Financial Turmoil Continues Unabated

MBA (10/13/2008 ) Velz, Orawin
Equity markets around the globe hemorrhaged as the problems in the financial system threatened to cause a global recession. Commodities (including energy and agriculture products) were in free fall over the fear that a worldwide recession will lead to flagging demand. Crude oil futures fell below $80 a barrel on Friday, the lowest in a year.
Another week brought more fiscal and monetary policy actions to tackle the financial crisis. On Tuesday, the Federal Reserve made an unprecedented move to alleviate the frozen commercial paper market, which has shrunk for the fourth consecutive week. The Fed announced creation of the Commercial Paper Funding Facility to backstop issuers of the short-term debt used by many businesses to meet daily needs. The special-purpose vehicle will purchase three-month unsecured and asset-backed commercial paper. This essentially enables the Fed to lend directly to businesses rather than to just financial institutions.

On Wednesday, as a part of a coordinated effort by major central banks around the globe, the Fed cut the federal funds rate by 50 basis points. The Fed cited weakening economic activity and intensified financial market turmoil as a motive of this inter-meeting rate cut. (The next Federal Open Market Committee meeting will be on October 28-29 and fed funds futures expected a further rate cut then).

In his speech on the same day, Treasury Secretary Henry Paulson Jr. suggested the possibility of injecting capital directly into financial institutions and, in effect, partially nationalizing those institutions. The Treasury maintained that the Emergency Economic Stabilization Act gave it the authority to provide capital in exchange for ownership stakes.

These actions failed to inspire investor confidence. Banks still did not trust each other and were reluctant to lend to one another, which resulted in rising borrowing costs for interbank lending. The London interbank offered rate continued to climb on Friday, with the three-month Libor rising to 4.82 percent—the highest since late December 2007.

Economic data were sparse last week. The first drop in August consumer credit outstanding in 10 years underscored households’ concerns about their finances and pointed to a retrenchment in consumer spending ahead. The trade deficit in goods and services narrowed in August but its improvement was not a result of strong overseas demand for U.S. products, as both exports and imports fell. One housing report offered some good news: pending home sales surged in August, fueled by pending sales (i.e., contract signing) of distressed properties in the West, suggesting existing home sales (closing) may rebound in the near term.

Stock markets extended their decline into an eighth day Friday. Investors continued to shift money into safe-haven assets, especially short-term Treasuries. The yield on the three-month Treasury bill plunged to 0.18 percent from 0.52 percent on Thursday. Longer-term Treasury yields did not benefit from a flight to quality and moved higher throughout the week. The yield on the 10-year Treasury note stayed around 3.87 percent mid-Friday afternoon, 38 basis points higher than the rate at the start of the week and 23 basis points higher than the rate on the previous Friday.

Housing and Mortgage Indicators:
The National Association of Realtors Pending Home Sales Index surged 7.4 percent to 93.4. The index was up 6.8 percent from last August, the first year-over-year increase since September 2005.

Pending home sales increased in every region of the country, led by an 18.4 percent increase in the West. The relatively stronger performance of existing home sales for the region partly reflects rising shares of foreclosed and distressed homes that were sold through the Multiple Listing Service. Attractive bargain prices have helped lure some buyers back into some local markets.

Pending home sales also rose strongly by 8.4 percent in the Northeast and rose modestly in the Midwest and the South by 3.6 percent and 2.4 percent, respectively.

The index is based on signed contracts for existing single-family homes, condos and co-ops. It is a leading indicator of NAR’s existing home sales, which are based on closings, as the signed contract for the purchase of a home generally precedes its closing by one to two months. The increase in June pending home sales suggests that existing home sales should increase in the near term.

Economic Indicators:
Total consumer credit outstanding fell $7.9 billion in August to $2.57 trillion—the largest decline in the level of consumer credit on record. The measurement of consumer credit does not include any loans secured by real estate. Revolving credit balances fell $600 million, while nonrevolving credit dropped $7.3 billion or 5.3 percent—the largest percentage decline since 1992, driven by a sharp drop in new vehicle sales.

The U.S. trade deficit narrowed to $59.1 billion in August from $61.3 billion in July. Exports decreased by 2.0 percent to $164.7 billion in August, while imports decreased by 2.4 percent to $223.9 billion.

Import prices declined 3.0 percent in September, the second consecutive decline and its largest since the 2003. Over the year, import prices were up 14.5 percent, decelerating from the 18.7 percent increase in August.

Prices for petroleum products declined 9.3 percent. Import prices excluding fuels fell 0.5 percent, the first month-to-month decline since February 2007.