European Bonds Post Monthly Decline as Inflation Accelerates

European government bonds fell on the month as signs German inflation is accelerating made it more likely the European Central Bank will lift interest rates again by year-end.
Benchmark 10-year bund yields touched a six-week high this past week after reports showed euro-region money-supply growth held near the fastest pace in 28 years in August and German inflation quickened to the highest rate in more than six years. Officials at the ECB this week said there are ``persisting'' risks to price growth among the 13 nations that share the euro.
The inflation ``data was exactly what the hawks on the ECB have been warning about for months,'' said Marcus Ostwald, a fixed-income strategist at Insinger de Beaufort SA in London. ``The risk on interest rates remains to the upside.''
The yield on the 10-year bund rose 11 basis points this past month to 4.33 percent by 4:15 p.m. yesterday in London.
The price of the 4.25 percent security due July 2017, which is more sensitive to inflation expectations than shorter-dated debt, dropped to 99.36.
Bunds returned investors 2.54 percent this quarter, compared with a return of 1.65 percent on two-year notes, according to indexes compiled by Merrill Lynch & Co.
Bunds pared their monthly decline after a German Federal Statistics report yesterday showed sales in Europe's biggest economy fell 1.4 percent in August, after gaining 0.6 percent the month before.
Benchmark debt was also buoyed yesterday after the Financial Times reported that Newcastle, England-based Northern Rock Plc had been forced to borrow a further 5 billion pounds ($10 billion) from the Bank of England since a Sept. 14 bailout.
German Inflation
Germany's inflation rate, measured using a harmonized European Union method, rose to 2.7 percent from 2 percent in August, the Federal Statistics Office said this week. That's the most since June 2001 and above than the 2.5 percent median forecast of 22 economist estimates in a Bloomberg News survey. Consumer prices rose 0.2 percent in the month.
M3 money supply, which the ECB uses to measure future inflation, grew 11.6 percent from a year earlier, after growing 11.7 percent in July, the central bank said this week.
ECB forecasts ``indicate continued growth and persisting risks for inflation,'' policy maker Guy Quaden, who is also governor of Belgian's central bank, said on Sept. 26.
Central bank President Jean-Claude Trichet this week told Dutch television it's ``too early'' to decide whether financial- market turmoil will hurt economic growth in the euro region.
This view was echoed by ECB Vice President Lucas Papademos who said in New York this week that ``so far, the effects of the market turbulence on the euro area economy have not been significant.''

Dollar Falls to All-Time Low Versus Euro on Fed Rate Outlook

The dollar fell to the lowest against the euro since the 13-nation currency's debut in 1999 as slowing growth and inflation increased speculation that the Federal Reserve will cut interest rates a second time this year.
The U.S. currency depreciated to an all-time low versus a basket of six of its major peers and posted the biggest monthly drop against the euro in almost four years. The dollar may decline further next week before a government report economists expect to show the U.S. unemployment rate rose in September to 4.7 percent, the highest in more than a year.
``Continued dollar weakness probably is still in the cards,'' said Ihab Salib, who helps oversee $3 billion in international bonds in Pittsburgh at Federated Investments Inc. ``I don't expect a meltdown in the dollar. It will be a moderate depreciation.''
The dollar fell 4.5 percent to $1.4267 per euro in September, reaching the record low of $1.4278 yesterday. It was the biggest monthly decline since December 2003. The U.S. currency reached all-time lows in each of the past seven trading days. The dollar posted a 5.1 percent drop in the third quarter, the biggest since the second quarter of 2006.
The New York Board of Trade's dollar index reached 77.66 yesterday, the weakest since the gauge began in 1973. The Fed's trade-weighted index comparing the dollar with major currencies dropped on Sept. 25 to the lowest since its inception in 1971.
Norway's krone was the biggest gainer this quarter, rising 9.4 percent against the dollar, while New Zealand's dollar lost the most, falling 1.9 percent. The dollar declined 6.8 percent to 114.81 yen over the same period.
U.S. Dollar Weakness
The U.S. dollar weakened against all of the 16 most actively traded currencies this month, falling 1.5 percent against the pound and 0.8 percent versus the yen. For the year, the dollar has lost 7.5 percent against the euro, 4.3 percent against the pound and 3.6 percent versus the yen.
The yen fell against all the major currencies except the dollar this month as the Fed's half-percentage-point rate cut on Sept. 18 encouraged carry-trade investors to resume borrowing in Japan to buy higher-yielding assets elsewhere. The yen lost 3.7 percent to 163.79 per euro, declining 7.1 percent against the Australian dollar and 6.6 percent versus the New Zealand dollar.
Japan's currency rallied on Aug. 17 to the highest against the dollar since June 2006 as higher borrowing costs related to subprime-mortgage losses led investors to avoid higher-yielding assets. The yen rose this quarter against all of the 16 most actively traded currencies except Norway's krone.
Consumer Confidence Plunges
Reports this week showed consumer confidence fell to almost a two-year low while new-home sales sank to the lowest in seven years. The price gauge tied to spending patterns and excluding food and energy costs, the Fed's preferred measure, rose 1.8 percent from August 2006, the smallest annual gain since February 2004.
Former Fed Chairman Alan Greenspan said yesterday in an interview with BBC Radio 4 that the chance of a U.S. recession is higher now than a few months ago.
The Labor Department will report on Oct. 5 that the unemployment rate rose to 4.7 percent this month from 4.6 percent a month earlier, according to the median forecast of 64 economists surveyed by Bloomberg News.
Futures contracts showed 86 percent odds yesterday that the central bank will cut its target to 4.5 percent at its next meeting Oct. 31, compared with a 14 percent likelihood a month ago.
Signs of Inflation
The euro also benefited this week as signs of rising inflation in Europe may increase speculation that the European Central Bank will boost interest rates before year-end.
Germany's inflation rate, measured using a harmonized European Union method, accelerated to 2.7 percent from 2 percent in August, the Federal Statistics Office said Sept. 27. That's the most since June 2001.
M3 money supply, which the ECB uses to measure future inflation, grew 11.6 percent from a year earlier after increasing 11.7 percent in July, the central bank said Sept. 27.
``This will get ECB concerned, and the expectation of an ECB ease was squashed,'' said Robert Sinche, head of global currency strategy in New York at Bank of America Corp. ``The euro-dollar move is a combination of dollar weakness and euro strength.''
The ECB is expected to keep its target rate at 4 percent when its board meets on Oct. 4, according to a Bloomberg survey. The Bank of England is expected to hold its rate at 5.75 percent the same day.
ECB President Jean-Claude Trichet yesterday told Dutch television it's ``too early'' to decide whether financial-market turmoil will hurt economic growth in the euro region.
The Euribor futures for delivery in December rose to 4.61 percent yesterday from 4.49 percent a week ago. The futures dropped to as low as 4.24 percent on Aug. 21 during the global credit crisis.

