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CAPITAL: How to Build a Credit Crisis
The public editor of The New York Times, who is sort of an outsider on the inside, wrote an intriguing column in the Sunday paper on the rumors that Gov. David Patterson of New York was the subject of a “salacious” investigative report. The Times has said nothing about the rumors and, not surprisingly, they have flourished, forcing the governor to defend himself.
I mention the article, because these rumors act much like liquidity crisis. In the markets, rumors can often create credit crisis all on their own. Consider the Naked Capitalism blog of yesterday. It chips at the notion that all is well on the credit markets, and it seems to imply that a crisis is on the way. Here’s what the blog says about junk bond prices:
As readers no doubt know all too well, the market premium versus safer ones contracts in robust times and widens in downturns. And since credit markets typically signal downturns months before the equity markets, junk bonds are one place to look for advance warnings of changes in economic fortunes (albeit with a risk of false positives).The Financial Times reports (hat tip reader Joe C) that sovereign debt worries are leading investors to exit junk bonds at a particularly rapid clip:
Investors are selling out of “junk” bonds at the fastest rate since September 2005, in the latest indication that concerns over sovereign debt are spreading to other credit markets.In the week that ended on Wednesday, nearly $1bn was withdrawn from US funds that hold high-yield corporate bonds (junk bonds), according to Lipper FMI – the largest outflow in almost four and a half years.As a result, the past month has seen the biggest sell-off of US junk bonds since the equity market bottomed out in March 2009, said Martin Fridson, chief executive of Fridson Investment Advisors, which specialises in high-yield bonds.Spreads – the difference between the yields on junk bonds compared with US Treasury bonds – have widened by more than 100 basis points since January 11, and now stand at about 700 basis points, as measured by the Bank of America Merrill Lynch Index.
Note the “legit” information source (the FT), the hard-and-fast statistic (“investors are selling out of ‘junk’ bonds at the faster rate since Sept 2005” — which specific bonds doesn’t seem to matter), and the notion that “credit markets typically signal downturns months before the equity markets.” All this points to rabid downward spiral toward credit market failure.
The truth is somewhere in between this article and a healthy market. Finding that point exactly — well, that’s the true challenge amid all the news and blogging noise.
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