Financial Times Editorial Comment: Global credit woes
Copyright The Financial Times Limited 2007
Published: June 28 2007 22:59 | Last updated: June 28 2007 22:59
Global credit markets are jittery. Like motorists driving past a crash, bond investors are taking a ghoulish interest in the wreckage of two Bear Stearns hedge funds hit by US subprime housing loans, and refusing to buy into the risky new deals on offer from investment banks. Without a more substantial external shock, however, this is unlikely to turn into a systemic meltdown in the credit markets.
The Bear Stearns funds in question were leveraged vehicles that bought derivatives backed by subprime mortgages. When the price of the derivatives fell, lenders to the funds asked for their money back, which meant the funds had to sell some of these structured mortgage-backed securities. That has proved to be very hard to do.
The market for these structured securities has grown exponentially but this saga has shown that the institutions of the market have not matched that growth. There is little trading or liquidity in products such as collateralised debt obligations and so no market prices. It is possible that they are systematically overvalued on the books of hedge funds, insurers and banks and a revaluation would cause pain.
The question is whether it could cause forced sales of bonds that undermined the wider credit markets. There are signs of nervousness: KKR, the buy-out firm, has had to delay a bond offering by US Foodservice, one of its portfolio companies, after investors refused to bite.
But widespread, lasting contagion from the subprime crash seems unlikely, because alongside these wobbles has come broadly good economic news. Real interest rates have risen as US investors reassessed the prospects for growth, and the chances of the Federal Reserve cutting interest rates this year.
Credit spreads remain unusually low – perhaps driven by global financial integration – and there is no question that the markets for securities such as high-yield corporate bonds are vulnerable to a fall. But a more substantial trigger than subprime will probably be needed for that setback to materialise.
The CDO market needs to grow up, fast. Participants need to improve the transparency and independence of pricing and develop more liquid markets for secondary trading. If the subprime slide does get worse, this lack of liquidity could lead to a wider crisis.
But balance of probability is that we are just seeing a shake-out in a market – subprime – that was always high-risk. If investors in other assets take note, and moderate their appetites for risk, today’s jitters may prevent a nastier credit crunch in months to come.