The whole idea of the bail-out or TARP program was supposed to be to purchase distressed assets from banks. When this program was announced and finalized there was a big rally in fixed income assets "bonds & securities". Now that Treasury Secretary Paulson has made it clear that he will only do direct injections of capital into banks and will leave the remaining 350 billion for the Obama administration the bond market for everything except treasuries has frozen once more. The impact upon financial stocks and those stocks especially exposed to the financial turmoil has been nothing short of breathtaking.
Let's start with bonds. Most companies use this method of funding as the primary means of funding long term projects. As of January 2007 the interest rates being paid by distressed companies or "junk bonds' was about 5% more than the going rate for treasury bonds or T-Bills with a default rate of about .75%-1.50%. Well, today the market for all corporate bond issuers has just exploded. This from the Financial Times.
Average yields on US junk bonds have topped more than 20 per cent for the first time amid rising concerns about a protracted recession and a wave of corporate defaults.
The spike in yields could have a dramatic impact on economic activity, making new debt prohibitively expensive for companies with credit ratings below investment grade. Such junk-bond issuers account for 17 per cent of the S&P 500 and nearly half the corporate bond market, according to Standard & Poor’s...
The yield on the benchmark Merrill Lynch US High-Yield index rose to 20.27 per cent on Tuesday, the latest data available. The previous high was 18.66 per cent in January 1991. The risk premium, or spread over comparable Treasuries, is nearly double what it was in 1991 when Treasuries were yielding more than 8 per cent.
Anyone like to know what the bond market thinks of American auto makers? here is the latest scoop.
Bonds issued by General Motors, one of the biggest non-investment grade issuers, have been yielding more than 50 per cent.
The latest surge in rates reflected ongoing uncertainty over a bailout of GM and other US automakers.
Here is the money quote regarding the recent actions by Secretary Paulson with regard to the bond market.
Investors were also rattled by last week’s announcement by Hank Paulson, Treasury secretary, that the US government had decided against buying toxic assets as part of its $700bn troubled asset relief programme.
What we are witnessing is a perfect storm that amounts to a run on the bank with respect to the international debt markets.
The rise in yields comes as debt markets are trying to cope with a flood of forced selling by hedge funds and other investors seeking cash to meet demands for redemptions. Banks are also selling assets as they reduce their risk profiles.
http://www.ft.com/...
For an idea of how crazy mixed up these markets are right now here is a little scoop from the Financial Times. Normally when an investor purchases a long term corporate bond they will also "insure" themselves against potential loss by purchasing a Credit Default Swap or CDS. A CDS pays the holder of the bond a fixed amount if the issuer fails or defaults. In essence a CDS pays if the bond becomes worthless, or nearly so. Well, here is an idea: NOTE: A "BP" = a basis point, or 1/100 of a % or.01%
It may be technical, it may be an abnormality. But it is a gift horse nonetheless. Corporate bonds are trading more cheaply than credit default swaps. That means investors can buy a bond and then receive a coupon that more than pays for the cost of insuring that bond against default. This is close to free money.
Normally, CDS spreads trade wider than cash bond spreads. First, because investors short credit by buying default protection; that pushes CDS spreads wider. Second, corporate bonds are typically viewed as attractive to hold because they can be used as collateral for funding. That narrows spreads on cash bonds.
This relationship has now reversed across the corporate sector. To take one example, the insurer Aviva: its five-year CDS trade at 190 basis points, while its long dated senior bonds are at a spread of 260bp.
Essentially what is happening is that banks, hedge funds, insurance companies and others are having to sell assets in order to reduce leverage and meet margin call.
http://www.ft.com/...
Here is a flash from the past from the ongoing credit crisis. Late last year and early this year the big story was the bond insurers or the monoline insurers. These folks started out providing insurance for municipal bonds. However, they found that boring and were sucked into the racket by providing insurance against default for some of the exotic securities being created by Wall Street. well, we learn today that the final blows are being dealt to this segment of the market.
