The cost of protecting European corporate debt against default surged on Thursday after bond insurer FGIC lost its triple-A rating and Standard & Poor’s cut or put on review ratings on $534 billion of mortgage-related debt.
The news more than wiped out any optimism provided by the Fed’s 50bp rate cut, and fuelled fears that chain reactions of rating downgrades, forced selling, and liquidations could lead to a severe drying up of credit.
“This again demonstrates to us that newsflow from the monolines and other entities’ exposure to the unwinding of the credit bubble, has the potential to be far more potent than the Fed in this cycle,” said Jim Reid at Deutsche Bank.
The European iTraxx Crossover, a closely watched measure of risk appetite, widened 30bp points to about 476bp, according to Markit Group. This means it now costs €476,000 annually to insure €10 million worth of mostly junk-rated corporate debt against default over five years.
S&P said banks would have to double their predicted mortgage-related losses from $130bn to $265bn. This puts further pressure on the banking sector, which has so far revealed only around $70bn of writedowns.
Fitch cut FGIC’s rating by two notches to AA and kept the rating on watch negative. This came as fellow bond insurer MBIA announced its largest-ever quarterly losses of 2.3bn.
Meanwhile, pressure on MBIA and fellow bond insurers increased after William Ackman, who runs activist hedge fund Pershing Square, released documents he said showed that MBIA faced losses in excess of $10bn.
“The market is taking this very seriously,” said one analyst.
The iTraxx Europe index of 125 investment-grade names widened to about 79bp, against a close of 72bp on Wednesday.