Linkages Part Deux

Location Date: 
June 24, 2011

It’s back.......!!  The subprime debt debacle of 2007/2008 will just not die, as evidenced by the Fed’s attempt last Friday to sell a measly $3.8 billion (face) of $30 billion Maiden Lane II assets it inherited courtesy of bailing out AIG.  The Fed, instead of selling the assets in one swoop (it had a bid of $15.7 billion for it), has been dribbling the securities out into the market.  Problem is, prices have now fallen from earlier February highs by close to 25%.  Add to this fact that European banks (yes, they own this stuff too but haven’t bothered to sell it) like Dexia (see last post) are also now planning/needing to sell into a falling market (on account of Basel IIII and balance sheet issues) and the exit for the Fed looks very challenging. 

The situation is exacerbated by U.S. real estate prices, which are falling again.  

The outlook is really not great.

But why should you care?  The problem is that when you cannot sell crap, you sell what you can or at least try to hedge it out, as can be seen in the demand for derivatives linked to junk bonds.  This linkage then causes damage across all the credit markets.  CDS prices on U.S. banks rise, investment grade credit spreads widen leading to HY, EM, ABX/CMBX spreads widening as well.  We have all seen this movie before.  Now, as we have said before, is a time for defense and hedging, not risk-taking!

Jim McGovern