U.S. stocks bounced around Wednesday as traders were at the mercy of each and every rumor that came out of Europe, and the hearsay was flying yesterday (on both sides, favorable and unfavorable).  In the end, the major indices ended mixed again – the Dow Industrials and S&P 500 up, while the NASDAQ Composite closed down.

Financial, health care and consumer discretionary shares were the leaders.  Energy, utilities and industrials were the laggards.

So yesterday’s session was filled with rumor, but there were some facts to report.

As we’ve talked about a few times now, the short-term funding mechanisms within the European banking system have seized up and that’s why ECB (eurozone’s central bank) lending has soared and the Fed eased dollar swap lines last week.  It’s being reported that 39 EU banks scrambled for dollar funding from the ECB totaling $52 billion yesterday, up from $2 billion the week before.  While this solves the short-term liquidity issue, it does nothing for the insolvency problem, which is evident by reports that the German government is going to force their banks to take capital injections, a la TARP.  The issue is counterparties (whether it be other European banks or U.S. institutions) don’t want to hold the collateral that banks currently have on their balance sheets.  But the ECB is willing to, which causes one to wonder just how this all ends for Draghi & Co.

Over 100 years ago Walter Bagehot (the British journalist/economist) explained that central banks should lend freely in times of distress, but at a strict rate and on valuable collateral.  Today’s central banks are certainly lending freely, but at the easiest rates ever and on mostly suspect collateral.

One can certainly argue about the rate at which central banks lend during times of distress (Bagehot believed the rate should be high so that healthy banks didn’t go running for money merely because it was cheap, thereby sucking reserves from the central bank – reserves that were limited to the amount of gold held by the central bank – and thus not having enough to lend to the troubled banks; in today’s situation we use fiat money that can merely be printed, which causes all kinds of other problems but does provide unlimited reserves with which to lend, so maybe the rate doesn’t matter).  However, there should be no arguing that the collateral be valuable.

Market Activity for December 7, 2011

Sector Activity for December 7, 2011

Mortgage Apps

The Mortgage Bankers Association’s applications index bounced 12.8% last week after slumping 11.7% in the previous week, which capped off a three-week slide.

As the average contract interest rate on the 30-yar mortgage hit a new low of 4.18%, both purchase and refinancing applications led the broad index higher – the former rallied 8.3% and the latter was up 15.3%.

Apps to purchase a home have bounced nicely off of what was a fresh 14-year low hit in mid October.  Hopefully, we see the cancelation rate come down (an outsized number of contracts are getting canceled as too many appraisals are running below the contracted selling price).  This is a function of buyers willing to pay more than the house is currently worth due to the very low rate environment and sellers having to list the home at this higher level because that’s what they need to pay off their mortgage.

Consumer Credit

The Federal Reserve reported that consumer credit rose a seasonally adjusted $7.6 billion in October (a $7.0 billion increase was expected) as the figure remains propelled by non-revolving (auto and student loan) borrowing.  Revolving credit (credit card lines) inched up $366 million – this segment has been trending lower since the financial crisis began, down 18.5% from the peak hit in 2008.

So auto and student loans are driving this figure, and it’s mostly student loans.  I don’t know if the rise in auto loans present a problem (although personally, I think this segment will run into another wall too), but I do see the dramatic rise in student loans as a serious problem.  Students are staying in school, taking on much more debt to engage in postgraduate education, simply because of the state of the labor market.  If the degrees being attained are not of the highest quality, these borrowers will have a tough time paying these loans back if the jobs market doesn’t improve markedly.

On credit in general, during the third quarter total household credit (both consumer credit and mortgage debt) fell $60 billion.  However, mortgage balances alone fell $114 billion, which was surely due to the disposition of housing (foreclosure).  Thus, strictly consumer credit (doesn’t include mortgage debt) actually rose for the quarter.  Bottom line:  We’ve got plenty more de-leveraging to endure.

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Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900