Some Signs of Credit Market Easing Spur False Hope
A: Sorry for the lack of content as I have been very busy over the past week or so; lets get back to work. The fed has showered the markets with stimulus since the Bear Stearns debacle and the huge $200Bn TSLF announced on March 11th that kicks in on Thursday. Thus far, the fed has poured over $478B worth of liquidity injections + expanded what may be used as collateral for these short term loans to ease the distress in the credit markets. Some Markit indexes show improvement BUT I am hearing the opposite from friends I know on the front lines. Bottom line, while some of the credit markets are seeing improvement, it is NOT across the board!
Lets be clear, there SHOULD be an easing effect given the amount of actions the fed took to avoid a systemic financial meltdown from a Bear Stearns bankruptcy, and to help ease secondary mortgage markets and credit spreads over the past two weeks. Watching Kudlow last night, I got this little tidbit regarding what the fed has done so far to address the credit crisis:
TSLF --> $200 Billion
TAF --> $100 Billion
REPOS --> $100 Billio
SWAPS --> $36 Billion
BSC --> $29 Billion
PDCF --> $13 Billion
-----------------------------------------
TOTAL = $478 Billion
Why is this important? Well, the fed's TOTAL balance sheet is $879 Billion making the actions taken thus far 54% of reserved bank credit!
So what is seeing improvement?
a) mortgage spreads - yay for buyers!
b) IG (investment grade) spreads
c) CMBX spreads - chart on right showing improvement (down is improving)
What isn't improving?
a) junk bond market
b) HY (high yield) spreads
c) commercial paper
d) money market rates (added on @ 12:48PM)
I think this rally was a typical fed induced rally powered by short covering and the unwinding of hedged positions in commodities; it is not a rally of returned confidence, clarity, and certainty about the near term. It seems the fed has prevented a crisis, but they did pay a big price for that luxury! While it fixes a few problems, (and when I say fixes we are only back to where we were a month ago), it doesn't solve everything!!
I guess it depends on what credit market you look at! If you look at mortgage rates, yes you probably saw a nice drop in the past week or so; and rightfully so. If you are working on a trading desk in a junk bond market or high yield commercial paper, things are still very bad!
According to Bloomberg's article, "Junk Bond Losses Top $35 Billion, JPMorgan Sees":
High-yield, high-risk bonds are off to their worst start ever, and the biggest investors say there's no recovery in sight. While the Federal Reserve has slashed benchmark interest rates by 3 percentage points since September, it has been unable to get investors to increase their purchases of the riskiest assets. The declines are choking off financing for speculative- grade companies, boosting defaults. The debt is likely to "struggle" for months as the economy enters a recession, according to JPMorgan Securities Inc., the top high-yield research firm in Institutional Investor magazine's annual poll.Enjoy the fed drugs until they wear off because this credit crisis is ongoing, de-leveraging will continue, more corporate deaths will pop up, and the economic data will start to come in showing how deep the slowdown is getting. To me, this is a lot of unanswered questions. There will be a time to get excited, I just think its still a bit early for the credit markets.Investors are demanding yields averaging 8.07 percentage points more than Treasuries, up from 5.92 percentage points at the end of last year, and a record low of 2.41 percentage points in June, index data from New York-based Merrill show. The spread reached 8.62 percentage points on March 17, the most since 2003.
Think of this. If the housing bubble burst caused the seizing up of secondary markets, which caused the debacle to the financials, which caused the credit crunch...what will happen when the recession actually hits? How can housing recover in a recession? The good news is we are closer to a bottom then we were 6 months ago. The bad news is that glimmers of hope are just that, glimmers of hope! We STILL do not know whether other securitized debt classes will cause trouble on wall street, the full effect of ARM resets, the full effect of foreclosures, and the full effect on the US economy.
When I see improvement across ALL credit markets, I'll report it to you and I will start to discuss clarity about the post credit / post housing recovery!
Comments (10)
I read somewhere recently that the deleveraging will continue until the price of the asset that was bought with leverage has dropped to where it will generate a reasonable return on equity if it were to be bought without leverage.
Does this make sense to you or any of your readers, and, if so, do you think it may be true?
Posted by Query1 | March 25, 2008 11:02 AM
hmmm, I am not an expert on this, but will ask someone I know to comment more intelligently than I could.
