If it’s Monday, it must be analysis time. Bloomberg says that the sudden proliferation of belly-up hedge funds shows the industry is “reeling from its worst crisis in a decade.” This crisis has been sparked by the hedge funds’ lenders increasing their margin calls, which require firms who borrow money to make investments to increase the collateral they have backing those loans—or pay them off. That collateral has either become worth much less than it once was or the banks are panicked that it will become worth much less.
Our Quote of the Day puts its succinctly:
”If you have leverage, you’re stuffed,” said Alex Allen, chief investment officer of London-based Eddington Capital Management Ltd., which has $195 million invested in hedge funds for clients. He likens the crisis to a bank panic turned upside down with bankers, not depositors, concerned they won’t get their money back…
“There has to be more in the next weeks,” Allen said. “There are people who have been hanging on by their fingernails who can’t hold on much, much longer.”
Bloomberg says its the worst crisis since 1998 when the Russian debt default sent global debt markets tumbling and Wall Street had to orchestrate the infamous bailout of the Long-Term Capital Management hedge fund to prevent a market meltdown.
The Berg also reports ominously that at least one bank is demanding more collateral on even U.S. Treasury investments “backed by the full faith and credit of the United States.”
Bloomberg writes that inflation-protected Treasury bonds are signaling extreme bearishness on inflation, having “never been so sure that the Federal Reserve will lose control of inflation.”
The wire service/terminal treasure chest says the yield on Treasury Inflation-Protected Securities is below zero for the first time ever. That signals that investors are so worried about inflation rising that they’re pouring into TIPS, driving up their prices, which move inversely to yields.
Essentially, a negative yield means investors are paying the government to borrow money. They’re doing that because the TIPS adjust the investors’ principal according to inflation, thus protecting them from price increases at a time when all investment markets are extremely unstable.
The man’s name is Engineer
The Financial Times leads its Companies & Markets section with news that margin calls and plain old panic over the prospect of further losses are squeezing debt instruments to record highs, which are in turn forcing the further unwinding of debt instruments, which will push prices higher and so on. The paper says the cost of insuring investment-grade U.S. debt more than doubled since January.
Liquidating structured credit instruments requires buying large amounts of protection using credit default swaps. This, in turn, drives the cost of protection higher, potentially triggering a chain reaction.
“There is potential for some wild and possibly inexplicable price movements as the unwinds get bigger,” said Mehernosh Engineer, credit strategist at BNP.
The Wall Street Journal reports a similar story in extreme jargon on C7. It says fear is creating a “vicious cycle” that is “crippling the market.”
This bond is unrated
In the you’ve-gotta-be-kidding department: Bond insurer MBIA begs Fitch Ratings to quit rating some of its units because MBIA is afraid Fitch is going to downgrade them, and it just doesn’t agree with that. If this doesn’t illustrate the fatal conflicts in the ratings business, we don’t know what does.
In a statement, (Fitch) said it could be difficult to maintain the ratings without access to nonpublic details of their insured portfolio and “it is unclear to us at this time as to whether MBIA will continue to cooperate with us in the rating process.”
Notably, the WSJ says that “Fitch has been the most aggressive of the three main rating firms in issuing negative assessments of bond insurers.”
More room to fall
The Wall Street Journal leads its A1 Business & Finance column with an analysis that finds that despite a 17 percent drop in the S&P 500 in the last five months (a 20 percent drop is considered an official bear market), stocks still aren’t cheap.
The Journal says stocks are trading at just 13.2 times earnings, well below the 16.5 “multiple” they’ve averaged since 1989. But inflation is rising, earnings are under pressure because of the all-but-official recession, and the outlook for everything under the sun is unsettled as the unwinding of the credit matrix continues to gather speed and force.
By the end of the bear market amid the nasty early 1980s recessions, stock prices fell to 8.7 times earnings. The current debt-market crisis and resultant economic downturn are increasingly seen as likely to be the worst since then, suggesting current stock prices have as much or more downside as they do upside.
A relatively stable sector