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5 CREDIT BUBBLE
BULLETIN Crunch time By Doug Noland
as leverage - the
attractiveness of doing trades for the funds dims.
As these major brokers pull back, the mortgage
market’s liquidity dries up, driving bond prices
lower. In turn, hedge funds are forced to cut the
value of their holdings. In the case of illiquid
securities like subprime bonds or collateralized
debt obligations, the funds are unable to value
them and have to suspend redemptions, or the
return of an investor's
principal in a security.”
November 13 –
Dow Jones (Anusha Shrivastava): “Fitch Ratings
downgraded… the credit ratings of $37.2 billion of
global collateralized debt, with more than $14
billion worth of transactions falling from the
highest-rated AAA perch to speculative-grade, or
junk, status… The rating agency said more than 60
CDO transactions are still on watch for potential
downgrade… On Monday, nearly $20 billion worth of
transactions was cut from investment-grade to
junk, said Kevin Kendra, managing director at
Derivative Fitch.”
November 12 – Bloomberg
(John Glover): “Losses stemming from falling
values of subprime mortgage assets may reach $300
billion to $400 billion worldwide, Deutsche Bank
AG analysts said. Banks and brokers will be forced
to write down as much as $130 billion because of
the slump in subprime-related debt…Mike Mayo, a
New York-based analyst at the bank, wrote… Banks
may have to write off $60 billion to $70 billion
this year, he wrote.”
November 16 –
Bloomberg (Bryan Keogh and Shannon D. Harrington):
“For the first time in at least a decade, the
world’s biggest financial institutions are paying
more to borrow in the corporate bond market than
the average company. Bonds of banks, brokerages
and insurance companies yield 1.49 percentage
points more than U.S. Treasuries, matching a
record high set in October 2002… The average
industrial company bond trades at a yield premium
of 1.34 percentage points.”
November 14 –
Financial Times (Deborah Brewster and Saskia
Scholtes): “Banks and mutual fund managers are
being forced to prop up their money market funds
to prevent ratings agencies from downgrading the
funds, as the credit crisis spreads further
through the financial system. Bank of America
yesterday said it would spend $600m on supporting
its money market funds… Legg Mason and SEI
Corporation have also provided capital support to
their money market funds in order to protect the
funds’ credit ratings. A drop in the credit rating
would not itself cause the fund to lose money, but
it would result in many investors pulling their
money out, creating an immediate liquidity drain
and a dent in the funds’ reputation as a safe
harbour.”
November 14 – Financial Times:
“There’s motherhood and apple pie. And then there
is the pledge by money market funds not to ‘break
the buck’ - or allow net asset value to fall below
face value, meaning losses for investors. Asset
managers would rather have teeth pulled than
suffer the hit to their reputation such a breach
would involve. Regulators, too, would have reason
to fear the investor panic this might cause. With
so much at stake, it is probably not surprising
that a few sponsors of money market funds have
stepped in to provide capital support if needed…
The issue is the funds’ exposure to commercial
paper issued by structured investment vehicles -
which are rapidly losing their raison d'etre.
SIVs, it turns out, are exposed to a whole lot
more refinancing risk than anyone supposed. And
the unravelling of the SIV sector is hard to
contain neatly. That is made worse because, since
SIVs do not benefit from vast back-up lines of
credit, they have to move fast to sell assets if
their troubles become too pronounced.”
November 15 – Bloomberg (Christopher
Condon and Rachel Layne): “A short-term bond fund
run by General Electric Co.’s GE Asset Management
returned money to investors at 96 cents on the
dollar after losing about $200 million, mostly on
mortgage-backed securities. The GEAM Trust
Enhanced Cash Trust, a short-term bond fund with
about $5 billion in assets, told non-GE investors
on Nov. 8 that they could withdraw their money
before losses mounted. Enhanced cash funds usually
offer higher yields than money-market funds by
investing in riskier assets. All outside
investors, who together held ‘several hundreds of
millions of dollars’ in the fund, pulled their
money, Chris Linehan, a GE Asset Management
spokesman…said… Most of the fund’s money before
the redemptions came from GE’s corporate pension
plan and remains invested. Enhanced cash funds
‘never promised to be stable value, though
investors may have believed that,’ said Peter
Crane, founder of Crane Data LLC…publisher of the
Money Fund Intelligence Newsletter. There are a
number these funds ‘under duress,’ he said.”
