Q: What do you get when you put a canary in a blender?
A: Shredded tweet.

Washington Mutual, whose stock is down 56% and a large purchaser of brokered loans on a wholesale basis, might be rethinking their strategy. Yesterday they announced that they will discontinue all subprime lending, cut 3,100 jobs (6% of its workforce), try to raise $2.5 billion in capital, reduce their dividend, “re-size” their home loan business, and cut their expenses. They are expecting a loss in the 4th quarter due to their home loan segment, and will be closing WAMU Capital, its institutional broker-dealer business. They will be closing 190 (out of 336) home loan centers and sales offices, eliminating 2,600 home loan positions, and cutting 550 corporate jobs. Whew! Their economists believe that national mortgage originations will shrink to $1.5 trillion in 2008, down from 2007’s expected $2.4 trillion. On their wholesale side, they are consolidating 27 Wholesale Loan Centers into 18.  As a result of this consolidation, their sales organization has been restructured, and they will be closing four Loan Fulfillment Centers in early 2008, leaving the remaining LFCs are in San Diego CA , Pleasanton CA , Downers Grove IL and Jacksonville FL.

Remember how the industry “sat up and took notice” of the House of Representatives bill a few months ago? Well, now it is the Senate’s turn. Senator Dodd, chairman of the Banking Committee, will be introducing legislation to bar lending practices widely blamed for contributing to a nationwide surge in foreclosures and defaults, enacting stricter standards for subprime loans made to borrowers with poor credit. For high cost loans, lenders would be required to determine that a borrower can pay back the loan over its full term and not just during an initial "teaser" phase. Lenders also would be required to set aside money to pay property tax and insurance bills. In addition, YSP’s would be banned for subprime and other “nontraditional” (I don’t know the definition) loans.

Today is the Fed meeting. They have sent a clear signal to the market: if the distress continues, the Fed will cut their short-term rates, even if the economic data was healthy. With housing, it has been dismal, but other parts of the economy are indeed doing well. Most look for the housing market to continue to restrain growth through deeper construction cuts and weaker consumption, so with growth well below potential and increased labor market slack, core inflation should remain tame. Ahead of their meeting, in “early morning trading”, the 10-yr stands at 4.12% and mortgages are better by about .125 in price.

LIBOR keeps sliding higher, and they are not pumping much liquidity into the short-term funding markets – so how high year end funding costs go? Remember that nearly all subprime and Alt-A ARMs are based on LIBOR, not Prime (or indirectly the Treasury), so the Fed doesn't directly control the rates related to adjusting ARMs at all. The dreaded Option ARM, in the majority of cases, uses a Treasury-based index instead of LIBOR.

Speaking of funding costs, the TED spread (Treasury versus Euro-dollars) is defined as the difference between the T-bill interest rate and LIBOR. The TED spread is a measure of liquidity and shows the flow of dollars into and out of the US. Many use it to gage credit risk, since U.S. T-bills are considered risk free while the rate associated with the Eurodollar is thought to reflect the credit risk of corporate borrowers. As the TED spread increases, default risk is considered to be increasing, and investors will have a preference for safe investments. As the spread decreases, the risk of default is considered to be decreasing.

The size of the spread is usually denominated in basis points, e.g. when T-Bills trade at 4.10% and ED trades at 4.50%, the TED spread is said to trade at 40bps. The credit crunch caused by the US subprime meltdown has increased the TED spread to a region of 150-200bps!

A little girl and a little boy were at day care one day. The girl approaches the boy and says, "Hey Stevie, wanna play house?"
He says, "Sure! What do you want me to do?"
The girl replies, "I want you to communicate."
He says to her, "that word is too big. I have no idea what it means."
The little girl smirks and says, "Perfect. You can be the husband."