Page 3 of
5 CREDIT BUBBLE
BULLETIN No
simple repeat of LTCM
fiasco Commentary and market
watch by Doug Noland
cities and hospitals
across the country expected yields on the debt to
move in tandem with benchmark rates when they
bought swaps to protect against rising interest
costs. Instead, the bonds' rates are up an average
3.1 percentage points since September, while the
one-month London interbank offered rate -- what
banks charge each other for funds -- has dropped
2.7 points. ‘It’s a universal problem,’ said Debra
Sloan, director of capital markets at…Partners
Healthcare System Inc., which has interest-rate
swaps on $450 million of its $600 million in
auction securities. ‘We try to structure them so
that over time there is a match.’ The failure of
the financial instruments compounds the pain for
borrowers stuck paying record-high interest on
auction-rate debt
billed
as a cheap alternative to traditional bonds."
February 28 – Bloomberg (Michael McDonald
and Michael Quint): "U.S. state and local
governments are paying more for their
variable-rate bonds as disruptions that first
appeared in the market for auction-rate securities
widen. The benchmark weekly interest rate that
tax-exempt issuers pay more than doubled in the
past two weeks as investor demand waned on
skepticism about the finances of insurers backing
the debt. The Wall Street dealers who help to find
buyers for so- called variable-rate demand
obligations have also refused to hold the debt
when they can’t attract investors, mirroring the
breakdown of the auction market, investors and
issuers said. ‘The variable-rate demand market
worked fine as long as everybody was confident
that at the end of the day somebody would open
their checkbook and buy the bonds,’ said Lance
Pan, director of investment research at Capital
Advisors Group…."
February 29 – Bloomberg
(Shannon D. Harrington): "MBIA Inc. is writing
‘very little’ new bond insurance business as
borrowers balk at buying a guarantee from a
money-losing company without stable AAA credit
ratings."
February 29 – Bloomberg (Emma
Moody): "Ambac Financial Group Inc., seeking to
avoid a crippling credit rating downgrade, cut its
dividend and will suspend writing guarantees on
new asset-backed securities for six months to
bolster capital."
February 28 – Financial
Times (James Mackintosh): "One of London’s most
successful hedge funds imploded Thursday when
Peloton Partners put the assets of its $2bn
flagship fund up for sale and froze its remaining
fund after geared mortgage bets left it unable to
meet lenders’ demands. Rumours of the crisis at
Peloton’s ABS fund, named best new fixed-income
hedge fund last month, helped drive the
high-quality mortgages in which it was invested to
all-time lows this week as traders prepared for
$9bn of assets to be dumped. The losses are
particularly striking because Peloton ABS was one
of the big winners from the US subprime crisis,
gaining 87% last year after betting against
low-quality mortgages. But last month Ron Beller,
co-founder, told the Financial Times that the firm
had begun investing in ‘good-quality assets that
are trading at deeply discounted prices’ –
including a large position in AAA-rated mortgages…
‘It is the classic story of when leverage goes
wrong,’ one investor said. ‘But I can’t believe
this problem is confined to these guys alone.’"
February 29 – Bloomberg (Pierre Paulden
and Caroline Salas): "Peloton Partners LLP, the
London- based hedge fund manager being forced to
liquidate a $1.8 billion asset-backed fund, said
it’s a victim of Wall Street's reduced lending.
‘Credit providers have been severely tightening
terms without regard to the creditworthiness or
track record of individual firms, which has
compounded our difficulties and made it impossible
to meet margin calls,’ Peloton co-founders Ron
Beller and Geoff Grant said in a letter yesterday
to clients."
February 29 – The Wall Street
Journal (Carrick Mollenkamp, Gregory Zuckerman and
Cassell Bryan-Low): "In a move reflective of how
banks are moving quickly to deal with troubled
borrowers, lenders have seized assets held by
troubled London hedge fund Peloton Partners LLP…
The moves by the banks come as they try and recoup
some of the money they loaned the fund."
February 28 – Bloomberg (Jody Shenn):
"Securities backed by Alt-A mortgages and other
home loans to borrowers with better-than-subprime
credit tumbled this month, causing investment
funds to unwind or meet margin calls and signaling
larger losses for Wall Street… Valuations for AAA
rated securities backed by Alt-A loans, deemed
between prime and subprime in terms of expected
defaults, slumped 10% to 15% this month, partly
because it's so difficult to trade or find prices
for them, Thornburg Mortgage… said… ‘There really
hasn’t been an orderly two-sided market in 2008,’
Arthur Frank, a mortgage-bond analyst…at Deutsche
Bank AG, said…"
February 27 – Bloomberg
(Neil Unmack): "Investors could be forced to wind
down as much as $150 billion of collateralized
debt obligations if rating companies adopt
proposals made by Fitch Ratings on the way the
securities are graded, according Royal Bank of
Scotland Group Plc. Fitch is considering changing
its criteria for CDOs backed by company debt to
reflect higher risks of default and lower recovery
rates."
