Scary Movie
The sometimes controversial journalist Ambrose Evans-Pritchard in the UK Telegraph sees mortgage resets peaking in the next few months (see chart above), and dislocations in the credit markets, and he worries:
It is hard to imagine a more plain-vanilla outfit than the Port Authority of New York and New Jersey, which manages bridges, bus terminals, and airports. The authority is a public body, backed by the two states. Yet it had to pay 20% rates in February after the near closure of the $330bn (£166m) “term-auction” market. It had originally expected to pay 4.3%, but that was aeons ago in financial time.
“I never thought I would see anything like this in my life,” said James Steele, an HSBC economist in New York. No sane mortal needs to know what term-auction means, except that it too became a tool of the US credit alchemists. Banks briefly used the market as laboratory for conjuring long-term loans at Alan Greenspan’s giveaway short-term rates. It has come unstuck. Next in line is the $45 trillion derivatives market for credit default swaps (CDS)….
Leverage is too extreme. Bank capital is too eroded. Monetary traction eludes the Fed. An “Austrian” purge is under way. UBS says the cost of the credit debacle will reach $600bn. “Leveraged risk is a cancer in this market.” Try $1 trillion, says New York professor Nouriel Roubin (sic). Contagion is moving up the ladder to prime mortgages, commercial property, home equity loans, car loans, credit cards and student loans…For the first time since this Greek tragedy began, I am now really frightened.
It’s always possible that Evans-Pritchard’s doom and gloom scenario is correct, but he undercuts his argument by using an extreme and misleading example — implying that the Port Authority had to issue bonds at 20% interest. It did not.
There was a failed sale of these dutch auction securities which were devised a quarter century ago to effectively issue long term debt at shorter term interest rates by having the bonds reprice frequently. In such a failed sale, the issuer pays the a penalty rate, per the bond documents, until another auction (in the case of the Port Authority, the new interest rate became 8% at the next auction). Part of the reason the auction failed was the uncertainty regarding bond insurers, a situation that the Treasury moved to address. (In fact, there is a heck of a bull market currently underway, from a buyer’s perspective, in munis and related instruments.)
We’re not saying that things are rosy, only that Evans-Pritchard’s painting with such broad strokes is not really helpful in understanding what is going on in the credit markets. (No doubt NYU Professor and Chairman of RGE Monitor Nouriel Roubini would also like his name spelled correctly in future articles.)