Investor's Business Daily, June 27th, 2007
Bear Stearns this month became the first swimmer exposed in what appears to be a receding tide of easy money.
It probably won't be the last.
After the investment bank said it would bail out one of two failing hedge funds with exposure to the subprime mortgage market, investors worried that demand for such assets in general would dry up.
Merrill Lynch failed to sell some $850 million in subprime-based assets on June 20. Other auctions have been postponed or met with mixed results.
Subprime problems are being blamed for lower earnings at Bear and rival Goldman Sachs.
The End Of Easy Money
Analysts say the fallout could signal the start of the end of years of free-flowing global liquidity.
"The willingness to extend credit in other areas -- high yield, bank loans and even certain segments of the AAA asset- backed commercial paper market -- should feel the cooling Arctic winds of a liquidity constriction," Bill Gross, head of bond house Pimco, said in a note Tuesday.
Easy money has fueled stock gains and a private-equity buyout boom despite lackluster economic growth.
GDP rose at a meager 0.6% annual rate in the first quarter, though most forecasts call for second-quarter growth closer to the historical average around 3%.
Stocks have struggled in recent days, with Bear falling to a nine-month low on Monday. However, Bear did rally 3% Wednesday in a broad market advance.
But the housing market remains on life support. Consumers are burdened by high gasoline and food prices.
In short, it has been a willingness to lend and invest that has kept the economy afloat.
Spreads between junk and investment grade bonds are widening as investors demand more compensation for greater risks.
Another uncertainty is Wall Street's true exposure to hugely popular and sometimes highly leveraged debt structures called collateralized debt obligations or CDOs, especially those backed by risky mortgage assets.
Loan volumes for subprime assets topped $500 billion in 2005 and held near that in 2006. Lenders and investment banks have sliced and diced the loans to a point where it's nearly impossible to tell who will be left holding the bag.
Now investors are stumbling as they wait to see just what those assets really are worth.
Subprime Debt Losing Face
Recent bids for some low-quality CDOs are at 60% of face value. High-quality paper is getting a slight haircut as well.
Such opacity has put some fear into a broader section of the lending market.
"You don't have a clue what their true book value is," said Richard Bove, an analyst with Punk, Ziegel & Co.
The Securities and Exchange Commission has started "about a dozen" probes into the CDO market, Chairman Christopher Cox said at a House hearing Tuesday.
The SEC also is looking into the Bear funds' near collapse, sources say.
The 10-year Treasury note rose on Wednesday, pushing yields to a three-week low, as some investors sought a safe haven.
Financial Stress Test
They're watching what may become a stress test for mortgage-backed securities. The outcome will determine if Wall Street's love for CDOs is really a more effective strategy for managing risk.
Hinting at higher subprime defaults, Markit's ABX index of subprime credit swaps continues to weaken, undercutting the lows set back in February when subprime worries first surfaced.
Defaults on high-yield debt and subprime mortgages are on the rise too, though not yet at a rate that will send lenders scurrying for the exits. But defaults on high-rated mortgages are ticking up as well -- a worrying sign that "the subprime carnage is now spreading," according to Nouriel Roubini at Roubini Global Economics.
The latest troubles also come as the Federal Reserve begins its latest meeting. Policymakers are expected to leave the fed funds rate at 5.25% on Thursday, but keep their tightening bias in place.
Yet thanks to subprime fears, futures traders are again betting on a rate hike by the end of 2007.
