A sign of relief is emerging as corporate bonds spreads - borrowing costs for investment grade and high yield companies - stabilize, even fall.

Rebecca Wilder on New N Economics also with an interesting post:

"A glimmer of light: Fed policy is working

There is a slew of bad economic news out there, but finally a glimmer of light emerges. The light is dull – a 40-watt rather than 200-watt light bulb- but is nevertheless there: Fed policy is working.

What is Fed policy? Fed policy is massive:

• Adding $1.4 trillion in liquidity to the domestic and global banking systems via loanable funds and currency swaps
• Making unprecedented loans to the private sector, American International Group and Bear Stearns
• Buying agency bonds directly
• Creating demand in the commercial paper market with $315 billion net transactions
• Using the Treasury to sterilize inflows
• On the horizon: buying U.S. Treasuries directly, mortgage-backed securities (MBS), and perhaps other instruments not yet mentioned (CDS, corporate debt, etc.)

Some signs that Fed policy is working:

Corporate spreads are stabilizing if not falling

The chart illustrates corporate bond indices for investment grade and high yield corporate bonds since the beginning of the year. A sign of relief is emerging as corporate bonds spreads - borrowing costs for investment grade and high yield companies - stabilize, even fall( THIS IS GREAT NEWS. IT SIGNALS SOME EASING IN THE FEAR AND AVERSION TO RISK ).

Corporate bond rates are important - the higher are the costs to borrow, the lower will the borrowing be for new capital investment( ABSOLUTELY. I WOULD STILL TARGET A TAX CUT TOWARDS INVESTMENT TO FURTHER EASE THE RISK AVERSION ). See this post to for corporate bond spread indices (against Treasuries) on a longer horizon.

The money supply – all measures of – is growing faster on a weekly basis

And surging on an annual basis

The chart illustrates various measures of the U.S. money supply (the data and definitions are listed here). The growth rate of non-M1 components of M2 (Table 4) started to fall slightly at the end of October, but has since then picked up speed. The 4-week average M2 – a better look at the trend – is growing at a record 8%. Finally, M3 (at least most of M3) is slowing on an annual, but it is reverting back to its longer-term trend rather than falling off a cliff. The Fed is keeping the money supply afloat; this will offset some of the negative price pressures going forward.( YES. GOOD NEWS )

Mortgage rates are falling

Who said that traditional monetary policy – cutting the target federal funds rate – was dead, because clearly it is not. In the wake of the Fed’s December 16th announcement, mortgage rates fell with force to 5.27% (as of 7am on December 19th from Bankrate.com). And with the Fed gearing up for its $500 billion MBS program, I expect that mortgage rates will fall further, potentially driving up buyer demand in the housing market. ( I'M FINE WITH THIS, BUT WOULD PREFER IF IT FELL NATURALLY, WITHOUT THE GOVERNMENT TARGETING IT )

It looks like the U.S. economy is just skirting a financial meltdown. Phew, now we have a recession to contend with.( I AGREE )

"about the only people who benefit from this new Treasury proposal are the homebuilders, who have been lobbying for a bailout."

Roubini and I basically agree on this ( I'm sure he was waiting to hear my view ) as well, but I want to talk it out. Via Clusterstock:

"From TechTicker: A new Treasury plan to lower mortgage rates won't solve the housing crisis and is a "essentially a direct bailout of the homebuilders," says Nouriel Roubini, economics professor at NYU Stern School and chairman of RGE Monitor.

Homebuilding stocks like Toll and Lennar surged early Thursday, a sign Roubini is not alone in sharing this view.

Using Fannie, Freddie and other GSEs, Treasury will "encourage banks to issue new mortgages at lower rates by offering to purchase securities underpinning the loans at a price equivalent to the 4.5% rate," according to the Wall Street Journal."

I'm not sure why he finds this so troubling. I'm not for it, but let's read on:

"The plan will be effective in lowering rates but interest rates aren't the key to resolving the housing crisis, Roubini says: "Prices went through the roof" and need to fall another 15% before housing bottoms and homes become affordable to the majority of Americans. (The new Treasury plan does nothing for Americans looking to refi but last week's Fed announcement was aimed, in part, to help existing homeowners and refi activity surged in reaction.)"

I don't disagree, but if people can buy houses at this price and afford them, then that's the price. Obviously, if interest rates are lower, then housing prices can be higher. But is that a law? When I bought my house, I got it for 10% less after bargaining.

"Furthermore, there's not enough Americans who are credit worthy and confident enough in the economy and/or their job security to absorb the record levels of unsold homes on the market, says the notoriously bearish economist. "For new programs you have to qualify. Very few people qualify," Roubini said. "If you are loosening the criteria then you are creating a credit risk for the government because you're creating mortgages people cannot afford and some of them are going to default. You create another fiscal problem down the line."

Well, loosening the criteria would truly be insane. If that's what will happen because of this plan, then it's a disaster in the making. However, I don't believe that. In fact, I don't think that this program is worth the money. It simply won't do what it's supposed to, precisely because there aren't a large number of people who are going to qualify, and those people who do would be better off waiting for housing prices to decline, unless you believe that mortgage rates are going to immediately shoot up.

"That being the case, about the only people who benefit from this new Treasury proposal are the homebuilders, who have been lobbying for a bailout. Unfortunately for the rest of us, it looks like their efforts have paid off."

Now I see what he's worried about, and I agree. Bailing out homebuilders is not enough of a reason for this plan. I understand the political pressure to do something about housing, but this is not, in my opinion, the way to deal with this problem.

"a clear policy implication — namely, that financial market reform should be pressed quickly, that it shouldn’t wait until the crisis is resolved."

