Credit Crunch?
June 26th, 2007 by 
reality
Good article in the WSJ this morning about the corporate version of the subprime loan bundle, the CLO. I read it in the paper version, and I don’t subscribe, so I can’t link.
It is interesting to note that some of the recently announced, but uncompleted, LBOs are now trading at substantial discounts to their buyout prices, indicating that folks are starting to price in some risk that the deal will not actually come to fruition. Also heard on Fleck’s site that banks may be starting to get edgy about adding to their bridge loan book.
Bill Gross’ July investment outlook is well worth reading. “And the U.S. economy? Of course it will be affected. Consumption will be reduced to say nothing of new home construction over the next 12-18 months. After all, attractive subprime pricing has been key to the housing market’s success in recent years. Now that has disappeared. Importantly, as well, and this point is neglected by most pundits, the willingness to extend credit in other areas – high yield, bank loans, and even certain segments of the AAA asset-backed commercial paper market should feel the cooling Arctic winds of a liquidity constriction.”
Updates - evening of 6/26:
From the Telegraph: “The United States faces a severe credit crunch as mounting losses on risky forms of debt catch up with the banks and force them to curb lending and call in existing loans, according to a report by Lombard Street Research.”
From Bloomberg: “Planned sales of collateralized debt obligations backed mainly by subprime mortgages are drying up and may shut down amid concerns about the integrity of the market following the near collapse of hedge funds run by Bear Stearns Cos., JPMorgan Chase & Co. said.”
Hat tip to Calculated Risk.
Posted in Fixed Income, Manias, The Economy | 
June 26th, 2007 at 4:21 pm
How do you think the likely decompression of the risk spread will leave returns/capital costs in other fixed AAA instruments and the Treasury market? Would a crunch push everything higher, or would the contriction at the lower levels push more liquidity into safer returns, factoring in the inevitable economic downturn?
June 26th, 2007 at 6:22 pm
I think it is productive to look at history to try and assess what a credit crunch could mean - i.e. does it assure a recession. The 2001 recession was not accompanied by an acute credit crunch or preceded by one - the crunch did not really take hold until late 2001 when the economy was actually emerging from recession and through 2002 when the economy was growing again. The credit crunch did result in a general shift down in risk preferences by investors and risky assets declined.
The 1998 credit crunch was accompanied by a global industrial recession centered in Asia but largely avoided in the US on a grand scale. The crunch spilled over into most risky assets but was only a temporary set back for large cap growth stocks.
The 1990-1991 credit crunch was accompanied by a recession but only a modest bear market in the average stock - and just a correction in large caps. The entire junk bond market imploded and the S&L crisis was massive.
My point is that a credit crunch and/or an associated stock market correction/bear market does not mean that a recession is likely. There is no question that the housing industry is in recession, but the industries tied to global growth are doing well and re-accelerating - particularly in the industrial space. I personally believe that a 1987 or 1998 style decline is the most accurate analog to the current conditions. Many market participants are WAY over leveraged and risk spreads are dangerously compressed. I find it difficult to reconcile a pending recession with the fact that ECRI’s WLI is at a 37 week high. The economy, credit and financial markets do not have a perfect correlation!