Post by psychecc on Aug 2, 2007 16:25:44 GMT -6
I think this is a pretty good article from Randall Forsyth on the liquidty dry-up. Lots of factual detail, not all of which I fully understand. Thought you experts might be interested.
Up And Down Wall Street: Will Bernanke Bail Out This Credit Meltdown? [¹]
By RANDALL W. FORSYTH, Barron's | 28 July 2007
"The turning point in leveraged finance has been reached," junk-bond guru Martin Fridson declared four weeks ago in the print version of Up and Down Wall Street (Dear Lord! July 2). Any doubters of that prophesy were disabused by Thursday's rout in the stock market that had the Dow Jones Industrial Average down by more than 400 points at its low.
Since then, the cost of credit has skyrocketed, imperiling the raft of corporate buyouts that have fueled the bull market. And Business Week's cover story of Feb. 19-- "It's a Low, Low, Low-Rate World: Money is cheap. And some experts say it could stay that way for years"-- is looking like a worthy successor to its infamous "Death of Equities" cover of 1979.
The entire spectrum of credit was being repriced, with far greater premiums to compensate for risk that had been cavalierly accepted by lenders and investors just a few short weeks ago. The notorious ABX.HE-- the index of credit default swaps on asset-backed securities, the main hedging vehicle for subprime risk-- not surprisingly took another tumble amid unrelenting bad news from home builders and in home sales data. And junk bonds had their worst day since the collapse of WorldCom in 2002, according to KDP Investment Advisors.
But the more important indicator has been the widening of spreads on corporate loans, the lifeblood of the deal business, evident in a further deterioration in the LCDX, an index which reflects credit default swaps (derivatives based on the cost of insuring against default on loans). The LCDX hit another new low in its young life, resulting in the cost of default insurance rising to 325.5 basis points (3.255 percentage points).
That represents a doubling in the risk premium on corporate loans since Fridson made his prescient statement at the end of June, and triple where it started in May. Wall Street firms and banks that made commitments to lend to private-equity firms at the previously narrow spreads may now be holding the bag.
As a result, the cost of insuring Wall Street firms' credit soared Thursday, Dow Jones Newswires reports. For instance, the cost of insuring $10 million of Bear Stearns debt soared to $105,000 from $83,500, a huge increase in a single day. Indeed, the credit derivatives market is pricing Bear and Lehman Brothers investment-grade debt as junk, the DJ story adds.
That's set off a chain reaction throughout the markets. "Large banks, choking on 'LBO bridge debt' that they cannot distribute [[this is debt that the banks advance the lenders until they are able to slice and dice the debt into asset backed securities, which they then unload onto the unwashed public: normxxx]], have likely tapped all their traders and risk takers to lower any and all risk positions and refrain from taking on any more, regardless of level," writes William Cunningham, head of global fixed-income research for State Street Global Markets.
"Job risk is greater than market risk in this environment," he adds pithily. In which case, discretion is the better part of valor for traders and portfolio managers.
All of which has accelerated the contraction of credit discussed ad infinitum in this space. And the evaporation of this propellant for the market's moonshot, to lift Cunningham's turn of phrase, sent the markets crashing around the globe.
"Equity investors should not ignore the message from the fixed-income markets," Richard Bernstein, Merrill Lynch's chief investment strategist, wrote in a note to clients before the market's open. "The rationing of credit means equity investors should discontinue their speculation regarding takeovers and LBOs."
As they heeded that advice, the market's slide recalled the minicrash of Oct. 13, 1989, when financing for UAL's proposed LBO fell through. That event marked the end of the junk-bond-financed takeover boom of the 1980s.
Cunningham of State Street likens Thursday's rout to the Long Term Capital Management crisis of 1998, when the collapse of that hedge fund caused the capital markets to seize up, even while the economy was in relatively good shape. At the behest of the Federal Reserve, the major banks and brokers arranged a bailout of LTCM. The Fed helped out by cutting its short-term interest rate target, even as growth was humming along.
The LTCM incident helped burnish the legend of the so-called Greenspan Put, the perceived insurance policy provided by the former Fed chairman to the markets when things got rough. After the crash of October 1987, the Maestro flooded the financial system with liquidity. And after the Tech Bubble burst, he did the same, slashing the overnight federal-funds rate all the way to 1% through 2003 into mid-2004, by which time the bull market and recovery were well along.
That's had two consequences: The cheap money inflated the housing bubble, which is now deflating with noxious effects. And it increases moral hazard-- the tendency of market participants to take on risk with impunity with the knowledge that they won't suffer the consequences if there's a bust. The expected Fed easing in reaction to any market setback is their Get Out of Jail Free card.
This episode marks Ben Bernanke's first test as Fed chairman. "Never mind foreign oil, the U.S. economy is addicted to easy credit, and an easing by the Fed in the current situation will only maintain this addiction, but it still may be necessary in the short term," asserts Cunningham. "The real test would be how quickly it was reversed, which was likely the mistake Greenspan made following LTCM," he concludes.