U.S. Stocks Have Biggest September Gain Since 1998 on Rate Cut

U.S. stocks rose this week to complete the steepest September advance since 1998 as the Federal Reserve's interest-rate cut helped energy and raw-material companies lead the market's recovery from a summer rout.
Exxon Mobil Corp., Freeport-McMoRan Copper & Gold Inc. and Monsanto Co. climbed after the falling dollar sent commodities to the biggest monthly gain in 32 years, led by crude oil, gold and wheat. Goldman Sachs Group Inc. rose the most during September in the Standard & Poor's 500 Index, which gained for the fifth straight quarter, after the securities firm reported the third- highest profit in its 138-year history.
The Fed's Sept. 18 reduction to 4.75 percent of its rate for overnight loans sustained the stock market's recovery from losses spurred by subprime-mortgage defaults. In July and August, the S&P 500 had the largest slump in four years.
``The Fed easing was the catalyst for everything,'' said Ed Peters, chief investment officer at PanAgora Asset Management in Boston, which manages $22 billion. ``Commodities will continue rising in price,'' lifting shares of their producers, because the rate cut may boost inflation.
The S&P 500 rose 0.1 percent to 1,526.75 this week, giving the benchmark a 3.6 percent September advance and a 1.6 percent third-quarter gain. The Dow Jones Industrial Average rose 0.6 percent to 13,895.63 this week, 4 percent in September and 3.6 percent during the past three months.
4.57 Percent
U.S. Treasuries completed the biggest quarterly rally in five years on expectations the Fed will cut interest rates even more in 2007. The yield on the benchmark 10-year note fell 0.05 percentage point to 4.57 percent this week, bringing its decline since June 29 to 0.45 point. Bond yields and prices move inversely.
Exxon, the world's largest oil company, surged 8 percent to $92.56 in September, for its steepest monthly gain since July 2006. Freeport, the world's second-largest copper producer, jumped 20 percent to $104.89. Monsanto, the world's largest seed producer, advanced 23 percent to $85.74 for the S&P 500's second- biggest September rally.
Energy shares in the S&P 500 rose 8 percent as a group, the most among 10 industries, followed by the 7.6 percent advance by raw-material stocks.
The 19-commodity Reuters/Jefferies CRB Index increased 8.1 percent in September, the most since July 1975. Wheat climbed to a record amid a global grain shortfall, boosting corn and soybeans. Oil also hit a record, and gold reached a 27-year high. The dollar's decline, which sent it to a new low against the euro this week, spurred the commodities rally.
$2.85 Billion Profit
Goldman surged the most in the S&P 500 in September, climbing 23 percent to $216.74. Goldman's third-quarter profit increased 79 percent to $2.85 billion after the company bet against the mortgage bonds that roiled credit markets. Earnings beat the highest analyst estimate by more than 20 percent.
General Motors Corp. had the biggest advance in the Dow average, rising 19 percent to $36.70. GM reached a contract agreement that takes $50 billion of future health-care obligations off GM's books and may transform the competitive landscape of the U.S. auto industry. The accord, ending a two-day strike, is designed to allow the Detroit automaker to operate with a cost structure closer to that of its Japanese rivals.
McDonald's Corp. gained 11 percent to $54.47. The world's largest restaurant company boosted its annual dividend by 50 percent as part of a plan to return as much as $17 billion to investors.
P&G Rises
Procter & Gamble Co. shares gained in 17 out of 19 trading sessions in September, rising 7.7 percent to $70.34.
Stocks may keep rising in the October-to-December period, if history is any guide. The S&P 500 has climbed in 11 of the past 12 fourth quarters.
``We'll continue to plod along,'' said Jack Ablin, who helps manage $52 billion as chief investment officer at Chicago-based Harris Private Bank. ``Earnings are still holding together.''
Unemployment in the U.S. rose to a one-year high in September and manufacturing slowed for a third month as the effects of the housing recession reverberated through the economy, economists expect reports next week to show.