Posted by Noah | March 25, 2008 11:59 AM
I will take a shot at this one, using real estate as an example. I do think de-leveraging will continue, which I recently wrote about. I am not sure asset prices have to decline to a point where they will present an equal return on equity with no leverage, because you can still get some debt to work with, whether it is to buy various securities or to buy real estate or develop real estate. But with a lower amount of leverage, making a worthwhile return is much harder. This argues for much fewer deveopment projects being pursued and for existing real estate to sell at higher cap rates (giving investors a better un-levered return). In most cases the value of the land used in a development project is the part that can swing around most through cycles (professional services costs and construction costs, just don't fall that much even in a downturn). So you are right that land values could come under severe pressure. In fact this is why the publicly held home builders have taken massive writedowns on the value of their land.
Posted by jeff | March 25, 2008 5:48 PM
So how does this affect NYC residential real estate, for example, in the short term and long term?
Posted by Andrew Weissman | March 25, 2008 6:13 PM
AW - its a discussion on the credit markets which is leading everything at this point. Until credit markets normalize, stocks will be pressured and capital will be crunched.
After all, its why we are in this mess. Relationship is NOT direct, but more ib's going under like Bear because of the distressed environment will lead to more layoffs and more uncertainty in the sector.
Posted by Noah | March 25, 2008 6:22 PM
The deleveraging will continue until the price of the assets drop low enough that people with cash (or access to cheap debt) think it's worth their while to start buying. There is currently a big disconnect between the prices the sellers are looking for and the prices the buyers are really willing to pay. In reality there aren't that many buyers with cash or an ability to access cheap financing - it's only the entities that don't have a legacy portfolio of crap and didn’t get burned with sub-prime/HY. So the buyer pool won't be any of the US banks.
It all boils down to what constitutes a "reasonable return on equity". In this environment "reasonable" to me means "a lot".
I wrote this in an email to Noah before but 2 weeks ago Bear Stearns was trading at $62. A few days ago it was down to $2 a share. One of those numbers is 3,000% more than the other. Today it's at $10 which is 400% more than it was a few days ago. Are you telling me all those prices were correct asset values when they were observed?
When price discovery mechanisms are this broken nobody is going to buy anything without a big cushion built in. So I’d expect to see prices drop to the point where assets have “a big return on equity on an unleveraged basis”.
Posted by JC | March 25, 2008 6:24 PM
JC,
I think the notion that risk premia (the return above the risk free rate demanded by investors) must rise due to this environment and the much lower leverage that can be applied (partly due to increased price volatility) does combine for a cocktail that spells lower prices for assets, before drawing in large amounts of investment money. I do agree that there are still disconnects between sellers and potential buyers. I am kind of amazed at the recovery in the stock market....but I have learned not to argue too stridently with the tape, which is making me a slow and patient scale buyer....who will buy more agressively if will roll down to a lower low, which I sort of expect. I am surprised by the interest people have in buying....particularly real estate. I just heard from a guy in charge of acquisitions for a big real estate family investment vehicle who is looking for deals. I take the buying interest as somewhat of a contrarian indicator, but I also suspect that many of the savvier of these buyers are looking for 50 cent on the dollar deals and just not finding them......yet.
Andrew,
What this means for NYC real estate is this. There is very little incentive to build new developments and its very hard to get land loans and construction loans. This is being exacerbated by the 421A program's imminent expiration. Long-term that's a good omen for NYC real estate shortages continuing. Short-term, all the uncertainty in the world, the likelihood of a citywide economic downturn and State & City budget deficits, mean it's no time to be aggressive as a buyer. Take your time, look for deals, be disciplined in bidding, but if you need a home, you need a home. I still see the best deals coming in LIC, Harlem and Brooklyn where lots of supply is still coming on in the next 6 - 12 mos.
Posted by jeff | March 25, 2008 8:21 PM
At the begining of this post, Noah wrote that he's very very busy. I've been reading this site for about a year and I think its been a few months since you last "feel" on this market. How is your feel on the current NYC market and what's keeping you busy?
Posted by nazuma | March 26, 2008 12:06 AM
BUYERS! I have about 15 buyer clients now plus a new listing in brooklyn that is coming back on market that is keeping me busy.
But mostly buyers. My personal feeling is that buyers are more interested in my services than sellers, and I have been focusing my time on sound, serious buyers lately. Thats whats keeping me running around past 3-5 weeks.
Posted by Noah | March 26, 2008 8:48 AM
Noah -
It is interesting to see more buyers than sellers in the market. Some sellers are mislead by this false hope that if they sit back for a while, market will come back. Yes it will come back, but not within their expected timeframe. I don't think we will see recovery until 2010. I think the NYC market will go down by another 10-20% before we see any recovery. Nationally it will go down another 40%.
Check out the chart I posted on my blog.
http://www.sulfura.info/economy/historical-home-prices.html
In historical terms, we are still overvalued.
-C
Posted by Chan | March 26, 2008 9:12 AM