It is LIke Drinking Water From a Fire Hose

I called a lot of my friends this week that work in the fixed income markets and their stories are off the charts. To say the market is dislocated is like saying Hurricane Katrina was just a mild tropical storm. The stories of the messed up muni-market dominated the headlines, though descriptions of credit-default swaps came a close second. There is definitely huge contagion in fixed-income securities with corporate bond spreads at historical wides, high yield spreads, mortgage-backed bonds, leveraged loans…. you name it. Spreads are so off the charts that hedge funds are scrambling to launch NEW funds for March 1st that are multiples in size of previous funds. I had a call this week with a distressed fund manager that is soon to launch a $9 billion fund. $9 billion. Though I challenged this very experience manager over the fund size he was quick to quote numbers as to how much supply has been created over the past couple of years and how much of that supply is in deep trouble. For money that is in this space already it cannot find the exit fast enough, and for new money, it is the opposite. How this is all going to shake out will be mighty interesting indeed.

More and more commentators are talking about the disconnect between what the fixed income markets are telling us and the relative strength of the equity markets. The former is predicting a truly nasty, nasty, shake-out and the latter is still not sure if in fact the US is in a recession. If the monolines get restructured the equity markets will likely experience a nice pop, but I still believe that any rally is a bear market one. Splitting the monolines will help the muni-market, but it will not do much for the other asset buckets.

Fingers are starting to point toward the Commercial Real Estate Market as well. Though defaults are at record lows, the numbers I have heard thrown around as to the cap rates of recent purchases is enough to make your hair fall out. Index spreads have already gotten hammered anticipating some mighty nasty default rates.

Where is the good news you ask? Hmm… very hard to find. Very. Corporations are sitting on a lot of cash ($611BB) , and the fed can still cut rates, but other then that, ?????

Oh my gosh… how could I not mention inflation and commodity prices? We got some disturbing numbers in the US ( CPI up 4.3% yr over yr ), but did you see China’s? I still firmly believe that the US rates are understated. All you have to do is take a look at overall commodity prices, or compare your own bills year over year. I will say it again… Stagflation, and know it seems like I am not the only one saying it.

In closing, a few random facts I pulled out of the papers this week
– 8.8 MM homeowners or 10.3% are underwater according to an estimate by Moodys, economy.com ( NYT Friday)
– Thrift industry posts a record $5,2 bb Q4 loss, the largest since they started collecting records in 1984.
– Quant Funds were down 6% as a group in Jan.
– Medicare unfunded liability is $74 trillion
– Sharper Image and Lillian Vernon file for bankruptcy.
– Credit Swiss announced a surprise loss resulting from pricing errors of $2.85 bb

Have a great week.. I am off to California!

Cash=Auction Rate Securities ….Not Anymore.

Cash = Auction Rate Securities … not any more

There was a story in the paper today about a guy who sold his business and was sitting in about a billion dollars of “cash”, oops, I mean PARS. As he learned today, those two are not the same things, though for as long as anyone remembers they have been.

For a definition of what these securities are here is the wikipedia link
http://en.wikipedia.org/wiki/Auction_rate_security

I will say it again.. what is going on in the credit markets is completely off the charts wild.

Municipalities who have long relied on the short term markets to access capital at rates reflective of their underlying loan quality simply cannot rely on it anymore. Because investors were unwilling to buy their bonds, the auctions ‘failed’, which resulted in parties that wanted out, to be shut down. It is not really that bad, as in most cased the interest rate kicked up nicely, but if you needed that money for something, tough bananas.

As a holder of ARS you of course bought it because you thought is was a cash-like piece of paper with quick liquidity. What in fact you bought was a 30 year piece of paper. If it fails to clear the market it resets to the highest rate as outlined in the paperwork and whoever is holding the hot potato, stays holding it, until the next auction of until the issuer calls it.

Of note is that firms like Goldman Sachs, who issued the first tax exempt ARS in 1988, was unwilling to step in to take down the bonds. Not a good way to build client relationships either with the investor or the issuer. Of course they were not the only ones doing it, but still. It is clear that everyone is in the “protect your balance sheet mode”. Big Time.

Now for anyone reading who has a money market fund thinking “Oh My Gosh”, money market funds cannot buy these securities as they are effectively 30 year bonds. Money market funds have other troubles, but this is not directly one of them. Indirectly it is very disrupting, but this alone does not affect the funds liquidity.

The First Guest Post on Purse Pundit – More on the Credit Markets

I have been emailing friends asking their thoughts on the markets and below is a very thoughtful response. The writer is a great guy, a smart and experienced guy, who has worked in the bond business for over 20 years. More then a few people I have spoken to are pointing the finger at Greenspan. He talked early on about “Irrational exuberance” but did little about it! ……………….. enjoy the read.

“I remain in the camp that on a valuation basis many stocks are probably cheap. That said, I do think, and have since early summer, that there remains at least some chance of financial Armageddon. The press and most experts really missed the subprime/real estate debacle. The fact that CNBC, or anyone for that matter, would care what some chief economist from the national association of realtors thinks of real estate values or trends in silly. Almost everyone missed the problems on MBIA and AMBAC and these guys have analysts from everywhere following them. In the Greenspan era, when he was flooding the markets with money, banking examiners and regulators turned a blind eye to the raping and pillaging going on in anything mortgage related. When the final book is written on Greenspan, his image will be torn to shreds and we will all come to understand how disastrous his bubble causing policies were. Unfortunately Bernanke gets the short term heat. He is way over his head and if he was smart he might open up his private phone lines to people who know something about capital markets. Might I suggest he dial 1-800-GOLDMAN for some smart advice?Clearly the capital markets are frozen. The leveraged loan market remains a huge problem. Not for just bank’s balance sheets, but for any new deals. Without a functioning secondary market, the new issue machine will remain dormant. The bond insurers’ situation remains our biggest short term threat. How they solve that I have no idea. Buffett taking over the muni side will help the muni market, but in-turn deprives the insurers of their best business. The business they should have never ventured from.Like I said, I think a complete meltdown is way less than likely. But it remains the threat, that should it occur will change all of our lives. Not very comforting to me is the fact that I place my hope in this event not happening largely because; well, “they” can’t let it happen. We deserve it to happen for sure. Living way beyond our means, pursuing a weak dollar policy while telling the world we have a strong dollar policy, fighting a very unpopular war while creating enemies in all corners, under-educating our children in the sciences and math, etc will ultimately hasten our decline as the world’s greatest nation. But in my heart of hearts I do believe that the sovereign wealth funds and all the trading partners with huge dollar reserves will somehow not let us completely fail.My hope is that we can solve some of these problems with good fiscal and monetary policies. The fact that we are in an election year should be a positive. Given the dollar and the easing, gold is probably worth owning as we inflate our problems away. Given the slowing of our economy and therefore the world’s, oil should probably move lower eventually (not withstanding that bum Chavez). Your protection on private equity holdings was choosing good managers and companies in the first place. The leveraged loan market problems should push any exit strategy out on the time line for sure. But the deal guys are hugely incentivized to create profits for you. Over time the good deals will succeed.”

… and that is all he has to say about that. Thanks Buddy.