Carlyle Raises EU5.4 Billion for European Buyout Fund

Carlyle Group, the buyout firm run by David Rubenstein, raised 5.4 billion euros ($7.4 billion) for takeovers in Europe, exceeding its target even as the pace of buyouts slows.
``There remain significant opportunities across the continent.'' Rubenstein said in an e-mailed statement today. However, ``the European market is maturing and the investment environment has become more challenging,'' he said.
Carlyle, which had planned to raise 5 billion euros, and rivals Kohlberg Kravis Roberts & Co. and PAI Partners are amassing their largest European funds as the low-cost loans used to pay for deals dry up. The value of buyouts dropped 80 percent to $20 billion globally in August, data compiled by Bloomberg show, as rising U.S. subprime mortgage defaults disrupted credit markets.
``Investors are looking to invest more in private equity and won't be deterred by short-term difficulties,'' said Nick Arnott, a managing director at London-based Private Equity Intelligence, which tracks the performance of buyout funds. ``We're not seeing any problems so far'' in raising money, he said.
Carlyle's third fund dedicated to takeovers in Europe is three times bigger than the 1.8 billion-euro pool the Washington- based firm raised in 2005. New York-based competitor KKR is seeking 7.7 billion euros for its third European fund, Private Equity Intelligence said last month. Paris-based PAI is gathering 10 billion euros for its Europe V fund.
Private-equity companies raised a record $260 billion for new funds worldwide in the first half of 2007. New York-based Blackstone Group LP pulled in $21.7 billion for the world's biggest fund last month.
Buyout firms use a mix of their own funds and debt to pay for takeovers. They typically seek to expand companies or improve performance before selling them within five years to other funds or investors

CPDOs Rated AAA May Risk Default, CreditSights Says

Credit derivatives awarded the top ratings by Moody's Investors Service and Standard & Poor's may be as vulnerable to default as high-risk, high-yield bonds, according to independent research firm CreditSights Inc.
Constant proportion debt obligations use credit-default swaps to speculate that a group of companies with investment- grade ratings will be able to repay their debt. An increase in credit rating downgrades for investment-grade companies may cause losses that CPDOs would struggle to recoup, CreditSights said in a report entitled ``Distressed CPDOs: We're Doomed!''
``If you assume defaults and downgrades come in bunches rather than being evenly spaced out, CPDOs' default rates are more what you would expect for low junk ratings than for AAA,'' David Watts, a CreditSights analyst in London, said in a telephone interview yesterday.
Investors and lawmakers have criticized Moody's and S&P, the two biggest ratings firms, for assigning their top Aaa or AAA grades to securities including those backed by U.S. mortgages, and failing to issue downgrades before prices plunged. U.S. Senate Banking Committee Chairman Christopher Dodd last month said credit rating companies must explain why they assigned ``AAA ratings to securities that never deserved them.''
Felicity Albert, a spokeswoman at S&P, and Moody's spokesman James Overstall, both in London, declined to comment on the CreditSights report.
Declining Value
CPDOs were first created last year by banks ranging from Amsterdam-based ABN Amro Holding NV, the largest Dutch lender, to New York-based Lehman Brothers Holdings Inc.
Banks set up at least $4 billion of CPDOs, promising annual interest as high as 2 percentage points above money-market rates.
The securities earn an income by selling credit-default swaps, a type of insurance contract that pays a buyer face value if the borrower can't meet payments on its debt. CPDOs typically provide debt insurance on a basket of 250 investment-grade companies by using the benchmark CDX North America Investment- Grade Index and the iTraxx index in Europe. The indexes rise when credit quality deteriorates.
Moody's and S&P assign their top credit ratings to CPDOs because of rules designed to ensure they never have to pay a debt insurance claim. The securities only reference investment- grade companies, ranked Baa3 or higher by Moody's and BBB- by S&P, and replace the contracts every six months when the indexes ``roll'' to weed out any companies cut to junk.
Dropping Out
The CPDO model is being challenged as worsening perceptions of credit quality reduce the value of the credit-default swap contracts included in the securities. Those CPDOs that provided insurance on the 125 companies in the CDX index in March for a premium of 36.75 basis points, or $36,750 for every $10 million of debt, will have to pay nearer 70 basis points to end the contract when the index rolls on Sept. 20, based on current prices.
To make matters worse, the CPDOs are likely to earn a lower premium on the new CDX Series 9 index because the credit risk will be lower as the downgraded companies drop out. At least five companies in the CDX and iTraxx indexes have lost investment grade ratings and will have to be replaced, according to Watts.
Without the downgraded companies, the new CDX index may be priced 11 basis points tighter than the current benchmark, JPMorgan Chase & Co. analysts led by Eric Beinstein in New York said in a report published this week.
Prices of CPDOs dropped to as little as 70 percent of face value last month.
``The removal of those five to eight names could cause spreads to tighten by more than CPDO models anticipated,'' said Watts. ``Even a relatively small number of downgrades in each index series means CPDOs will suffer and their ability to repay par at maturity will be far from certain.''

