Page 3 of
5 CREDIT BUBBLE
BULLETIN The
breakdown of Wall Street
alchemy Commentary and weekly review by Doug
Noland
$4.9bn. That is largely the result
of a change in methodology. Last time AIG did not
mark its exposure to where the cash bonds were
trading - instead it made an adjustment for where
it believed the CDS should trade. Now, it has
effectively acknowledged there is not good enough
market data on the CDS, so it has reverted to
pricing off the cash bonds… The trouble is, the
AIG numbers are only marked as at November 30. Its
$63bn of exposure to subprime CDOs is likely to
have taken a further hit since then."
February 14 - Financial Times (Aline van
Duyn and Michael Mackenzie): "A collapse in
confidence in a $330bn corner of the debt market
has left US municipalities and student loan
providers facing spiralling interest rate costs.
The implosion of the so-called
auction-rate securities market -
amid worries that bond insurers guaranteeing much
of this debt could face rating downgrades - is the
latest incarnation of the credit crisis. The
market, heavily used by municipal borrowers and
backed by triple-A rated guarantees from bond
insurers such as Ambac and MBIA, was until now
used as a safe harbour for investors. The interest
rates on such bonds reset either weekly or monthly
and a lack of interest from investors can trigger
a sharp rise to compensate holders. The market's
sudden slump has pushed interest rates as high as
20% for entities from the Port Authority of New
York & New Jersey to a hospital. 'The auction
securities market is falling apart,' said David
Cooke, chief financial officer at Park Nicollet
Heath Services in Minneapolis."
February
13 - The Wall Street Journal (Liz Rappaport and
Randall Smith): "The credit crunch that has so far
caused more than $100 billion of losses for big
Wall Street investment firms now extends to
students in Michigan, and it could soon hit many
other borrowers, ranging from California museums
to the prestigious Deerfield Academy prep school
in Massachusetts. Yesterday, the Michigan Higher
Education Student Loan Authority, a state agency,
said…that 'due to the current and unprecedented
capital-markets disruption' it will stop making
loans under the state's Michigan Alternative
Student Loan, or MI-Loan, program. More than 100
Michigan colleges and universities participate in
the program. In the past few days, problems have
mounted for many borrowers as an obscure -- but
important -- corner of the credit market called
auction-rate securities has gone into a deep
freeze. Borrowers ranging from student-loan
authorities to municipalities to big bond funds
depend on this market to raise money for making
loans and funding projects. They do so by selling
securities whose interest rates are reset every
week as they change hands in auctions arranged by
Wall Street firms like Goldman Sachs Group Inc.,
Citigroup Inc. and J.P. Morgan Chase & Co.
Moody's… estimates the size of this market at $325
billion to $360 billion. In recent days, the money
managers and other investors who typically buy
auction-rate securities have been balking, out of
fear the credit turmoil is spreading."
February 13 - Bloomberg (Martin Z. Braun):
"A wave of bonds sold by US municipal borrowers
with rates set through periodic auctions failed to
attract enough buyers in recent days as banks
including Goldman Sachs Group Inc. and Citigroup
Inc. that run the bidding wouldn't commit their
own capital to the debt. Rates on $100 million of
bonds sold by the Port Authority of New York and
New Jersey, with bidding run by Goldman, soared to
20% yesterday from 4.3% a week ago… Presbyterian
Healthcare in Albuquerque and New York state's
Metropolitan Transportation Authority also had
failures, officials said. Investor demand for the
securities has declined on waning confidence in
the credit strength of insurers backing the debt,
and on reluctance by dealers to submit bids and
risk ending up with too many of the bonds… It's
the beginning of the end for the auction-rate
market,' said Matt Fabian… with… Municipal Market
Advisors. 'Banks have stopped supporting the
market.'"
February 13 - Dow Jones: "Failed
auctions of mostly municipal debt totaled
approximately $6 billion Tuesday, with Citigroup
the lead underwriter on the bulk of the sales…
Auction-rate securities, a type of bond that
investors can re-sell at regularly scheduled
auctions, have been knocked by the turmoil in
credit markets… The failed auctions Tuesday follow
at least six others, sparking concerns that this
once safe corner of the credit markets is the next
area to crumble. When an auction fails, the
holders of the securities are paid a premium until
the paper can be sold."
February 11 -
Bloomberg (Thomas R. Keene and Mark Pittman):
"Subprime fires have found 'new dry brush to
burn,' according to UBS AG strategists, who
compare turmoil in the auction-rate securities
market with last year's crisis in structured
investment vehicles. 'It's like SIV stress all
over again in that a business that made the banks
very little money comes back as a black hole of
the balance sheet that could steal critical
capital away from the engines of profits that the
banks so sorely need at present,' writes William
O'Donnell…"
February 15 - Financial Times
(Henny Sender): "Leading banks are being advised
that it would be cheaper to walk away from big
buy-out deals than incur further losses on their
funding commitments, increasing the chances that
more private equity transactions will collapse.