Ambac’s share price hit an all-time low on Wednesday, falling below $1 a share for the first time in the company’s history as a public company.
Why? A rather savage downgrade from S&P, which cut the bond insurer’s financial strength rating to A from AA, The outlook on the ratings is negative, meaning further cuts are likely in the medium term...
The move comes two weeks after Moody’s cut Ambac to Baa1, which is two notches lower than S&P’s rating. The Moody’s downgrade required the insurer to post collateral and to move money from its financial guarantee arm to its investment unit.
From the downgrade release (emphasis FT Alphaville’s).
The negative outlook reflects our view that Ambac’s exposure to domestic nonprime mortgages and related exposures to CDO of ABS have likely damaged its franchise and that the company faces extremely limited new business flow
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The outlook for the bond insurance industry is, flatly, bleak. Per RBS analyst Michael Cox this morning:
Several of the protagonists in the monoline story are experiencing death-throes. Syncora was only a reserve release away from breaching minimum statutory capital requirements. FGIC is barely better. Ambac and MBIA continue to see their ratings hacked at by the rating agencies. Even FSA, previously viewed as the safest of the major names, has had to fall into the arms of a rival in an attempt to prevent being subjected to the same treatment.
http://ftalphaville.ft.com/...
According to Bloomberg they report that market watchers say that prices of bonds reflect a belief in the market that businesses will fail over the next year or two at "depression era rates". NOTE: "Benchmark rates = the interest rate being paid by a US T-Bill of the same maturity".
Depression-Level Defaults?
``Either the market is right and expecting a default rate considerably higher than it was in the Great Depression, or we have such profound dislocations and selling pressures going on that it really is creating extraordinary fundamental value.''
Commercial-mortgage securities are also plunging following reports yesterday that two borrowers with $334 million of loans bundled into bonds were about to default.
The cost of credit-default swaps on AAA rated bonds rose 161.8 basis points to 714 basis points based on the latest Markit CMBX index contracts, according to administrator Markit Group Ltd.
Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A rise indicates deterioration in the perception of credit quality; a decline, the opposite.
Yields on top-rated bonds backed by commercial mortgages rose a record 264 basis points to 1,118 basis points more than benchmark interest rates, according to Bank of America Corp. data. A basis point is 0.01 percentage point.
http://www.bloomberg.com/...
Now for some even grimer news. The reason so many stocks, especially financials fell today was because the markets are starting to believe that the US may be entering a deflationary cycle. In many ways deflation is much worse than inflation. A deeper discussion will wait for another occasion, but I will add some information for folks to consider.
The chilling prospect of a deflationary US economy and collapsed car industry sent Wall Street stocks on Thursday to their lowest levels since the financial crisis began.
Investors took fright at labour department data that showed the cost of living plunged the most since records began in 1947, and the first decline in so-called core consumer prices, which exclude food and energy, in more than 25 years.
Sheryl King, senior US economist at Merrill Lynch, said the data suggested there was a "genuine risk that the US economy could fall into a corrosive deflationary phase".
And a primer of what happened to the US financial stocks today.
Financials led the market declines, down 11.5 per cent overall to a 13-year low. Insurers suffered more losses in part over fears that they may face delays in securing funding under the government’s troubled assets relief programme.
http://www.ft.com/...
For many Americans the true superstar of investing is Warren Buffet aka the Oracle of Omaha and listed by Forbes as the richest person in America (and a big funder of democratic causes). he owns more than 80 companies that are all held by a firm called Berkshire Hathaway. This stock fell the more in one day today than it has in the past 23 years. The scoop.
Warren Buffett's Berkshire Hathaway Inc. fell the most in at least 23 years, dropping for the eighth straight day since reporting a 77 percent decline in third- quarter profit.
The stock plunged $11,550, or 12 percent, to $84,000 in New York Stock Exchange composite trading at 4:01 p.m.