ECB Leaves Interest Rates Unchanged, Shelving Plan for Increase

The European Central Bank left interest rates unchanged today, shelving plans for an increase as the U.S. housing slump threatens to curb economic growth.
Policy makers meeting in Frankfurt kept the benchmark refinancing rate at 4 percent, as forecast by 44 of 56 economists in a Bloomberg News survey. The bank may raise the rate to 4.25 percent in October, a separate survey shows.
The collapse of the U.S. subprime-mortgage market has made banks reluctant to lend, pushing up the cost of credit and causing turmoil on world financial markets. The ECB earlier today added 42.2 billion euros ($57.7 billion) in emergency cash to ease a credit drought that had pushed overnight deposit rates to a six-year high.
``The ECB finds itself in a dilemma,'' said Rainer Guntermann, an economist at Dresdner Kleinwort in Frankfurt. ``Economic fundamentals require at least one more rate increase and inflation concerns haven't eased. On the other hand, it needs to deal with market turbulence.''
Trichet will hold a press conference at 2:30 p.m. in Frankfurt to explain today's decision. ECB President Jean-Claude Trichet on Aug. 27 retreated from a stance of ``strong vigilance'' on inflation, language he used to signal previous rate increases.
Central banks worldwide are refraining from raising rates as they assess how the credit squeeze will affect economic growth.
The Bank of England today left its benchmark lending rate at 5.75 percent, and in Indonesia the central bank kept its key rate at 8.25 percent. The Australian and Canadian central banks also opted yesterday to keep borrowing costs unchanged. The Bank of Japan last month stepped back from plans to raise interest rates.
Bernanke's Pledge
U.S. Federal Reserve chairman Ben S. Bernanke said Aug. 31 the bank will do what's needed to prevent the credit rout from undoing America's six-year economic expansion.
Concern that defaults on U.S. home loans to people with poor credit histories would curb growth in the world's largest economy prompted a slide in stock and commodity markets and pushed up corporate borrowing costs in early August.
Central banks added more than $400 billion to money markets since Aug. 9 to ease lending between banks. Australia's central bank said today it will buy debt backed by home loans to add cash to the financial system.
While those actions succeeded in reducing money-market rates for a time, by yesterday the overnight deposit rate for euros had climbed to 4.68 percent, the highest in six years. It fell to 4.10 percent after the ECB's injection today.
`Finger on Trigger'
``The key question is now whether the ECB keeps its finger on the rate trigger, hoping conditions will return to normal quickly, or whether it thinks market volatility will spill over into the real economy,'' said James Nixon, an economist at Societe Generale SA in London.
The ECB will publish new growth and inflation forecasts today, its first estimate of how the credit squeeze may affect the economy.
In June, the ECB predicted economic growth of about 2.6 percent in 2007 and 2.3 percent in 2008, and said inflation would average about 2 percent this year and next. The bank aims to keep inflation below 2 percent. In 2006, growth reached 2.7 percent, the most since the turn of the decade.
Since then, Europe's economy has cooled. The expansion ebbed to 0.3 percent in the second quarter from 0.7 percent in the first. Manufacturing and service-industry growth slowed in August, and consumer and business confidence dropped more than economists forecast. German manufacturing orders dropped the most in at least 16 years in July, a government report showed today.
OECD Cuts Forecast
The Organization for Economic Cooperation and Development yesterday lowered its forecasts for U.S. and European economic growth and said they may be reduced further following the rout on financial markets. ``Downside risks have become more ominous,'' Jean-Philippe Cotis, the OECD's chief economist, said in Paris.
For now, ``the euro-area economy is still growing at an above-potential rate,'' said Kenneth Broux, an economist at Lloyds TSB Bank Plc in London. ``The current turbulence is a short-term issue, it's not going to derail economic expansion. Growth will re-accelerate in the third quarter.''
Klaus Baader, chief European economist at Merrill Lynch and Co. in London, said concerns that expensive credit will prevent companies from investing are misplaced.
``I don't believe that there is going to be an indiscriminate credit crunch where good companies won't get access to cash,'' he said. ``The only thing that may happen is that it slows credit growth, and that is not necessarily a bad thing.''
The ECB has cited credit growth as an inflation risk. Loans to the private sector grew 10.9 percent in July from a year earlier, the bank said Aug. 28. M3 money-supply growth, which the ECB uses as a gauge of future inflation, accelerated to the fastest pace in 28 years.
The bank is also concerned that economic growth will allow companies to pass on higher costs to consumers, boosting inflation. Oil prices have surged 51 percent since mid-January.
``The rate hike is just postponed, not canceled,'' said Guntermann.

