Morning Report

Vital Statistics:

	Last	Change	Percent
S&P Futures	1397.6	0.8	0.06%
Eurostoxx Index	2339.0	16.3	0.70%
Oil (WTI)	104.3	-0.2	-0.20%
LIBOR	0.466	0.000	0.00%
US Dollar Index (DXY)	78.87	-0.046	-0.06%
10 Year Govt Bond Yield	1.92%	-0.02%
RPX Composite Real Estate Index	173.4	0.1

Markets are generally flat this morning after the release of Q1 GDP, which came in light. The economy expanded at a 2.2% annual rate in Q1 vs expectations of 2.5% and lower than the 3% number in Q4. This more or less confirms the slowdown we have been seeing in other data as well. Yesterday, initial jobless claims came in at 388k.

Yesterday, the National Association of Realtors released their March Pending Home Sales Index, which is a forward-looking index of housing activity based on contract signings. The first quarter's activity was the highest in five years. Supply and demand are becoming more balanced.  It will be interesting to see whether the banks start letting more REO go to meet the increased demand of if they continue to drip out inventory gradually.

Bill Gross continues to bet that Operation Twist continues as a mortgage play. Further, he believes that QEIII is a possibility, especially if the employment numbers weaken. Interestingly, he is also looking at this trade as a volatility bet - if you are long mortgages, you are short bond volatility - and is betting that the 10 year has more or less found its level for the next couple of years.

A pet peeve of mine is this whole idea that the repeal of Glass-Steagall somehow caused the financial crisis. It turns out that Tim Geithner agrees with me that GS didn't play a material role. No other country in the world (EU, Japan, UK, Canada) separates commercial and investment banking, or even draws a distinction between the two for that matter. Glass-Steagall was instituted because investment banks were stuffing their sister commercial banks with poorly underwritten bonds after the market crashed in 1929. If the investment bank couldn't sell the paper to public at par (or close to it), they sold it to their captive banks who bought it at par and marked it there until bank runs exposed the fact that these bonds were worthless. The investment banks did the same thing with the insurance companies, which is why insurance companies were included. The point of G-S was to prevent this sort of thing and to ensure that these transactions would be arm's length.

The financial crisis didn't occur because JP Morgan was selling suspect bonds to Chase at the end of a gun barrel. Or Citi selling worthless paper to Travelers for that matter. The cause of the financial crisis was a deflating real estate bubble, which hit banks with large derivatives exposure (Bank of America and Citi) as well as small community banks that were in the very ordinary business of making mortgages, car loans, and business loans. It turns out that the smaller banks are the ones who can't repay TARP. If we didn't have a real estate bubble, we wouldn't be having this conversation.Why did we have a real estate bubble?  There were a lot of contributing factors, but the biggest was the Fed and a psychological belief on the part of the public that real estate was a one-way bet.

People forget the reason why we repealed Glass-Steagall in the first place. The main reason was that the big international investment banks like UBS and Deutsche Bank were able to undercut the US investment banks because they were able to borrow at zero, while Goldman and Merrill had to fund their balance sheets at LIBOR. "Wall Street" was turning into Nomura, Barclay's, Credit Suisse, and ING. Second, there were a couple of commercial banks who had become hybrids - JP Morgan and Bankers Trust - with Citi and Bank of America close behind. Glass-Steagall was becoming irrelevant anyway and the repeal was more or less an acknowledgment what had already happened.