A Sea Change In Our Love of Debt

Full fathom five thy father lies;
Of his bones are coral made;
Those are pearls that were his eyes:
Nothing of him that doth fade
But doth suffer a sea-change
Into something rich and strange.

The Tempest, Act one, Scene two

Would it be such a bad thing if we're witnessing a sea change in the way people feel about debt? Shakespeare had Ariel sing the lines above in the Tempest. She sang it to poor Ferdinand, whose father was transformed by the ocean from a living, breathing man into a jungle gym for fish.

A sea change does not automatically denote death and decay. But it does suggest a transformation. And judging by the recent action in the asset-backed securities market, investors are re-thinking the idea of debt-backed assets.

Specifically, the Wall Street Journal reports that investors are shying away from bonds backed by credit card receivables. In July, there were just US$4.4 billion worth of credit-card receivable backed bonds issued. That's down 56% from March, where issuance hit US$10.08 billion.

Can you see what's happening? The longer the credit crunch goes on, the harder it is to pass off other people's debts as assets. It's not just credit cards either.

If you thought the subprime mortgage mess was bad, wait till you see the default and foreclosure rates on Alt-A and prime mortgages in the U.S. A lot of people are going to be underwater by the end of the year. There will a lot of coral corpses.

It's no surprise, then, that the Federal Reserve in the U.S. didn't move rates a bit. The Fed left short-term interest rates at 2% and indicated that while it's a wee bit worried about inflation, it's a wee bit more worried about recession.

The Fed clearly finds itself between the devil and the deep blue sea. Neither raising nor cutting rates is desirable. Raise rates and you kill off mortgage lending and house prices (prolonging the agony). Cut rates and you feed the inflation conflagration. So it chooses to do the next best thing: nothing!

Here in Australia the Reserve Bank appears equally petrified (standing stock still). The RBA moved ahead by staying put yesterday. But this line at the end of Glenn Steven's statement got the pundits in a lather: "Nonetheless, with demand slowing, the Board's view is that scope to move towards a less restrictive stance of monetary policy in the period ahead is increasing."

The rate cuts are coming! The rate cuts are coming! Or are they?

We'll see. But as we wrote yesterday, a more accommodative monetary policy by the RBA won't necessarily translate into lower lending rates by the major Aussie banks. The share market will probably like it though.

Dan Denning
The Daily Reckoning Australia

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