The opaque black hole of losses at the heart of the dollar markets can not be penetrated by the outsider’s gaze, but the signs are that conditions are worsening fast. While the publicly quoted financial institutions have gone quite a long way down the road of acknowledging mortgage derivative losses, not a squeak has been heard from hedge funds, though they have massive exposure. Hedge fund investors know that the devil will take the hindermost: to the extent they can cash out before the hedge funds have disclosed their losses on CDOs, etc., they may escape their share of them – leaving their share of the losses to the guys left holding the baby. Meanwhile, hedge funds are no doubt sliding out of as much exposure as possible – and selling anything else they can get value for.
The most toxic of the BBB-minus abx indices was 07-1 (with prices from January) and that is now off more than 80%; at which level it seems to have settled for the past two weeks, after a rocky early October in which it fell by a third. The AA 07-2 issue (starting July) also fell by a third during that period, from 90 to 60, but has carried on down by another third to below 40 now. As this started life after the late-June Bear Stearns fiasco, for supposedly AA prices to take such a beating is extraordinary.
Though we have been mostly accurate in foreseeing these trends, something clearly seems to be going on that we will not know about for a while yet – if ever!
The condition of the banking system is clearly suffering a further de-rating, to judge from the further rise in the Ted spread in the past couple of weeks. At a 1½% differential, Libor is at a premium to T-bills only matched since the glory days of Paul Volcker the Inflation Terminator during the Great Crash in the stock market in 1987. Are we heading into 1982 – the worst recession since the war – or the revivalist, highly leveraged boom-bust of 1988- 91? The deflationary alternative looks more probable.
The credit spread plague is spilling over to junk bonds – so the collateral damage from the mortgage crisis that has blighted private equity since the summer may not ease much soon.
Small wonder the euro hit a new $1.48 high on Tuesday – this is beginning to smell of crisis.
