The Great Credit Contraction of 2007

Wednesday, July 25, 2007 | 07:31 AM

What is the inter-relationship between Housing, LBOs & Stock Buybacks?

Last month, I noted 6 reasons why rising yields were a threat to equity prices:

The M&A/LBO Put
Share buybacks
Consumer spending

As of late, we have seen the threat of two of these issues increase dramatically: The M&A/LBO Put and Share buybacks are being pressured by the increasingly expensive credit. 

Much of this is derived from the mess in Housing: As many of the ARM/liar loans in the Sub-prime and Alt-A mortgage group increase their default rates, the residential mortgae backed securities (RMBS) that were packaged into CDOs have begun to unravel (See WTF is going on in the ABX Markets?). All told, the many variations of these were a prime source of cheap financing. This was what has been driving private equity buying frenzy and many share buybacks. That financing source is rapidly fading. 

How much is the credit drying up?  According Merrill's Richard Bernstein:

"Bloomberg Radio reported this morning that the monthly issuance of Collateralized Debt Obligations (CDOs), or packages of debt instruments bundled together to form a "portfolio" of debt, dropped from $42 billion to $3 billion in the latest month. That 93% drop represents a significant tightening of liquidity that is starting to ripple throughout the credit markets. The fixed-income markets appear to be starting to understand that the days of free-flowing liquidity are likely to be behind us. Most credit spreads are widening."

See Bill Gross latest for further discussion of the great credit contraction of 2007. 

Lastly, for those hoping this marks the bottom of the Housing derived credit crunch, according to the UK Telegraph, "some $2 trillion of subprime and 'Alt A'  mortgage debt is falsely priced on the books of banks and funds worldwide.” 

And to imagine: Some tv pundits -- cretins of the lowest order -- actually have been insisting that the Housing market would have absolutely zero impact on credit, the economy, markets and retail.   What a bunch of tools . . .


UPDATE July 25, 2007 10:47am

Both CNN/Money and Reuters are confirming what the WSJ reported this morning, that Chrysler's bankers could not sell the $12B in loans for the auto business and they are getting stuck with $10B of it with Daimler and Cerberus likely responsible for the balance.

The expectation is that the finance unit will eventually get done -- but at terms that are considerably more attractive to investors. Bloomie is reporting that KKR was forced to accept much higher loan costs on the Alliance Boots deal.

Expect more term deals to falter like this in the near future . . .

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I would like some of what Poole is smoking!!!!!

Poole Says Moderating Inflation Doesn't Need Quick Fed Response

By Anthony Massucci and Vivien Lou Chen

William Poole of the the Federal Reserve Bank of St. Louis July 24 (Bloomberg) -- Federal Reserve Bank of St. Louis President William Poole said he sees signs that inflation is ``moderating just a bit'' and suggested the central bank can afford to wait before lowering interest rates.

``Given that the real economy is doing quite well, there is certainly no reason to believe we have to quickly respond to signs of moderation in inflation,'' Poole said in response to questions from reporters following a speech in Wilmington, Delaware.

Poole, 70, voted with all other members of the Federal Open Market Committee last month to leave the benchmark lending rate at 5.25 percent. Fed Chairman Ben S. Bernanke last week told Congress that economic growth will pick up slightly next year and inflation will recede.

``There is no necessity to make any tradeoffs at this time,'' Poole said. ``That clearly would be more difficult if the economy were to stall out.''

In his speech to the Wilmington Club, Poole said the U.S. economy has ``performed well'' in the face of rising energy prices and inflation remains ``contained.''

``Consumers have reduced their consumption of more expensive energy,'' he said. ``Yet they have been able to maintain strong overall demand for consumption goods.''

Oil Futures

Crude oil futures on the New York Mercantile Exchange reached $76.13 on July 20, the highest intraday price for a front-month contract since Aug. 10. Prices are up 20 percent this year. A report tomorrow may show refineries operated at 91.6 percent of capacity, a 10-month high, according to a Bloomberg News survey.

``Although economists are a bit nervous about this situation, the U.S. economy has performed well despite the oil price increases,'' Poole said. ``We are nervous because those of us of a certain age remember well how different the situation was in the 1970s.''

The recent increases are ``roughly comparable'' in percentage terms to those in the 1970s that led to recession, Poole said. This time, though, ``overall inflation has remained relatively contained'' and ``energy in the United States remains quite inexpensive'' relative to the cost of other goods, he said.

``The impact has been real, but the magnitude small enough that price increases have not disrupted the normal processes of economic growth,'' the bank president said.

``There are certainly strains from the high price of energy,'' Poole said. ``However, there is no energy crisis and households and firms are adjusting in a sensible way to price increases.''

``In my judgment, markets will continue to handle energy problems well and the future for the U.S. economy is bright.''

Subprime Mortgages

In reply to another question from reporters, Poole said he doesn't expect losses from defaults on subprime mortgages to spread beyond the real estate industry.

``The damage, I think, is going to remain primarily in the real estate sector,'' he said. ``We do not have a bank involvement and therefore bank lending for the normal sort of economic projects is alive and well.''

The bank president is a former economics professor at Brown University in Providence, Rhode Island. He joined the St. Louis Fed as its president in 1998.

To contact the reporters on this story: Vivien Lou Chen in San Francisco at ; Anthony Massucci in Wilmington

Posted by: rubberbandman | Jul 25, 2007 7:47:13 AM

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