Mild recession likely, Morgan Stanley says

The U.S. economy is likely to slip into a mild recession in 2008, said economists at Morgan Stanley, which is the first major Wall Street firm to predict a recession.

WaMu Write Down $1.6 Billion, cuts 3,150 jobs, & closes 190 home loan centers

Washington Mutual Inc., the largest U.S. savings and loan, will write down the value of its home lending unit by $1.6 billion in the fourth quarter and cut 3,150 jobs as losses in the mortgage market increase.

Washington Mutual also will cut its quarterly dividend to 15 cents a share from 56 cents and close 190 of 336 home loan centers, the Seattle-based bank said in a statement today. The company said provisions for loan losses in the quarter will be $1.5 billion to $1.6 billion, about twice as much as it previously expected.

Fitch Ratings downgraded the firm's rating to ``A-'' from ``A,'' citing ``worsening asset quality,'' and ``extremely challenging conditions in the U.S. residential mortgage market.'' Washington Mutual said it plans to raise $2.5 billion to shore up its capital by selling convertible stock.

Industry-wide mortgage originations will probably shrink 40 percent in 2008 to $1.5 trillion, down from about $2.4 trillion this year, Washington Mutual said in the statement. The firm plans to cease lending through its subprime mortgage channel.

Takeover or Break Up for Citigroup

As Citi struggles to break free from the grip of its writedowns, and with capital levels hovering dangerously low, a takeover by a smaller banking rival is a distinct possibility, warn CreditSights.

In a gutsy - and perhaps mercurial - call, analysts at CreditSights say a takeover from JPMorgan isn’t unlikely, given the outlook for Citi. Otherwise, there’s also the threat of a breakup. At the very least, it’s a sluggish, troubled end to the decade for the world’s biggest bank - with the dividend remaining under threat for years to come.

It will take Citi three years to recoup losses on CDO writedowns, according to the report, and problems may get much, much worse.

First and foremost, Citi is faced with further big capital hits from its seven ailing SIVs, between them with $66bn AUM. CreditSights think this will be the next test of strength for the bank. The M-LEC superfund-cum-stumbling block, then, is far more critical for Citi than previously given credit.

Secondly, CreditSights hint at further CDO writedowns in the offing. Indeed, with a definite sense that the super-senior CDO debt market is fast collapsing, Citi can expect more trouble. The bank has $45bn in super-senior CDO exposure.
All in all, it amounts to a serious - potentially crippling - lead weight strung around Citi’s neck.

The Citi board meets on Monday and Tuesday to discuss the appointment of a new CEO.

UBS to Sell Stakes After $10 Billion in Writedowns

UBS AG, Europe's largest bank by assets, said it will write down U.S. subprime investments by $10 billion and raise 13 billion francs ($11.5 billion) by selling stakes to investors in Singapore and the Middle East.

UBS expects a loss in the fourth quarter, and may have a loss for 2007, the Zurich-based company said in an e-mailed statement today.

Securities firms and banks had announced about $66 billion of losses and markdowns linked to the collapse of the U.S. subprime mortgage market this year. UBS reported its first loss in almost five years in the third quarter after the subprime contagion led to about $4.66 billion ijavascript:void(0)
Publish Postn markdowns on fixed-income securities and leveraged loans.

Bank of America Money Market Fund down 70% & closed

The Columbia Strategic Cash Portfolio fund for institutional investors that was worth $40 billion only a couple months currently has about $12 billion in assets, Charlotte-based bank said.

The loss is related to the subprime-mortgage crisis that has rippled across the globe, Bank of America spokesman Jon Goldstein said.

"The conditions have really weakened the performance across the industry, including this one," Goldstein said.

Goldstein denied a CNBC report that the fund had been frozen, saying that clients were being offered the option of cash redemptions or of switching their assets into other Columbia-managed funds.

