Page 3 of 5 CREDIT BUBBLE
BULLETIN Confirmations on the bleak
side Commentary and weekly review by Doug
Noland
soared to a record as investors
purchased credit-default swaps to hedge against
mounting losses in the $2 trillion market for
collateralized debt obligations. ‘The market is
full of rumors of unwinding of CDOs, and the price
action suggests that people believe the rumors,’
said Peter Duenas-Brckovitch, head of European
credit trading at Lehman… ‘It sort of has that
Armageddon feel, and the market is feeding on
itself.’ Constant proportion debt obligations,
which package indexes of credit-default swaps, may
have to unwind about $44 billion of assets,
UniCredit SpA analyst Tim Brunne in Munich said…
Some so-called synthetic CDOs that sold
credit-default swaps on an estimated $1 trillion
in debt also are at risk as investors grow
concerned about plunging market values, Morgan
Stanley
analysts
led by Sivan Mahadevan wrote… ‘The mark-to-markets
on these have got to be pretty nasty,’ said Byron
Douglass, an analyst at Credit Derivatives
Research LLC… ‘I would imagine that as spreads go
wider, more and more CDOs are probably being
unwound.’"
February 19 – Financial Times
(Chris Hughes): "Credit Suisse cast itself as the
champion of risk management and transparency among
investment banks when it unveiled record annual
profits last week. But Tuesday’s revelation of a
$2.85bn mark-down in its trading book has
undermined the reputation for prudence that it has
so assiduously tried to cultivate. Losses in the…
bank’s structured credit book emerged early last
week, although Brady Dougan, the chief executive,
says he was unware of the situation when he
presented its results on February 12. The
difficulties centre on the bank’s trading
inventory in residential mortgage-backed
securities (RMBSs) and collateralised debt
obligations (CDOs)… As the losses worsened, the
bank was unaware of what was going on… The result
– a $2.85bn hit on the trading book which, after
adjusting for lower revenue-related bonus payments
and tax, will dent first quarter net income by
$1bn."
February 20 – Financial Times
(Gillian Tett): "US banks have been quietly
borrowing massive amounts of money from the
Federal Reserve in recent weeks by using a new
measure the Fed introduced two months ago to help
ease the credit crunch. The use of the Fed’s Term
Auction Facility…saw borrowing of nearly $50bn of
one-month funds from the Fed by mid-February. US
officials say the trend shows that financial
authorities have become far more adept at
channelling liquidity into the banking system to
alleviate financial stress… However, the move has
sparked unease among some analysts about the
stress developing in opaque corners of the US
banking system and the banks’ growing reliance on
indirect forms of government support."
February 21 – Bloomberg (Aaron Kirchfeld
and Neil Unmack): "Dresdner Bank AG, Germany’s
third-largest bank, agreed to rescue its $18.8
billion K2 structured investment vehicle, joining
Citigroup Inc. and HSBC Holdings Plc in putting
capital at risk to bail out investment funds…
Dresdner…will provide a credit line to enable K2
repay all of its senior debt… Dresdner will cut
the size of the fund, which has been reduced from
$31.2 billion since July, according to the
statement."
February 20 – Bloomberg (Neil
Unmack): "Standard Chartered Plc abandoned a plan
to refinance its $7.15 billion Whistlejacket
Capital Ltd. structured investment vehicle, the
largest SIV run by a bank to collapse. The
London-based bank blamed the ‘continuing
deterioration in the market’ for its decision…
Whistlejacket will become the sixth SIV to default
if it doesn’t make a payment by Feb. 21 when a
three-day grace period ends…"
February 22
– Bloomberg (Christopher Condon): "Northern Trust
Corp. agreed to provide capital to some of its
money-market funds if they suffer losses on debt
issued by Whistlejacket Capital LLC and White Pine
Finance LLC. The… bank may provide as much as $229
million to eight funds managing net assets of
$85.7 billion…"
February 20 – Bloomberg
(Patricia Kuo and Edward Evans): "KKR Financial
Holdings LLC, Kohlberg Kravis Roberts & Co.’s
$18 billion publicly traded credit fund, delayed
repaying some of its asset-backed commercial paper
and started restructuring talks with its
creditors…. About half the debt will be due by
March 3 instead of Feb. 15, with the rest owed on
March 25. The talks come less than six months
after the fund received a $230 million cash
infusion from investors after being hurt by losses
on residential mortgages…"
February 21 –
Bloomberg (Darrell Preston): "The collapse of the
auction-rate bond market, where state and local
governments go to raise cash, demonstrates that
regulators are no match for Wall Street. Hundreds
of auctions have failed this month, sending
borrowing costs as high as 20 percent because
dealers from Goldman Sachs Group Inc. to Citigroup
Inc., UBS AG and Merrill Lynch & Co. stopped
using their own capital to support the sales.
