Panic chills credit market

The Straits Times
Dec 9, 2008 | 8:25 AM
Panic chills credit market

NEW YORK - THE panic in the credit markets has dissipated but it's been replaced by a malaise that bodes poorly for investors hoping for a rebound in lending.

Even as the Dow Jones industrial average rose nearly 300 points on growing confidence on Wall Street, a Treasury bill auction yielded a new low of less than 0.01 per cent, noted Miller & Tabak analyst Tony Crescenzi.

That's a sign that investor demand for T-bills, considered the safest short-term assets around, is still on the rise despite a return of nearly zero.

'Things are bad, and they don't look like they're getting better,' said JPMorgan Chase economist Michael Feroli.

The tone of the market on Monday was a bit better than last week, and Treasury yields recovered modestly on expectations of a US$15 billion (S$22.5 billion) automaker bailout, but he cautioned against looking too much into 'the day-to-day movements.'

As the reality of the mortgage meltdown and its massive, widespread aftershocks set in, investors and the financial industry are readjusting their strategies and becoming more cautious.

Even if the government's bailouts and other actions succeed in propping up the housing market, unemployment is worsening - a factor that will mean more losses for banks, and a tougher time for the government as it tries to stabilise the fragile economy.

'You can try to slow down the damage, but the losses have to be taken. You can do it all at once and get a Great Depression, or have a 15-year malaise like in Japan. Hopefully it won't be like either of those, but something in between,' said Mr T.J. Marta, fixed-income analyst at RBC Capital Markets.

Back in April, Goldman Sachs CEO Lloyd Blankfein said the credit crisis, if it were a football game, was 'probably in the third or fourth quarter.'

But on Monday, Goldman analysts said the current credit cycle, already 1 1/2 years old, has only now reached half-time.

Because there is no national precedent for the housing market downturn and ensuing collapse in credit, one must examine similarly large home price drops and unemployment spikes that happened on a regional basis, wrote the Goldman investment research analysts led by Mr Richard Ramsden.

In those cases, the report said, reserve building by banks lasted three years, with reserves to loans reaching 3 per cent.

Now, about 18 months into the current crisis, the industry's reserves have doubled to 2 per cent, and banks have taken half of the estimated US$1.8 trillion in losses related to US credit, the analysts said.

The report said that until now, current credit woes were driven by home price depreciation, but now the cycle is broadening and unemployment is replacing home prices as the 'main loss driver.'

On Friday, the Labour Department reported that 533,000 jobs were lost in November - the most in 34 years.

With the unemployment outlook worsening, banks are lending less, and with much tougher standards.

The US government and others around the world have been injecting huge amounts of cash into banks, but that cash is being used to shore up reserves in preparation for future losses, Mr Marta pointed out.

'This money isn't going to be put to work,' Mr Marta said, calling the banks 'rational' for stockpiling the money rather than lending it in a deteriorating credit climate.

Last week, Treasury yields plunged as investors rushed to buy US government debt. Any short-term rebound seen in Treasury yields is more a matter of anticipating huge amounts of government debt coming in the market, rather than a sustained recovery in risk appetite, analysts say.

This week, the Treasury will be selling US$28 billion in three-year notes and US$16 billion in 10-year notes.

On Monday, the two-year Treasury note slipped 1/32 to 100 18/32, and its yield rose to 0.96 per cent from 0.94 per cent late on Friday.

The 10-year note fell 4/32 to 108 26/32, and its yield rose to 2.72 per cent from 2.70 per cent. The 30-year bond fell 7/32 to 126 8/32, and its yield was flat at 3.14 per cent.

Those yields are still historically very low. And the yield on the three-month Treasury bill yielded 0.02 per cent on Monday, the same as late on Friday. Yields near zero suggest high levels of anxiety in the market.

And when the London Interbank Offered Rate, or Libor, is well above T-bill yields, it shows that banks consider other financial institutions to be risky borrowers.

Libor on three-month loans in dollars rose on Monday by 0.004 percentage point to 2.19 per cent, according to the British Bankers' Association.

Corporate bond yields are still historically very high, with most investors worried about taking a chance on debt issued by individual companies.

Mr Marta said RBC Capital Markets has noticed a slight rise in corporate bond buying, but 'it's nibbling ... it's not a massive rush,' he said.

'People are still very gun-shy. We are not seeing the smart money, but the brave money, being able to step in. But it's not like anybody is loading the boat.'

The worry with corporate bonds among investors is the increasing chance of default. Moody's Investors Service reiterated on Monday that it expects the global corporate default rate to rise to 10.4 per cent in a year.

Another big company filed for bankruptcy protection on Monday - the media conglomerate Tribune, which owns the Chicago Tribune and the Los Angeles Times. -- AP