Overbought in an Unfavorable Market Climate

Now, if the belief in “Fed liquidity injections” was not so clearly misguided, I could launch into detailed speculation about how much “stimulus” the Fed might provide, and how long that liquidity will take to “work itself through the pipeline.” But as I detailed last week, the Fed has only “injected” about $16 billion into the banking system since March, all of which has been drawn out of the banking system as currency. Suffice it to say that I see speculation about the Fed's "stimulative" impact as useless because it is based on the demonstrably false premise that the Fed is actually injecting meaningful “liquidity” in the first place. Despite investors' flight to the safety of Treasury securities, commercial lending rates are not responding either (though economic softness is providing downward pressure that moderates the competing upward pressure from rising default risk).

Also, as I've frequently emphasized, monetary policy is not, and cannot be independent of fiscal policy. All the Fed does is to determine whether government liabilities take the form of Treasury bonds sold to the public, or currency and reserves held by the public directly or indirectly through the banking system. Monetary policy determines the mix of government liabilities held by the public (and even then only at the margin). Fiscal policy determines the total quantity of those government liabilities, most which are absorbed these days not by the Fed but by foreigners (in an amount many, many times what the Fed absorbs). If you want to worry about some entity that could have enormous impact on U.S. economic activity, ignore the Fed and focus on the real “maestros:” foreign purchasers of U.S. Treasuries, particularly China and Japan.

In the continuing saga of repo rollovers masquerading as “liquidity injections,” the total amount of Fed repos outstanding declined to $45 billion last week, which may be somewhat thin given the holiday shopping season. Most of this predictably comes due again this week, so the FOMC will initiate at least $33 billion in new repos by Thursday (a $12 billion repo matures on Monday, with $13 billion to roll over on Wednesday, and $8 billion on Thursday) – more if it refinances the rolls on Monday and Wednesday with 1-3 day repos. This fairly stable $45 billion pool of “liquidity” provided by FOMC actions is useful in maintaining the similar quantity of “required reserves” in the U.S. banking system. It is helpful in accommodating the day-to-day demand for currency and reserves (monetary base), but has no material impact on the volume of bank lending, nor the solvency of the $12.7 trillion banking system or the mortgage market in general.

Again, the Federal Open Market Committee (FOMC) has “injected” only about $16 billion of “liquidity” into the U.S. banking system since March – all via short-term repos that are continually rolled over. Meanwhile, foreign investors (particularly China's central bank) have provided about $2 billion in fresh “liquidity” per day, mostly by purchasing U.S. securities (primarily Treasuries).

As I noted last week, “The market has now cleared the oversold condition that it established a week ago. Stocks aren't overbought here, but overbought conditions in unfavorable Market Climates tend to be rare. The steepest bear market losses tend to follow immediately on the heels of such overbought conditions.”

So we remain defensive here, both with regard to the stock market, and with regard to the economy as a whole. Possible enthusiasm about the Fed notwithstanding, an overbought condition in a negative Market Climate is rarely a prescription for strong returns at acceptable risk.

Why the Fed Can't Solve the Liquidity, let alone, the Insolvency Crisis

You may have seen this chart before. Central banks can only affect the bottom two parts of the chart, high powered money and M3. M3 the Federal Reserve is growing as fast as it can in order to indirectly support the much larger problem of securitized debt and derivatives but risking a return of inflation pushing long term yields up and bond prices down.



These two phenomenal pockets of debt are supported by asset prices: when asset prices (which act as collateral) decline, the credit market contracts & liquidity gets sucked out of the system. So the purpose of pumping new money into the system is to keep nominal asset prices up to protect collateral values of the real problem of leverage in the system that the Fed cannot directly control. It takes more and more money & the creation of new debt to do this because people are having huge problems servicing the debt they already have.

So we have two huge forces fighting each other right now: central banks desperately attempting to re-flate (increasing the money supply & giving lenders fresh cash to create more debt) and the market grudgingly but purposefully attempting to deflate by paying back (which the bureaucrats are trying to help with) or more likely destroying (write-offs) that debt. We have extremely high volatility as these two forces fight it out.

Looking at the chart, which do you think will win? The Federal Reserve or the contracting credit market.