Remember that "D" word I used?

You know, DEFLATION?

Well, as I noted, the way it comes is via tightening credit. To the point that the attempts to pump and bail out are simply gnats on an elephant's ass.

Its starting. A partial list from the last few days:

• The GSEs will no longer buy some paper they were willing to before (tightening CLTV requirements, especially in "bad" areas - that is, declining markets. Guess what - that'll be all 50 states soon)


• Mortgage insurers are in some cases doubling premiums for certain borrowers, and also tightening restrictions.


• First Marblehead gave up on securitizing some student loans that would have formerly gone to the market without question.


• Moody's put a bunch of SIVs on "credit watch" and basically said that this model was dead, strongly implying that they won't be cut - they'll be destroyed. That's hugely deflationary.


• Bush and Paulson's "bailout" plan for "subprime", if it is anything more than election-year posturing, will instantly decimate investor demand for mortgages that are non-agency paper (e.g. ARMs, Jumbos, etc.) As noted before there are so many stakeholders surrounding the issue of these securities that its not so simple as to say "oh it helps homeowners and prevents foreclosures." Specifically, the AAA-tranche holders could see their coupon cut which might actually be WORSE than the lower tranches going in the trashcan, especially if you can wind down the structure! Those who wrote some derivatives - a requirement for some to buy these securities - will get screwed even though they made the correct bets. Oh, and Congress is now trying to go even further.


• Moody's is now predicting a 30% house price decline. Take the value of all residential real estate and mutliply that one out. Make sure you're sitting down - that's real collateral impairment that hits real credit availability. Deflationary? Uh, yeah.


• Merrill Lynch's latest update is even more bearish, forecasting negative earnings not only for 4Q (duh!) but into 2008. Earnings power stock prices and credit growth in the commercial space.


• Ohio's AG is now potentially after not only the brokers in subprime deals but also the Wall Street investment banks. This is the "money shot" from this week guys; if indictments come out of this for racketeering (and this article strongly hints this may be where the investigation is headed!) it has the potential to actually sink one or more of these companies! Holy liquidity contraction Batman!

That's just in the last two days, and I'm sure I missed a few. The news items have been coming so fast and furious it would be impossible not to.

The Fed can't touch this and neither can the government, but you can bet they'll both try.

Next week we will get the schizoid master of them all, the Fed decision on 12/11. I am personally in the camp of either hold or cut 25 bips, depending on the EFF/FFR spread on Monday. There's a SLIGHT skew towards a 25 bips cut, but not much. In addition the slosh has been going up the last couple of months but hasn't unlocked the credit markets. The BOE cut and was "rewarded" with an opposing move in LIBOR that immediately took a big part of it back in the real world. This is the danger for The Fed - there comes a point where they lose control, and they got a stern warning from the BOE and LIBOR behavior this week.

Oh, and let's not forget the hot wage inflation print from last week. That's the sort of inflation The Fed REALLY fears, because its a genie that is very hard to stuff back in the bottle once it gets out. Still think we might get 50 bips eh? I don't think so!

As those with money go from "ok, I'll lend" to "no mas!" to "get ocularly penetrated!" the deflationary thesis gains legs, and they get longer and stronger.

Here's a quick technical look at the week ahead...