November 14 – Bloomberg (William Selway
and David Evans): “The Florida agency that manages
about $50 billion of short-term investments for
the state, school districts and local governments
holds $2.2 billion of debt cut to junk status. The
downgrades affect more than 4% of what the Florida
State Board of Administration has purchased for
the funds… Some $3.6 billion, or 7.3%, of the
securities may be downgraded by credit-rating
companies, according to the document, provided to
Bloomberg by the state board. Florida rules
require the state’s short-term investments to only
be top-rated, liquid securities, so taxpayer funds
aren’t placed at risk. The data from Florida shows
how far the effects of the bursting of the housing
bubble are being felt as complex investment
vehicles once marketed as high-yielding safe
havens are now backed by collateral shunned by
investors… Florida’s state funds were affected by
bad investments in asset-backed commercial paper,
short-term debt sold by financial institutions
that is secured by collateral such as mortgage
securities and credit-card receivables… Florida’s
short-term holdings include $400 million of Axon
Financial Funding LLC debt, which was cut to junk
status… The others rated below investment grade
are $850 million of KKR Atlantic Funding
Trust…$577 million of KKR Pacific Funding Trust
debt…and $319 million of debt issued by Ottimo
Funding Ltd…. Joseph Mason, a finance professor at
Drexel University…said that the nearly 1,000
school districts, cities and counties invested in
the fund, now informed of its downgraded debt,
will be tempted to pull money out. ‘This sets up
the danger for a run on the bank,’ said Mason, a
former economist at the U.S. Treasury Department.
Commercial money-market funds, established as a
high-yielding alternative to savings accounts,
have also invested securities battered by
the…subprime mortgage crisis. Money market funds
with total assets of $300 billion have invested in
securities related to mortgages extended to
borrowers with poor…credit histories…"
November 14 – Financial Times (Peter
Garnham): “The yen carry trade is in trouble
again. On Monday, the Japanese currency rose
through Y110 against the dollar for the first time
in 18 months, and climbed 2% against the euro,
2.4% against sterling and an eye-watering 4.4%
against the Australian dollar… The success of a
given carry trade requires two elements: a funding
currency with a low yield, such as the yen, and
stability in asset markets… Clearly, low Japanese
yields are still in place. However, it is the
asset side of the equation that has been called
into question amid increasing worries over the
health of the financial sector. Benedikt Germanier
at UBS says the bank’s FX Risk index suggests the
market is once again close to fear levels last
seen in mid-August at the start of the recent
turmoil. ‘Financial stocks in the US and Europe
have weakened substantially… Spillover into other
sectors and ultimately into the real economy is
looming. This doesn't bode well for carry trades,
which typically perform in an environment of
stable or rising growth expectations and low
market volatility.’”
November 14 –
Bloomberg (Edward Evans): “British financier Guy
Hands said large leveraged buyouts are close to
impossible and returns will drop as bankers slash
funding for new deals. ‘Bankers are like dogs,’
said Hands, the CEO of London-based Terra Firma
Capital Partners Ltd., at the industry’s
SuperInvestor conference… ‘They hunt in a pack and
go into a feeding frenzy. When hit, they whimper,
and hide in their baskets. The bankers have been
hit very hard, and they’re not going to come out
of their baskets.’”
November 16 –
Financial Times (Paul J Davies): “Bankers and
investors in Europe’s leveraged, or high-yield,
loan markets do not expect to see a significant
recovery from the summer’s liquidity crunch until
the middle of next year at the earliest.
Furthermore, banks that underwrote the most
aggressively structured deals for their private
equity clients could be stuck with them through
the economic downturn that may be on its way,
unless they are prepared to seriously adjust the
prices they will accept for them. These downbeat
messages were repeated a number of times at a
packed industry conference in London yesterday…
The global market for high-yield debt, which
provides the majority of the funding for private
equity backed buy-out deals, still has a roughly
$350bn backlog of underwritten debt to clear
before banks can start writing significant amounts
of new business.”
November 15 – Bloomberg
(Neil Unmack): “The net asset value of structured
investment vehicles, companies that borrow short
term to buy higher yielding securities, has fallen
to 69.7% as the credit slump erodes their
holdings, Fitch Ratings reported. The amount that
would be left after selling SIV assets and
repaying debt dropped from 71% on Oct. 19 and
above 100% in July, data compiled by Fitch show.”
November 15 – Bloomberg (Ben Livesey and
Jon Menon): “Barclays Plc, the U.K.’s
third-biggest bank, wrote down about 1.3 billion
pounds ($2.7 billion) on credit-related securities
tied to the U.S. subprime-mortgage market
collapse.”
Currency
Watch November 14 – Bloomberg (James G.
Neuger and Simon Kennedy): “‘It may be our
currency, but it’s your problem’ was Treasury
Secretary John Connally’s taunt when the U.S.
unhooked the dollar from the gold standard in
1971, unilaterally rewriting the rules of world
business in America’s favor. Now the world is
taunting back. Almost four decades after the U.S.
tore up the monetary arrangements that governed
the post-World War II international economy, the
dollar’s fall from grace amounts to a tectonic
shift in the global hierarchy. This time, the U.S.
currency is on the losing side. After declining in
five of the last six years, the weakest dollar in
the era of floating currencies reflects a period
of diminished U.S. political and economic
hegemony. Whoever wins the White House next year
will confront two unpopular choices: Accept the
fall in U.S. clout and the rise of new rivals, or
rein in record public and consumer debt that the
rest
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