage of the prior weeks' gains and sold off certain equity positions. Bonds surrendered a lot of ground, as well, as investors reacted to the newfound inflationary fears and tried to make heads or tails about the joint liquidity-infusion plan. The yield on the benchmark 10-year now stands above 4.2%. As the year winds down, many investors will engage in tax-loss harvesting strategies and portfolio window dressing, while others may need to raise excess cash to cover expenditures made during the holiday season. [Too bad, more of us weren't privy to the insight of Goldman's structured products trading group].
* Reflects changes in interest rates over various time frames.
Weekly Economic Calendar
Fed Policy Meeting Statement
As expected, cut funds by 25 bps to 4.25%
Balance of Trade (10/07)
Highest level in 3 months on rising oil prices
Treasury Budget (11/07)
Deficit increase due to $17 bln in early benefits pmts
Retail Sales (11/07)
Larger than expected increase in activity
Higher gasoline costs led to biggest jump in 34 years
Initial Jobless Claims (12/08/07)
Decrease in claims implies continued labor strength
Biggest rise in retail inflation in over 2 years
Industrial Production (11/07)
Better than expected increase
The Week Ahead
Housing Starts (11/07)
GDP (3rd Qtr)
Initial Jobless Claims (12/15/07)
Personal Income/Spending (11/07)
Gentle Ben is becoming quite the high-wire artist these days. On one hand, with the country mired in a credit crisis that some believe will lead to recession, the Fed has engaged in a rate-cutting campaign central bankers hope will limit the fallout from the subprime and housing crises. On the other hand, oil prices have surged throughout the year and the prospects for inflation grow more likely with each passing month. Against that backdrop, the Fed cut the Fed Funds Rate by 25 basis points just days before the Labor Department announced that the Producer Price Index, or PPI [wholesales inflation], jumped by the largest percentage in 34 years. While Dr. Bernanke may have been chastised by some who wanted a larger rate cut [undoubtedly due to their own interests], his actions ultimately seemed quite prescient once the inflation fears reappeared. On Friday, the Consumer Price Index (CPI) also advanced more than expected and even the core [ex-food and energy] index experienced its biggest increase in 10 months. Can the Fed continue to slash short-rates in the face of such growing inflationary pressures? Let's hope Bernanke and his cohorts can masterfully handle this tightrope balancing act.
In a potentially positive precursor to the holiday season, retail sales for November soared by 1.2%, double what economists were expecting. Still, naysayers pointed out that retailers benefited from a full shopping week after the Thanksgiving holiday. [Can't these guys just enjoy the moment for a change?] This week is brings with it a light economic calendar as the holiday season rapidly approaches. Any big plans, Dr. B? No one deserves a vacation more than you. Welcome to the U.S.A., Joey.
About the Author
Before he moved into the investment-research business in 2005, William (Bill) Patalon III spent 22 years as an award-winning financial reporter, columnist, and editor. Today he is the Executive Editor and Senior Research Analyst for Money Morning. With his latest project, Private Briefing, Bill takes you "behind the scenes" of his established investment news website for a closer look at the action. Members get all the expert analysis and exclusive scoops he can't publish... and some of the most valuable picks that turn up in Bill's closed-door sessions with editors and experts.