This advice from lawyers contrasts with the
conventional wisdom that banks would risk serious
damage to their reputations if they were to drop
out of deals… 'It is the tipping point argument,'
said a senior partner at one of the biggest
private equity firms, who asked not to be named.
'The banks have so many issues with their balance
sheets that they are considering a new policy.'
However, such a change could have a dramatic
impact on the markets. 'If you want to come up
with news that could make the Dow drop another 500
or 1,000 points, this would be it,' said one
lawyer specialising in private equity for a New
York law firm."
February 15 - The Wall
Street Journal (Diya Gullapalli): "The freeze-up
in the little-known but important 'auction rate'
debt market is starting to create big problems for
leveraged closed-end funds and their investors.
Closed-end funds are a cousin of mutual funds that
issue a fixed number of shares and essentially
trade like stocks. To boost returns for common
shareholders, many closed-end funds employ
leverage, which essentially involves borrowing at
short-term interest rates and investing the
proceeds in higher-yielding assets. That approach,
however, is now coming under extreme pressure, as
the auction-rate securities market many of the
funds tap for borrowing has seized up. In recent
days, hundreds of such auctions have failed amid
the broader credit crunch. Besides closed-end
funds, the lack of trading is also hurting big
borrowers like student-loan authorities and
municipalities."
February 15 - Financial
Times (Aline Van Duyn and Michael Mackenzie):
"Eliot Spitzer, New York governor, yesterday gave
bond insurers three to five business days to find
fresh capital, or face a potential break-up by
state regulators who want to safeguard the
municipal bond markets."
February 14 - Dow
Jones (Michael Wilson): "The cost of holding
corporate debt, as measured by the spread over
risk-free government bonds, has risen to levels
not seen since the last global downturn, according
to new research from Deutsche Bank. The Markit
iBoxx corporate bond index, which tracks the price
of corporate cash bonds and is considered the
conventional measure of the price of corporate
credit, now trades at around 165 bps over
risk-free assets. These spreads are at the widest
levels since the bear market peak of 2002, when
the index traded at 175 bps… However, the iBoxx
index has only existed for around a decade. To see
further into the past, Deutsche Bank also used
Moody's historical spread data, which span several
decades, in place of iBoxx spreads. The bank found
that the price of investment grade credit has now
reached its highest level in the last 70 or 80
years."
February 11 - Bloomberg (Abigail
Moses): "Banks are driving the cost of protecting
corporate bonds from default to the highest on
record as they seek to hedge against losses on
collateralized debt obligations, according to
traders of credit-default swaps. Contracts on the
benchmark Markit iTraxx Crossover Index soared 17
bps to 547… according to JPMorgan Chase & Co…
'Banks have taken losses, spreads are going wider
and they are just cutting positions,' said Andrea
Cicione, a senior credit strategist at BNP
Paribas… 'Lenders are probably reducing risk
positions in a deteriorating credit environment by
unwinding CDOs.'"
February 12 - Bloomberg
(Patricia Kuo): "Citigroup Inc. and seven other
top investment banks may need to write down at
least $15.1 billion on unsold loans and bonds for
leveraged buyouts in their first quarter earnings,
according to Bank of America Corp. analysts. As
prices of high-yield debt continue to fall this
year, banks including Goldman Sachs Group Inc.,
JPMorgan Chase & Co., Morgan Stanley and
Merrill Lynch & Co. may have more writedowns
for $157 billion of loans and bonds than they did
in the third-quarter, analysts led by…Jeffrey
Rosenberg wrote…"
February 12 - Financial
Times (David Oakley): "A growing number of
leveraged loans backing private equity buy-outs
are in danger of breaching covenants or
defaulting, according to research by Standard
& Poor's. These companies are carrying much
more debt than they should, a sign of potential
trouble, particularly in the event of a US
recession or more turbulence in the markets, says
the rating agency. Analysts say loans backing
private equity buy-outs are the most likely
casualties as the economic outlook darkens because
any fall in earnings will raise debt-to-equity
ratios, which could lead to the breaking of
covenants and defaults."
February 14 - New
York Times (David Jolly): "UBS offered no hope for
a near-term turnaround in its business after it
posted a huge fourth-quarter loss on Thursday and
warned that 2008 would be a difficult year. UBS,
the largest Swiss bank and the largest in Europe
in terms of assets, reported a fourth-quarter net
loss of $11.3 billion after it wrote off $13.7
billion in soured United States investments,
mostly on subprime loans. It also said it had lost
$2 billion on so-called Alt-A mortgages… One
worrying sign that things could worsen is the
disclosure that UBS has additional exposure of
$26.6 billion in Alt-A mortgages."
February 14 - Financial Times (David
Oakley and Gillian Tett): "European companies are
increasingly being forced to turn to the dollar
markets to raise funding as the credit crunch
makes it almost impossible for them to launch
deals in the euro-denominated market. A gap
between the two markets has opened up with US
investment grade issuance at a record high for a
January, while Europe slumped to a record low,
according to
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