Recent events...

Hi guys

I haven't been paying attention to what's been happening in the markets for the past 6 weeks or so because I've been busy/preoccupied with other stuff. I checked out the WSJ today and found out that we're in the middle of a liquidity crisis and things are getting pretty scary in some places. Can anyone link to a good article/site that summarizes what has been going on and what set this stuff off? All of my normal news sources have articles that assume prior knowledge of the situation, and I can't figure out what set the whole thing off. I know people have been warning about the subprime sector for awhile now, but it looks like the market has only been performing poorly for about 5-6 days. Was there some kind of fund blow-up, macro event, or other impetus for this change, or did banks just realize how out of hand things have gotten?

Thanks,
Luke

 

my opinion..

the credit market has been where most of the action has been happening. recently equities have caught the bug (last week/early this week). DJIA dropped 200 on friday, 120 today..

buzz words of the summer: -subprime -CDO/CLO -cov lite -LBO

Starting ~June 20th, read any article on the A1/C1 of WSJ to with these words to get a sense of these issues.

catalysts behind market volatility:

-blow up of Bear Stearns AM's two leveraged HFs due to losses of CDOs backed by suprime (appx. June 20th)

-investor push back on huge anticipated HY loan pipeline related to LBO activity and pushback on covenant lite loans, investors demanding to be better compensated for risk

fallout:

-credit spreads widening/credit repricing -technical problems in credit market (i.e. too much supply, no demand) however, no sign yet of fundamental problems in credit (i.e. increasing defaults)

-loss of liquidity across all credit areas -flight to quality, rallying treasuries

ah..there is more..but thats a start. feel free to ask questions if this start doesnt help...

i generally recommend the front article of barron's too..you could read the 6 of them that came out while you were gone and have a broad overview of market issues

 
Best Response

luke, i'm glad you're being proactive. In the fall, during recruiting season, this credit crisis will be on most of the recruiter's minds.

The high yield market has been extremely illiquid and anyone working in debt/m&a/pe has probably lost sleep over this.

The equity markets just started sliding, but the credit markets were pretty bad starting at the end of june until now. Every day, new headlines and bad news coming up. American Home was one that popped up on the news today.

It looks like a grim outlook by most of the traders and hedge funds. A short-everything mentality has appeared to create a bit of irrationality in the market. The street has decided that the street has made some bad bets and is bidding against itself to bet against itself. Overall, credit quality hasn't declined. Defaults are at historic lows, and yet we have liquidity problems. Earnings are strong - GM, Ford, Airlines, Rescap, Banks.

Hung bridges are a good thing to read up on. WSJ and Barrons are a good place to get started. You don't need to know everything, but pick a couple of stories that interest you and read up on that.

 

Definitely look for banks - both investment and commercial - to take it in the shorts on this. The former because of equity bridges and massive LBOs that haven't been sold at market yet and will sit on their balance sheets like lead weights. If equities/the economy correct as well and as sharply, bye-bye PE shop ability to cover all the covenant-lite crap bond interest expense the banks are writing and, in some cases, still own.

PE is going to go low-profile for a while, though there's always portfolio work to do and smaller deals; returns won't be as glamorous, lifestyle and pay will probably take a hit. DCM is going to be nervous. I personally think M&A could get more interesting. Less easy deals, and smaller deals, but potentially more strategics moving in and making "smart" acquisitions. Not to say that doesn't make for an awful time down here in the trenches, but the quality and interesting features of deals might work to our advantage.

 

Do most you think that some of the institutional and retail investors for equities are blowing the credit problem out of proportion? In general the US economy looks pretty good. Unemployment is at 4.5%, inflation is relatively stable, and earnings for companies at 10% is more than double expectations. It's true oil is priced quite high, but consumers are still spending like crazy and because of a weak dollar exports are doing quite well too.

Again many of these figures are lagging indicators, but why would widening spreads and reduced LBO activity call for such losses not in just the usual sectors, but in unrelated industries like technology , healthcare, and utilities? And wouldn't corporations still be eager to acquire or sell in M&A with a lot of cash tinkering around in their balance sheet--not requiring that much financing? Am I wrong or is a lot of this selloff in equities and buying into treasuries more irrational do to put and stop executions, or does it have more warrant than what I said?

 

While everyone has made valid points above I think it is important to remember that the underlying issue is not sub-prime debt; sub-prime debt is merely the trigger that has caused investors to re-evaluate risk/reward. It seems that investors have forgotten over the course of the past few years that loans default. As investors demand a greater return on increased risk, spreads have widened (itraxx widens 300 bps) causing liquidity to dry up, leverage and outsized gains to decrease, and ability for PE shops to fund deals (i.e. Cadbury Schweppes on hold as consortium cant get financing).

I currently work as 2nd year PE analyst and am trying to hang in there for another year and head off to a safe harbor, aka b-school 08'.

 

Subprime defaults - people with bad credit ended up actually deserving worse credit, and defaulted on loans.

This affected other loan grades because investors assumed the current risk-reward requirements needed correction (ie loans previously at 4 % need to be at 5%).

This will have an effect on almost everything, with a spotlight on PE which was so high profile recently.

The equity markets will be correcting, I have no idea the amount. I'm thinking this is a good time period to buy and look for assets that were "over" corrected.

I hope people let me know if any of my info is off.

 
h4zin:
how long do you think financial company stock will continue to tank? a friend is saying around 2 months until the subprime lending crap blows over, in this case i would short some of these companies, what do u guys think

Are you seriously soliciting investment advice from an ibankingoasis.com forum?

Seeing as every other post on this site pertains to questions like "what is the best high school for investment banking?" or "what kind of cars do investment bankers drive, and how fast / awesome are they?", I'd recommend taking any advice you get with much more than a grain of salt.

 

Ha. Yeah, in two months, the whole sub-prime mortgage "crap" will just blow over. It will be a thing of the past, despite being an enormous sector that is just beginning to show the problems. The bulk of the 2/28 mortgages are set to re-set between october and february of 2007-2008. Some are calling for almost 100% default on those. People simply can not afford the homes they bought, and absolutely will be unable to afford them once the interest rates re-set.

What about Fannie Mae and Freedie Mac? Do you not think that they have the ability to absolutely destroy our economy for a while? This could make the SL scandal look like nothing.

 
Jimbo:
you say it's gonna blow over, then you say there will be toms of defaults...which do you think will happen?

Sorry, I was being sarcastic when I said that it will blow over. I think we are in for some serious trouble. But, this happens every once in a while, things correct, the wealth is redistributed in some way, and then things start over.

 

Can someone explain to me why credit spreads are widening?

Is it because of possible repricing of credit - people are asking for larger spreads to "hedge" the volatility? I.e. charge higher bid/ask to make sure the actual value of the investment vehicle held does not suddenly rise/drop outside of the spread?

The above is me taking a stab at the reason...I've only just come across this idea today while reading the thread.

How does the issue of widening spreads affect the economy at large?

Thanks for the help, +Hammy

 

The spreads that have been all over the news lately are the spreads investors demand to be compensated for riskier investments...credit was dirt cheap up til now but everyone's starting to ask for more compensation for risky returns because they're realizing things can go apeshit wrong (see bear stearns's hedge funds or ahm)

 

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