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The Great Credit Contraction of 2007

Posted By Barry Ritholtz On July 25, 2007 @ 7:31 am In Credit,Derivatives,Economy,Markets,Real Estate | Comments Disabled

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 [1]:

Valuation
The M&A/LBO Put
Competition
Profits
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? [2]). 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 [3]:

"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 [4] 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 [5], "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 [6] and Reuters [7] are confirming what the WSJ [8] 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 [9]on the Alliance Boots deal.

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


Article printed from The Big Picture: http://www.ritholtz.com/blog

URL to article: http://www.ritholtz.com/blog/2007/07/the-great-credit-contraction-of-2007/

URLs in this post:

[1] 6 reasons why rising yields were a threat to equity prices: http://bigpicture.typepad.com/comments/2007/06/why_bond_yields.html

[2] WTF is going on in the ABX Markets?: http://bigpicture.typepad.com/comments/2007/07/wtf-is-going-on.html

[3] Merrill’s Richard Bernstein: http://rsch1.ml.com/9093/24013/ds/12045794.PDF

[4] Bill Gross: http://www.pimco.com/LeftNav/Featured+Market+Commentary/IO/2007/IO+August+2007.htm

[5] UK Telegraph: http://blogs.telegraph.co.uk/business/ambrosevanspritchard/july07/bearstearnspoppedthebubble.htm

[6] CNN/Money: http://money.cnn.com/2007/07/25/news/international/chrysler/

[7] Reuters: http://www.reuters.com/article/bondsNews/idUSN2537325720070725

[8] WSJ: http://online.wsj.com/article/SB118537491026477594.html

[9] KKR was forced to accept much higher loan costs : http://www.bloomberg.com/apps/news?pid=20601102&sid=atMCUV7EiyLI&r

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