Bank of America’s lead credit market analyst, Jeffrey Rosenberg, is calling a bottom. This way a bandwagon comes?
Not quite. In fact, Rosenberg is pretty specific:
The combined actions of governments globally engineer the bottoming of financial risk.
Consider: nearly 70 per cent of all US bank liabilities are now backed by government guarantee. Even unsecured lending is now effectively secured.
When thought about, it’s quite a significant financial credit market bottom. The pricing of credit instruments is – supposedly at least – based around the risk of default. There’s a ceiling on the upside for credit, so it’s the downside that counts. And there isn’t a downside anymore – not for the next three years on some bank issued bonds anyway (the FDIC’s guarantee lasts this long).
One can’t help but feel this is one of those things which may likely have an awful lot of unforeseen consequences. How do you price a credit instrument when the main thing it’s priced around is now discounted? Do all yields head to zero? On which note, to what extent did ever lower returns on investment-grade bonds drive the structured finance arms race that caused this mess in the first place? Mispriced credit is not good.
It is indeed an “engineered” bottom, as BofA says. By which one might read created, conjured or even invented.
And so we move to the major caveat in all this bottom-calling. The credit market ex-financials – and more or less all of the equity market – is still exposed and likely to suffer. An expression of that coming suffering, in graph form:
And for a more historical perspective on that, we’ve dug up this chart which shows speculative grade default rates between 1920 and 2008:
The BofA call:
Recovery means recapitalizing the banking system and weaning our corporate and consumer segments from a culture of debt and leverage. For corporates this phase means re-equitization – issuing equity to meet near-term funding requirements that debt markets are incapable or unwilling to provide while at the same time strengthening capital and reducing future default risks.
In short: stabilising financials and senior credit markets has passed the buck: to junk credit and to the equity market.
Last week’s huge falls in stock markets might just be the first realisation of that. It’s a credit crisis afterall, and equity is the first loss tranche.
Related links
Be it resolved: Shares are derivatives – Paul Kedrosky