Lehman Sees `Material Hit' to Europe Investment Banks

European investment banks will take a ``material hit'' to earnings from the fallout of rising U.S. subprime-mortgage defaults, according to Lehman Brothers Holdings Inc. analysts.
Deutsche Bank AG and Credit Suisse Group were downgraded and had their share price estimates cut by London-based Jon Peace and Robert Law, who predicted that European banks will suffer after- tax writedowns of as much as 25 percent of full-year earnings this year, based on the pace of first-half gains. The impact would not threaten the solvency of the banks, the analysts wrote.
Central banks have pumped more than $350 billion into the world's money markets in the past month after U.S. subprime mortgage delinquencies sparked an increase in credit costs. Deutsche Bank Chief Executive Officer Josef Ackermann yesterday said markets are stabilizing, a day after UBS AG analysts cut their 2008 earnings estimates for firms including Deutsche Bank.
``The year 2007 has been a rollercoaster year,'' the Lehman analysts wrote in a note to clients yesterday. ``While we expect more earnings downgrades and negative news flows near term, we note that, once greater certainty over loss potential and revenue generation emerges, if markets do start to recover, the investment banks are typically quick to react.''
Investment-banking divisions may see a 40 percent decline in second-half revenue from the first six months, as income from fixed-income trading drops and debt issuance and mergers and acquisitions slow, they said in the report.
`Turbulent Market Conditions'
Ackermann said ``turbulent market conditions'' in August crimped the value of holdings in the sales and trading division, which accounts for about half of revenue. ``Market corrections, triggered in part by the drying-up of liquidity, have been significant and impacted mark-to-market valuations in our trading books and leveraged loan book,'' Ackermann said in a statement.
Companies that depend on commercial paper, debt due in 270 days or less, are facing funding shortages as investors refuse to buy debt secured by assets including subprime mortgages. IKB Deutsche Industriebank AG and Landesbank Sachsen Girozentrale had to receive emergency funding last month to keep them afloat after vehicles that they supported couldn't refinance in the markets.
The European Central Bank added more than 200 billion euros of extra cash to stabilize the money market between Aug. 9 and Aug. 14. It said today it may act tomorrow to soothe money markets if needed. The U.S. Federal Reserve and the Bank of England have also taken steps to address the credit crunch.
`Bad to Non-Existent'
Disclosure by European banks about subprime-related assets, collateralized debt obligations, leveraged lending obligations and asset-backed commercial-paper conduits ``ranges from the bad to the non-existent,'' the Lehman analysts wrote.
The analysts cut their recommendation on Frankfurt-based Deutsche Bank, the biggest German bank, to ``underweight'' from ``overweight.'' They slashed their price estimate to 94 euros ($127.7) from 146 euros.
They also reduced their recommendation on Zurich-based Credit Suisse, the second biggest Swiss bank after UBS, to ``equal weight'' from ``overweight'' and their price estimate to 90 Swiss francs ($74.28) from 123 francs. They kept their ``equal weight'' recommendation on UBS and reduced the price estimate to 71 francs from 91 francs.
Deutsche Bank fell 2.1 percent to 92.22 euros in Frankfurt trading. Credit Suisse declined 1.5 percent to 79.7 francs in Zurich and UBS dropped 1.3 percent to 63.45 francs.
New York-based Lehman itself, along with Morgan Stanley, will report lower third-quarter earnings because of declining fixed-income revenue, Citigroup Inc. analyst Prashant Bhatia wrote to clients today. Goldman Sachs Group Inc.'s profit will rise, in part because of an asset sale. Shares of New York-based Morgan Stanley, the No. 2 securities firm by market value after Goldman, offer the best risk-reward ratio for investors, he said.
The following is a table of Lehman's other changes to the ratings of European bank stocks. Bank New rating Old rating
Credit Suisse 2-equalweight 1-overweight
Deutsche 3-underweight 1-overweight
UBS 2-equalweight 2-equalweight
Banco Espirito Santo SA 1-overweight 2-equalweight
Credit Agricole SA 1-overweight 2-equalweight
HBOS Plc 1-overweight 3-underweight
Banco Popolare Scrl 3-underweight 1-overweight
Banco Comercial
Portugues SA 3-underweight 2-equalweight
Bradford & Bingley Plc 3-underweight 1-overweight
Northern Rock Plc 3-underweight 2-equalweight
Societe Generale SA 3-underweight 2-equalweight
Unione di Banche
Italiane Scpa 3-underweight 1-overweight

NextStudent Inc. Announces $1.4 Billion Securitization

NextStudent Inc., a leading Phoenix-based education funding company, announced today that, through its affiliate companies, it will be coming to the domestic and international capital markets next week with its second securitization when NextStudent Master Trust I issues $1.4 billion in auction-rate student loan-backed notes.
J.P. Morgan Securities Inc. will be the lead investment banker on the deal. Co-managers include Goldman, Sachs & Co., Morgan Stanley & Co. Inc. and Banc of America Securities LLC.
"We look forward to the successful launch of our second securitization as NextStudent continues its transformation from a student loan scholarship search and marketing company to a full-service student loan finance company," says John F. (Jack) Wallace, III, Executive Vice President of Finance.
The proceeds from the securitization will be used to purchase federally guaranteed consolidation loans previously held in an asset-backed commercial paper conduit. An additional $350 million "will be used to provide additional student loan capital and purchase Federal Consolidation Loans originated during the next six months," according to Wallace.