Regulators, who allowed the manipulation of bids
and lack of information to persist even after two
probes in the past 15 years, are now watching a
$342 billion market evaporate at the expense of
taxpayers. Inadequate disclosure ‘may have masked
the impact of broker-dealer bidding on rates and
liquidity,’ Martha Haines, head of the Securities
and Exchange Commission’s municipal office, said…
‘The large numbers of recent auction failures,
which are reported to have occurred due to a
reduction in bidding by broker-dealers, appears to
indicate those concerns were well founded.’"
February 22 – Bloomberg (Jeremy R. Cooke):
"California, Florida schools and the operator of
John F. Kennedy International Airport joined a
growing list of municipal borrowers exiting the US
auction-rate bond market as record failures push
taxpayer costs higher. Thousands of auctions run
by banks to set rates on the debt failed this
month as investors shunned the securities and
bankers refused to submit bids, sending interest
costs to 10% or higher on some bonds. Auctions
covering as much as $26 billion of bonds a day
failed to attract enough buyers since Feb. 13…"
February 22 – Bloomberg (Jenny Strasburg):
"AQR Capital Management LLC’s largest hedge fund
fell almost 15% this year through Feb. 15 as
market swings tripped up computer models the
managers use to make trades… The assets of AQR’s
Absolute Return fund dropped to $2.9 billion last
month from $4 billion in the fourth quarter…
Quantitative managers who rely on computers to
make trades have struggled as global equity
markets declined…"
February 20 – Bloomberg
(Pierre Paulden, Caroline Salas and Jody Shenn):
"A year ago $20 million would have gotten Luminent
Mortgage Capital Inc. access to $640 million in
loans to buy top-rated mortgage-backed securities.
Now that much cash gets the firm no more than $80
million. ‘There’s nobody out there trying to lend
money on securities,’ said Luminent CEO Trezevant
Moore. Six lenders are offering five times
leverage… while a year ago, 20 banks extended 33
times, he said. Wall Street firms, reeling from
$146 billion in losses on their debt holdings, are
fueling a credit crisis by clamping down on
lending to investors and hedge funds that use
borrowed money to purchase securities."
February 21 – Bloomberg (Christopher
Condon and Michael McDonald): "State regulators
are scrutinizing sales of auction-rate securities
by closed-end mutual funds as investors complain
they can’t get out of the investments, which were
billed as the equivalent of cash. Massachusetts
Secretary of State William Galvin asked nine fund
companies for information about failed auctions
that left investors unable to sell their holdings,
his office said in a statement yesterday. Ohio
Attorney General Marc Dann may file lawsuits after
state funds bought the securities, spokeswoman
Jennifer Brindisi said yesterday in an e-mail. ‘I
wanted something as good as cash, and now I’ve got
a lot of money in there that I needed to get at
quickly,’ Aaron E. Some, an investor in Delray
Beach, Florida, said… The investor said he has
$4.5 million tied up in auction-rate securities
issued by closed-end funds."
February 21 –
Bloomberg (Hugh Son): "MasterCard Inc., the
second-biggest payment-card network, said it may
be unable to sell about $252 million in
auction-rate securities because of a ‘failure’ of
the bidding mechanism… ‘There may be no effective
mechanism’ for selling the securities, which are
collateralized by US student loans, the firm
said."
February 20 – Financial Times
(Robert Cookson and Gillian Tett): "International
regulators are stepping up pressure on the
financial industry to introduce a clearer system
for settling contracts after a corporate default
in the $45,000bn credit derivatives market. In
particular the New York Federal Reserve and UK’s
Financial Services Authority are urging industry
associations such as the International Swaps and
Derivatives Association…to introduce binding rules
about how credit default swaps (CDS) contracts are
settled in default. The moves come amid growing
expectations that corporate bond default rates
will rise sharply in the next couple of years. It
also comes amid signs that some mainstream
investors are becoming uneasy about the ability of
the CDS infrastructure to withstand a wave of
defaults – particularly as settlement procedures
are still relatively untested. Settlement has
become a particular concern because the CDS market
has expanded so dramatically this decade that the
volume of derivatives contracts can sometimes be
ten times bigger than the underlying cash bonds on
which the CDS are based."
February 20 –
The Wall Street Journal (Rob Curran): "Options can
offer investors protection against sharp moves in
the value of their stock. But some observers think
surging demand for options may be increasing the
frequency of big market swings. Through options,
investors get the right to buy or sell stock at
fixed prices. The Wall Street banks that broker
those deals end up taking the other side of the
trade. If their clients make money, the banks
lose. To offset that exposure, banks have to
‘delta hedge.’ That means selling stock when
clients make bets that prices will fall and buying
stock when clients stake out positions that will
pay off if prices rise. The more a stock rises or
falls, the more a bank must buy or sell to hedge
its risk. As a result, brokers are buying when
markets rise and selling when they fall, and
they're doing so in greater volumes. That may well
be exacerbating stock moves in each direction,
said Lars Kestner, a managing director in equity
derivatives at Deutsche Bank…"
February 21
– Bloomberg (Jody Shenn): "Bank of America Corp.,
Citigroup Inc., and the eight other US commercial
banks with the
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