February 26 – Dow Jones (Mark
Brown): "Two years after the so-called
‘correlation crisis’ hit trading in credit
derivatives, bankers fear that a second crisis is
brewing as correlation hits fresh highs.
Correlation describes the likely pattern of
defaults that some credit market participants
anticipate. High correlation means markets are
expecting a broad-based or ‘systemic’
deterioration in credit conditions. When
correlation is low, credit risk is
‘idiosyncratic,’ meaning default risk is seen as
focused on specific companies or sectors.
Correlation is driven up or down by investors who
trade different slices, or tranches, of credit
default swap indexes."
February 28 –
Financial Times (Michael Mackenzie): "Banks
working on injecting up to $3bn into Ambac, the
bond insurer, in the hope of staving off ratings
downgrades and preventing the need for writedowns,
might face further losses indirectly related to
bond insurers, analysts have warned. The latest
source of concern is variable interest entities
(VIEs), another three-letter acronym that now
holds toxic properties… VIE is an accounting term
that covers a multitude of activities in almost
any kind of special purpose vehicle - from
conduits and structured investment vehicles (SIVs)
to individual CDOs themselves… Accounting for VIEs
has been increasingly in the spotlight since US
banks began to reveal more details about their
exposure to various vehicles, such as the
asset-backed commercial paper conduits used to
fund investment in mortgage-backed bonds and other
structured debt."
February 28 – Financial
Times: "According to Dealogic, total leveraged
buy-out volume so far in 2008 is down two-thirds
year-on-year, at $34bn. Just one of last year’s
mega-deals would dwarf that number. When leveraged
loan volumes last collapsed, after 2000, they took
three years to recover."
February 27 –
Bloomberg (Neil Unmack and Shannon D. Harrington):
"Sigma Finance Corp., the investment company run
by London-based asset manager Gordian Knot Ltd.,
may have its Aaa ratings on $27 billion of debt
cut by Moody’s… A drop in holdings of more than 3
cents on the dollar since late July and ‘continued
inability to issue senior debt’ have helped
increase the risk that the company won’t be able
to repay investors, Moody’s said… ‘Asset prices
have continued their unprecedented decline,’
Moody’s analysts…said…"
February 23 – The
Oregonian (Jeff Manning): "Local cities, ports,
hospital chains and colleges face significantly
higher interest payments on some of their
outstanding debt, another impact of the national
mortgage bust that continues to bruise the U.S.
economy. The city of Portland, the Port of
Portland, Oregon Health & Science University,
Reed and Lewis & Clark colleges and
PeaceHealth, the hospital chain…combined hold a
total of more than $1 billion in outstanding debt
on so-called auction rate bonds… ‘Investors have
just lost confidence in the whole market,’ said Ed
McFarlane, Reed's treasurer."
February 27
– Bloomberg (Adam L. Cataldo): "The Pennsylvania
Higher Education Assistance Agency will stop
making loans next month because of increasing
interest costs paid on auction-rate bonds. The
agency services and buys existing obligations and
makes about $500 million in new loans annually,
said chief financial officer Tim Guenther.
Officials, who made 140,000 student loans in the
12 months through June 30, said they will halt
making new ones on March 7. ‘The decision was
taken because with the auction rates resetting
where they are, bringing on new loans is a
guaranteed loss at this time,’ Guenther said.
‘Basically, since Feb. 13 every auction has
failed.’"
February 27 – Financial Times
(Joanna Chung): "Yields on bonds issued by
eurozone governments are diverging more widely
than at any time since the 1999 creation of the
euro, a stark sign that the global credit crisis
is infecting sentiment in traditionally safe
European sovereign debt markets. The development
is being fuelled by investors who have been
shunning bonds considered more risky and instead
buying those of Germany - the region's largest and
most liquid market. The result is that governments
whose bonds trade in smaller, less-liquid markets
have to pay higher risk premiums to sell their
bonds than they did before, threatening to push up
the cost of borrowing for some governments."
Currency Watch February 28 –
Financial Times (Javier Blas, Robert Cookson and
Sarah O’Connor): "It was D-day for the dollar
yesterday – ‘D’, as in downward, devalued and
dumped. The greenback sank to all-time low versus
a basket of currencies, and broke through the
psychological $1.50 level against the euro, as Ben
Bernanke suggested that he would continue to cut
interest rates to prop up the US economy. The
emphasis on growth rather than inflation by the
chairman of the US Federal Reserve prompted
investors to seek refuge in real assets such as
gold and crude oil as a hedge against future
inflation… Ashraf Laidi, of CMC Markets in New
York, said: ‘The record lows in the US dollar and
the record highs in gold and oil mark a key
tipping point in currency markets.’ He added that,
rather than subscribing to the notion that the
Fed’s aggressive rate cuts were a positive for the
US economy and hence for the dollar, the greenback
was ‘being damaged across the board on the notion
that the ultra low interest rates at the expense
of escalating inflation is the only way forward.’"
February 28 – Bloomberg (Chris Young and
Lilian Karunungan):
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