Recession Risk Rises as Consumers Feel Credit Tighten

The pain from higher borrowing costs may be spreading as consumers and businesses follow investors in shying away from risk, increasing the odds of a recession.
``While there is no basis for predicting a recession right now, the risks have surely gone up,'' says former Treasury Secretary Lawrence Summers, now a professor at Harvard University in Cambridge, Massachusetts. ``The combination of softness in the housing sector, contractions in credit, increased uncertainty and volatility, and losses in wealth make the chances significantly greater now.''
Economists at JPMorgan Chase & Co., Lehman Brothers Holdings Inc. and Merrill Lynch & Co. are among those lowering economic forecasts as the rising cost of credit prolongs the worst housing recession in 16 years. Now, two areas of the economy that have held up well so far, jobs and consumer spending, no longer appear immune to the fallout.
Already, the financial turmoil has put a dent in consumer and business confidence, according to surveys taken in August. Wal-Mart Stores Inc., the world's largest retailer, lowered its earnings forecast for this year. Financial-services companies including Atlanta-based SunTrust Banks Inc. announced plans to eliminate thousands of jobs.
Though reports show a strong start to this year's third quarter, economists will be watching this week for U.S. auto sales and August employment to see whether spending and the job market might follow housing into a slump.
`Fear in the Markets'
``We're taking the pulse of the economy a little more frequently,'' says Jonathan Basile, an economist at Credit Suisse Holdings in New York. ``If the spillover from the credit crunch gets into autos, it would be the second major sector to fall and would solidify a lot of the fear in the markets.''
Federal Reserve Chairman Ben S. Bernanke is under pressure to cut interest rates this month after the central bank said Aug. 17 that ``downside risks to growth have increased appreciably.'' Futures trading shows investors are betting the Fed will cut its benchmark rate at least a quarter percentage point, to 5 percent, at its Sept. 18 policy meeting.
The Fed ``continues to monitor the situation and will act as needed to limit the adverse effects on the broader economy that may arise from the disruptions in financial markets,'' Bernanke said at the Kansas City Fed's annual symposium in Jackson Hole, Wyoming, on Aug. 31.
More Pessimistic
Confidence is critical at key junctures in the economy. If consumers and companies turn more pessimistic about the outlook and cut back on their spending, such gloominess can prove to be self-fulfilling, triggering a recession.
A sudden drop in consumer confidence at the end of 2000, coupled with a contraction in manufacturing and a two-year-low in motor-vehicle sales, helped set the stage for the last recession, which began in March 2001.
The omens today aren't particularly promising. An index of global business confidence compiled by Moody's Economy.com in West Chester, Pennsylvania, fell in late August to its lowest level since the middle of the U.S.-led invasion of Iraq in 2003.
Spending on U.S. construction projects unexpectedly fell in July by the most since January, a government report today showed.
Consumers are also showing signs of being spooked by the turmoil in financial markets. U.S. consumer confidence tumbled last month by the most since Hurricane Katrina struck two years ago, according to the Conference Board, a private research group in New York.
`Significant Risk'
``I think there's a significant risk of recession now,'' says Martin Feldstein, president of the National Bureau of Economic Research, the unofficial arbiter of when recessions begin and end. ``The consumer will be spending less. The most recent consumer confidence numbers are down. That's going to be reinforced by everything happening in the housing market.''
Americans have ``pulled back on buying big-ticket items; and pulling back means that unless there is a rate cut, you will have a recession,'' Michael Jackson, chief executive officer of AutoNation Inc., said in an interview Aug. 29. AutoNation, based in Fort Lauderdale, Florida, is the largest U.S. auto retailer.
The pace of car and truck sales in the U.S. has dropped for seven consecutive months, the biggest string of declines in at least 31 years, according to data compiled by Bloomberg. Economists forecast little change for August when car makers report sales figures today.
Incentives
General Motors Corp., the biggest U.S. automaker, raised incentives on pickup trucks and sport-utility vehicles in August after its U.S. sales dropped 22 percent in July. The Detroit- based automaker also slowed production at six North American plants that assemble these vehicles.
``U.S. consumers continue to be under difficult pressure economically,'' Wal-Mart Chief Executive Officer H. Lee Scott said on Aug. 14. The Bentonville, Arkansas-based company blamed the housing slump and high gasoline prices when it reduced its profit forecast.
The pressure on consumers may increase if jobs become harder to get. First-time applications for jobless benefits have risen for five straight weeks, the longest streak since May last year.
``Employers are turning more cautious about taking on workers,'' says Steven Director, a professor at the School of Management and Labor Relations at Rutgers University in New Brunswick, New Jersey. ``The jobs market is softening.''
Payroll growth may slow in September to 50,000 jobs from more than 100,000 in August as businesses pull back on hiring, according to Kurt Karl, chief U.S. economist at Swiss Reinsurance, the world's largest reinsurer, in New York.
Rising Incomes
Still, Karl, who estimates the chances of a recession at about 35 percent, says the effect of the credit crunch on jobs will be temporary. He expects that consumers are more likely to pause than retreat for as long as incomes continue to rise. Earnings increased 3.9 percent in July from a year earlier, according to the Labor Department.
The economy chalked up its highest growth rate in more than a year during the second quarter, and there is evidence the strength carried over into the third quarter. Retail sales, durable-goods orders and new-home sales all surpassed economists' estimates in July. Those figures show the economy was strong before credit markets seized up in August.
More recent indicators ``are going to be looming larger as people try to get a handle on what's happening in the financial markets,'' says Joshua Shapiro, chief U.S. economist at Maria Fiorini Ramirez Inc. in New York.
The expansion may hinge on how business reacts to the curtailment of credit, economists say. U.S. business capital spending helped sustain growth in the second quarter.
A report today from the Tempe, Arizona-based Institute for Supply Management showed manufacturing cooled in August as factories trimmed orders.
``Business spending is the big concern,'' Swiss Reinsurance's Karl says. ``If that tanks, we could be heading for a recession.''

