Hang on. Maybe the painless recovery from the 5% correction won’t be so painless. Investors on Wall Street fled the Dow in late afternoon New York trading. The index closed down 150 points on the day, with all of that loss coming after one o’clock.
Why are investors so jumpy all of the sudden? Is it too much caffeine? Not enough yoga and meditation? Or could it be the realization that the credit markets are no longer free and easy? Has the east-money punch bowl been thrown out the window?
“There is not one signal that says the credit markets are okay; there is a tremendous amount of uncertainty, and it is going to take some time for confidence to return to the market,” says Mike Malone, trading analyst at Cowen and Company. Who owns the suddenly toxic mortgage risk? And how much are those mortgage-backed bonds really worth?
A strong distress signal, maybe even a mayday, came from American Home Mortgage Investment Company—the tenth largest mortgage lender in the U.S. The company shares were halted on Monday. When they resumed trading on Tuesday they fell by 90%, from $10.47 at the open to $1.04 at the close. The firm says it will have to liquidate assets to meet margin calls from nervous lenders.
And if that is not enough bad news for one day from the credit markets, Bear Stearns is at it again. Early this morning the Wall Street Journal (soon to be owned by Rupert Murdoch) reported that Bear Stearns, “already forced to shut two hedge funds that bet heavily on the risky subprime-mortgage market, is now facing big losses in a third fund that has roughly $900 million in mortgage investments, according to people familiar with the matter.” The company has halted redemptions on the fund.
Does any of this American meltdown have anything to do with Australia? Yes. Bloomberg reports this morning that, “Macquarie Bank Ltd., Australia’s largest securities firm, said investors in some of its high- yield funds may lose as much as 25 percent of their money amid the fallout in U.S. subprime mortgages. Macquarie Fortress Investments Ltd. was forced to sell assets and use the proceeds to reduce borrowings and comply with lending covenants, it said in a statement. Investors may lose A$300 million ($255 million).”
This follows the decision by Absolute Capital Group Ltd. to suspend withdrawals from two of its funds last week. And then there’s Basis Capital Fund Management, which hired the Blackstone group to negotiate with its bankers to limit losses. It turns out this slow-boiling subprime crisis has spread further and deeper than many expected.
Where to from here? Macquarie’s Peter Lucas says that none of the assets in the portfolio in question have defaulted, and that interest and principal payments are still being made. The trouble is the assets fell 4% in value in July. Lucas says the assets could fall by another 20-25% in value.
And here’s the scary thing, the assets in the Macquarie fund were not subprime loans. They were secured corporate loans. But it doesn’t seem to matter much these days. The entire market is having a quick re-think over the quality of securitised and collateralised assets. Investors are selling.
Unable to sell these loans on the market, banks will have to hold them on their own balance sheets. They will be forced to eat their own cooking, instead of serving it up as slop to hedge funds, pension funds, and insurance companies. This means banks will be making fewer loans, having to hold capital in reserve against the loans on the books. Do you hear that crunching sound? That’s the sound of credit being smashed up into little crunchy pieces.
Meanwhile, the bonds of investment banks like Bear, Merrill Lynch, and Lehman Brothers have lost US$1.5 billion according to data from Moody’s. That gives them junk status, unofficially. It’s a pretty simple trade now, isn’t it? Sell financials and buy tangibles.
Speaking of tangibles, oil futures are in backwardation. That simply means near-term futures contracts are much higher than longer-dated contracts. Even more simply, it means the market thinks oil will be more expensive in the next three months that it will be in six or nine months. Accordingly, crude futures in New York closed at a record high of $78.21. “There’s significant growth in global energy demand and production isn’t keeping up,” says our old friend Peter Schiff.
With all this talk of tighter global credit, the exact opposite is going on in Australian household credit. The Reserve Bank reported yesterday that household credit grew by 1.8% in June, higher than expected. And over the last twelve months, the growth rate was 15.4%. Broad money supply growth (M3) clocked in at 14.1% in the last month.
Does this mean a rate rise is in the cards? It depends on why people are borrowing. Are they borrowing, as the RBA speculated, to contribute money to super before the expiration of the June deadline? Or are people borrowing money to meet living expenses that can’t be met with wage increases….because wage increases are not keeping up with the real cost of living? You tell us…email@example.com
The Daily Reckoning Australia