Or Bernanke could show he's no Gentle Ben and apply some tough love to the adolescents in the markets who don't know any limits.
investment.suite101.com/discussion.cfm/54/356-359
Up And Down Wall Street: Will Bernanke Bail Out This Credit Meltdown? [¹]
By RANDALL W. FORSYTH, Barron's | 28 July 2007
"The turning point in leveraged finance has been reached," junk-bond guru Martin Fridson declared four weeks ago in the print version of Up and Down Wall Street (Dear Lord! July 2). Any doubters of that prophesy were disabused by Thursday's rout in the stock market that had the Dow Jones Industrial Average down by more than 400 points at its low.
Since then, the cost of credit has skyrocketed, imperiling the raft of corporate buyouts that have fueled the bull market. And Business Week's cover story of Feb. 19-- "It's a Low, Low, Low-Rate World: Money is cheap. And some experts say it could stay that way for years"-- is looking like a worthy successor to its infamous "Death of Equities" cover of 1979.
The entire spectrum of credit was being repriced, with far greater premiums to compensate for risk that had been cavalierly accepted by lenders and investors just a few short weeks ago. The notorious ABX.HE-- the index of credit default swaps on asset-backed securities, the main hedging vehicle for subprime risk-- not surprisingly took another tumble amid unrelenting bad news from home builders and in home sales data. And junk bonds had their worst day since the collapse of WorldCom in 2002, according to KDP Investment Advisors.
But the more important indicator has been the widening of spreads on corporate loans, the lifeblood of the deal business, evident in a further deterioration in the LCDX, an index which reflects credit default swaps (derivatives based on the cost of insuring against default on loans). The LCDX hit another new low in its young life, resulting in the cost of default insurance rising to 325.5 basis points (3.255 percentage points).
That represents a doubling in the risk premium on corporate loans since Fridson made his prescient statement at the end of June, and triple where it started in May. Wall Street firms and banks that made commitments to lend to private-equity firms at the previously narrow spreads may now be holding the bag.
As a result, the cost of insuring Wall Street firms' credit soared Thursday, Dow Jones Newswires reports. For instance, the cost of insuring $10 million of Bear Stearns debt soared to $105,000 from $83,500, a huge increase in a single day. Indeed, the credit derivatives market is pricing Bear and Lehman Brothers investment-grade debt as junk, the DJ story adds.
That's set off a chain reaction throughout the markets. "Large banks, choking on 'LBO bridge debt' that they cannot distribute [[this is debt that the banks advance the lenders until they are able to slice and dice the debt into asset backed securities, which they then unload onto the unwashed public: normxxx]], have likely tapped all their traders and risk takers to lower any and all risk positions and refrain from taking on any more, regardless of level," writes William Cunningham, head of global fixed-income research for State Street Global Markets.
"Job risk is greater than market risk in this environment," he adds pithily. In which case, discretion is the better part of valor for traders and portfolio managers.
All of which has accelerated the contraction of credit discussed ad infinitum in this space. And the evaporation of this propellant for the market's moonshot, to lift Cunningham's turn of phrase, sent the markets crashing around the globe.
"Equity investors should not ignore the message from the fixed-income markets," Richard Bernstein, Merrill Lynch's chief investment strategist, wrote in a note to clients before the market's open. "The rationing of credit means equity investors should discontinue their speculation regarding takeovers and LBOs."
As they heeded that advice, the market's slide recalled the minicrash of Oct. 13, 1989, when financing for UAL's proposed LBO fell through. That event marked the end of the junk-bond-financed takeover boom of the 1980s.
Cunningham of State Street likens Thursday's rout to the Long Term Capital Management crisis of 1998, when the collapse of that hedge fund caused the capital markets to seize up, even while the economy was in relatively good shape. At the behest of the Federal Reserve, the major banks and brokers arranged a bailout of LTCM. The Fed helped out by cutting its short-term interest rate target, even as growth was humming along.
The LTCM incident helped burnish the legend of the so-called Greenspan Put, the perceived insurance policy provided by the former Fed chairman to the markets when things got rough. After the crash of October 1987, the Maestro flooded the financial system with liquidity. And after the Tech Bubble burst, he did the same, slashing the overnight federal-funds rate all the way to 1% through 2003 into mid-2004, by which time the bull market and recovery were well along.
That's had two consequences: The cheap money inflated the housing bubble, which is now deflating with noxious effects. And it increases moral hazard-- the tendency of market participants to take on risk with impunity with the knowledge that they won't suffer the consequences if there's a bust. The expected Fed easing in reaction to any market setback is their Get Out of Jail Free card.
This episode marks Ben Bernanke's first test as Fed chairman. "Never mind foreign oil, the U.S. economy is addicted to easy credit, and an easing by the Fed in the current situation will only maintain this addiction, but it still may be necessary in the short term," asserts Cunningham. "The real test would be how quickly it was reversed, which was likely the mistake Greenspan made following LTCM," he concludes.
Or Bernanke could show he's no Gentle Ben and apply some tough love to the adolescents in the markets who don't know any limits.
investment.suite101.com/discussion.cfm/54/356-359