Regulators Urge Refinancing of Securitized Mortgages

U.S. bank regulators urged mortgage lenders to ease terms on the subprime loans they packaged into bonds, seeking to stem foreclosures that may aggravate what's already the worst housing slump in 16 years.
The Federal Reserve and other bank regulators asked lenders to review their authority under pooling and servicing agreements to identify borrowers at risk of default and offer to refinance to help them keep their homes, the agencies said in a joint statement released today in Washington.
``We encourage servicers of securitized mortgages to reach out to financially stressed homeowners,'' Fed Governor Randall Kroszner said in a statement.
The regulators' recommendation is part of a broader push by the federal government to stem the growing rate of foreclosures among borrowers with weak credit or high debt and to quell the recent turmoil in the credit markets.
Last week, President George W. Bush unveiled his plan to help homeowners avoid foreclosure, including a new initiative that would allow the Federal Housing Administration to help borrowers facing rising mortgage payments stay in their homes.
The number of U.S. homes under foreclosure almost doubled in July from a year earlier as property owners with adjustable-rate mortgages faced larger monthly payments, according to RealtyTrac Inc., the Irvine, California-based seller of foreclosure data.
The regulators urged lenders to use their authority under the securitization documents to identify borrowers at risk of delinquency or default, including those facing interest-rate increases on their loans, and contact them to assess their ability to repay.
They should consider helping borrowers avoid foreclosure by deferring payments, converting loans to a fixed-rate mortgages and other ways that help homeowners manage payments, the regulators said.

General Electric linked to £4bn Southern Water bid

The US conglomerate General Electric has reportedly joined Goldman Sachs in a £4bn bid for Southern Water, which supplies about 1m households in south-east England.
Southern was put up for sale by its owner, the Royal Bank of Scotland's private equity division, earlier this year.
GE joins other big hitters in the Goldman consortium, including the Australian firm Babcock & Brown. The consortium is said to be up against rivals led by the investment bank Morgan Stanley, and funds led by JP Morgan and Merrill Lynch.

The asset-rich utility sector has become a prime target for takeover activity.

India’s economy set for more strong growth, say analysts

India looks set for another year of strong growth after the economy unexpectedly accelerated by a scorching 9.3% during the first three months, analysts say.Last Friday’s first-quarter data, driven by robust manufacturing and services output, surprised many analysts who had forecast growth as low as 8.5% after five interest rate hikes in a year.The aggressive monetary tightening and a stronger rupee, which has hit exports, means it is unlikely India will repeat last year’s torrid 9.4% expansion, the fastest in 18 years, analysts say.But India’s “growth story,” which has prompted foreigners to pump billions of dollars into shares, infrastructure and other investments, remains intact.Expansion is being “consumption led” with “rising incomes and a growing middle class” in the country of 1.1bn people, said Deepak Lalwani, director at London investment house Astaire and Partners.“The economy has gained its own strong momentum due to cumulative reforms,” said Lalwani, who sees growth of 8.5-9% in the fiscal year to March 2008.Agriculture, which has pulled down the broader economy, also fared better than expected during the first quarter, posting 3.8% growth.While 9% is at the upper end range of most full-year forecasts, economists have raised their expectations following the quarterly figures.JP Morgan boosted its growth estimate from eight to 8.6% and Morgan Stanley from 7.7% to 7.8%. India’s HDFC bank said it was looking at “8.5% plus” from an earlier 8.3%. Other investment houses said they were considering hiking their forecasts.Finance Minister P Chidambaram said he was “confident GDP growth will remain close to 9% this year” even though first-quarter growth was “a shade below” the 9.6% expansion logged in the year-ago period.India’s economy, which has expanded by an average annual 8.6% in the past three years, is the fastest growing after neighbouring China. China’s economy expanded by a roaring 11.9% in the second quarter.Analysts say India’s growth would cool in coming quarters as the central bank’s tight money policy, which has pushed interest rates to five-year highs, crimps capacity expansion and hurts credit growth.Sales of cars are already slowing due to higher loan costs and spending on consumer durables has fallen.“There is some softness already in credit growth and rail freight and exports,” said Abheek Barua, chief economist at HDFC Bank.But the central bank is unlikely to ease its hawkish monetary policy stance rapidly.Data on Friday showed inflation fell to below four% for the first time in over 15 months to 3.96% but the strong first-quarter growth means that fears of overheating are still alive, analysts said.“It does not seem likely the central bank will loosen rates in a hurry... (as) the economy continues to grow at an above trend pace,” said Manika Premsingh at Edelweiss Capital brokerage.The new inflation rate is far below the bank’s annual target of “close” to five%. But economists say the drop was mainly due to a high base effect from a year earlier when inflation stood at 5.6%.“The bank won’t be lulled,” said Soumitra Chaudhuri, economic advisor to credit rating agency ICRA.“Inflation isn’t dead, the economy is growing fast, and if you don’t watch inflation it will come back with a vengeance