Paul Krugman has a post today in the NY Times:

"One answer to these questions is that nobody likes a party pooper. While the housing bubble was still inflating, lenders were making lots of money issuing mortgages to anyone who walked in the door; investment banks were making even more money repackaging those mortgages into shiny new securities; and money managers who booked big paper profits by buying those securities with borrowed funds looked like geniuses, and were paid accordingly. Who wanted to hear from dismal economists warning that the whole thing was, in effect, a giant Ponzi scheme?"

I don't see it as a Ponzi Scheme. One could read my thought experiment about looking into some of the more risky and complex inverstments as early as 2005, and being able to conclude that they were simply too risky. A number of things could have been done to keep this crisis from occurring or being this bad, whereas a Ponzi Scheme has Fraud built right into it. But I agree with the basic point, that it's hard to intentionally slow the economy down when so many people are still making money in it. It's one reason that I think it unlikely that the Fed, on its own, using a blunt instrument like raising interest rates across the board, will find it easy to raise rates to slow the economy down. Nevertheless, I believe that middle of the party is the part of the party where real diligence needs to be taken. In other words, focus on emerging problems in the economy when things start really going well, especially for a long period of time. Although it's hard to do, it's necessary.

"There’s also another reason the economic policy establishment failed to see the current crisis coming. The crises of the 1990s and the early years of this decade should have been seen as dire omens, as intimations of still worse troubles to come. But everyone was too busy celebrating our success in getting through those crises to notice.

Consider, in particular, what happened after the crisis of 1997-98. This crisis showed that the modern financial system, with its deregulated markets, highly leveraged players and global capital flows, was becoming dangerously fragile. But when the crisis abated, the order of the day was triumphalism, not soul-searching.

Time magazine famously named Mr. Greenspan, Robert Rubin and Lawrence Summers “The Committee to Save the World” — the “Three Marketeers” who “prevented a global meltdown.” In effect, everyone declared a victory party over our pullback from the brink, while forgetting to ask how we got so close to the brink in the first place.

In fact, both the crisis of 1997-98 and the bursting of the dot-com bubble probably had the perverse effect of making both investors and public officials more, not less, complacent. Because neither crisis quite lived up to our worst fears, because neither brought about another Great Depression, investors came to believe that Mr. Greenspan had the magical power to solve all problems — and so, one suspects, did Mr. Greenspan himself, who opposed all proposals for prudential regulation of the financial system."

There is some truth in this, but it misunderstands the nature of the triumphalism. The system worked because of government and Fed actions that were taken during these years. This led to a complacency in the nature and strength of the implicit and explicit government guarantess of intervention in a financial crisis. It was less relief at our wisdom, than a realization of the nature and depth of government backing of our financial system. The downside of excessive risk was thereby consigned to government accounts and salvation, a view that has proven remarkably prescient.

"And because we’re all so worried about the current crisis, it’s hard to focus on the longer-term issues — on reining in our out-of-control financial system, so as to prevent or at least limit the next crisis. Yet the experience of the last decade suggests that we should be worrying about financial reform, above all regulating the “shadow banking system” at the heart of the current mess, sooner rather than later.

For once the economy is on the road to recovery, the wheeler-dealers will be making easy money again — and will lobby hard against anyone who tries to limit their bottom lines. Moreover, the success of recovery efforts will come to seem preordained, even though it wasn’t, and the urgency of action will be lost.

So here’s my plea: even though the incoming administration’s agenda is already very full, it should not put off financial reform. The time to start preventing the next crisis is now. "

I disagree here as well. The real fear is that we will regulate excessively in the midst of this crisis, focusing in on the problems of this last crisis, and not putting into place a system that focuses less on actual regulation than recognition of the problems in our finacial system, some of which won't need more than supervision, while some might need regulatory oversight.

And to reiterate, just like value investing, we should be especially vigilent and fearful when things are going well, not after they've turned bad. I know it's going to be hard, but it's simply the patience, vision, and wisdom, of the value investor, a strategy that human beings have been able to execute.

"Even as the Fed Funds Rate has fallen from 5.5% to 1%, mortgage rates have failed to decline along with it"

Just when you're sick of charts, here's another interesting one from Bespoke:

"30-Year Fixed Mortgage Rate Chart

Talk of the 30-year fixed mortgage rate falling back below 6% filled the airwaves yesterday, so below we provide a two-year chart of the rate for those that are interested. Even as the Fed Funds Rate has fallen from 5.5% to 1%, mortgage rates have failed to decline along with it, which hasn't done much to help the struggling housing market. Economists and investors are hoping that the Fed's actions yesterday will start pushing mortgage rates lower. This will help ease the credit crisis as banks will become more willing to lend, providing better interest rates for potential homebuyers. 5.81% is better than the 6.4% seen at the start of the month, but the rate could still stand to drop quite a bit.

Here's the Fed Funds Rate:

Change (basis points)
Date	Increase	Decrease	Level (percent)
2008
October 29	...	50	1
October 8	...	50	1.5
April 30	...	25	2.00
March 18	...	75	2.25
January 30	...	50	3.00
January 22	...	75	3.50
2007
December 11	...	25	4.25
October 31	...	25	4.50
September 18	...	50	4.75

I know, it's hard to read. I apologize.

So, you can see that Mortgage Rates have remained high, while the Fed Funds Rate has gone down.

There are a host of explanations for this:
1) Banks are using the spread to recapitalize, etc.
2) There's a risk premium do to fear by the lenders
3) The lenders actually have to pay more for deposits because depositors need more reward for the felt risk of their deposits
4) Lenders are waiting for the housing market to bottom, until then, there's a risk premium

I'm sure that there are others. However, they are now coming down, and the plan just announced by the Fed should help as well.

Not everyone likes this though, so I'll try and get to that later today.