This CDS report was written by Markit’s Gavan Nolan
Macabre analogies were abundant yesterday after the House of Representatives voted against the US government financial bailout plan. But the predicted “bloodbath” or “cataclysm” didn’t materialise today, with both the credit and equity markets recovering much of Monday’s losses. State intervention is anathema to many of the Republican members of Congress, and so it proved yesterday. The extent of the rebellion – joined by a sizeable number of Democrats – was a surprise, and a devotion to Schumpeter’s forces of “creative destruction” is unlikely to be the only explanation. The bailout is deeply unpopular in many parts of America, and the temptation for many of the representatives seeking re-election to go down the populist route must have been great.
Today’s rally is based on a belief that many of these mutineers will get cold feet having seen a trillion dollars wiped off the stock market yesterday. Congress is to reconvene tomorrow and it is unclear whether the Emergency Economic Stabilisation Act (EESA) is still on the table. President Bush’s statement today suggests that it is. Whatever its flaws – a lack of firm action on bank recapitalisation stands out – it is better than nothing and the market can be expected to rally in the short-term if it is passed.
European banks rallied on expectations that Congress will put its partisan squabbling to one side and approve the legislation. However, one bank in particular failed to participate. HBOS’ spreads widened sharply on rumours that Lloyds TSB may try to renegotiate the terms of the £12 billion takeover announced last week. HBOS’ shares are trading at a significant discount to Lloyds, indicating investor skepticism that the deal will go through. The divergence of CDS spreads between the two banks – Lloyds is trading around 200bp today – suggests the same conclusion. The government was involved in the merger discussion and would make every effort to prevent the deal collapsing. But it still needs to be approved by 50% of Lloyds shareholders and some of them might prefer sweeter terms.