Mailbag Mailbag: Three Reasons Credit Levels Will Stay High

Minyan Peter,With respect to the potential for banks being forced to move loans back onto their balance sheets and shore up $60-80 bln in liquidity, my understanding is that Goldman Sachs (GS), as one example, assembled a distressed fund and raised $20 bln for it in about a week.I cannot imagine it is alone and have to believe that others are not sitting back waiting for their flagships to come unglued without some new storied distressed guy sitting around waiting to take advantage of the blood in the streets. Am I getting those issues confused, or couldn't those distressed funds buy and provide liquidity for exactly that kind of fall out?Prof. Katz,There is no doubt that there is a rapid move underway from "sell side" focus to "distressed buy side" among the banks. I think the issue is one of timing. My guess is that the distressed teams have their hands full right now with just the available subprime paper in the market. If you go back to the RTC days, the distressed teams waited until the government took the bad loans from failing institutions and then sold them at a discount. And my guess is that we are too early for many of the distressed teams to act.I would also add that Goldman's $20 bln is not comparable to the $60-80 bln figure I presented. I doubt that Goldman will be able to leverage the fund 10:1 the way the banks can. Then again, I have seen more crazy leverage of late than I ever imagined. Minyan Peter,When I talk to friends in the distressed market, they are indeed twiddling their proverbial thumbs. Their fear is that there are several reasons that may suggest credit may never trade down to levels where they would feel enticed, and consequently won’t get paid. The three reasons I get for this are:
i) Fed will bail out the credit markets (although I think people are kidding themselves when they think that a FF rate cut will help – this issue in subprime in my mind is that the lies a lot of people told to get the loans in the first place would never be accepted today as ‘evidence’ of one’s financial ability to repay). Getting a loan based on your ‘stated income’ is a thing of the past. Obviously their revised debt to income ratios will not help them either.ii) Opportunistic hedge funds will front run the distressed guys and pay higher prices than the distressed funds would – we’ve already seen some evidence a la Citadel/ Sowood. Most of my distressed friends saw that as being a very risky and premature bid by Citadel given what’s been transpiring. iii) Lastly, there is so much money bet against the credit markets right now. Credit derivatives are supposedly 8x the size of the entire credit markets. ( I’m getting that from people who are much smarter and more in touch with that market than myself). Prof. Succo has done a great job in pointing out the inherent counterparty/credit risk in this equation, but I believe one has to respect the potentially contrarian nature of a bet that size, and the incentive by the banks to defend certain asset pricing levels… otherwise, someone is going to be left without a seat in this game of musical chairs.
The reason I’m pointing out the GSCO distressed fund is because I do believe they very well can get that kind of leverage. In April of this year, the margin rules on institutional accounts changed: funds are now able to obtain margin based on the net exposure of the portfolio as opposed to having margin requirements on individual positions. It’s the reason we’ve seen some betas at large, global macro funds, skyrocket… because some of them were indeed using leverage in the neighborhood of 10-1. We’ve seen funds up 30% gross on the year that were actually up more like 3% on their invested assets. So a 5% reversal in invested assets crushed them. It’s a big bone of contention right now among institutional investors who have been doing a better job educating themselves about how the hedgies eek out their results and how they do or don’t manage risk.Now based on the current environment, I believe to a certain extent you are probably right and they won’t get the leverage that they were getting as recently as three months ago, but they will still get to leverage that money beyond 2:1. It’s one of the revenue streams by the big IBs that is at risk and I don’t hear anyone talking about: their margin lending revenue. Anyway, I am tremendously grateful for the contributions that are offered from members of the community such as yourself. Thank you for pointing out where the rubber is meeting the road in consumer spending. It is one of the biggest wild cards right now and your example on Target (TGT) was some of the first "apples to apples" empirical evidence that I’ve seen about the quality of the consumer’s dollar and the pitfalls in earnings quality of some retailers