Berkshire has posted four straight profit declines, the worst streak in at least 13 years, on investment losses and falling returns at insurance businesses. Buffett, ranked by Forbes magazine at the richest American, has committed at least $28 billion this year to acquire companies, finance buyouts and purchase securities as prices fell and competitors were hobbled by limited access to credit.
http://www.bloomberg.com/...
Now for a little of the carnage that was today's action in the firms that have received more than 100 billion for TARP or bail-out money from the Treasury with the news on Ford & GM added for good measure.
Bank of America Corp., the lender that's buying Merrill Lynch & Co., dropped $2.13, or 14 percent, to $13.06. Goldman Sachs Group Inc. dropped $6.85, or 11 percent, to $55.18, the lowest close since the company's initial public offering in 1999.
The S&P 500 Financials Index tumbled 12 percent to a 13- year low as all 84 of its companies retreated. JPMorgan Chase & Co., the biggest U.S. bank by market value, lost $3.67, or 11 percent, to $28.47, its lowest closing price since 2003.
Lincoln National Corp. plunged 40 percent, the steepest decline in the S&P 500, to $7.31. The Philadelphia-based life insurer said it expects a charge of as much as $300 million because of declining equity markets last month. Insurers in the S&P 500 lost 11 percent collectively...
Citigroup Inc. tumbled 23 percent to $6.40, a 13-year low, on a plan to buy $17.4 billion of troubled investment-fund assets. General Motors Corp. slid 9.7 percent to its lowest price since the 1940s, while Ford Motor Co. lost 25 percent. Fourteen companies in the Standard & Poor's 500 Index fell 20 percent or more as government data signaled the recession is deepening and expectations grew that insurers will post more investment losses.
What is noteworthy is that Citi was at $20 just two weeks ago, or down 66%+ over that time and the rest of the financials are not far behind with JP Morgan/Chase at $41.71, Bank of America at $26.53 and Goldman Sachs at $80+ just two weeks ago. Since the TARP was passed and a "bottom" made after the September/October meltdown. Today's close marks the major stock markets falling below these lows.
http://www.bloomberg.com/...
Finally, today the Federal Reserve released the notes from their last Open Market Committee meeting from October 28-29. This release is especially noteworthy because they are making a significant downgrade on future growth, personal consumption and inflation.
Growth Forecasts
Fed officials lowered their economic growth projections to 0 percent to 0.3 percent for 2008 from 1 percent to 1.6 percent previously, according to the median forecast of Fed governors and district-bank presidents. The predictions for GDP next year ranged from a contraction of 0.2 percent to growth of 1.1 percent. In June, the so-called central tendency estimate was an expansion of 2 percent to 2.8 percent.
The panel estimated 2008 inflation, excluding food and energy, at 2.3 percent to 2.5 percent, from 2.2 percent to 2.4 percent in June. The Commerce Department's so-called core personal consumption expenditures price index is seen rising 1.5 percent to 2 percent next year, compared with forecasts of 2 to 2.2 percent in June.
http://www.bloomberg.com/...
NOTE: also noted in the report was the expectation for unemployment to reach 7.5% in 2008 with continued depressed levels in 2009 with reductions coming in 2010 or 2011. This was a significant departure from previous estimates.
So, what we are seeing is a blood in the streets moment and most all of the chatter about the markets having found a bottom has subsided under the weight of 6% losses in the S&P 500 and 6.5% losses in the tech heavy NASDAQ. What is clear is that there is a buyers strike happening throughout the economy. Be it folks going to Best Buy, buying stocks or corporate bonds. Regardless, folks are scared and are doing the same thing the banks are, hoarding every copper cash they can.
As an admitted rank amateur I am waiting for New Deal Democrat or Jerome A Paris to weigh in with their words of wisdom. I believe that today's events are of such a magnitude that directly effect the auto makers and their efforts, the financials and lending or the capacity for us to do what we need to with respect to our money.
Best wishes to all.